5 ways to improve your utility’s bond rating
The bond rating measure of your utility’s financial health
The bond rating is a key measure of financial health. An organization can receive ratings from Moody’s, S&P, and Fitch. The bond ratings organizations use tools like the Moody’s rating scale to determine credit-worthiness. A high bond rating is key to maximizing cash flows. How do you drive a higher rating? Improving key metrics that Moody's, S&P, and Fitch analyze should be part of the utility strategy.
Debt is part of the utility business. Utilities build long-term infrastructure, with a useful life of 30-40 years to serve customers and finance that infrastructure with long term debt such as revenue bonds. Customers pay for debt service on that debt thought their rates, charged for current use of the system. This reliable cash flow from ratepayers is pledged to repay revenue bond debt.
Bond ratings from the major ratings agencies (S&P, Moody’s, Fitch) are the report card that determines the interest rate paid by a utility when issuing long-term debt.
The higher the bond rating the lower the interest rate that is required to be paid on the debt issue. The interest rate spread between the highest rating (AAA) and a rating a few notches lower (A) is up to 100 basis point, or 1%. So, a $10 million bond issue at the higher rating will pay $100,000 less in interest payments annually, freeing cash flow for use in utility operations or funding capital improvements, rather than paying that amount to bondholders.
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Power plant financing - A higher bond rating means a lower interest rate
The top 5 ways to maintain a great bond rating
Here are 5 top ways to keep your electric utility’s bond rating steady or improving.
1. Rate stabilization reserves - setting aside a “rainy day fund” gives comfort to the ratings agency that funds are available to finance leaner earning years and pay bondholders.
2. Long range forecasting and financing plan over a 15-30 year period - long-term planning shows management’s commitment to implementing and financing long-term strategies.
3. Regular rate increases and the political will of the oversight body to pass needed increases - this show the understanding of oversight Boards that strategy needs financing and customer rates must cover financing costs.
4. Fallback strategy and mitigation plans for budgets that are missed - a fallback/mitigation plan is needed when things do not go as planned.
5. Having a defined plan for funding long-term obligations - the aging workforce is driving long-term obligations for pension and post-employment benefits, customer rates need to fund these obligations.
Excellent sources of information and further insights can be found at the website of each bond rating agency. The bond rating agencies provide the playbook. of the biggest jobs of the utility Chief Financial Officer is to manage the utility bond rating. The steps are not hard, but systematic.
About Russ Hissom - Article Author
Russ Hissom, CPA is a principal of Utility Accounting & Rates Specialists a firm that provides power utilities rate, expert witness, and consulting services, and online/on-demand courses on accounting, rates, FERC/RUS construction accounting, financial analysis, and business process improvement services. Russ was a partner in a national accounting and consulting firm for 20 years. He works with electric investor-owned and public power utilities, electric cooperatives, broadband providers, and gas, water, and wastewater utilities. His goal is to share industry best practices to help your business perform effectively and efficiently and meet the challenges of the changing power and utilities industry.
Find out more about Utility Accounting & Rates Specialists here, or you can reach Russ at russ.hissom@utilityeducation.com.
The material in this article is for informational purposes only and should not be taken as legal or accounting advice provided by Utility Accounting & Rates Specialists. You should seek formal advice on this topic from your accounting or legal advisor.