OREANDA-NEWS. Fitch Ratings has affirmed the Issuer Default Rating (IDR) for Hawaiian Electric Company (HECO) at 'BBB+' with a Stable Rating Outlook. In addition, Fitch has maintained Hawaiian Electric Industries, Inc. (HEI, IDR 'BBB') on Rating Watch Positive. Fitch expects to resolve the Rating Watch on the conclusion of the merger transaction with NextEra Energy, Inc. (NEE, IDR: 'A-'/Outlook Stable), which is expected in the first half of 2016.

Once the transaction is completed, HEI (or its successor within NEE)would become a first-tier holding company under NextEra Energy Capital Holdings, Inc. Fitch expects to equalize the IDR of HEI with that of HECO once the bank is spun off and the acquisition with NEE is completed. The acquisition would not result in any change in rating of HECO. The structural weakness in HECO's service territory due to rising penetration of rooftop solar, the concessions offered for merger approval and the uncertainty regarding the fleet modernization plan until the Power Supply Improvement Plan (PSIP) is approved by the regulators offset the positives of NEE's ownership and a sharp decline in oil prices over last year. Over the long term, Fitch sees a bias toward positive rating actions for HECO and HEI under NEE's ownership.

In the event that the merger is not completed (not anticipated by Fitch), Fitch believes the credit profile of HECO and HEI remains robust. HEI would retain American Savings Bank FSB (ASB), whose financial profile remains strong. HEI would use retained earnings and access to capital markets to fund equity infusions in HECO as the utility embarks upon a fleet modernization plan. Fitch expects HEI to maintain a balanced approach to funding and for HECO to maintain its regulatory approved capital structure.

KEY RATING DRIVERS FOR HECO

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% to 30% above mainland pricing benchmarks. While HECO's retail electricity rates at approximately $0.25 per kWh at present have benefited from a sharp drop in oil prices since last year, these still remain more than 2.5x the national average.

Declining Electric Demand: The combination of high electricity prices, abundant solar resources and government financial incentives are resulting in declining electric demand over the past decade as consumers invest in rooftop solar systems and energy efficiency. At year-end 2014, approximately 12% of HECO's residential customers have rooftop solar PV systems that substantially reduce their own consumption of, and receive credits toward, utility supplied power. Hawaii Public Utilities Commission (HPUC) authorized revenue decoupling, cost-of-service recovery mechanisms (CSRM) and earnings-sharing mechanisms 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. 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 is expected to moderate the growth of rooftop solar systems over the medium term.

Aggressive Renewable Targets: The state of Hawaii has set aggressive renewable portfolio standard (RPS) with targets stepping up from 15% by year-end 2015 to 30% by 2020 then up to 100% by 2045. HECO is well placed to meet those targets over the medium term with renewables sources (including distributive generation) meeting more than 20% of energy needs in 2014. Nonetheless, the 100% renewable target by 2045 is aggressive. In addition to the integration challenges posed by high renewable penetration rates, HECO will also need to make significant investments to replace its predominantly oil-fired generation fleet with renewable sources. 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.

Progressive Regulatory Framework: Fitch views the regulatory construct in Hawaii as constructive, with many progressive regulatory mechanisms partly offsetting 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 7.9% for last-12-months at Sept. 30, 2015, compared to an authorized ROE of 10%. The concessions offered by HECO and NEE for merger approval, which includes a four-year rate case moratorium and $60 million of forgone revenue increases among other concessions, could prolong the under-earning at HECO.

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, including adjusted debt to EBITDAR of 3.0x and FFO-adjusted leverage of 3.1x at Sept. 30, 2015. Fitch expects adjusted debt to EBITDAR to range between 3.0x -3.5x over the forecast period (2015 - 2018) and FFO adjusted leverage to range between 3.2x - 3.8x over this time. The strong performance reflects expectations of parental support to retain the existing 58% equity capital structure and adequate and timely recovery of proposed capital investments. Fitch expects HECO to retain its present capital structure and leverage profile with periodic equity infusions from HEI during the fleet modernization period.

KEY RATING DRIVERS FOR HEI

Ratings Supported by Solid Subsidiary: The ratings for HEI are supported by the strong credit profile of HECO and reflect expected spin-off of its banking subsidiary, ASB, the third largest bank in Hawaii with about $5 billion in assets. In the event that the merger with NEE is not approved (not anticipated by Fitch), HEI plans to retain ASB.

