Hawaiian Electric Industries Inc (HE) 2007 Q1 法說會逐字稿

Good day, Ladies and Gentlemen, and welcome to the Hawaiian Electric Industries 2007 first quarter earnings conference call. My name is Cami, and it will be my pleasure to be your coordinator today. At this time all participants are in a listen only mode. We will conduct a question and answer session toward the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder this conference is being recorded for replay purposes.

I would now like to turn the presentation over to the Manager of Treasury and Investor Relations, Ms. Suzi Hollinger. Please proceed, ma'am.

Thank you, aloha and good afternoon. Thanks for joining us for an update on HEI. Here with me from Senior Management and speaking today are Connie Lau, HEI's and ASB's President and CEO, and Mike May, HECO President and CEO. Also on the call are are Eric Yeaman, HEI Financial Vice President, Treasurer and CFO, Financial Vice President and for HECO, Tayne Sekimura, and Alvin Sekimura, ASB, Executive Vice President, Finance. Connie will start the presentation with a few comments on first quarter earnings and then Mike will follow with an update on the utility. Connie will come back to discuss the bank and then we'll make some closing remarks. Upon conclusion of the presentation we'll open it up for your questions. Before I hand the call over to Connie I would like to alert you that forward-looking statements will be made on today's call. Please reference roman four of our first quarter form 10-Q that was filed this morning for information about forward-looking statements. Now let me turn the call over to Connie to begin the formal comments. Connie?

Thanks, Suzi, and aloha to all of you.

As we stated in our year-end conference call in February, the challenges that we experienced in 2006 continued through the first quarter of 2007. Our utility continued to see rising operation and maintenance expenses, and our bank's earnings were impacted by a difficult interest rate environment and non-interest expenses remained high. These factors, combined with a $7 million net of tax write-off of capital costs related to our Keahole expansion project caused first quarter earnings to be down by $26 million or $0.32 per share when compared to the first quarter of 2006.

As you know, the write-off of the Keahole project cost was part of a settlement agreement with a consumer advocate in connection with our big island rate case. The financial details of the quarter were included in the earnings release that went out last night and in our form 10-Q that was filed this morning. I'll assume that most of you had a chance to read through the release, so I won't go through it, but we will be happy to answer any questions you have at the end of the formal presentation.

While the near term picture is challenging, the long term outlook for the Company remains positive and we are focusing our efforts on the key items that will drive long term earnings growth, namely rate relief at our utility and the bank's strategic transformation to a full service community bank. We recently received interim rate relief for our big island utility, which we began collecting in early April. Also, our utility moved one step closer to rate relief for its Maui subsidiary, when it filed a 2007 test year rate case for that service territory, in February. Our 2007 test year rate case for our Oahu utility was filed at the end of 2006. Mike will discuss the details of our rate cases when he updates you on the utility.

At the bank, we are working to offset net interest margin pressure by continuing to diversify the loan portfolio and maintaining and attracting low cost deposits and increasing non-interest income. Overall, we continue to operate our two core subsidiaries for long term earnings growth to support the dividend. Now, let me hand the call over to Mike to discuss the utility.

Thanks, Connie. Aloha and good afternoon or good morning to some of you. As noted earlier, first quarter was a challenging one for us.

I'll spend most of my time today discussing those challenges and what we're doing to address them going forward. In the first quarter 2007, sales were up 0.6% over the same quarter in 2006. We expect this trend of moderate sales growth to continue. In 2007, 2008, and 2009, we are currently estimating sales to be moderately higher over the prior year by 0.6%, 1.6%, and 1.3% respectively.

Because of several years of economic growth in our State, overall demand for electricity has increased. This growth has caused a tightening of our generation reserve margins on Oahu and Maui during peak usage periods. As we've mentioned in previous calls, our O & M expenses have been rising as a result of running our units harder. This has required more extensive and frequent maintenance and repairs to our system. Also contributing to our rising O & M expenses are increased retirement benefit expenses. We expect these O & M levels to remain high.

To address the challenges, we are executing a strategic plan that focuses on making needed reliability investments and seeking recovery of costs through a rate case process. In line with a strategy over the next five years, we are focusing approximately $1.2 billion in gross capital expenditures to increase generation capacity and maintain an improved reliable electric service for our customers. This slide shows the anticipated utility capital expenditures by year. In recent years, we have been able to finance almost all of our capital expenditures with internal sources of funds. Although we still expect to finance the majority with internal sources, with our larger investment and reliability projects, we expect our borrowing levels to increase.

Our strategic plan includes seeking rate relief at all three utilities to cover these reliability investments and increased O & M expenses. As this chart illustrates, in April, we received an interim decision from the PUC for our HELCO rate case. Additionally we filed a rate case for MECO, our Maui county utility. We are encouraged by the timely interim decisions by the PUC on our rate cases. In our HECO 2005 case, we received an interim decision shortly after the evidentiary hearings were held and our HECO 2006 rate case, we received a prompt interim decision after filing our statement of probable entitlement. Over the next several slides, I will cover in greater detail the status and progress for each of these rate cases.

