Historically, electric utility companies throughout the U.S. have used securitization as a means to recover various costs, including, but not limited to, those related to the following:

• Stranded assets, defined as generating assets owned by a regulated utility that have become uneconomical to operate due to deregulation;
• Storm damages;
• Wildfire damages and related risk mitigation expenses;
• Winterization/hardening of electrical grids; and
• Extraordinarily high fuel costs.

In certain U.S. states, the securitization of costs related to impactful events like those shown above has been made possible by state statute. In general, such statutes provide that said costs, along with debt service on the bonds and transaction fees and expenses, among others, will be paid through a surcharge appearing on the monthly bill of the utility's retail customers. The state statute and the related financing order, which is more prescriptive in nature than the statute, issued by the public utility commission (i.e., regulator) mandate that the initial surcharge be adjusted periodically through a true-up mechanism. Importantly, the true-up mechanism, which is typically uncapped, ensures the collection of funds sufficient to provide for timely payment of debt service and related fees and expenses.

Below, S&P Global Ratings answers some questions concerning: 1) the rationale behind a utility's decision to employ securitization as financing tool; 2) the rapid increase in utility-related securitization issuance levels that commenced in 2021; 3) the potential impact of securitization on the credit rating of a utility acting as servicer for a transaction; 4) the outlook for future issuance; 5) how utility-related securitizations can potentially achieve a higher rating than that of its servicer; and 6) potential risks to the asset class.

In addition, table 1 in the Appendix section provides more detailed information on utility-related securitizations at the individual transaction level, including information pertaining to the true-up mechanism, among others.

Frequently Asked Questions

Why do utility companies use securitization as a financing method?

Securitization is typically a cost-effective financing tool that diversifies a utility's sources of funding. U.S. regulated electric utilities primarily utilize securitization for the following three reasons:

• Following securitization, the utility immediately has cash to pay for expenses already incurred;
• Securitization modestly reduces regulatory risk; and
• A utility's credit measures usually improve.

Securitization allows utilities to recover sizable costs associated with impactful, and oftentimes unexpected, events upfront through the receipt of cash upon issuance of the bonds. This cash can be used to repay relatively expensive debt and equity financing traditionally used by utilities to initially absorb costs.

A second reason why utilities choose to issue securitization bonds is that it modestly reduces regulatory risk. Using securitization is usually less impactful on the customer bill than alternate forms of financing that the utility may pursue, such as the issuance of equity and/or corporate debt, which may be more costly. This typically results in less customer complaints, increasing the likelihood that the utility can continue to manage its regulatory risks effectively.

Furthermore, securitization often results in improved credit measures for the utility. Because securitization bonds are typically recovered through a dedicated source of revenue--in the form of an irrevocable, non-bypassable charge on the customer's bill with full recovery mandated by statute--S&P Global Ratings will often deconsolidate (i.e., remove) securitization debt from the utility's balance sheet. Accordingly, this improves a utility's financial measures and credit quality.

However, to issue securitization bonds, a utility must operate in a state that has already passed a law that allows for the use of securitization. Furthermore, the utility must also receive authorization from its regulatory commission, which will usually request of the utility to submit a net present value assessment. This includes demonstrating that securitization is in the best interest of customers when compared to other forms of financing.

Why has issuance increased in the last few years?

The growth in issuance of utility-related securitizations since 2021 was driven by a combination of factors, including to recover costs associated with natural disasters (e.g., catastrophic wildfires and related mitigation efforts in California), severe weather events (e.g., hurricanes in Louisiana and damaging storms in North Carolina), stranded assets (e.g., retirement of coal plants in Indiana and Michigan), and excessive fuel costs (e.g., weather-induced spikes in the cost of fuel used by utilities to produce electricity in Oklahoma), among others.

Chart 1 below lists the transactions rated by S&P Global Ratings by number and issuance amount from 2018-2023.

Chart 1

Chart 2 below shows the use of proceeds for utility-related securitizations from 2022-2023.

Chart 2

Chart 3 below shows the S&P Global Ratings-rated issuance of utility-related securitizations by state from 2022-2023.

Chart 3

Why do securitization bonds typically have a higher rating than that of the servicer?

The rating on the bonds in a utility-related transaction is based on the strength of the transaction's structure, the necessity of the service provided (the distribution of electric power), and the provisions in the enabling statute and financing order, which generally provide that a successor servicer is authorized/required to impose and collect the charge in the event the servicer can longer perform its duties.

Listed below are some of the key provisions we typically consider in the legislation:

• State's pledge to not impair the value of the property or charge to be imposed;
• State's public utility commission oversight (we note that this might not be the case for cooperatives in certain states, such as Texas);
• True-up mechanism, which enables the servicer to increase or decrease the securitization charge periodically to cover the timely payment of interest and scheduled principal as well as to replenish any drawings on the reserve account and to cover fees and expenses paid in the priority of payments; and
• Irrevocable financing order.

