Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) for Hawaiian Electric Industries, Inc. (HEI) at 'BBB' and Hawaiian Electric Company, Inc. (HECO) at 'BBB+'.

The Rating Outlook for both entities has been revised to Positive from Stable. HECO is the core subsidiary, providing 70%-75% of net income with the balance coming from upstream dividends from American Savings Bank (ASB; BBB/Stable).

HEI's and HECO's Positive Rating Outlooks reflect Fitch's expectation that both entities should be able to keep very strong credit metrics for their rating category due to more predictability provided by the new regulatory construct implemented a year ago. In addition, both HEI and HECO have maintained strong credit metrics for their rating in both 2020 and 2021 despite pandemic-related economic impact on Hawaii.

Fitch expects to resolve the Positive Outlook within a 12-18 month timeframe as HECO goes through the full calendar year of the new rate construct, which should drive an improvement in ROE.

Key Rating Drivers

HEI's Improving Credit Metrics: HEI's consolidated credit metrics as measured by FFO leverage remain comfortably positioned at or below its positive sensitivity leverage threshold over Fitch's forecast period. Fitch projects HEI's FFO leverage in the 4.0x-4.5x range over 2022-2024, due to expected improvement in cash flows at the utility post-2021, and an increase in the bank dividend vs. 2020. Given projected cash flow generation, Fitch does not expect any equity issuance over the forecast period due to the strong dividends from both businesses. Fitch believes that HEI would issue equity if needed to maintain its current capital structure and investments.

HECO's Resilient Credit Metrics: Fitch expects HECO to maintain strong credit metrics compared with its 'BBB+' peers despite the near-term temporary cash flow erosion caused by the electric sales decline, pandemic related costs and absence of rate relief in 2020. FFO leverage is projected to remain in the 3.6x-3.8x range over 2022-2024, down from 4.0x in 2021. Although Fitch does not expect the ROE lag to be removed completely over the next couple of years, the new regulatory construct provides more predictability and should enable the company to keep the earned ROE more stable. The construct also provides a well-defined framework within which the company can manage its capital investments and O&M.

HECO has successfully identified cost cuts to offset absence of the rate relief from 2020 rate cases. Management has focused on keeping O&M growth below inflation and offsetting costs that rise faster than inflation (audit fees, insurance premiums, healthcare benefits), and has cut O&M by around 2% in 2020 vs. 2019, keeping it flat in 2021. Recent labor agreements and inflationary adjustments provided under the current regulatory mechanism should provide stability of earnings and cash flow and slow down inflationary impact on the O&M. HECO deferred about $28 million as of YE 2021 in pandemic-related expenses and recently filed with the commission for a three-year recovery period.

Bank Performance Strong: American Savings Bank (ASB; BBB/Stable) had very strong 2021 results primarily due to the reversal of the high provisioning for expected credit losses from 2020 as the economy continued to recover from the pandemic. The bank also benefited from strong loan origination, including PPP loan fees. These positives were partially offset by lower interest margins, due to the very low interest rate environment.

The bank's net interest margin in 2021 was 2.91% vs. 3.29% for 2020 (2020 was 56 basis points lower than the net interest margin in 2019). The recent rise in interest rate should have a positive impact on ASB's net interest income and net interest margin, as rate sensitive assets start repricing.

Pandemic economic slowdown has put pressure on ASB's earnings due to the lower net interest income margins and higher potential loan losses in 2020. Bank has paid $31 million in dividends to HEI in 2020, and has resumed its regular quarterly dividend in 2021 paying $59 million in dividends. Dividends are expected to modestly increase over the forecast period.

New Regulatory Construct Provides Predictability: Fitch views the implementation of the performance based ratemaking (PBR) construct at HECO as a credit positive as it provides more clarity for HECO's earnings and cash flow. Although the PBR has been in place for only a year it has provided a more stable framework for the utility to deliver on its earnings.

