Fitch Ratings has affirmed Hawaiian Electric Industries, Inc.'s (HEI)
Long-Term Issuer Default Rating (IDR) at 'BBB' following the rejection
by the Hawaii Public Utility Commission (HPUC) of the proposed
acquisition by NextEra Energy, Inc. (NextEra, rated 'A-'/Stable Outlook)
and subsequent termination of the merger agreement. The ratings have
been removed from Rating Watch Positive. Fitch placed the ratings for
HEI on Positive Watch on Dec. 4, 2014 following HEI's announced
agreement to be acquired by Nextera. Fitch has also affirmed the
Long-Term IDR of Hawaiian Electric Company, Inc (HECO) at 'BBB+'. The
Outlook for both companies is Stable.
The rating affirmation reflects Fitch's view that the political and
regulatory framework in Hawaii, while adverse to the proposed merger
with NextEra, will remain ultimately supportive of HECO's credit profile
as the utility faces rising penetration of distributed generation and a
capital intensive fleet modernization plan. Fitch will closely monitor
the outcomes of the on going and planned regulatory filings that include
HECO's Power Supply Improvement Plan (PSIP), approval for the 60 MW
Hamakua Energy Partners plant purchase and the proposed rate cases to be
filed by HECO utilities in 2016.
Fitch acknowledges that meeting the 100% renewable target by 2045 could
be a daunting task for HECO, without NextEra's capital and technological
support. However, it is still too early to determine what the fleet
transformation plan would look like; what kind of capital investments
will be required; and what the rate impact on customers would entail.
The rapidly declining cost of renewables and of battery storage and the
headroom provided by the decline in oil prices are currently working in
HECO's favor. Fitch believes HECO is well positioned to meet the 30%
renewable target by 2020. Fitch expects HECO's credit metrics to remain
strong for the ratings in 2016 - 2018, providing room for a ramp up in
capex as the utility prepares to meet 100% of its generation needs from
renewable resources by 2045. Fitch believes a supportive regulatory
environment could enable HEI to fund the future elevated capital
investments in a credit supportive manner.
HEI's ratings are supported, in turn, by the credit profile of its
subsidiaries: HECO and American Savings Bank FBS (ASB). HEI plans to
retain ASB, as the spin-off of the banking subsidiary was conditional
upon consummation of the merger agreement with NEE.
KEY RATING DRIVERS FOR HECO
High Penetration of Distributed Generation: Thirteen percent of HECO's
total customers had rooftop solar PV systems at year-end 2015 for a
total of 487 MW of capacity. The rapid adoption of rooftop solar in
Hawaii was fuelled by a combination of high electricity prices, abundant
solar resources and government financial incentives. Combined with
energy efficiency initiatives, this resulted in a 6% decline in electric
demand during 2011 - 2015. HPUC authorized revenue decoupling- and
cost-of-service recovery mechanisms (CSRM) help to reduce the impact of
sales variations on earnings. While revenue decoupling protects margins,
declining sales further pressure unit costs and render investments to
upgrade the electric grid more challenging over the long term. Fitch
expects the reduction in government financial incentives for renewable
generation combined with a higher minimum monthly bill, the introduction
of time-of-use rates design, and a reduction in credit for excess
electricity generated to moderate the growth of rooftop solar systems
over the medium term.
Aggressive Renewable Targets: The state of Hawaii has set aggressive
renewable portfolio standards (RPS) with targets culminating to 100% by
2045. HECO is well placed to achieve the 30% renewable target by 2020
with renewables sources (including distributive generation) meeting 23%
of energy needs in 2015. Nonetheless, meeting the 100% renewable target
by 2045 will require significant investments to modernize the electric
infrastructure throughout the service area as well as presenting
execution and technological risks. The PSIP and ability to petition the
HPUC on a case-by-case basis for rate base additions exceeding the CSRM
will moderate the stress on the capital structure but could pressure
already elevated electric rates.
Atypical Electricity Market Structure: HECO operates in isolated island
markets with separate power grids, which result in a higher operating
cost structure and necessary investment in redundant infrastructure.
Electricity generation remains predominantly fuel oil based, resulting
in high power prices as imported fuel oil in Hawaii is typically 25%
above mainland pricing benchmarks. While HECO's retail electricity rates
at approximately $0.23 per kWh at present have benefited from a sharp
drop in oil prices since last year, these still remain about 2x the
national average.
Progressive Regulatory Framework: Fitch views the regulatory construct
in Hawaii as supportive of HECO's credit profile, notwithstanding the
prolonged and ultimately unsuccessful review process of the proposed
merger. Many progressive regulatory mechanisms partly offset the
below-average authorized return on equity (ROE). In addition to revenue
decoupling, HECO benefits from forward test years, fuel adjustment and
purchase power adjustment clauses, as well as surcharge mechanism to
facilitate the recovery of renewable energy infrastructure investments.
Nonetheless, earned ROE at HECO's main operating subsidiary was 7.85%
for the last-12-months (LTM) at March 31, 2016, compared to an
authorized ROE of 10%.
Strong Credit Metrics: HECO's credit measures compare favourably to
Fitch's target credit metrics for 'BBB+' integrated electric utilities,
including adjusted debt to EBITDAR and FFO-adjusted leverage of 3.0x at
March 31, 2016. Fitch expects adjusted debt to EBITDAR and FFO adjusted
leverage to remain relatively stable over the forecast period. This
reflects expectations of parental support to retain the existing 58%
equity capital structure and adequate and timely recovery of proposed
capital investments.