Chart 4 below shows S&P Global Ratings' issuer credit ratings (ICR) for the various utilities that utilized utility-related securitizations as a financing tool in 2022-2023. It should be noted that Denton County Electric Cooperative Inc. and Long Island Lighting Co. (d/b/a LIPA) do not have a ICR from S&P Global Ratings and, therefore, have been omitted from this chart. The chart demonstrates how utility-related securitizations consistently achieve higher ratings than that of the related utility/servicer. To date, all utility-related securitizations rated by S&P Global Ratings have been assigned 'AAA (sf)' ratings.

Chart 4

What are potential risks for the asset class?

Some of the key areas of focus in terms of risk include:

• The securitization charge as a percentage of the average bill for a residential customer: If the charge becomes excessive, it increases the possibility of politically driven challenges to the enabling legislation and financing order (i.e., customer revolt). When modeling the cash flows associated with a transaction, we observe how high the projected securitization charge becomes as a percentage of a residential customer's bill and how long the charge remains at such elevated levels, to assess this risk.
• Potential population migration out of the territory: Utilities with customer bases that have material exposure to the residential customer class are considered to be relatively more stable than those with higher exposure to industrial customers given their inherit cyclicality.
• Increases in self-generation (e.g., rooftop solar system): Self-generation could potentially allow customers to disconnect entirely from the electric grid and, therefore, bypass the securitization charge altogether. However, from a practical standpoint, currently, customers still likely need to be connected to the electric grid to draw power when they aren't able to use power produced by solar. And, as a mitigant, certain states with high exposure to this risk have opted to use customer count as opposed to electricity consumption when designing the true-up mechanism. In this case, the true-up would be based on the number of customers in the service territory as opposed to customer usage.
• Ballot initiatives or referenda: States that have ballot initiates or referenda could allow voters, through enactment of future legislative changes, to weaken the statute authorizing securitizations. In these situations, we typically focus on how these processes can potentially impact the irrevocability language and the state pledge included in the enabling statute and financing order. Furthermore, we expect the issuer's counsel to provide an analysis of the constitutional protections that may serve as a mitigant for additional clarity.
• Servicer bankruptcy: The enabling statute typically addresses this problem by requiring any successor to the utility, whether through bankruptcy, merger, or sale, to perform all of the utility's obligations in connection with the securitization. Additionally, in the case of Pacific Gas and Electric Co., the servicer continued to operate throughout the Chapter 11 bankruptcy process due to the essential nature of the service provided.
• It is possible that receivables generation could be interrupted due to natural disasters or reduced due to a decline in the customer base. There are typically various levels of liquidity support to address these risks. First and foremost is the true-up mechanism. However, the true-up is not quite the same thing as an unlimited cash collateral account. Because the true-up will only be as good as collections in the following year, the amount of a current year's shortfall might not be fully recovered in the next year due to charge-offs and forecast errors in that year. The amount will decrease over time, however, as successive true-ups are implemented. Also, there is typically a buffer between the scheduled maturity and the legal final. This buffer allows for further true-ups as necessary to reduce the shortfalls that cannot be collected because they occur in what might have been originally contemplated as the final year of the transaction. Second, typically scheduled principal can be used to pay interest without a default on the basis that the true-up would recoup this amount.

How does securitization affect the issuer credit rating on the servicer, which is typically the utility?

S&P Global Ratings views securitization as positive for the corporate credit rating on the originator. Absent securitization, a utility would typically recover the associated expenses over a longer timeframe, leveraging the utility's balance sheet and weakening its financial performance and credit quality. Furthermore, S&P Global Ratings typically makes an analytical adjustment to the financial statements of the sponsoring utility that effectively removes utility-related securitization bonds from its balance sheet, thereby improving the utility's credit metrics. In addition, since a utility's risk of default is usually higher than the risk of recovering costs through a non-bypassable charge on the customer's bill, the interest rate for securitization is usually lower than a utility independently financing these costs. As such, the impact to the customer bill is less, modestly reducing regulatory risk for the utility.

What is our outlook for issuance over the next few years?

We believe that costs associated with natural disasters and severe weather events, driven by climate change and efforts to decarbonize the energy sector, are just some examples of the factors that could potentially continue to drive the need for securitization, which is typically a more cost-effective alternative source of funding .

Based on regulatory filings, certain states appear to be in the process of preparing to issue utility-related securitizations. Recent examples include Kentucky Power and Hawaiian Electric Industries. Kentucky Power received approval in January 2024 from the local public utility commission to potentially use securitization as a financial tool to recover costs related to major storm outages. Regarding Hawaiian Electric Industries Inc., in January 2024, state lawmakers introduced a bill that would allow the company's electric utility to potentially securitize costs related to damages caused by wildfires.

Appendix

Table 1 below displays the true-up as a percentage of the customer's bill, among other useful information, for those transactions rated by S&P Global Ratings during 2022-2023.

Table 1