Healthy Hawaiian Economy: The Hawaiian economy is strong with unemployment well below the national average at 3.4% and state GDP growth expected to reach 2.8% in 2015. Tourism, a key driver of the Hawaiian economy, is healthy with arrivals up 4.1% September year-to-date and stable median single family home prices year-on-year as of October 2015.

Strong Financial Flexibility: Financially, HEI has been dependent on upstream dividends from ASB ($36 million in 2014 and $40 million in 2013) to continue its financial management strategies, including maintaining the common dividend, which totals approximately $130 million per annum. While the post-merger financial strategy remains uncertain, Fitch has assumed no material change in HEI's capital structure post-merger approval. Fitch expects NEE to support HEI in making required equity infusions in HECO during periods of heavy capital investments.

Pending Merger: Fitch view's HEI pending merger with NEE favorably. HECO will benefit significantly from NEE's ownership, in Fitch's view, given the access to NEE's expertise in developing renewable projects, superior operational performance, and successful fleet modernization at its Florida utility in addition to greater access to capital. The regulatory approval process is turning out to be more prolonged and challenging than Fitch's original expectation, but a final resolution is expected in the coming months. The process for the spin-off of ASB is also on track, and is expected to be completed immediately preceding the consummation of the merger.

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 banking market. At Sep. 30, 2015, ASB was well capitalized with core and Tier 1 risk-based capital ratios of 8.8% and 12.2% respectively, according to the Federal Deposit Insurance Corp (FDIC). Its operations are highly profitable with a solid net interest margin of 3.53% and asset quality was good with charge-offs of only 0.01% for the 12 months ended Sep. 30, 2015.

KEY ASSUMPTIONS

Fitch's key assumptions within its rating case for the issuer include:

--Completion of the merger with NEE and concurrent spin-off of ASB in the first half of 2016;
--$60 million Rate Adjustment Mechanism (RAM) reduction over the four-year rate case moratorium as per merger commitments offered by NEE and HECO;
--Structural drag of about 200 bps on authorized ROE over the forecast period;
--HECO base capex of about $350 million per year. Growth capex reflects the Schofield generation station and modest expansion of generation fleet as well as potential investments in battery storage and smart grid;
--HECO capital structure of about 58% equity-to-capital, with debt issuances and equity contributions as needed;
--Near-term debt maturities at HEI refinanced, increase in HEI debt, dividend and/or equity contribution to/from NEE in 2016-2018 as needed to maintain current stable capital structure.

RATING SENSITIVITIES

HECO:

Positive: Future developments that may, individually or collectively, lead to positive rating action include the following:

--A successful execution of the PSIP under NEE's ownership and with no material pressure on retail rates;

--FFO adjusted leverage less than 4.0x on a sustainable basis.

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;
--Accelerating competitive inroads by distributed generation and energy efficiency;
--FFO adjusted leverage greater than 5.0x on a sustainable basis.

HEI:
Positive: Future developments that may, individually or collectively, lead to positive rating action include the following:

--Successful closing of the acquisition by NEE.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

--Failure to consummate acquisition by NEE;
--Change in financial strategy that disproportionately relies on debt funding;
--Downgrade in HECO's IDR driven by material deterioration in regulatory environment.

LIQUIDITY

Consolidated liquidity was adequate at Sept. 30, 2015, with $228 million of cash on hand, adequate availability under revolving credit facilities totalling $350 million, and modest debt maturities over the rating horizon. HEI has $200 million of long-term debt maturing in 2016, and Fitch currently expects these to be refinanced.

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 16% at third-quarter end 2015.

HECO maintains minimum cash on hand, as is typical for a regulated utility, and had $105 million available under its $200 million syndicated revolving credit facility (also maturing in April 2019) as of Sept. 30, 2015. 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) equity capitalization of at least 35%. HECO traditionally maintains equity capitalization of about 58%, 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. Financial institutions providing HECO's credit facility have consented and agreed that the proposed merger with NEE, where HECO would become a wholly-owned subsidiary of NEE, shall not constitute a change of control.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings with a Stable Outlook:

HECO
--Long-term IDR at 'BBB+';
--Senior unsecured debt at 'A-';
--Subordinated debt at 'BBB';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.

Fitch maintains the following ratings on Rating Watch Positive:

HEI
--Long-term IDR 'BBB';
--Senior unsecured debt 'BBB';
--Short-term IDR 'F3';
--Commercial paper 'F3'.