Rating Action: Moody's downgrades Hawaiian Electric Company to Baa2 from Baa1; Outlook stable
Approximately $600 million of debt affected
From Moody’s Global Credit Research - 03 Aug 2016
New York, August 03, 2016 -- Moody's Investors Service, ("Moody's") today downgraded Hawaiian Electric Company (HECO)'s senior unsecured rating to Baa2 from Baa1. Parent holding company Hawaiian Electric Industries' (HEI)'s short-term rating for commercial paper was also downgraded to P-3 from P-2. The outlooks for HECO and HEI are stable. The ratings and outlook for HEI's bank subsidiary, American Savings Bank, FSB (a3 Baseline Credit Assessment, Baa1 issuer rating, stable), were unaffected by today's rating action. See below for the complete list of ratings and rating actions.
"The ratings downgrade is prompted by our concern that HECO will continue to face significant challenges in transforming its generation base to 100% renewable sources in an unpredictable and highly political regulatory environment," said Toby Shea VP -- Senior Credit Officer of Moody's. "We believe that the regulatory environment could become contentious as this transformation is executed despite recently falling customer bills, driven by lower fuel oil prices, and the company's decision to moderate it's still significant capital expenditure program," he added.
The rating downgrade reflects the strained relationship with its regulators and interveners as it strives to replace its fossil-based generation with renewable sources. We expect there to be continued friction with regulators and interveners because HECO is expected to implement, through its utility operations, ambitious public policy goals, such as achieving a 100% renewable portfolio standard by 2045. These demands would be challenging for any utility in the US but only more so for a company the size of HECO, which only has about 460,000 customers.
Tempering our concerns is HECO's robust suite of regulatory cost recovery mechanisms and a supportive legislative framework to facilitate the transformation. Hawaii's cost recovery mechanisms provide for, among other things, revenue decoupling, a forward test year and automatic recognition of baseline capital expenditures. The legislature has also supported HECO with legislation that directs the Hawaii Public Utilities Commission (HPUC) to consider stranded cost recovery on retiring fossil plants to expedite the transformation to renewable generation. HECO and its utility subsidiaries receive an above industry average authorized equity capitalization of 56%, though the company's authorized returns on equity are on par with the industry norm.
HECO's cash flow to debt metrics are consistent with its Baa2 rating but could be considerably higher if not for its large underfunded pension obligations. HECO's adjusted CFO Pre-WC/debt is around 18% to 20% but would be in the high 20% range without the $500 million imputed debt associated underfunded pension liabilities. Even though HECO has a pension tracker, we do not expect the underfunding levels to improve materially because the tracker only assures the eventual collection of the underfunding but not necessarily on a timely basis.
The downgrade of HEI's commercial paper rating to P-3 reflects HEI's heavy dependence on HECO. Although HEI also owns American Savings Bank, we view HECO as the primary credit and ratings driver of the parent company.
HECO has adequate liquidity for the demands of its operations. The latest capital expenditure plan will likely result in about $100 million of negative free cash flow before dividends in 2017. In comparison, HECO has a $200 million revolving credit facility. HECO has no debt maturities for the remainder of 2016 and 2017 except for about $13 million of commercial paper outstanding at the end of first quarter 2016. HEI can provide additional liquidity with its $150 million revolving credit facility and a consolidated cash balance of $334 million at 31 March 2016 but it also has $125 million term loan coming due in October of 2017 and $82 million of commercial paper outstanding at the end of first quarter 2016.
HEI and HECO's revolving credit agreements expire in April 2019. They do not contain any rating triggers that would affect access to the commitment and do not require material adverse change (MAC) representation for borrowings.
The stable outlook reflects our expectation that Hawaii's strong existing regulatory provisions and legislative support will be sufficient to counterbalance HECO's execution challenges as it transforms its generation base to all renewables in an unpredictable and political regulatory environment.
What Could Change the Rating - Up
We could take a positive rating action if we believe HECO's challenges of transforming its generation base have fundamentally diminished; if the regulatory environment becomes more credit supportive and less political.
What Could Change the Rating - Down
We could take a negative action should HECO encounter additional difficulties with regulators and interveners as it executes on its renewable capital spending plan; any of its existing, supportive regulatory provisions are adversely changed or scaled back; or if its CFO Pre-WC/debt falls to the low teens.
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SA: The credit rating company said the move was due in part to an “unpredictable and highly political regulatory environment” in Hawaii.