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Announcement:

Moody's changes the US regulated utility sector outlook to negative from stable

18 Jun 2018

Key financial credit ratios have declined over the past 12 months, and are expected to decline further through 2019 before stabilizing and recovering

New York, June 18, 2018 -- Moody's Investors Service ("Moody's") has changed the fundamental sector outlook for the US regulated electric and gas utility industry to negative from stable. The change in outlook primarily reflects a degradation in key financial credit ratios, specifically the ratio of cash flow from operations to debt, funds from operations (FFO) to debt and retained cash flow to debt, as well as certain book leverage ratios. The change in outlook also reflects uncertainty with respect to the timing and extent of potential changes in regulatory recovery provisions, authorized returns and equity layers or self-help options by individual companies in response to lower cash flow.

"Regulated utilities will be exposed to a higher level of financial risk for the next 12 to 18 months" said Ryan Wobbrock, Vice President -- Senior Analyst. "For utility holding companies, the consolidated ratio of FFO to debt has been on a steady decline, from 19% in 2013 to 17% at year-end 2017, and we expect it to decline further toward 15% through 2019."

The change in fundamental sector outlook reflects a declining financial trend, which is a function of higher holding company debt levels incurred in the last few years and a lower deferred tax contribution to cash flow going forward due to tax reform. In aggregating sector financials, Moody's examined 42 of the largest US utility & power holding companies with at least 10 years of historical financial data.

To mitigate this declining financial trend, several holding companies are taking defensive measures in 2018 to strengthen their balance sheets. On average, however, we expect debt to capitalization ratios to stay around 54% (up from 49% in 2016), large capital spending plans to persist, and dividend growth to increase -- all at the same time that FFO is falling. This trend will also keep debt to EBITDA at a ten year high level of around 5.0x for the next several years.

"With respect to financial mitigation measures, we see more activity in the pursuit of regulatory cost recovery relief than we do with management teams executing material changes to financial policies," said Wobbrock. "Thus far, there has been no discernible adjustments to dividend policies and most utilities continue to incorporate a heavy reliance on debt financing for their sizable negative free cash flow funding needs."

Management teams' defensive efforts and a few initial signs of supportive regulatory responses to tax reform are important first steps in addressing the sector's increased financial risk. However, we believe that it will take longer than 12 -18 months for the sector to exhibit a material financial improvement from these actions.

The fundamental sector outlook could return to stable if Moody's expects that the sector's financial profile will stabilize at today's lower levels, with consolidated FFO to debt metrics remaining steady at 15%. A positive outlook could be considered if we expect a recovery in key cash flow metrics where consolidated cash flow starts to improve by roughly 15%-20% or the ratio of consolidated FFO to debt indicates a return to the 17%-19% range.

The fundamentals sector outlook could stay negative if the key cash flow ratios continue to decline, or if there are signs that a more contentious regulatory environment is emerging. A more contentious regulatory environment is one where litigation is the preferred path of regulatory proceeding (instead of settlements), or where the suite of authorized recovery mechanisms begins to become more limited. Lower authorized returns on equity do not, by themselves, signal a weakening regulatory relationship.

US utilities continue to be viewed as critical infrastructure assets, which means they have a roughly 3x lower probability of default than their non-financial corporate peers. From a liquidity perspective, Moody's incorporates a view that US investor owned regulated electric and gas utilities will maintain unfettered access to the capital markets. In addition, Moody's continues to view regulated utilities as a defensive investment alternative in the event of a wide-spread, short-duration financial market shock. These factors provide the sector with a strong, investment grade credit profile, which continues to be the case, notwithstanding the negative sector outlook.

The report, "Regulated Utilities -- US: 2019 outlook shifts to negative due to weaker cash flows, continued high leverage," is available to Moody's subscribers at

https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1128302

************************************************************************

NOTE TO JOURNALISTS ONLY: For more information, please call one of our global press information hotlines: New York +1-212-553-0376, London +44-20-7772-5456, Tokyo +813-5408-4110, Hong Kong +852-3758-1350, Sydney +61-2-9270-8141, Mexico City 001-888-779-5833, São Paulo 0800-891-2518, or Buenos Aires 0800-666-3506. You can also email us at mediarelations@moodys.com or visit our web site at www.moodys.com.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Ryan Wobbrock
Vice President - Senior Analyst
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

Michael G. Haggarty
Associate Managing Director
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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