Key Performance Metrics
Hawaii's transition to a clean energy future requires significant investment, ensuring a robust electric grid to maintain service quality and reliability while increasing the development and deployment of renewable energy resources affordable to our customers. The ability to attract investors to provide the upfront funding for these projects requires a financially sound utility. The financial strength of the utilities is measured through numerous metrics, but two important indicators are: 1) the Return on Common Equity (book and ratemaking); and 2) Credit Ratings issued by the rating agencies of Fitch Ratings ("Fitch"), Moody's Investors Service ("Moody's"), and Standard & Poor's Ratings Services ("S&P").
Ratemaking Return on Common Equity (“Ratemaking ROE”)
Shareholders help provide upfront funding for capital improvement projects that serve our customers. The Public Utilities Commission ("PUC") determines a reasonable "return on equity" ("Authorized ROE") or profit for shareholders. Although this profit is what is authorized by the PUC, it does not mean that shareholders are guaranteed this level of profit. In each company's rate case, the PUC determines the Authorized ROE after reviewing the company's and interveners' positions regarding the company's composite cost of capital (which includes the return on equity).
Book ROE is a measure of a company's actual profit or "return" on shareholders' investments. Ratemaking ROE is a measure of a company's profit or "return," adjusted for items not included in rates, on rate base investments funded by shareholders. The primary difference between the book ROE and the Ratemaking ROE is due to items that are not included in rates. For example, incentive compensation and certain other costs are incurred by the companies as part of running their business, but those costs are not paid by customers. Therefore, they are excluded when determining ratemaking profit, resulting in a higher Ratemaking ROE than book ROE. At the end of each year, the Ratemaking ROEs are used to determine whether there will be any sharing of actual earnings that exceed the PUC's Authorized ROEs. Under the current method of calculating rates called Decoupling, each company's Ratemaking ROE as of December 31 is compared to its Authorized ROE1. If the Ratemaking ROE as of December 31 exceeds the Authorized ROE, a portion of excess earnings is credited to customers through the earnings sharing mechanism. Decoupling went into effect on March 1, 2011, April 9, 2012, and May 4, 2012 for Hawaiian Electric Company, Hawaii Electric Light Company, and Maui Electric Company respectively.
The gap between PUC-allowed ROACEs and the ROACEs actually achieved is primarily due to: the consistent exclusion of certain expenses from rates, the lower RBA interest rate (currently a short-term debt rate rather than the actual cost of capital), O&M increases and return on capital additions since the last rate case in excess of indexed escalations, and the portion of the pension regulatory asset not earning a return due to pension contributions and pension costs in excess of the pension amount in rates.
Hawaiian Electric Company
Hawaiian Electric's current Authorized ROE of 10% was established by the PUC in Docket No. 2010-0080, the company's last general increase rate case. As shown in the graph below, Hawaiian Electric's Ratemaking ROEs as of December 31, 2013, December 31, 2014, December 31, 2015 and December 31, 2016 were 8.95%, 9.85%, 9.20% and 9.46%, which amounts to 1.05%, 0.15%, 0.8% and 0.54% below its authorized level. As of December 31, 2012, Hawaiian Electric’s Ratemaking ROE exceeded its authorized level by 0.7% which amounted to approximately $2.6 million of earnings being returned to customers in the 2013 decoupling rate adjustment.
Maui Electric's current Authorized ROE of 9% was established in May 2013 by the PUC in Docket No. 2011-0092, Maui Electric's last general increase rate case. As shown in the graph below, its Ratemaking ROEs as of December 31, 2013 and December 31, 2014 were 9.35% and 9.47%, which amounts to 0.35% and 0.47% above its authorized level, which resulted in approximately $400,000 being returned to Maui Electric customers in its 2014 decoupling rate adjustment and $500,000 being returned to Maui Electric customers in its 2015 decoupling rate adjustment. As of December 31, 2012, December 31, 2015 and December 31, 2016, the Company's Ratemaking ROEs were below the respective authorized level by 3.31%, 0.24% and 0. 66%.
