This is Part 2 of a 2 part blog post on utility financial risk. Part 1 focuses on utility revenue risk, and Part 2 focuses on utility debt risk.
In our first blog post on utility financial risk, we discussed how debt risk in addition to revenue risk were significant contributing factors in the Energy Future Holdings bankruptcy, the largest bankruptcy of a leveraged buyout on record. While it is relatively rare for utilities to declare bankruptcy, it is not unusual for utilities to carry high levels of debt. In fact, utilities often have capital structures with high amounts of debt combined with highly rated credit quality, signaling that they have a strong ability to repay that large debt. Typically as debt levels increase, the risk and cost of bankruptcy increases, and credit quality decreases. The degree to which bankruptcy risk increases as debt increases varies between companies and industries. For most companies, there is a certain optimum level of debt where the company balances out the benefit of a tax shield and the risk/cost of bankruptcy. Determining this optimal capital structure is difficult for all companies, not just utilities.