California Utilities May Risk Junk-Debt Status as PG&E Unravels
(Bloomberg) -- California’s utilities could get closer to junk-bond status as PG&E Corp.’s collapse highlights the hazards of wildfire liability in the state.
Edison International’s Southern California Edison Co. as well as Sempra Energy’s San Diego Gas & Electric Co. were downgraded by S&P Global Ratings on Monday. The credit grader cited the continued risk of climate change crises and the absence of protective regulation for the largest power companies in California, where scant rainfall and dry winds exposed millions of acres to uncontrollable blazes. S&P could lower ratings on both companies further if politicians and regulators don’t “explicitly address these growing risks” in the next few months, S&P said.
S&P cut Edison and SoCalEd one notch to BBB, the second-lowest investment-grade level, and lowered SDG&E one grade to BBB+. Separately, Fitch Ratings updated its outlook on Edison to negative from stable on Tuesday, affirming the company at BBB+. Sempra Energy has around $24 billion in debt, while Edison International has more than $14 billion, according to regulatory filings.
“Without a timely, credit supportive regulatory response, multi-notch downgrades cannot be ruled out over the coming 12-24 months, given the increased frequency and magnitude of these destructive fires,” Fitch analysts led by Phil Smyth said in their report.
Wildfires in November forced PG&E to plan for bankruptcy as it faces $30 billion in damage liabilities. The state’s largest utility company has unsuccessfully tried to overturn a legal doctrine known as inverse condemnation, which holds California utilities responsible for wildfire damage caused by their equipment, whether or not they act negligently. The company has said that it was dangerously exposed to what it called “climate-driven extreme weather.”
The negative credit outlooks for Edison and SDG&E reflect they “will continue to experience catastrophic wildfires because of climate change and without sufficient regulatory protections due to California’s common law application of the legal doctrine of inverse condemnation,” S&P analysts including Gabe Grosberg wrote.
“Without an updated legislative, legal and regulatory framework to address wildfire liabilities, the impacts will likely further compromise the financial health of our state," a representative for SDG&E said. “Ultimately our customers are going to be hurt by this rating-agency action, because it will mean higher borrowing costs, which may result in higher electric rates over time.”
A representative for Edison said the company “continues to actively engage with state leaders to develop comprehensive public policies to address statewide wildfire mitigation and liability reform.” A representative for PG&E declined to comment.
The swift collapse of PG&E has been a reminder to investors how quickly things can unravel. The California utility holding company, which held investment-grade ratings from all three major credit raters at the beginning of this month, is planning to file for bankruptcy by the end of January.
If PG&E goes bankrupt as expected, it will be the first investment-grade name to default without entering the U.S. high-yield market since MF Global in 2011, Bank of America strategists led by Hans Mikkelsen said in a note.
SDG&E and Edison’s bonds have been punished in the wake of the wildfires and PG&E’s planned bankruptcy. The spread on Edison’s 4.125 percent notes due 2028 more than doubled to 270.9 basis points since early November, while the spread on SDG&E’s 4.15 percent notes due 2048 widened by more than 40 basis points to about 135 basis points over the same period, Trace bond-price data show.
The prospect of further downgrades may be increased after lawmakers didn’t change the state’s inverse condemnation law last year despite lobbying by the utilities and support from former Governor Jerry Brown. Changes to regulation in favor of utilities will likely be seen as a government bailout by voters, an unpopular move that makes it unlikely politicians will take immediate action.
This risk of potential wildfire liabilities may cause less damage to PG&E’s peers, according to Bloomberg Intelligence analyst Jaimin Patel. The majority of bonds issued by Southern California Edison and SDG&E are secured, unlike those of PG&E.
”No first mortgage bond has ever suffered impairment in the history of the U.S. utility industry,” Patel said. “In Southern California Edison’s case, because the bonds are secured as first mortgage bonds, they would have preferential treatment, meaning if they were going to be repaid through a refinancing or restructuring, they would be given preference in terms of payment,” added Patel. By contrast, PG&E bondholders will now see their claims rivaled by homeowners whose property was scorched when the company files on or around Jan. 29.
Outside of a bankruptcy scenario, however, companies may issue more unsecured debt at the parent level to fund liabilities because California regulators limit borrowing at the utility. These claims may leave holding companies more vulnerable because “parent debt means greater reliance on the utility’s cash flow,” said Patel, meaning in any PG&E-type scenario it “becomes exposed and likely impaired.”
This has greater impact on Edison and Sempra because the relative value of their debt is larger than PG&E’s, according to Patel. Sempra is one of the most leveraged parent holding companies in the sector, he said, though SDG&E’s specific territory Southern California location has proved less susceptible to wildfires and Sempra has significant subsidiaries outside the state and internationally, according to Patel.
©2019 Bloomberg L.P.