Hawaii Electric Light
Hawaii Electric Light's current Authorized ROE of 10% was established in February 2012 by the PUC in Docket No.2009-0164, Hawaii Electric Light's rate case. As shown in the graph below, its Ratemaking ROEs as of December 31, 2012, December 31, 2013, December 31, 2014, December 31, 2015 and December 31, 2016 were 7.79%, 7.46%, 6.65%, 7.49% and 7.61%, which amounts to 2.21%, 2.54%, 3.35%, 2.51% and 2.39% below its authorized level.
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Credit rating agencies evaluate a company's ability to repay debt. Based on their assessment using their methodology, they assign credit ratings (Grades A, B, C, etc.). The credit rating impacts a company's ability to borrow money and the interest rate which it has to pay. The lower the rating, the higher the interest cost. Conversely, the higher the rating, the lower the interest cost. The cost of debt (weighted average interest rate) is included in each company's composite cost of capital which becomes the rate of return on average rate base embedded in electric rates that the Companies charge their customers.
Ratings are grouped into categories ranging from 'Prime' (highest rating and lowest cost) to 'In Default' (lowest rating and highest cost or unable to borrow). Ratings from 'Prime' to 'Lower Medium Grade' are considered 'Investment Grade'. Ratings below 'Lower Medium Grade' (Fitch's and S&P's BBB- and Moody's Baa3) are considered 'Non-Investment Grade', or speculative or junk bond. Companies with 'Non-Investment Grade' ratings would be at risk of having higher interest costs and/or not being able to attract investors for its bonds.
|Rating Agency Credit Scale||Fitch||Moody's||S&P|
|A+||A1||A+||Upper Medium Grade|
|BBB+||Baa1||BBB+||Lower Medium Grade|
Credit ratings below B-/B3/B- and above D/C/D not included in above chart
Rating outlooks indicate the direction (e.g. positive, negative, stable) a rating is likely to move, generally over a one-year to two-year period. They incorporate trends or risks that have not reached a level that would trigger a rating action, but may trigger one if such trends or risks continue. Ratings may be placed on credit watch if events or circumstances occur that may affect a credit rating in the near term. Updating a rating outlook or placing a rating on credit watch does not mean a change in credit rating is inevitable.
The most recent ratings and credit outlooks issued by Fitch, Moody's, and S&P for Hawaiian Electric as a consolidated entity (including Maui Electric and Hawaii Electric Light) are presented in the table below. On August 3, 2016, Moody's downgraded Hawaiian Electric's senior unsecured rating to 'Baa2' from 'Baa1' and downgraded other ratings. The outlook is stable. On December 27, 2016, S&P affirmed Hawaiian Electric's long-term issuer credit rating at 'BBB-' with a stable outlook. On January 18, 2017, Fitch affirmed Hawaiian Electric's long-term issuer default rating at 'BBB+' with a stable outlook.
2 Fitch Ratings dated January 18, 2017
3 Moody’s Credit Opinion dated August 8, 2016
4 S&P Research dated December 27, 2016
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There are three terms that appear often in financial discussions: ratemaking, cost of service regulation, and rate base. Here are some brief explanations of what these terms refer to.
Utility rates charged to consumers are set through a formal regulatory process ("ratemaking" process). The process is typically carried out through a rate case presented by a public utility before the Public Utilities Commission.
Cost of Service Regulation
In a rate case, the Commission determines the total annual revenues required by the Utility to cover both its expenses and the opportunity to earn a fair return on its investments. The determination is based on the Commission's review of the estimates submitted by the Utility. Expenses are allowed for ratemaking purposes if they are prudent and related to providing safe and reliable service to the customers.
Rate base is the value of facilities and other investments used to provide service to customers, net of funds from non-investors (e.g., customer deposits and accumulated deferred income taxes). Return on the investments is calculated by applying the weighted average rate of return on capital (e.g., long-term debt, preferred stock, and common stock) to the net investment amount, or rate base.