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SSR Utilities and Renewable Energy

Eric Selmon and Hugh Wynne

Office: +1-646-843-7200; +1-646-532-9596

Email: eselmon@ssrllc.com; hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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July 31, 2023

Rates Cases Impact Utility Stock and Bond Returns and Utilities’ Cost of Capital – but Not Necessarily as Expected

We have analyzed 368 different rate cases filed by U.S. electric utilities over the period 2012-2022 to assess how rate case filings and rate case decisions affect the returns on utilities’ stocks and bonds. We find that over the twelve months following the filing of a rate case, the equity performance of a filing utility tends to reflect investors’ expectations of its regulators’ decision; the announcement of rate case decisions, by contrast, had no discernible impact on subsequent equity performance. For bonds, the impacts were reversed – over the twelve months following the filing of utility rate cases, the bond yields of utilities filing rate cases differed little from those that did not; over the twelve months following rate case decisions, however, bond yields increased markedly for those utilities awarded the lowest ROEs.

The post-filing equity performance of electric utilities tends to reflect the track record of the state in which the case was filed in reducing utilities’ requested revenue increases, with the stocks of utilities filing in states with a record of large cuts to revenue requests materially underperforming those of their peers. Over the twelve months following the filing of rate cases in such states, we estimate the cost of equity of the filing utilities increased by ~15 to ~20 basis points. We found a similar effect among the bonds of utilities awarded the lowest ROEs in their rate cases: over the twelve months following the rate case decision, these bonds suffered an increase in their spreads to Treasuries of ~12 to ~19 basis points relative to the bonds of utilities receiving more favorable ROEs.

• We have analyzed 368 different rate cases filed by U.S. electric utilities over the period 2012-2022 to assess how rate case filings and rate case decisions affect returns on utilities’ stocks and bonds. In each rate case, we tracked the performance of the filing utility’s stocks and bonds in the months following its filing of the rate case and the months following the final decision in the rate case. We compared these returns to those of all other publicly traded electric utility stocks and bonds over the same period.

• In Exhibits 1 through 3 we present the post-filing equity performance (expressed as a percentile rank among all publicly traded utilities) of the filing utilities, broken down into five groups based on the regulatory track record of the state in which the rate case was filed. As these exhibits illustrate, the shares of utilities filing rate cases in states with a history of sharply reducing requested revenue increases performed much worse in the months following their filings than the shares of utilities filing rate cases in states that historically have been less aggressive in reducing revenue requests. The difference in stock performance between these two groups of utilities is significant over the three months following the filing (ranging as high as 11 percentiles; see Exhibit 1) and widens further over the twelve months following the filing (ranging as high as 20 percentiles; see Exhibit 3.)

• Certain models for estimating utilities’ cost of equity calculate this cost by solving for the discount rate that equates the present value of the utility’s future dividend stream to the price of its stock (e.g., the dividend discount model and Gordon dividend growth model). Pursuant to these models, the underperformance of a utility’s stock following the filing of a rate case in an unfavorable regulatory jurisdiction would cause its cost of equity to rise relative to its peers.

– As can be seen in Exhibit 20, the shares of utilities filing rate cases in the states ranking in the fourth and fifth (worst) quintiles in terms of the scale of their cuts to utilities’ revenue requests underperformed by 4.6 and 4.5 percentage points, respectively, vs. the average of their peers.

– Manipulating the Gordon dividend growth model (P=d/(r-g)) to solve for the discount rate applied to a stock’s future dividend stream (r=d/P+g), we can estimate what such a deterioration in share price implies for the cost of equity. In an industry where dividend yields tend to range from ~3% to ~4%, a 4.5% reduction in share price drives an increase in cost of equity as estimated by the Gordon model of ~15 to ~20 basis points.

