Trading in Thames Water debt has been multifaceted in the wake of first Moody's and then S&P making ratings cuts below investment grade — as we predicted here and here. Those rating actions were widely tipped to be a prompt for IG debt holders to sell their paper.

But the pricing dynamics tell a different story to what was expected.

The class As have all started to trade in line at roughly 70-75 cents regardless of maturity given the expectation they’ll all be pari in a restructuring, according to a bond trader, while there is evidence of a short squeeze on the class Bs, which is “causing some funds a lot of pain,” the trader said.

Today the 2.875% May 2027 notes are back up at 32 cents (class Bs), having previously fallen precipitously from the 55 cent area in mid-July down to 27 cents last Thursday, noted the trader.

“That was definitely the low print at 27,” added the trader. “We had seen a previous short-squeeze on the way down around the 35 cents mark, but this is much more pronounced. It's evident in that, even on occasions when the class As have dropped a point the class Bs have rallied half a point.”

Signs of this technical squeeze on the class Bs have mounted, with one buyside portfolio manager telling 9finpricing was at odds with their expectation the notes should go to zero. They added the 70% area on class As was also above their 50% fundamental level.

Earlier this week, in making its downgrade, S&P said it expected class As to recover at 70% and class Bs not recover anything, “in a hypothetical default scenario”.

There are only £250m of class B bonds out there and one firm controlled about a quarter of those already, and it is seen as the cheapest way to influence the restructuring by getting a seat at the table, so the price could keep going up.

“It's already insanely high when you do the maths on where Thames needs to get its debt to asset base,” the bond trader commented.

Those buying the class B paper may be doing so in expectation they will be equitised in a restructuring. But it is not clear at what level that would happen, and the presence of class As and class Bs in the equity may act as a deterrent to other investors putting in new equity.

Further, on Thames Water's class A debt, the potential pricing of a takeback loan that would address all class A debt could be the driving force for bond action.

For example, the 2.375% April 2040s were quoted week ago around 60 cents — an area they had struggled around for several months — but have risen back up around 66 cents in the last few sessions, noted the trader. The 8.25% April 2040s were quoted around 75 after a drop from 97 at the start of the month and have levelled off in the past week to 77.5.

One notable difference between notes amid this price compression is z-spreads. Thames's June 2025s are priced around 78 cents but carry a massive spread around 3,300bps.

Any restructuring that takes out the nearer-dated, high coupon bonds, and leaves the longer dated poses a risk to this assumption.

Looking for more distressed content? Then make sure you check out our latest legal deep dive on Thames Water.