Rating Action: Moody's downgrades Orange & Rockland Utilities to Baa2; outlook stable
Global Credit Research - 26 Jan 2021
New York, January 26, 2021 -- Moody's Investors Service, ("Moody's") today downgraded the long-term ratings (including senior unsecured and long-term issuer rating) of Orange and Rockland Utilities, Inc. (O&R) to Baa2 due to a weakened financial profile and higher political and regulatory risk in New York, it's primary service territory. At the same time, Moody's affirmed O&R's commercial paper rating at P-2. O&R's outlook is stable.
"O&R's weakening financial profile comes at the same time that political intervention and regulatory risk is rising" said Ryan Wobbrock -- Vice President and Senior Credit Officer. "With a less predictable business environment and projected cash flow to debt ratios expected to be around 15% for a sustained period of time, O&R's credit profile is better aligned with Baa2-rated peers" added Wobbrock.
O&R's cash flow from operations has declined due to lower deferred taxes and cash outflows in regulatory accounts over the past two years, despite higher net income and depreciation recovery provided in multi-year rate plans. For example, in years 2015-2018, cash flow from operations before changes in working capital (CFO pre-WC) averaged about $210 million, whereas 2019 and LTM 3Q 2020 has been roughly $180 million, even when normalizing 2020 cash flow for COVID-19 impacts. At the same time, total adjusted debt has increased from about $1.0 billion in 2015 to $1.2 billion at 30 September 2020. High pension obligations continue to weigh on O&R's adjusted metrics, representing about 20% of total adjusted debt -- one of the highest percentages in the utility industry.
We expect weaker financials to continue over the next 2 years, resulting in an average ratio of CFO pre-WC to debt of about 15%, which excludes the effects of a prolonged COVID-19 scenario. We project that new rate plans will be effective in 2022, but that outcomes will maintain relatively low levels of equity capitalization (e.g., 48% versus an industry average of approximately 50% at December 2020) and lower allowed ROEs (e.g., 8.8% versus industry average of 9.4% at December 2020). While New York authorized ROEs tend to be below US averages, we note that an 8.8% allowed ROE is roughly 700 basis points above long-term treasury rates, representing a higher equity risk premium relative to long-term historical averages.
We also see O&R facing incremental headwinds with heightened political pressure in New York, where roughly 85% of O&R's rate base resides. This rising risk is evidenced by increasing regulatory powers to levy higher penalties and fines due to perceived service inadequacies. For instance, the state's governor has introduced legislation that, if approved, would amend current laws to codify certain performance standards for the state's utilities, eliminate statutory penalty caps for violations and provide greater authority to the state's Department of Public Service (DPS) and the Public Service Commission (PSC), including giving the PSC the ability to prohibit any utility provider from operating in the state.
We view these more recent developments as the latest in a trend of political intervention into utility regulation, which undermines the consistency and predictability of the New York regulatory framework, relative to other states. Moreover, if legislation is passed in New York that heightens financial and operating risks for utilities, the legislative and judicial underpinnings of the state's regulatory environment could also become less credit supportive.
Environmental considerations incorporated into our credit analysis for O&R are primarily related to air pollution and regulations around carbon, methane and other greenhouse gas emissions. As a T&D and LDC company, O&R is less exposed to the direct production of greenhouse gases; however, these are emitted during the natural gas life cycle, including through the production of the energy that O&R delivers and via their own gas infrastructure.
Moreover, these issues are central to state legislative actions that seek to reduce greenhouse gas emissions, thereby affecting O&R's current and future operations. For example, New York has formed a Climate Action Council, a 22-member committee that will develop a plan to achieve the state's clean energy and climate agenda, including reduced reliance on natural gas and a 40% reduction of greenhouse gas emissions by 2030 and 80% by 2050.
While this adds some near-term uncertainty until a final plan can be determined (a draft scoping plan is scheduled for year-end 2021), we view the effort to form a cohesive, economy-wide plan as being helpful to long-term utility planning and instructive for regulators to shape utility cost recovery to support credit during the transition.
Social risks are primarily related to health and safety, demographic and societal trends, as well as customer relations in the company's attempts to provide reliable and affordable service to customers and safe working conditions to employees. Regarding affordability, we see rising social risks associated with the COVID-19 pandemic and its effect on the New York economy, given the 1 October 2020 downgrade of the State of New York's General Obligation bonds (to Aa2 from Aa1; stable outlook), due to the economic and fiscal consequences of the coronavirus crisis. The economic impacts in New York and New Jersey could have mitigating effects on any rate increases that O&R seeks in 2021.
O&R's governance is guided by that of its parent, CEI. CEI has generally strong financial policies which include relatively low holding company leverage (e.g., around 10% of consolidated debt is issued at the parent level) and annual issuance of common equity. For example, accroding to CEI's February 2020 earnings release, the company's financing plan includes approximately $1.1 billion in aggregate of common equity during 2021 and 2022. This type of public equity commitment over a forecast period is rare in the utility sector.
O&R's stable outlook reflects our expectation that the various ratios of cash flow to debt will remain between 14-16%, even when normalizing for COVID-19 impacts and considering the potential for new rate filings to be made over the next 12 months. The stable outlook also incorporates a view that political and regulatory pressures will continue in 2021, which could temper revenue increases if economic pressures persist.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Factors that could lead to an upgrade
O&R could be upgraded if its ratio of CFO pre-WC to debt were to increase over 16% or CFO pre-WC less dividends to debt were to increase over 14% on a sustainable basis. Also, O&R could be upgraded if New York's political and regulatory environment were to become more predictable and supportive of credit.
Factors that could lead to a downgrade
O&R could be downgraded with a further degradation in the degree of predictability and supportiveness of the New York political and regulatory environment, or if its ratio of CFO pre-WC to debt were to drop below 13% for a sustained period.
..Issuer: Orange and Rockland Utilities, Inc.
.... Issuer Rating, Downgraded to Baa2 from Baa1
....Senior Unsecured Regular Bond/Debenture, Downgraded to Baa2 from Baa1
..Issuer: Orange and Rockland Utilities, Inc.
....Senior Unsecured Commercial Paper, Affirmed P-2
..Issuer: Orange and Rockland Utilities, Inc.
....Outlook, Changed To Stable From Negative
The principal methodology used in these ratings was Regulated Electric and Gas Utilities published in June 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1072530. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.
These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.
The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.
The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.
Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.
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Ryan Wobbrock VP - Senior Credit Officer Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Jim Hempstead MD - Utilities Corporate Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653
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