The ROE gap remains significant, but Fitch expects it to improve as 2022 will be the first year with the full impact of the PBR, which will remove some of the timing lag from the previous regulatory construct. Management has also been successful in achieving O&M savings to offset the customer dividend payment, which should stabilize and improve ROE going forward. In addition, potential upside from the new performance incentive mechanisms (PIMs) could provide additional support to the credit metrics. Fitch does not expect a significant contribution from the PIMs in the near future.

PBR also keeps in place all existing trackers such as the sales decoupling, which has provided protection from the pandemic impact on sales (although with a delay in cash flow recovery); energy cost and purchased power recovery/adjustment clauses, which limits exposure to the oil cost spikes and provides timely recovery; pension benefit trackers and renewable energy infrastructure program. These are all important mechanisms to maintain earnings and cash flow stability.

Aggressive Renewable Targets: While Hawaii's long-term renewable portfolio standards (RPS) are aggressive, HECO's capital plans to meet and exceed the 40% target by 2030 presents, in Fitch's view, modest execution and financing risk despite the recent delays in some of the renewable projects. HECO exceeded the 30% RPS target set for 2020 and was at 38.4% at YE 2021. However, achieving the 100% renewable target by 2045 will require significant investments to modernize the electric infrastructure throughout the service area and presents execution and technological risks.

New renewable generation is needed to replace the oil-fired generation that provides close to 70% of energy and contributes to high and volatile power prices and one of the highest customer bills in the USA. Current spike in oil prices further underscores the need to move away from fossil fuels, which is causing significant pressure and volatility in customer bills.

The utilities completed Phase I and Phase II of a Request for Proposals (RFP) for renewable projects, which have potential to add ~490 MW of solar and ~3GWh of storage by ~2024. A total of 16 PPAs have been so far approved by the Commission and four more projects are pending approval. Utilities are working on launching Phase III RFP.

There have been delays in some of the project completion dates, primarily because of supply chain issues, and two PPAs have been cancelled. However, HECO does not anticipate that these delays and cancelations will impact its ability to achieve the statutory RPS target or cause any reliability issues. HECO is still on track to add 75 MW of solar in total by the end of this year.

Parent Subsidiary Rating Linkage: Parent subsidiary linkage exists between HEI and HECO. Fitch determines HEI's standalone credit profile based upon consolidated metrics. Fitch has followed the stronger subsidiary path, as it believes HECO has a stronger credit profile on a standalone basis. Fitch considers the legal ring fencing for HECO porous, given the general protections afforded by regulatory capital structure and other restrictions.

Access and control are porous. HEI and HECO maintain separate treasury functions, and HECO issues its own short-term and long-term debt. HEI does not guarantee HECO's debt. However, HEI is the sole source of equity for HECO. Due to these considerations, Fitch generally limits the IDR notching difference between HEI and HECO to two.

Derivation Summary

Comparing leverage levels, HEI is better positioned than its parent holding company peers, Cleco Corp (Cleco; BBB-/Stable), CMS Corp (CMS; BBB/Stable) and DTE (DTE; BBB/Stable). While HEI, DTE, Cleco and CMS own low risk, regulated businesses, CMS and DTE are better positioned with almost all of its income from its low-risk Michigan based utilities. HEI owns a bank, ASB, which contributes a larger 30%-35% of operating income, while Cleco receives about 30% from electric sales under medium to long-term contracts with cooperative and municipal electric systems.

DTE has a small non-regulated business contributing less than 10% of the earnings following the divestiture of midstream operations. Like Cleco, CMS, and DTE, HEI's utilities benefit from constructive utility regulation, although Hawaii's regulation is considered more challenging than Michigan's and Louisiana's. They all operate in a single jurisdiction, but DTE and CMS have more diversity as they own a regulated electric and gas company.

All have parent-only debt, and HEI parent-level debt was about 29% of the total in 2021, compared to approximately 25% for CMS, 30% at DTE and around 46% for Cleco. HEI's FFO leverage is projected to be of 4.0x-4.5x from 2022 through 2024, better than DTE's at 5.1x-5.5x CMS' at 5.0x through 2024, and Cleco's at 5.0x-5.5x over 2022-2024.

