Have AI and wildfires made electric utility bonds less of a safe haven?: Fridson

Rapid developments in artificial intelligence and cryptocurrency over the past few years and a series of high profile wildfires have raised questions about electric utilities’ traditional image as a stodgy but reliable defensive hedge.“Buy utilities. Even when times are tough, people still have to pay their electric bills,” was the simple advice a Morgan Stanley sales manager gave to customers following the stock market crash on October 19, 1987. I was heading research in corporate bonds at Morgan Stanley at the time.That sales manager’s comment about steady revenue in the electric power industry highlighted the fact that this sector was not where investors looked for robust growth. For the most part, potential customers were already connected to the power grid, so increases in demand for electricity were largely a function of the slowly expanding population. Recently, though, utilities have acquired something of a growth aura, thanks to the tremendous energy intensity of AI and cryptocurrency.Less favorably, electric utilities have recently attracted significant negative attention, as these companies have suffered actual or potential financial damage as a consequence of wildfires purportedly caused by storm damage to power lines. In August 2023, the price of Hawaiian Electric’s 5.23% bond due 2045 plummeted by one-third in the wake of the Maui wildfires. More recently, the devastating California wildfires have spurred massive lawsuits against Southern California Edison.Risk, though, is by no means a new element in the utility equation. These are regulated entities, so the companies’ revenues have long been subject to shifting political winds at state public utility commissions. Additionally, demand from industrial customers, unlike consumer usage, is sensitive to economic conditions.RISK ASSESSMENTWhere do things stand in 2025? To determine whether electric utility bonds can still be considered a refuge in times of financial stress, it is useful to study their risk premiums, or “spread”, which refers to the amount by which a corporate bond’s yield exceeds that on so-called ‘risk-free’ U.S. Treasury bonds. Spread on corporate bonds typically increases when the economic outlook worsens. Underlying yields on Treasury bonds tend to decline under such circumstances, but by less than spreads increase, especially in the case of medium- and low-rated corporate bonds. The net effect is that corporate bonds’ yields rise, which means their prices fall, when the economy softens.I recently analyzed the spreads on all medium-quality (BBB) electric utility bonds included in the ICE BofA US Corporate Index. The index uses composites of various agencies’ ratings to classify these bonds from lowest to highest risk, i.e., BBB1, BBB2, BBB3. For each of the BBB category’s 52 electric utilities, I calculated the 2025 median spread on its outstanding bonds. I compared that number with the median spread of its corresponding rating subcategory. If the utility’s median exceeded the median for its rating subcategory, it meant the market considered the company high-risk compared to its rating peers. A smaller-than-median spread would indicate the market considered the utility to be comparatively low-risk.This analysis shows that BBB-rated electric utility bonds were close to evenly divided between the high-risk and low-risk categories, as of February 28. Importantly, that was a credit environment with narrow spreads overall. In contrast, on September 30, 2022, when widening BBB spreads signaled the highest credit risk in recent years, 55 electric utilities’ bonds were skewed toward below-group-median spreads by a statistically significant margin.These results imply that if currently rising recession fears are realized, electric utility bonds should constitute a defensive sector. Based on recent history, we should expect that as the median spreads of the rating subcategories skyrocket, utilities’ spreads will increase more modestly.So despite the change electric utilities have faced in recent years, yields in this sector, on the whole, can still be expected to rise – and therefore, prices to fall – by less than in the overall corporate bond market.(The views expressed here are those of Marty Fridson, the founder of FridsonVision High Yield Strategy. He is a past governor of the CFA Institute, consultant to the Federal Reserve Board of Governors, and Special Assistant to the Director for Deferred Compensation, Office of Management and the Budget, The City of New York.)