KEY RATING DRIVERS FOR HEI
Ratings Supported by Solid Subsidiaries: The ratings for HEI are
supported by the strong credit profile of HECO and ASB, the third
largest bank in Hawaii with about $6 billion in assets. HECO has
historically represented about 70% - 75% of net income and upstream
dividends with ASB accounting for the remainder. Both subsidiaries
exhibit relatively stable cash flow generation and conservative capital
structure commensurate with a 'BBB' category credit profile.
Healthy Hawaiian Economy: The Hawaiian economy is healthy with state GDP
growth expected to exceed 3% in 2016, compared with 4.0% growth in 2015,
supported by relatively stable housing market and a modest deceleration
in tourism expected in 2016, after a strong 2015. Unemployment rate
continues to decline and remains well below the national average at 3.1%
(seasonally adjusted) at March 31, 2016.
Consistent Bank Performance: ASB exhibits a strong financial profile
weighed against its relatively small size and market concentration. ASB
is the third largest bank in Hawaii, a highly concentrated but stable
banking market. At March 31, 2016, ASB was well capitalized with core
and Tier 1 risk-based capital ratios of 8.7% and 12.0% respectively,
according to the Federal Deposit Insurance Corp (FDIC). Its operations
are highly profitable with a solid net interest margin of 3.62% and
asset quality was good with nonperforming assets of only 1.03% for the
12 months ended March 31, 2016.
KEY ASSUMPTIONS
Fitch's key assumptions within its rating case for the issuer include:
--Constructive outcomes in the rate cases to be filed by HECO's three
utilities over 2016 - 2018 with ROE maintained at current authorized
levels. Fitch's financial forecasts reflect a structural drag of about
200 bps on earned ROE over the forecast period;
--HECO capex of about $450 million in 2016, $480 million in 2017 and
$500 million in 2018;
--HECO capital structure of about 58% equity-to-capital, with debt
issuances and equity contributions as needed;
--ASB ownership maintained over the forecast period with stable
operating performance and dividend payout ratio of 70%;
-- $90 million termination fee from NEE, plus $5 million for
reimbursement of expenses, used to reduce HEI borrowings;
--Debt maturities at HEI refinanced, increase in HEI debt, dividend
and/or equity contribution in 2016-2018 as needed to maintain current
stable capital structure.
RATING SENSITIVITIES
Positive: An upgrade of HECO is considered unlikely over the next 12 -
18 months, given the uncertain path to meeting the aggressive RPS
program and the potential impact of the large capex program on the
credit metrics.
Negative: Future developments that may, individually or collectively,
lead to negative rating action include:
--An inability to earn an adequate and timely recovery on invested
capital, including adverse outcomes to pending requests with the HPUC
and planned GRCs in 2016 - 2017;
--Accelerating competitive inroads by distributed generation and energy
efficiency;
--FFO adjusted leverage greater than 5.0x on a sustainable basis.
HEI:
Positive: An upgrade of HEI is considered unlikely over the next 12 - 18
months, as it would be predicated upon an upgrade of HECO's IDR.
Negative: Future developments that may, individually or collectively,
lead to negative rating action include:
--Change in financial strategy that disproportionately relies on debt
funding;
--Downgrade in HECO's IDR driven by material deterioration in regulatory
environment.
LIQUIDITY
HEI and HECO have ample liquidity, with modest cash on hand and adequate
availability under revolving credit facilities totalling $350 million at
March 31, 2016. Post quarter-end, the liquidity position was bolstered
by the receipt of the $90 million break-up fee and up to $5 million for
reimbursement of merger-related expenses from NextEra and the release of
$54 million held in reserve to pay a special dividend conditional upon
the now terminated merger agreement.
Debt maturities are modest over the rating horizon with HEI having
entered into a $75 million term loan (maturing in March 2018) to
refinance an equal amount of senior notes maturing in March 2016.
HEI has access to a $150 million syndicated revolving credit facility
(maturing on April 2019), which also serves as backstop for its
commercial paper program. Under the credit agreement, HEI must maintain
a ratio of funded debt to total capitalization (on a non-consolidated
basis) of 50% of less. This ratio stood at 17% at first-quarter end 2016.
HECO maintains minimum cash on hand, as is typical for a regulated
utility, and had $187 million available under its $200 million
syndicated revolving credit facility (also maturing in April 2019) at
March 31, 2016. HECO's credit facility serves as a backstop for its $200
million commercial paper program. HECO's credit facility has one
financial covenant requiring consolidated (for HECO and its
subsidiaries) funded debt to capitalization ratio not to exceed 65%.
HECO traditionally maintains debt-to-capital ratio of about 42%, as per
its regulatory capital requirement. HECO serves as a guarantor for notes
and bonds issued by Maui Electric Company and Hawaii Electric Light
Company.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings with a Stable Outlook:
HEI
--Long-Term IDR at 'BBB';
--Senior unsecured debt and credit facility at 'BBB';
--Short-Term IDR at 'F3';
--Commercial Paper at 'F3'.
HECO
--Long-Term IDR at 'BBB+';
--Senior unsecured debt and credit facility at 'A-';
--Subordinated debt at 'BBB';
--Short-Term IDR at 'F2';
--Commercial Paper at 'F2'.
Date of Relevant Rating Committee: July 20, 2016
There were no financial statement adjustments made that were material to
the rating rationale outlined above.
Additional information is available on www.fitchratings.com.
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1009198
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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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