• We also analyzed 284 rate cases involving electric utilities with publicly traded debt, allowing us to conduct a similar analysis of the performance of electric utility bonds. We found that the returns on electric utility bonds over the year following rate case decisions are relatively insensitive to the results of these decisions, with one exception: when rate case decisions result in a very low allowed ROE relative to the national average allowed ROE at the time, materially eroding the debt service coverage ratios of the affected bonds relative to their peers. (See Exhibits 21 and 22.)

– When measured over the twelve months following the rate case decision, the spread to Treasuries on the bonds of the utilities received the lowest allowed ROEs increased, on average, by ~12 to ~19 basis points relative to the bonds of utilities receiving more favorable ROEs.

Details

To assess how the performance of U.S. electric utilities’ stocks and bonds are affected by rate cases, we have analyzed 368 different rate cases filed over the period 2012-2022 and assessed the performance of the filing company’s bonds and shares (or those of its holding company) in the months that followed. [1]

We measured the performance of these securities over periods of one, three, six and twelve months following the filing of the rate case as well as following the release of a final decision in the case. We then compared the performance of the securities of the company filing the rate to similar securities of all the other investor-owned electric utilities. Comparing the performance of the bonds and shares of the companies filing rate cases to those of the companies that had not, we calculated the percentile rank of the bonds and shares of the companies filing rate cases. In the sections that follow, we summarize below the patterns of post-filing and post-decision performance that emerged from this analysis.

To assess the importance of different factors in predicting the outperformance or underperformance of the securities of electric utilities filing rate cases, we have ranked the rate cases on a number of different criteria. One such criterion was the tendency of the state in which the rate case was filed to set allowed ROEs in electric utility rate cases at levels above or below the national average ROEs set in electric utility rate cases the same year. Another was the historical tendency of the state in which the rate case was filed to reduce the revenue increases requested in electric utility rate cases.

Most of the criteria we tested had no discernible impact on the relative bond or stock performance of those utilities that filed rate cases, or that received final decisions in their rate cases. Rather than discuss all the criteria which had no discernible impact on returns, this research report focuses on (i) those characteristics whose presence or absence appears to be linked to a discernible difference in the post-filing or post-decision performance of the filing utility’s bonds or stock and (ii) those characteristics that would be expected to have such a link but where no such impact could be found.

Electric Utility Equity Returns Following Rate Case Filings

In this section we discuss the stock performance of electric utilities following their rate case filings. We focus on two analyses, the results of which show a significant divergence in the performance of the filing utilities’ shares relative to those of the universe of publicly traded electric utilities.

The first of these analyses tests how the performance of the filing utility’s shares in the months after the filing are affected by the regulatory track record of the state in which the rate case was filed. We assess this track record based upon the average percentage reduction in electric utilities’ requests for revenue increases mandated by the state over the years 2010 through 2022. Based on this metric, we grouped the states into five quintiles from best (1st quintile) to worst (5th quintile). We then compared the post-filing performance of the shares of the filing utilities in each group of states to that of the shares of all other publicly traded electric utilities in the months following each utility’s filing.

In Exhibits 1 through 3 we present the post-filing equity performance (expressed as a percentile rank among all publicly traded utilities) of the filing utilities, broken down into five groups based on the regulatory track record of the state in which the rate case was filed. As these exhibits illustrate, the shares of utilities filing rate cases in states with a history of sharply reducing requested revenue increases (ranked in quintiles 5 and 4 along the x-axes of the charts below) performed much worse in the months following their filing than the shares of utilities filing rate cases in states that historically have been less aggressive in reducing revenue requests (ranked in quintiles 3, 2 and 1 in the charts below). The difference in stock performance between these two groups of utilities is significant over the three months following the filing (ranging as high as 11 percentiles; see Exhibit 1) and widens further over the twelve months following the filing (ranging as high as 20 percentiles ; see Exhibit 3.)

