Despite the many risks and challenges that COVID-19 presented to the U.S. regulated utility industry, we believe the industry was successful in offsetting most of these risks and preserving credit quality. Throughout the COVID-19 pandemic, operating cash flows for many investor-owned utilities in the U.S. were pressured given the economic challenges the pandemic introduced. In particular, many utility customers delayed paying bills or did not pay at all and some utilities are continuing to deal with this today. In many states, policymakers and regulators implemented moratoria on disconnections for non-paying customers, and most utilities halted disconnections for some time on a voluntary basis. Taken together, this introduced incremental pressure for utilities' credit metrics (North American Regulated Utilities' Credit Quality Begins The Year On A Downward Path, April 7, 2021). That said, most states that put a hold on disconnections have let these rules expire and many utilities have resumed their normal billing and collection practices, including disconnects for non-payment. Furthermore, utilities have started to implement bill increases via various regulatory mechanisms at a more normalized pace. Overall, we are seeing operating cash flows begin to recover to pre-pandemic levels, and we expect this trend to continue, leading to higher predictability in operating cash flows.

How Lower Cash Collections Affect Credit Metrics

Given that most regulatory jurisdictions allowed their utilities to establish regulatory assets, deferring much of the bad debt expense related to the COVID-19 pandemic for future recovery, their funds from operations (FFO) did not take a big hit from increased bad debt expense. However, operating cash flows did, significantly weakening operating cash flows throughout the industry. During 2020 and 2021, utilities with disconnect moratoria in effect typically had higher bad debt expense, increased delays in cash collections, and higher accounts receivables. All in all, we estimate that the industry's 2020 operating cash flows decreased by about 10% due to delayed payment or non-payment of bills. For the most part, we expect the cash recovery of these expenses to occur in rate cases or in other regulatory proceedings, and generally with some regulatory lag.

Although Sectorwide Cash Flows Are Getting Back To Normal They Lag Pre-Pandemic Levels

Although many utilities continue to struggle with the after-effects of COVID-19, some operating cash flow improvement is already apparent for the sector in 2021 as the economy strengthens and many states end their disconnect suspensions. However, the industry's operating cash flows still remain about 5% behind pre-pandemic levels on a normalized basis after accounting for the impacts of extreme weather (an approximate $15 billion hit on operating cash flows) after weakening by about 10% in 2020. Overall, we estimate that cash flows for the rolling-12-months ended June 30, 2021, are up about 2%-3% from year-end 2020 after we normalize for cash flow impacts related to extreme weather events. We attribute much of this uptick not only to a reversal of accounts receivables but also to bill increases that have taken effect in the first half of the year. Although we have yet to see operating cash flows recover entirely to pre-pandemic levels during the first six months of 2021, we expect the upcoming expiration of the remaining disconnect moratoria, economic improvement across the U.S., and expected recovery of incurred bad debt expense through various mechanisms to result in better operating cash flow. Furthermore, though the degree and timing of this recovery varies by state and by utility, we anticipate that as utilities restart more regular disconnects for nonpayment, their accounts-receivables balances and bad debt expense will decrease.

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Some Utility Companies Deal With Lower Cash Collections

For the most part, utilities in states that extended the suspensions experienced higher bill payment delinquencies. Of the 10 utility holding companies that saw the largest increases to their accounts-receivables balances in 2020 compared to historical trends, we found that eight of them had large portions of their operations in states with prolonged mandated disconnect moratoria ending past the second quarter of 2020.

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We also found that seven of the top 10 utility operating companies with the largest increases to their accounts-receivables balances in 2020 compared to historical trends are located in states with lengthier disconnect moratoria.

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After we normalize cash flows for companies accounting for the material impacts from extreme weather events, which we estimated using public disclosures, we note that for those utilities and holding companies with large portions of their operations in states with active disconnect moratoria in place through the end of third quarter, operating cash flows are largely still not at pre-pandemic levels (we only normalize cash flows in these instances to better isolate companies' delayed bill payments, not to adjust our forecasts for their credit metrics). Furthermore, we maintain a negative outlook on about a third of these companies, many because of minimal financial cushion for their current ratings.

We note that our stable or better rating outlooks on many of the companies in these states benefit from other supportive credit features. This includes being members of a larger more diversified group (e.g., AVANGRID Inc., National Grid North America Inc. and subsidiaries, and WGL Holdings Inc. and subsidiary), having operations in other states (e.g., SJW Group, American Water Works Co. Inc., and Black Hills Corp.), or having more financial cushion in their metrics (Avangrid subsidiaries, San Diego Gas & Electric Co., Atlantic City Electric Co., Jersey Central Power & Light Co., Public Service Electric & Gas Co., South Jersey Industries Inc. and subsidiaries, and Potomac Electric Power Co.).

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Spending Continues To Rise Despite Reduced Operating Cash Flow

Although operating cash flows are still recovering to pre-pandemic levels, utility companies increased their capital spending levels by about 5% in 2020, with capital spending on an upward trend through the first half of 2021. This has led to continued negative free operating cash flow for the industry, even on a normalized basis not accounting for the impact of the aforementioned extreme weather events. Although negative free operating cash flow is typical for the utility industry, the level has increased significantly from historical levels. From 2014 to 2020, we estimate that negative operating cash flow has grown by about 6x on a normalized basis, with a 1.5x growth between 2019 and 2020.

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Shareholder Returns Remain A Priority

Even in the face of reduced operating cash flows and continued elevated capital spending, utility companies continue to increase dividend payments. In 2020, we estimate dividend payments to shareholders grew by about 6%, compared to the average growth between 2015 and 2020 of about 7%. The higher dividend payments to shareholders also contribute to the negative discretionary cash flow for the industry as a whole.

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A Look At Financing Trends

The use of debt remains a main source of funding for utilities. And while the use of equity and hybrids is another funding source among utilities, many utilities still rely on debt financing to fund most of their external funding needs. This trend did not change in 2020 given the low interest rate environment and proactive steps many utilities took at the onset of the pandemic to strengthen their liquidity position. As such, we expect that they will continue to fund most of their higher capital spending and dividends with debt, leading to continued pressure on the industry's financial measures and credit quality.

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Overall, we anticipate that the lower cash flow collections as a result of COVID-19 is transitory and should not result in a permanent increase in leverage because many utilities across the U.S. were able to defer bad debt expense as a regulatory asset to be recovered from customers over the near term. In addition, despite some uncertainty as a result of different COVID-19 variants as well as the pace of vaccinations across the U.S., almost every state, with the exception of three, has ended its disconnect moratoria as of the beginning of December, and many utilities have resumed normal billing and collection practices. Nevertheless, despite the upward trend in operating cash flow for the utility industry, which ordinarily should lead to stronger financial measures, we expect that potential financial improvement is more likely to be muted because of simultaneously rising capital spending and dividends.

Related Research

• North American Regulated Utilities' Credit Quality Begins The Year On A Downward Path, April 7, 2021