Fitch Assigns Initial Ratings to Hawaiian Electric Industries & Hawaiian Electric Co.
News Release from Fitch Ratings January 21, 2014
NEW YORK--Fitch Ratings has assigned initial ratings to Hawaiian Electric Industries, Inc. (HEI) and Hawaiian Electric Company (HECO) as follows:
--Long-term Issuer Default Rating (IDR) 'BBB';
--Senior unsecured debt BBB;
--Short-term IDR 'F3';
--Commercial paper 'F3'.
--Long-term IDR 'BBB+';
--Senior unsecured debt 'A-';
--Subordinated debt 'BBB';
--Short-term IDR 'F2';
--Commercial paper 'F2'.
The Rating Outlook is Stable.
HEI is the parent of HECO and American Savings Bank FSB, a $5 billion bank headquartered in Honolulu, Hawaii with branch offices throughout the Hawaiian Islands. Due to the uncommon business mix of a utility and bank and incompatibility of key financial statement and performance metrics, Fitch analyzes and assigns ratings to HEI based on its cash flows, in the form dividends received from HECO and ASB, as opposed to its consolidated financial profile.
HEI KEY RATING DRIVERS
--Ownership of two investment grade subsidiaries;
--Subordination of cash flows;
--Moderate degree of parent level debt leverage.
HEI's credit profile reflects that of its investment grade subsidiaries, HECO and ASB with ratings pressured by a moderate amount of parent level debt leverage and a moderately high common dividend payout ratio. HECO is the larger of the two subsidiaries, accounting for approximately two thirds of earnings and cash flows. Fitch normally factors in cash flow subordination for utility parent companies which are reliant on dividends from subsidiaries; for HEI, such subordination is elevated as dividends from ASB are subject to various federal regulatory restrictions and/or approvals.
HEI exhibits strong financial flexibility. In Fitch's base case and stress case models, HEI's contractual obligations consist only of debt service on parent level debt averaging approximately $20 million per annum, while the common dividend to shareholders (approximately $100 million per annum) represents the majority of HEI's cash use. Fitch has assumed an upstream dividend rate to HEI equal to 70% of HECO's and ASB's net income providing a small cushion to meet HEI's cash needs. HECO's earnings and cash flows reflect substantial stability and predictability based on a revenue decoupling mechanism, while ASB's earnings can be more volatile, it performed well during the recent financial crisis and is entering a more stable macroeconomic environment which should result in continued stable performance.
HECO will be free cash flow negative through 2015 reflecting a large capital investment plan and will be dependent on HEI for equity infusions in order to manage its capital structure currently at regulatory authorized levels at a 56% to 57% equity component. HEI, in turn, will require external financing to meet its equity commitment to HECO and has entered into an equity forward agreement with third parties. In December 2013, HEI drew $32 million under the forward agreement to downstream as equity to HECO. Fitch also expects HEI to issue debt to partially meet its equity commitment to HECO consistent within the existing consolidated capital structure.
Fitch uses the multiple of equity investment in subsidiaries to consolidated equity as a proxy for double leverage. At year-end 2012, HEI's investment in HECO and ASB totaled $1,970 million while its consolidated equity was $1,594 million resulting in parent/subsidiary leverage of 1.24x. Fitch expects parent level leverage to remain steady through the elevated capex program at HECO.
Liquidity is adequate. HEI has an upcoming $100 million debt maturity of relatively high coupon 6.51% debt which Fitch models to be refinanced at a coupon approximately 150bps lower than the maturing debt. Fitch believes HEI has ready access to public and private placement markets. Short-term liquidity is provided by a $125 bank credit facility maturing in 2016 which also supports a commercial paper program.
Credit concerns are principally centered on the higher risk business profile through ownership of a bank especially in contrast with the low risk business profile of HECO. Financially, HEI is dependent on upstream dividends from ASB in order for HEI to continue its financial management strategies, including maintaining the common dividend which totals approximately $100 million per annum and represents over 70% of consolidated earnings. The dependence on ASB dividends will be particularly acute over the 2013 to 2015 time period when HECO will be free cash flow negative.