Investors appear to anticipate far more rate relief from rate cases filed in states with a track record of small or moderate reductions to utilities’ requested revenue increases than from rate cases filed in states with a track record of large reductions. Investors’ expectation that a utility filing a rate case in a state with a track record of modest reductions to utilities’ revenue requests will enjoy a larger revenue increase may in turn drive expectations of more rapid earnings growth by utilities in such jurisdictions.

Exhibit 1: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Three Months Following the Filing of Rate Cases (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Exhibit 2: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Six Months Following the Filing of Rate Cases (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Exhibit 3: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Twelve Months Following the Filing of Rate Cases (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Our second analysis tests how the performance of the filing utility’s shares in the months after the filing are affected by the extent to which the state in which the rate case was filed tends to set allowed ROEs above or below the average allowed ROE set in electric utility rate cases nationally. We assess this track record based upon the average of the allowed ROEs set by the state in electric utility rate cases as a percentage of the average allowed ROE set in electric utility rate cases nationally in the same year. Based on this metric, we grouped the states into five quintiles from best (1st quintile) to worst (5th quintile). We then compared the post-filing performance of the shares of the filing utilities in each group of states to that of the shares of all other publicly traded electric utilities in the months following each utility’s filing.

When we classify the 368 electric utility rate cases filed over 2012-2022 on this basis, a far less intuitive result emerges. Contrary to what might be expected, the stocks of the utilities filing rate cases in states whose authorized ROEs were, at that time, lowest relative to the national average (those in fifth quintile in the charts below) performed better than the stocks of the utilities filing rates cases in states whose authorized ROEs were highest relative to the national average (those in the first quintile in the charts below). This effect is most marked over the three and six month periods following the filing date, but less so over twelve months. (See Exhibits 4 to 6.)

That the stocks of utilities filing rate cases in states with the lowest allowed ROEs should outperform the stocks of utilities filing rate cases in states with the highest allowed ROEs may reflect an expectation that ROE decisions in these outlier states would revert to the national mean, i.e., that the states that historically awarded the lowest ROEs relative to the national average would tend to authorize higher ROEs going forward while the states that historically awarded the highest ROEs might begin to award lower ones. Alternatively, reflecting the continuous decline over 2012-2022 in the allowed ROEs set in electric utility rate cases, it could reflect concern that the greatest risk of reductions in allowed ROEs would be in states that have historically granted the highest ROEs and the lowest risk in the states that had granted the lowest ROEs.

Exhibit 4: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Three Months Following the Filing of Rate Cases (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Exhibit 5: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Six Months Following the Filing of Rate Cases (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Exhibit 6: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Twelve Months Following the Filing of Rate Cases (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Electric Utility Equity Returns Following Rate Case Decisions

Of the 368 rate cases filed over 2012-2022 that we analyzed above, only 318 have been decided long enough ago for us to have twelve months of post-decision performance data. Analyzing these 318 cases, we find that the impact of rate case decisions on utilities’ subsequent stock performance is much less marked than the impact of rate case filings.

In Exhibits 7 through 9 we examine how a state’s reduction in a utility’s requested revenue increase, measured relative to investor expectations, is reflected in the stock performance of the filing utility over the months following the decision. To assess this effect, we compared the post-decision stock performance of utilities ranked on the ratio of (i) the percentage reduction in the utility’s requested revenue increase set by the state in its rate case to (ii) the average percentage reduction in electric utilities’ requested revenue increases over 2010-2022 in the state in which the rate case was filed. As in the charts above, we have grouped the rate case decisions into quintiles: the first or best quintile comprises those rate cases with the smallest cut to the filing utility’s requested revenue increase relative to the state’s historical average while the fifth or worst quintile comprises those rate cases with the largest cut relative to the state’s average. Thus, a decision cutting a utility’s revenue request by 15% in a state whose decisions had historically cut utilities’ revenue requests by an average of 20% would be considered a favorable surprise and rank in a lower (or better) quintile, while a decision to cut a utility’s revenue request by 10% in a state that historically had averaged only 5% cuts would be considered an unfavorable surprise and rank in a higher (or worse) quintile.

