On April 1, 2020, S&P Global Ratings included public power, electric cooperative, water, sewer, and gas utilities in its assessment that all U.S. public finance sector outlooks are now negative (see "All U.S. Public Finance Sector Outlooks Are Now Negative"). By comparison, in January, we published reports stating that these sectors' outlooks are stable (see "U.S. Public Power And Electric Cooperative Utilities 2020 Sector Outlook: Heading Into A New Decade On A Familiar Road," published Jan. 15, 2020, and "U.S. Municipal Water And Sewer Utilities 2020 Sector Outlook: Finding Stability Between Headline Risk And Credit Risk," published Jan. 14, 2020).

Rate-Setting Autonomy Supports Sound Financial Performance

Historically, S&P Global Ratings has viewed these utilities as very stable and largely immune to pronounced effects from changing economic conditions. We have typically reflected this view in the mid-investment-grade ratings we have assigned to utility enterprises.

The investment-grade ratings are a function of utilities' consistently sound financial performance, coupled with the almost universal autonomous rate-setting authority utilities possess. Under ordinary circumstances, this authority offers financial nimbleness to respond to changing situations by adjusting rates to preserve a sound alignment among revenues, expenses, and debt service. However, recent weeks have been anything but ordinary, calling into question the degree of credit support that the legal right to establish rates autonomously provides. S&P Global Ratings believes that there is a meaningful distinction between the legal right to adjust rates and the practicalities of adjusting rates.

The essential nature of electric, water, sewer, and gas utility services is another key rating strength. Essentiality has translated into historical sales that have largely been resilient in the face of recessionary pressure, as well as other stresses. Other notable elements underpinning the utility ratings are the benefits of generally secure customer bases and the absence of a profit motive, which removes incentives for management to place capital at risk.

The recession's fallout will be deep

That was then, but this is now. Due to the significant and unprecedented events of recent weeks, our view of the resilience of the not-for-profit utility space is now open to reexamination.

In mid-March, S&P Global Economics projected a 1% first-quarter GDP decline, followed by a 6% "sharp contraction" in second-quarter GDP. Only a few weeks later, our economists revised their forecast to say, "The world's biggest economy will contract 5.3% this year--including a historic (annualized) decline of almost 35% in the second quarter." (See "An Already Historic U.S. Downturn Now Looks Even Worse," published April 16, 2020.) The revised assessment came in almost the blink of an eye, as more than 90% of the U.S. population fell under stay-at-home restrictions and business activity collapsed. The economy's rapid decline triggered our assigning a negative outlook to the not-for-profit utility sectors.

As coronavirus contagion accelerates and economic activity contracts due to illness and social distancing directives, S&P Global Ratings views these utilities as increasingly vulnerable to the potential economic effects of the pandemic.

Certain Utilities Are More Exposed

Our revised view of the capacity for financial and operational resilience among utilities doesn't mean that we foresee a wholesale negative revision of individual utilities' outlooks, as we did in other public finance sectors that we consider more vulnerable to the financial fallout from the pandemic and the recession. Those sectors include health care and transportation. Rather, our revised view for water, sewer, electric, and gas utilities means that we believe ratings on certain utilities are increasingly susceptible to the negative effects of the recession. In addition, it's unlikely during the near term that ratings on utilities will exhibit upside potential in the face of the strong recessionary obstacles, particularly given the indefinite duration and depth of the recession and the pandemic. This recession is unique relative to past recessions because of its wide-ranging cessation of economic activity.

Weakening sales and political considerations will play a part

Although we expect that the essential nature of water, sewer, electric, and gas utility services will perpetuate significant demand for these products, we nevertheless believe that the widespread shuttering of commercial establishments and industries will remove a potentially meaningful component of sales, thereby exposing utilities' cash flows and liquidity to declines if shutdowns persist. In addition, voluntary and mandated moratoriums on service shutoffs for nonpayment, coupled with unemployment levels at extreme multiples of historical highs, add to the vulnerability of utility cash flows to delayed payments or nonpayment by customers.

We believe the prevailing and extreme recessionary pressures impair utilities' ability to exercise their authority to raise rates in response to revenue stream erosion. The barriers frustrating this autonomy might take many forms, including customers' lack of capacity to pay their utility bills, irrespective of whether they are unemployed residential customers or shuttered commercial or industrial businesses. The inability to exercise autonomous rate-setting authority could also manifest in the form of reluctance by the elected board or council members to raise rates during a deep recession, at the risk of poor optics that could fuel customer ire.

We expect that for individual utilities, the effects of the pandemic and recession will vary depending on service area characteristics such as customer class distribution, customers' income levels, and other economic factors.

Stresses Come From Many Sources

In our assessment of rated utilities, we are examining numerous financial, economic, and operational factors to identify vulnerabilities that could affect ratings. We believe that utilities that could face the greatest exposure to the stay-at-home orders and the ensuing recessionary pressures include those with some or all of the following attributes:

• Significant revenue dependence on commercial and industrial businesses that are subject to closure orders.
• Commercial and industrial businesses that are unlikely to reopen after closure orders expire, either due to their inability to survive the shutdown or their customers' skittishness to patronize businesses such as restaurants and entertainment venues whose very essence is social proximity.
• Concentrated customer base in industries that are particularly exposed to recessionary pressures, such as the travel and leisure industry or ethanol producers that are facing diminished demand because of the extreme declines in national gasoline consumption.
• A prevalence of working-class residential customers who are susceptible to layoffs or furloughs and who might lack the financial capacity to pay their utility bills if they are not receiving regular paychecks.
• Limited access to a sufficiently robust liquidity cushion that could temper the effects of customers' delinquent or unpaid bills.
• Deferral of critical and nondiscretionary maintenance or capital projects to preserve liquidity, thereby creating the potential for longer-term reliability issues and financial pressures.
• Nondiscretionary capital projects that could place upward pressure on rates when utilities lack rate-setting flexibility.
• Illness among labor is compromising operations and, in turn, the revenue stream.
• Lack of robust pandemic contingency plans.
• Associated local government that is facing its own financial pressures, possibly leading it to look to the utilities to increase transfers of surplus revenues or reserves to prop up government coffers.

Internal And External Factors Will Determine Utilities' Resilience

The U.S. is only a few weeks into the onset of this pandemic. Residential, commercial, and industrial customers that paid their March and April utility bills might not be able to do so in May or June. In addition, the prospects for continuing to provide utility services to some business customers might evaporate if those businesses can't withstand a protracted lockdown and are unable to reopen after stay-at-home directives end.

S&P Global Ratings will maintain an active dialogue with utilities' management to assess the exposures utilities are facing as the pandemic and recession continue. We believe the financial impacts of the recession and pandemic on individual utilities and the stability of the ratings will depend on the duration and severity of these interlinked events, the sufficiency of liquidity available to serve as a shock absorber, the level of cash flow available for debt service, and the demographics of individual utilities' service territories.