HECO KEY RATING DRIVERS
Constructive regulatory environment: Fitch considers the regulatory environment in Hawaii to be constructive and progressive. HECO enjoys full revenue decoupling, fuel and purchased power pass-through recovery, rates based on forward test years, a strong 56% equity component in its authorized capital structure, and recovery of increases in certain operating expenses and capital investments between rate cases through riders. These key features reduce regulatory lag and afford earnings and cash flow stability.
Fitch expects HECO to file two General Rate Cases in 2014, one for its Oahu utility operation and another for the Maui Electric subsidiary. Fitch has not factored in material changes to the tariff or recovery mechanisms in its financial models.
Solid credit profile: Historical and projected credit measures are strong and are modestly in excess of Fitch's target credit metrics for 'BBB+' integrated electric utilities. Over the financial forecast period through 2015, Fitch estimates EBITDA/Interest and Funds from Operations (FFO)/Interest will average more than 6.0x and 5.0x, respectively, with FFO/Debt more than 20% and Debt/EBITDA at approximately 3.0x. The strong performance reflects expectations of parental support to retain the existing 56% capital structure and adequate and timely recovery of proposed capital investments.
Elevated capital investment cycle: Fitch expects capex at HECO to approach $950 million over the two-year 2014 to 2015 time horizon. Fitch expects HECO to retain its present capital structure and leverage profile with periodic equity infusions from HEI during the build-out period.
Atypical power/retail 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% to 30% above mainland pricing benchmarks. HECO's retail electricity rates at approximately $0.32 per kwh are more than 2.5x the national average. While Hawaii has fairly aggressive Renewable Portfolio Standards (RPS), due to the high cost of existing generation and good wind resource, renewable generation can economically replace existing fossil fuel generation. Consequently, Fitch does not have specific concerns over the RPS requirement.
Emerging competitive landscape: A number of emerging industry issues are playing out in Hawaii today. HECO's retail electricity sales have declined approximately 8% over the five year period from 2008 to 2012 and continue to be under pressure in 2013. While revenue decoupling protects HECO's margins, declining sales further pressures unit costs. Declining electricity sales is attributable to customers using self-generation through rooftop solar photovoltaic (PV) systems (distributed generation), and to a lesser extent, energy efficiency. Given the high retail price of electricity, distributed generation and efficiency investments are economical even without subsidies.
Approximately 8% to 9% of HECO's customers have rooftop PV systems that substantially reduces their own consumption of utility supplied power and through net metering, allows customers to sell excess generation back to the utility. With utility system operating and maintenance expenses largely collected based on consumption, there is some measure of cost shifting to non-net metering customers. This in turn further pressures unit costs and improves the economics of new distributed generation and efficiency investments that will further reduce electricity sales. Continued declines in electricity sales would pressure HECO's credit profile even with continued revenue decoupling and residential rate design changes that address cost shifting.
Fitch maintains a private rating opinion on ASB to support its credit analysis and rating of HEI. 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 banking market. Notably, ASB's financial performance was fairly stable during the recent financial crisis.
Future developments that may individually or collectively lead to positive rating action include:
--A positive rating action for HEI is not considered likely given its present business mix. A positive rating for HECO post completion of its elevated capex program in 2015 is possible.
Future developments that may individually or collectively lead to a negative rating action include:
--HEI is dependent on dividends from HEI and ASB. If operating performance or regulatory restrictions reduce dividend payments, HEI's ratings would be pressured.
--An inability to earn an adequate and timely recovery of invested capital would likely lead to lower ratings at HECO and pressure ratings at HEI.
--Accelerating competitive inroads by distributed generation and energy efficiency would pressure HECO's ratings.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', Aug. 5, 2013;
--'Recovery Ratings and Notching Criteria for Utilities', Nov. 18, 2013;
--'Global Financial Institutions Rating Criteria', Aug. 15, 2012.
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Recovery Ratings and Notching Criteria for Utilities
Global Financial Institutions Rating Criteria