We find very little difference in the post-decision stock performance of electric utilities ranked on this basis. Over the months following a rate case decision, the stock performance of the filing utility generally does not diverge significantly from the median of the publicly traded electric utilities as a group (the 50th percentile). This would suggest that by the end of a rate case sufficient information has been released (in the form of staff recommendations, draft decisions by administrative law judges and the like) to allow investors to estimate the outcome with considerable accuracy, even if these outcomes diverged from the state’s historical practice. The similarity in the post-decision stock price performance of the filling utilities, regardless of the relative severity of the reduction in the utility’s requested revenue increase, is most evident in the three and six month periods following the decision.

Exhibit 7: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Three Months Following the Rate Case Decision (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Exhibit 8: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Six Months Following the Rate Case Decision (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Exhibit 9: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Twelve Months Following the Rate Case Decision (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

We also examined how post-decision equity returns are affected by the ratio of (i) the allowed ROE authorized by the decision relative to (ii) the national average allowed ROE prevailing at the time. As can be seen in Exhibits 10 to 12, during the months following the ROE decision, there is little difference in stock performance between utilities that were awarded high (first quintile) or low (fifth quintile) allowed ROEs relative to the national average. The similarity in utilities post-decision equity performance regardless of the relative attractiveness of the ROEs awarded them is particularly evident over the six and twelve month periods following the decision. (See Exhibits 11 and 12.). Again, it would appear that by the end of a rate case sufficient information has been released to allow investors to estimate with considerable accuracy the allowed ROE likely to be awarded in the decision.

Exhibit 10: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Three Months Following the Rate Case Decision (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Exhibit 11: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Six Months Following the Rate Case Decision (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Exhibit 12: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Twelve Months Following the Rate Case Decision (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Electric Utility Bond Returns Following Rate Case Filings and Rate Case Decisions

In addition to analyzing the performance of electric utilities’ stocks following rate case filings and decisions, we also analyzed 284 rate cases involving electric utilities with publicly traded debt, allowing us to conduct a similar analysis of the post-filing and post-decision performance of electric utility bonds. Interestingly, the reaction of electric utility bonds to rate case filings and rate case decisions is different from that of stocks.

Utility bonds tend to react very positively to rate case filings and do so in a way that does not discriminate between regulatory jurisdictions based on their historical track record of reducing utilities’ revenue requests or setting allowed ROEs. As can be seen in Exhibit 13, the bonds of electric utilities tend to outperform markedly over the day following the rate case filing; oddly, however, the performance of the bonds of electric utilities filing in states that historically have required the smallest cuts to utilities’ requested revenue increases (those in the first or best quintile) is almost indistinguishable from that of the bonds of electric utilities filing in states that historically have required the largest cuts to utilities’ requests (those in the fifth or worst quintile).

Exhibit 13: Debt Performance of U.S. Publicly Traded Utilities Over the Day Following the Rate Case Filing (Percentile Rank Among All U.S. Utility Bonds)

Source: FactSet, SSR research and analysis

When the 284 rate cases are sorted based upon the historical track record of the state in which the rate case was filed in setting allowed ROEs relative to the national average allowed ROE, a similar pattern emerges. On average, the bonds of utilities in each of the five quintiles outperform significantly, but there is little difference in performance across the quintiles. (See Exhibit 14.)

Exhibit 14: Debt Performance of U.S. Publicly Traded Utilities Over the Day Following the Rate Case Filing (Percentile Rank Among All U.S. Utility Bonds)

Source: FactSet, SSR research and analysis

By contrast, the returns on electric utility bonds following rate case decisions appear to be sensitive to the results of these decisions. This is particularly so when these decisions result in low allowed ROEs relative to the national average allowed ROE at the time – eroding the debt service coverage ratios of the affected utilities relative to their peers.