HECO is an integrated electric utility, much smaller in size than its peer Puget Sound Energy (PSE; BBB+/Stable), but modestly larger than Public Service Company of Oklahoma (PSO; BBB+/Stable) and Indianapolis Power and Light (IPL; BBB+/Stable). HECO, like its peers, operates in a single state. IPL operates in a more supportive environment in Indiana than HECO in Hawaii or PSE in the challenging regulatory environment in Washington State. PSO regulatory environment in Oklahoma, which has been challenging, has shown signs of improvement in the past couple of rate cases.

Fitch expects HECO's leverage will average between 3.6x-3.8x between 2022-2024. HECO leverage compares favorably to that of PSO, which is projected to average around 4.8x; and IPL's, which is expected to average around 4.1x, and is comparable to PSE's mid-3.0x, during the forecast period.

Key Assumptions

HECO capex of about $400 million on average over 2022-2024;

Modest contribution from PIMs in 2022-2024;

$6.6 million rate refund annually from 2022-2025 based on annual savings per the accelerated Management Audit commitment;

Recovery of pandemic-related costs starting in 2023;

HECO capital structure of about 57% common equity/capital, with debt issuances and equity contributions as needed to maintain regulatory capital structure;

No equity issuance over the forecast period;

To better represent the risk to the consolidated company, Fitch deconsolidates the bank and adds the contributions as recurring dividends to HEI, and assumes about $70 million of annual dividend payment from the bank from 2022-2024.

RATING SENSITIVITIES

Hawaiian Electric Industries:

Factors that could, individually or collectively, lead to positive rating action/upgrade:

An upgrade of HEI's ratings would be predicated upon an upgrade of HECO;

Sustained FFO leverage of less than 4.5x.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A change in financial strategy that disproportionately relies on debt funding to offset utility cashflow/bank dividend shortfalls;

A material deterioration in HECO's regulatory environment;

FFO leverage greater than 5.2x on a sustained basis.

Hawaiian Electric Company:

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Continued improvement in the cash flow following a full year implementation of the new rate making methodology;

Sustained FFO leverage of less than 4.0x.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

An inability to earn an adequate and timely recovery on invested capital;

Failure to recover revenues offsetting declines attributable to DG and energy efficiency;

Changes in the rate making methodology that would result in unpredictable regulatory outcomes;

FFO leverage greater than 4.8x on a sustained basis.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: As of March 31, 2022 the total amount of available borrowing capacity (net of commercial paper outstanding) under the company's committed lines of credit was approximately $304 million. At the end of the quarter, HEI and Hawaiian Electric had approximately $66 million and $6 million of commercial paper outstanding, respectively.

HEI has access to a $175 million revolving credit facility (maturing in 2026), which also serves as a backstop for its commercial paper program.

HECO has adequate liquidity to meet its operating needs. HECO maintains minimum cash on hand, as is typical for a regulated utility, and has access to its $200 million syndicated revolving credit facility (maturing in 2026). HECO's credit facility serves as a backstop for its $200 million CP program. Debt maturities are modest over the rating horizon and Fitch expects HECO to occasionally access the debt markets to fund its capex plans.

Issuer Profile

HEI is a parent holding company of integrated regulated electric utility HECO and ASB, a bank, and Pacific Current. HECO is engaged in the generation, purchase, transmission, distribution and sale of electric energy in Hawaii. ASB is the third largest bank in Hawaii with $9.2 billion in assets and $8.2 billion in deposits as of Dec. 31, 2021. Pacific Current invests in non-regulated clean energy in Hawaii.

Summary of Financial Adjustments

The cash flow and earnings from the bank were deconsolidated and the cash distributions were included in FFO. Additionally, the bank deposits were added to the balance sheet (representing the bank liabilities) and offset by off-balance sheet liabilities.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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