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Moody's: North American utilities generally practice credit-friendly governance

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Moody's: North American utilities generally practice credit-friendly governance

Publicly traded North American energy and water utilities have corporate governance practices that Moody's says are generally supportive of the credit quality of those companies. However, executive compensation designs, and board oversight and effectiveness practices of companies had more mixed alignment with Moody's governance benchmarks.

In the Sept. 19 sector-in-depth paper, Moody's applied its governance scoring methodology to the board-level policies and disclosures of 50 North American utilities and power companies that have a combined $760 billion in debt. It found the median score of those companies was governance assessment level 1, or GA-1, which indicates the presence of "corporate governance characteristics and disclosures that are closely aligned with what we define as a credit friendly benchmark."

Governance risks are a key factor in the credit quality for all bond issuers, including for publicly traded companies, Moody's said in a related sector-in-depth analysis released the same day. "Governance failures can lead to severe reputational and financial risks, including increased debt financing costs or, at the extreme, complete loss of access to capital markets."

As for its review of energy companies, Moody's gave an overall governance score of four or higher out of a possible score of five to half a dozen companies: Atmos Energy Corp., Avangrid Inc., Black Hills Corp., Consolidated Edison Inc., El Paso Electric Co. and water utility Aqua America Inc.

But even those companies did not score the highest across all categories. For example, Moody's found Avangrid has the least independent board and committees of the companies examined. Avangrid also scored low against Moody's benchmarks for diversified share ownership structure primarily because Iberdrola SA holds an 81.6% ownership stake in the utility. A majority shareholder can exert direct influence over governance practices, Moody's said.

But most other utilities have broadly diversified share ownership; maintain a one-share, one-vote principle; and have strong oversight on conflicts of interest and regarding when related parties are involved in company transactions. "Related-party transactions can present risk to creditors and shareholders in terms of the efficiency of financial allocation decisions, possible fraud, use of inefficient or inappropriate vendors, or distortion of financial disclosures," Moody's explained.

Only two companies, Vistra Energy Corp., and FirstEnergy Corp., received high scores regarding compensation designs. Moody's generally gave better scores to companies that aligned their executive compensation and pay structures with sustainable operating performance rather than equity-related metrics.

Moody's explained: "A company’s failure to align pay and compensation structures with sustainable operating performance can harm interests of debt investors, encourage excessive risk-taking and incentivize short-term equity outcomes over a longer-term stable credit profile." As a result, companies with compensation structures that primarily favor shareholder interests can, in some cases, "underperform peers in terms of long-term capital efficiency and profitability."

As for the oversight and effectiveness of the companies' board of directors, Moody's found most have a highly-independent board — meaning the board members do not have a relationship with the company except as directors — as well as good policies on director qualifications, experience, and replacement practices. In particular, Enbridge Inc., AES Corp., Exelon Corp., TC Energy Corporation, and Fortis Inc. "are seen as having the most experienced and qualified boards," Moody's said.

But some companies are not aligned with Moody's standards for having board members with related-sector experience. Less than one-quarter of board members at Consolidated Edison, Atmos, El Paso Electric and Southwest Gas Holdings Inc., have related sector experience, according to the report.

Most companies scored generally relatively well when it came to financial oversight and capital allocation, compliance, controls, reporting practices and disclosures. For example, "all companies received scores indicating the highest alignment with our benchmarks for transparency of financial reporting and audit quality. This is not surprising given the highly regulated nature of the business," Moody's said.