Thus, in rate cases where allowed ROEs are set, the bonds of utilities awarded the lowest ROEs relative to the national average (those in the fifth or worst quintile) performed markedly worse over the following day than those awarded the highest ROEs (those in the first or best quintile). The performance of the bonds in the worst quintile on allowed ROE was in the 50th percentile of all utility bonds, equivalent to the median of the group, while the performance of the bonds in the best quintile on allowed ROE was in the 67th percentile. Over the month following the decision, the bonds in the worst quintile on allowed ROE fell to the 39th percentile, or eleven percentiles below the median of the group. (See Exhibits 15 and 16.)

Measured over the three month period following the rate case decision, the performance of the bonds in the fifth quintile on allowed ROE improves somewhat, rising to the 44% percentile. When measured over the twelve months following the rate case decision, however, the average performance of the bonds in the fifth or worst quintile measured on allowed ROE falls to the 37th percentile, lagging that of the bonds in the first or best quintile by eleven percentiles and underperforming the industry median over the same period by thirteen percentiles. (See Exhibits 17 and 18.)

Exhibit 15: Debt Performance of U.S. Publicly Traded Utilities Over the Day Following the Rate Case Decision (Percentile Rank Among All U.S. Utility Bonds)

Source: FactSet, SSR research and analysis

Exhibit 16: Debt Performance of U.S. Publicly Traded Utilities Over the Month Following the Rate Case Decision (Percentile Rank Among All U.S. Utility Bonds)

Source: FactSet, SSR research and analysis

Exhibit 17: Debt Performance of U.S. Publicly Traded Utilities Over the Three Months Following the Rate Case Decision (Percentile Rank Among All U.S. Utility Bonds)

Source: FactSet, SSR research and analysis

Exhibit 18: Debt Performance of U.S. Publicly Traded Utilities Over the Twelve Months Following the Rate Case Decision (Percentile Rank Among All U.S. Utility Bonds)

Source: FactSet, SSR research and analysis

Implications for Utilities’ Cost of Capital

As noted above, the equity performance of U.S. electric utilities following the announcement of rate case decisions appears to be relatively insensitive to the content of those decisions, whether measured by (i) the reduction in the utility’s requested revenue increase relative to the historical average reduction in utilities’ requested revenue increases in the state where the rate case was filed (see Exhibits 7 to 9) or (ii) the ratio of the allowed ROE granted the utility to the national average of the allowed ROEs granted in all electric utility rate cases in that year (see Exhibits 10 to 12). This suggests to us that by the end of a rate case sufficient information has been released (in the form of staff recommendations, draft decisions by administrative law judges and the like) to allow investors to estimate the outcome with considerable accuracy, thereby limiting the information of the decision itself. It is difficult, therefore, to use the post-decision equity performance of electric utilities to estimate the impact of adverse or supportive regulatory decisions on utilities’ cost of capital.

On the other hand, we saw that the equity performance of electric utilities following the filing of rate cases seemed to align more closely with the expected outcome of the case, with equity returns lowest for utilities filing in states with a historical track record of large cuts to utilities’ requests for revenue increases. In Exhibit 19 below, we illustrate the average equity outperformance or underperformance of utilities filing rate cases in states grouped by the scale of their historical cuts to utilities’ requested revenue increases. As can be seen there, the equity returns of utilities filing rate cases in states with a history of sharply reducing requested revenue increases (the states grouped in the fourth and fifth quintiles in Exhibit 20) averaged 11 to 13 percentiles below the median equity return of all publicly traded electric utilities (i.e., the 50th percentile) and 10 to 20 percentiles below the average equity return of utilities filing rate increases in states with track records of modest reductions to requested revenue increases (the states grouped in the first and second quintiles in Exhibit 19).

