A system for issuing debt long cherished by Japan's electric utilities is, after a five-year grace period, set to be terminated. This has credit implications.

In March 2025, the grace period for issuing bonds with statutory preferential rights will end. Japan's major electric power companies have long been allowed to issue these bonds. They allow issuers to use their total assets as collateral for repayment. They give holders of such bonds repayment seniority over ordinary creditors. The favorable financing system was established for electric power companies to supply electricity in an inexpensive and stable manner.

This system will come to an end after 2020 revisions to the Electricity Business Act come into effect in April 2025. Our credit analysis and utilities' financial management are both in for a shakeup.

Issue Ratings Related To The Same Entity May Soon Diverge

Issue ratings on corporate bonds newly issued by Japan's 10 major electric power companies and those on existing bonds may be different. This is because the grace period that allowed the companies to continue issuing bonds with statutory preferential rights ends March 31, 2025. Corporate bonds that the electric power companies issue will therefore change to unsecured bonds from bonds with statutory preferential rights (see Appendix).

A subordination, or priority ranking, will arise at issuers between existing bonds and newly issued unsecured bonds.   The degree of and prospects for subordination risk of new bonds in comparison with existing bonds vary by electric power company. Consequently, we need to scrutinize the impact of the move to issuing unsecured bonds by companies when we assign issue ratings.

The Change Affects A Large Amount Of Debt

We will closely monitor the effects of the end of the current debt system. The amount of debt issued by the electric utility sector is significant. Aggregate debt held by the 10 electric utilities totals nearly ¥30 trillion. About ¥13 trillion of this figure is made up of bonds and loans with statutory preferential rights.

During the transition to a new system (April 2020 to March 2025), the outstanding amount of the electric utilities' bonds with statutory preferential rights increased further. This is because, due to rising demand for funds triggered by higher fuel prices, the utilities actively raised funds through the issuance of bonds with statutory preferential rights.

Therefore, the ratio of the electric power companies' debt with statutory preferential rights to total financial obligations declined only moderately over the transitional period (see chart 1). Some electric utilities raised funds with subordinated debt during the period. However, the amount raised in this way was small relative to overall issuance.

Chart1

The ratio of secured debt at four of the 10 utilities will remain above 50% in March 2025, according to our estimate. The four utilities are:

• Tokyo Electric Power Co. (Tepco) Holdings Inc. (BB+/Stable/-);
• Hokuriku Electric Power Co. (not rated);
• Hokkaido Electric Power Co. Inc. (not rated); and
• Okinawa Electric Power Co. Inc. (A+/Negative/A-1).

The secured debt ratio for the 10 electric power companies in aggregate remains high at around 50% (see chart 2).

We consider secured debt to be the total of debt with statutory preferential rights and regular secured debt (see charts 3 and 4).

Chart 2

Chart 3

Subordination Risk For Unsecured Debt Will Ease With Time

The subordination risk of unsecured debt will likely ease at each utility soon after the current system for bonds ends, in our view. Unsecured debt is subordinated to secured debt for repayment. If the secured debt accounts for a high proportion of an issuer's capital structure, the unsecured debt is likely to be exposed to greater subordination risk.

We will consider rating unsecured debt one notch lower than the issuer credit rating, if the percentage of secured debt exceeds 50% of total debt.   Nevertheless, we predict the percentage of electric utilities' secured debt to total financial obligations will likely decline hereafter, in line with the progress of redemption of existing bonds with preferential rights and their refinancing with unsecured debt. We forecast the ratio of secured debt will fall below 50% in the next two to three years at all electric power companies (see chart 4).

Chart 4

Financing Policies Can Influence Subordination Risk

Issuers' financing policies could mean the subordination risk for unsecured debt may not decline to the degree we assume, or conversely, it may rise. For example, fundraising through project financing or subsidiaries increasing rapidly would have adverse effects on the ratings on unsecured corporate bonds that electric power companies issue (see Appendix).

We will incorporate financing policies into our assessments when assigning issue ratings on unsecured bonds.   We will also take into account the ratio of secured debt and priority debt on a company's books.

Chart 5

Pressure To Improve Financial Management

The end of the favorable system that allowed issuance of bonds with statutory preferential rights will push companies to change their financial management, in our view.

Business risk in the domestic electric power business has increased compared with the era of cost-plus and regional monopoly systems. Given the higher risk, the companies will need to enhance the stability of their debt management. They could do so by further diversifying and dispersing financing sources and periods.

Electric utilities have been increasingly dependent on borrowings from financial institutions for long-term funding since the Great East Japan Earthquake in 2011 (see chart 6). However, additional lending capacity at some domestic financial institutions may have reduced, in our view. This is because they further increased lending to electric power companies in the past few years.

