This report does not constitute a rating action.
Key Takeaways
- The volume of senior debt issued by North American (N.A.) investor-owned regulated utilities so far in 2024 is almost 15% lower than during the same period in 2023, even as cash flow deficits continue to rise from robust capital spending.
- This is due, in part, to the industry issuing more than 3x the amount of hybrid securities during the first six months of 2024 than it did during the entirety of 2023. S&P Global Ratings expects hybrid issuance by N.A. investor-owned regulated utilities will set a new record this year.
- However, the industry's issuance of common equity, which we view as most supportive of credit quality, remains insignificant and below 2023 levels through June 2024, highlighting our ongoing negative outlook for the industry.
The N.A. Regulated Utility Industry Set Multiple Records In 2023
The N.A. investor-owned regulated electric, gas, and water utility industry's capital spending reached an all-time high of almost $200 billion in 2023. This reflects a 16% increase compared to the prior year. The industry also issued a record level of senior debt at about $140 billion, including senior unsecured notes and first-mortgage bonds, to fund its elevated cash flow deficits, weakening financial measures.
Chart 1
Chart 2
The Industry Proactively Managed Its Borrowing Costs In 2023
To ease the effects of higher borrowing costs on ratepayers and financial measures in 2023, utilities responded to the Federal Reserve raising its target rate by 525 basis points (bps) between March 2022 and July 2023 by issuing long-term debt with shorter tenors. This decreased the weighted average tenor for the industry's senior debt issuance by 12% in 2023 compared with the prior year (see Chart 5). Although this moderated the effect of higher borrowing costs on the industry's funds from operations (FFO), the significant debt levels weakened the industry's FFO to debt by about 70 bps relative to 2022. The industry's FFO to debt in 2023 was 13.7% compared to 14.4% in 2022.
Insignificant Common Equity Issuance In 2023
Minimal common equity issuance in 2023 also contributed to the industry's weaker financial measures. The industry raised only about $8 billion of new common equity in 2023, which is meager in comparison to its historical average run rate of about $20 billion annually between 2018 and 2020. However, in actuality, common equity issuance since 2021 has been weak and consistently below our expectations, pressuring the industry's financial measures.
Chart 3
Hybrid Issuance Is On The Rise In 2024
So far in 2024, the industry's capital spending-driven cash flow deficits have continued to rise, but senior debt issuance trails 2023 levels by almost 15%. This is primarily because companies are issuing hybrid securities at record levels. S&P Global Ratings generally assesses hybrid securities as having high (100%) or intermediate (50%) equity content. Therefore, we view hybrid financing as more credit supportive than debt and believe this rise in hybrid issuance reduces some of the negative financial pressure the industry experienced in 2023. The industry has already issued over $11 billion of hybrid securities during the first six months of 2024, which dwarfs 2023 levels of about $3.7 billion for the entire year. The industry's current record for hybrid issuance is almost $14 billion, which was issued in 2019. Given that only about 10% of the industry issued hybrid securities during the first half of 2024, we therefore expect total 2024 issuance will most likely surpass this 2019 level.
Chart 4
The Industry Continues To Proactively Manage Its Borrowing Costs In 2024
The industry continues to manage its interest expense by issuing shorter-term debt in 2024. As mentioned above, the weighted average tenor of the N.A. utilities' senior debt issuance decreased by about 12% in 2023, and a further 5% so far in 2024. Over the past decade, the average tenor of the industry's senior debt was over 15 years. The industry's 2024 senior debt issuance is about 15% below this historical average, at about 13 years. From a credit perspective, we view this strategy of issuing shorter-term debt as supporting credit quality because it reduces the near-term impact on customers' bills and helps maintain a consistent financial performance amid the higher interest rate environment. We believe this strategy may also ultimately benefit the industry if the Federal Reserve begins to lower interest rates in the near future, as S&P Global economists expect under their base case (see "U.S. Business Cycle Barometer: Recession Risk Remains Above Historical Norm," published June 18, 2024, on RatingsDirect).
Chart 5
The Industry's Common Equity Issuance Remains Insignificant So Far In 2024
Although we believe the industry's use of hybrid financing in 2024 is positive for credit quality, common equity issuance remains insignificant and well below our expectations. For the first six months of 2024, the industry raised about $1 billion in common equity, compared with slightly over $8 billion for the entirety of 2023 (see Chart 3). It was only five years ago that the industry funded its 2019 cash flow deficits (excluding short-term debt and asset sales) with about $20 billion in common equity, or over $32 billion when combined with hybrid issuance. Dwindling over time, the percentage of common equity to the industry's total external funding mix has weakened annually since at least 2019, directly contributing to the industry's weakening credit quality. However, we note that during the second quarter of 2024, several companies announced sizeable at-the-market equity issuance programs, which we believe could increase the industry's common equity issuance to-date. However, details around issuance amounts have yet to be disclosed in quarterly financials.
Overall, we view hybrid financing as an intermediary funding option that is more credit supportive than debt. However, without more significant common equity issuance, we expect the industry's financial measures will continue to weaken, albeit gradually, supporting our negative outlook on the industry.
Chart 6
| Primary Credit Analyst: | William Hernandez, Dallas + 1 (214) 765-5877; william.hernandez@spglobal.com |
| Secondary Contact: | Gabe Grosberg, New York + 1 (212) 438 6043; gabe.grosberg@spglobal.com |
| Research Assistant: | Piyush Seth, Pune |
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