Exhibit 19: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Twelve Months Following the Filing of Rate Cases (Percentile Rank Among All U.S. Utility Stocks)

Source: FactSet, SSR research and analysis

Exhibit 20: Equity Performance of U.S. Publicly Traded Utility Stocks Over the Twelve Months Following the Filing of Rate Cases (Percentage Point Under- or Outperformance Relative to the Average of U.S. Electric Utility Stocks)

Source: FactSet, SSR research and analysis

Certain models for estimating utilities’ cost of equity calculate this cost by solving for the discount rate that equates the present value of the utility’s future dividend stream to the price of its stock (e.g., the dividend discount model and Gordon dividend growth model). Pursuant to these models, the underperformance of a utility’s stock following the filing of a rate case in an unfavorable regulatory jurisdiction would cause its cost of equity to rise relative to its peers. To provide a basis for estimating this increase, we have analyzed the average equity underperformance or outperformance of utilities filing rate cases in states with track records of aggressive and moderate cuts to utilities’ requested revenue increases. As can be seen in Exhibit 20, the shares of utilities filing rate cases in the states ranking in the fourth and fifth (worst) quintiles in terms of the scale of their cuts to utilities’ revenue requests underperformed by 4.6 percentage points and 4.5 percentage points, respectively, vis-à-vis the average of their peers. If we manipulate the Gordon dividend growth model (P=d/(r-g)) to solve for the discount rate applied to a stock’s future dividend stream (r=d/P+g), we can estimate what such a deterioration in share price implies for a utility’s cost of equity. In an industry where dividend yields tend to range from ~3% to ~4%, a 4.5% reduction in share price drives an increase in cost of equity as estimated by the Gordon model of ~15 to ~20 basis points.

A similar assessment can be made of the impact of rate case decisions on utilities’ cost of debt. As discussed above, the returns on electric utility bonds following rate case decisions appear to be sensitive to the level of the allowed ROE set in these decisions. In rate cases where allowed ROEs are set, the bonds of utilities awarded the lowest ROEs relative to the national average (those in the fifth or worst quintile) performed markedly worse than those awarded the highest ROEs (those in the first or best quintile). When measured over the twelve months following the rate case decision, the average performance of the bonds in the fifth or worst quintile measured on allowed ROE ranks in the 37th percentile, lagging that of the bonds in the first or best quintile by eleven percentiles and underperforming the industry median over the same period by thirteen percentiles. (See Exhibit 21.)

Exhibit 21: Debt Performance of U.S. Publicly Traded Utilities Over the Twelve Months Following the Rate Case Filing (Percentile Rank Among All U.S. Utility Bonds)

Source: FactSet, SSR research and analysis

In Exhibit 22, we illustrate the underperformance of the bonds of utilities awarded the lowest ROEs relative to the national average in terms of the widening of their spread to Treasuries over the 12 months following the rate case decision relative to the average change in spread experienced by all the bonds of similar maturity of U.S. electric utilities. As can be seen there, the spread to Treasuries of the bonds of utilities awarded the lowest ROEs widened by an average of 16 basis points relative to the average spread of all electric utility bonds. By contrast, the spread to Treasuries of the bonds of utilities whose allowed ROEs ranked them in quintiles 1 to 4 saw average changes in their spreads relative to those of all electric utility bonds ranging from a tightening of 3 basis to a widening of 4 basis points. This suggests that the utilities granted the lowest allowed ROEs saw an increase in their borrowing costs of 12 to 19 basis points.

Exhibit 22: Debt Performance of U.S. Publicly Traded Utilities Over the Twelve Months Following the Rate Case Decision (Percentile Rank Among All U.S. Utility Bonds)

Source: FactSet, SSR research and analysis

Appendix: Methodology

The goal of this analysis was to identify negative regulatory decisions and determine quantitatively whether they affected the cost of capital of the utilities affected. We calculated the impact on capital cost by analyzing the effect of the decisions on the cost of debt of the operating utility as measured by the spread of their bonds over U.S. Treasuries of a similar duration and on the cost of equity as measured by the parent company’s equity performance. Underperformance of the stock price or bond yield drives an increase the cost of equity and debt capital relative to the utility sector over the same time period and outperformance drives a decrease. In general, company stock and bond prices will move with the market and their sector with under or outperformance based on company specific factors, with the biggest movements driven by unexpected news, such as changes in earnings guidance or disappointing regulatory decisions.