Chart 6

Diversifying financing options key to creditworthiness

We expect the electric power companies to strive to further diversify their financing options once the current system ends in April 2025. During the grace period for bonds with statutory preferential rights, many electric utilities sought to expand their investor base by issuing green bonds, transition bonds, and subordinated debt. As the electric power companies need a large amount of capital expenditures and other capital, we believe diversifying financing sources in response to investor demand trends will likely contribute to stable financial management following the end of the favorable funding system.

We predict the electric power companies will increasingly raise funds in overseas markets. We base this on the following:  

• Persistently high investment levels;
• A likely moderate rise in domestic long-term interest rates; and
• Limited capacity to raise additional funds in the domestic market.

Since September 2024, Kyushu Electric Power Co. Inc. (not rated) has issued corporate bonds in the overseas market for the first time in 18 years and Chugoku Electric Power Co. Inc. (BBB+/Stable/-) did so for the first time in six years. Jera Co. Inc. (A-/Stable/-), part of former general electric utilities, also issued corporate bonds in the overseas market in 2024 for the first time in two years. At the electric power companies, issuance of foreign bonds had decreased significantly since the 1990s due to declining needs of funds for capital expenditures and lower domestic interest rates.

Showing a long-term strategy is essential

We believe that the electric utilities will likely lengthen and diversify debt maturities. At the same time, we anticipate they will continue with sufficient liquidity on hand through continued prudent financial management. In the new issuance of Japanese publicly traded bonds by the electric utilities, the proportion of long-term bonds with maturities of 10 years or more (in value terms) has recovered to about 70% (see chart 7). In the past two to three years, the electric power companies have set relatively long non-call periods (the period until early redemption becomes available) when they issue subordinated corporate bonds (unsecured), in our view.

Long-term debt allows for investments in electric power networks (power transmission and distribution networks), power plants, and fuel supplies for decarbonization. Accordingly, we believe electric power companies will work to continue to extend the maturity structure of their debt obligations. Many utilities may need to articulate to investors prospects for their long-term business portfolios and cash flow generation and corresponding financing strategy.

Chart 7

The ending of issuance of bonds with statutory preferential rights will likely have a long-lasting impact on the electric power companies' financing activities. Subordination risk for new bonds may be mitigated over the next two to three years. The electric power companies are likely to continue seeking a stable funding framework to ensure financial soundness commensurate with their business risks.

Appendix

Electric utilities' bonds with statutory preferential rights

Under revisions to the Electricity Business Act, the special provision that allows the electric power companies to issue bonds with statutory preferential rights were repealed as of March 31, 2020. A grace period to enable power generation and transmission companies to issue such bonds until the end of March 2025 was also established. This helped ensure the changes in the system would not affect their funding underpinning stable electricity supply.

There was a system that government-related entities (GREs) provided general corporate loans with statutory preferential rights to electric utilities in the past. Examples of the GREs include Development Bank of Japan Inc. (DBJ) and Okinawa Development Finance Corp. These GREs made the loans under the following legislation: Act on Security for Loans from the Development Bank of Japan to Electric Utility Corporations, and the Act on Special Measures for the Promotion and Development of Okinawa.

This system was also terminated in March 2020 because the law related to the DBJ was abolished and the other was revised. Loans newly extended by DBJ and Okinawa Development Finance Corp. to the electric power companies became unsecured from April 2020. These loans were not given a grace period, unlike bonds with statutory preferential rights. As a result, the outstanding balance of the electric utilities' borrowings with statutory preferential rights decreased.

Subordination risk stemming from increased uses of project finance

When the electric power companies actively raise funds through project financing, secured debt increases, which could raise the subordination risk of unsecured debt. Specifically, Jera, a joint venture of Tepco and Chubu Electric Power Co. Inc., has seen its secured debt increase over the past three to four years. We assume this is because Jera aggressively used project financing to raise funds.

Jera has not issued bonds with statutory preferential rights; its existing corporate bonds are unsecured only. Nevertheless, the company recorded secured debt of ¥737.9 billion in fiscal 2023. The ratio of secured debt to total debt was 24%, which is below 50%.

It should be noted that, if electric utility assets procured through project financing increase excessively, the proportion of consolidated cash flow which is used to repay unsecured debt will decline considerably. Furthermore, in a case where an issuer pledges a large amount of its assets (such as shares in the company it has invested) as collateral for the debt that its unconsolidated invested company borrowed through project financing, we will likely consider its potential impact.

Subordination risk resulting from an increase in subsidiaries' debt

When an operating subsidiary of an electric power company increases its own fundraising, its priority debt ratio will rise, which would lead to an increase in subordination risk of unsecured debt of the issuer (parent company). Nevertheless, we consider the risk to be limited for the foreseeable future, unless the company conducts a change in organizational structure.

At present, Tepco and Chubu Electric Power are the only electric utilities whose subsidiaries raise funds independently on a notable scale. We predict that that many electric power companies will likely continue to pursue financial management under which they allocate funds that their parent companies raised from outside sources to their group companies through such scheme as intercompany loans.

Related Criteria

• Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018