Confused About the Board of Director's Role in Managing a Utility Bond Rating? Let’s Clear Some of That Up!
- Jan 12, 2022 2:42 am GMT
It’s easy to manage a bond rating
Hah, this is no joke. A utility’s Board of Directors can definitely influence a bond rating. Utilities finance projects with combinations of cash flow from operations and revenue bond debt. We are now entering an era of rising interest rates, mainly to combat rising inflation. So, the squeeze is on, i.e., debt service will increase due to higher interest rates, and project costs will increase due to inflation. These two occurrences are a negative impact on cash flow. What moves can management and utility Board of Directors make to manage in this environment?
The leading bond rating agencies are Moody’s, Standard and Poors, and Fitch.
Managing the bond rating is part of the role of the oversight board of the utility through the approval of budgets and short and long-term strategy.
Enhancing or maintaining the bond rating of a utility is not difficult, but it takes time and attention.
Oversight Utility Boards must take politics out of decisions as much as possible.
The current rising interest rate and inflationary environment will squeeze utility cash flow, and maximizing the utility’s bond rating is one way to counter some of the impacts.
The Board of Director’s role in managing the bond rating
When issuing debt, such as revenue bonds, a utility aims to issue revenue bonds at as low an interest rate as possible. The interest rate of the revenue bond issue is based on the utility’s bond rating, i.e.the, bond rating takes the temperature of a utility’s financial health. In this case, the higher the rating, the lower the interest rate. A lower interest rate means that bondholders pay less for interest expense, providing greater cash flow for the utility.
Bond ratings are provided by the firms Moody’s, Standard and Poors, and Fitch. These three firms are the leading players in providing bond ratings, and a Moody’s rating, a Standard and Poor’s rating, and a Fitch rating all carry equal weight.
One of the most essential jobs of utility management and boards is to manage the utility’s financial structure to maximize its bond rating. Moody’s, Standard and Poors, and Fitch use rating scales to determine the bond rating.
For example, the Moody’s rating scale weights financial ratios to determine the utility’s bond rating. The rating scale heavily weights the debt service coverage ratio, debt to equity ratio, debt to assets ratio, free cash flow, and cash reserves to arrive at its weighting.
Management tools to a better bond rating
Management and the utility board of directors can manage ratios and metrics through budgeting, capital improvement plans, long-range forecasts of future projects, revenue bond debt issued, electric rate increases, and their impacts on cash flows. Some of these tools include:
Focusing on key performance indicators. Since the agencies are focused on the key financial ratios, so should management. Budgets should be developed around cash flows, with emphasis on:
Cash reserves – the bond ratings agencies measure the days of available unrestricted cash, i.e., cash that is not dedicated to debt service or projects. Common measures include:
Debt service coverage ratio – this ratio measures the amount of cash available to pay bond principal and interest amounts due. Some common measures for this ratio include:
Debt to total assets – Capitalization - This ratio measures the percentage of debt to total assets, an indicator of borrowing capabilities. A higher ratio of debt to assets will negatively impact the bond rating.
Strategies to dress up your utility’s financial statements
There are strategies that well-run utilities use that make their financial statements attractive to potential bond buyers and rating agencies. This does not mean that anything untoward or deceptive is going on in the organization. Still, it does mean that management and oversight boards have taken steps to manage finances, and this is reflected in the financials.
No discussions yet. Start a discussion below.
Get Published - Build a Following
The Energy Central Power Industry Network is based on one core idea - power industry professionals helping each other and advancing the industry by sharing and learning from each other.
If you have an experience or insight to share or have learned something from a conference or seminar, your peers and colleagues on Energy Central want to hear about it. It's also easy to share a link to an article you've liked or an industry resource that you think would be helpful.