Given the large number and wide range of regulatory decisions, it is impossible to analyze every regulatory incident, nor identify which were surprises. Instead, we focused on those decisions whose impacts could be quantified - rate cases and credit downgrades driven by regulatory decisions. Although negative decisions can occur during the course of the case, that is unusual, so we looked at performance of the equity and bonds from the date of the rate case decision. Due to the potential impact on stock and bond pricing from the act of filing a rate case in a jurisdiction perceived as risky or biased against utilities, we also analyzed performance from the date of the filing of the rate case.

As we were unable to identify upfront which rate cases were most relevant, we created quantitative metrics to rank each rate case outcome and the average outcomes of each state. We then compared these rankings against the rankings of the equity and bond performance from the relevant dates to determine if the regulatory decisions in the form of rate cases were having an impact on cost of capital. For credit downgrades, we calculated performance from the date of the downgrade, as downgrades are generally unexpected, and looked at the average relative performance of the downgraded stocks and bonds to the performance of the other stocks and bonds on the same date.

In ranking the rate cases and states, we focused on two metrics for the rate case outcomes and two metrics for the rate case filing. For the rate case outcomes, we ranked the decisions based on the reduction in the requested rate increase as a percentage of the utility’s revenues and on the allowed ROE relative to the national average ROE in the year it was decided. For the rate case filings, we ranked the states based on the percentage reduction of revenues requested and on the reduction of revenues requested as a percentage of the utility’s pre-rate case revenues.

In addition to these for four metrics, we also reviewed the data on four additional metrics, two for the rate case outcomes and two for the rate case filings. The additional metrics for the rate case outcomes were rankings of the decisions based on the reduction of the requested rate increase as a percentage of the initial rate increase requested and on the allowed ROE relative to the state average allowed ROE for that regulatory jurisdiction. For rate case filings, we ranked the rate cases filed on the size of their revenue request as a percentage of the utility’s pre-rate case revenues and we ranked the states on their average allowed ROEs relative to the national average ROE granted in the same years. However, these four showed no significant relationship so we do not include the full analysis of these metrics in the note.

To analyze the relationship between the rate case/state metrics and the cost of equity and debt capital we first ranked the rate cases by quintile for each metric. For the state metrics (e.g. the state’s average reduction in revenue requested), we ranked the rate case by the percentile rank of the state in which it took place. Then we averaged the percentile ranks of the equity and debt performance of the rate cases the fell into each quintile. Finally, we looked to see whether the average percentile rank of the equity and debt returns in each quintile were above or below average and if returns followed the rate case quintiles – in other words, did the worst quintile (5) have the lowest average percentile rank for returns and did the average percentile ranks of returns increases with as the quintiles improved.

©2023, SSR LLC, 680 East Main Street, Suite 624, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

[1] We have excluded from our analysis rate cases in Illinois, where adjustments to allowed ROEs and utilities’ revenue requirements are determined by a comprehensive, forward-looking formula, so that rate case outcomes are generally predictable by capital market participants in advance and announced decisions therefore have little incremental impact on stock or bond prices. We have also excluded from our analysis single issue rate cases and rate cases involving requests for de minimis increases in allowed revenues (less than 1% of pre-rate case revenues). While the outcome of these rate cases might be dramatic when measured against the utility’s request (a utility requesting a 0.5% revenue increase, for example, might receive almost no increase once regulators’ adjustments are made) the small scale of these request renders it unlikely that the decisions would have a material impact on the value of utility’s stocks or bonds. Including these less significant rate cases might therefore distort the results of our analysis, causing us to focus instead on proceedings of a more material nature.