As Connie mentioned, for its 2006 rate case, our Hawaii Island utility, HELCO recently received a decision in April 2007 allowing for a $24.6 million or 7.58% increase in annual revenues. The interim P & L had reflects the terms of a settlement that we reached with a consumer advocate on the rate case. This includes an after-tax write-off of approximately $7 million of some plant and service costs for the Keahole project in the first quarter of 2007. The decision also includes pension assets and rate base and the restoration of book equity for rate making purposes. This reverses the decrease in HELCO's book equity that occurred at year-end when we recorded a charge to accumulated other comprehensive income to reflect the funded status of our retirement benefit plans at the end of 2006.

In addition, it approves a tracking mechanism for pension and other post-retirement benefit costs and a continuation of the energy cost adjustment clause. An evidentiary hearing is scheduled for May 2007. Again, we view this timely interim decision as an indication of regulatory support.

In December, we also filed a 2007 test year rate case for HECO on Oahu. We are requesting a $99.6 million, or 7.1% increase in revenues, with an 11.25% return on common equity. An interim decision is expected in late 2007.

In February of this year, we filed a rate case for our Maui County subsidiary, MECO, with 2007 test year. We are requesting $19 million or a 5.3% increase in revenues and an 11.25% return on common equity. Like the HELCO and HECO cases, this case proposes a tiered rate structure for encouraging energy efficiency. We expect an interim decision by early 2008.

We are awaiting for a final decision for our Oahu's 2005 rate case. There is no statutory deadline for the PUC to issue a final order. We continue to collect $41 million increase in our annual revenues as a result of the interim decision received earlier.

To sum up, a growing Hawaii economy has impacted our utilities reserve margins and from a financial perspective, our earnings. We expect this earnings pressure to continue in 2007. To address these challenges, we are increasing our capital expenditures, adding generation capacity, and other reliability investments. To recover increasing cost, we have several rate cases in progress with a focus on improving our earned rate of return. I want to emphasize that our plan will take several years and involve all three of our utilities. Over time, we look forward to an improvement in our earnings.

Now I'd like to turn things back to Connie to discuss the bank.

Thanks, Mike.

For the bank, the first quarter was another tough quarter. High short-term interest rates, the shape of the yield curve, and high non-interest expenses impacted results for the quarter. In spite of the difficult interest rate environment, we are pleased by the performance of the bank's lines of business during the quarter and the improvement of the net interest margin over the prior quarter. Deposit rates and balances stabilized. Credit quality remains strong. Non-interest income continued to grow, and the bank's credit rating were upgraded by both major rating agencies.

During the quarter, our lending areas continued to perform well. Commercial loan balances grew by 9% during the quarter. Overall, growth in loan balances during the quarter was more modest, as the increases in residential and commercial loans were partially offset by lower commercial real estate and consumer loan balances. As we mentioned in previous quarters, we expected the decline in commercial real estate balances due to the scheduled pay off of several large construction loans. This, combined with our shift in emphasis back to income property lending contributed to the net decrease in commercial real estate balances.

First quarter net interest margin improved to 3.07% compared to 3.05% in the fourth quarter of 2006. This was in large part due to the fact that deposit balances were stable during the quarter. Equally important was the fact that we were able to accomplish this while holding deposit costs relatively steady, a change from the increasing deposit cost that we experienced throughout 2006. Managing deposit costs and retaining deposits will continue to be a challenge in the current interest rate environment.

Credit quality remains strong during the quarter due to the continued strength of the local economy. The health of the local residential real estate market remains good. Although transaction volumes have fallen off, prices have remained stable, and we have not experienced the declines in value or increases in foreclosures seen in many mainland markets. In a recent survey conducted by Royalty Track, Hawaii's foreclosure rate was among the lowest in the nation. In March in 2007, foreclosure activity in Hawaii ranked 43rd out of all the 50 states.

We are also pleased that our efforts to strengthen the bank through our strategic initiatives were recognized by both major rating agencies when they recently upgraded American Savings Bank's credit rating. Among the reasons cited for the ratings upgrades were the improvement in the bank's interest rate sensitivity and funding profiles, strong asset quality measures and good capital level. In particular, they noted that the bank's ability to manage its net interest margin through the current interest rate cycle was helped by the growth of commercial and commercial real estate loans, the growth of the deposit franchise, and the ability to control deposit costs, all core goals of the strategic transformation.

Our overall outlook has not changed since our previous call. We are expecting the difficult interest rate environment to persist through 2007, and do not expect significant relief from the pressure on net interest margin. Our expectations continue to be for modest growth in the loan portfolio, and we will continue to be challenged to grow deposits while managing deposit costs. Given the outlook for the Hawaii economy, credit quality is expected to remain good; however, factors such as significant growth in the loan portfolio, situations with specific borrowers or changes in outlook for the economy may cause credit costs to increase.

Recent results were impacted by higher non-interest expenses, primarily due to higher legal and litigation costs. While these costs may decline as matters are resolved, we expect overall non-interest expenses to remain near current levels. The bank has always had a focus on building sound infrastructures to support its transformation growth, and this year, we are strengthening our risk management and compliance infrastructure. Overall, we continue to believe that the adherence to our strategic plan has and will continue to help us manage through the current environment, and put the bank in the best position to grow and compete once the operating environment normalizes.

Now, let me wrap up the presentation with a few closing comments. First, a word about the dividend. You may have seen our dividend release yesterday announcing the Board's approval of a $0.31 per share dividend on our common stock. The dividend is payable on June 13th to shareholders of record on May 15th. Our dividend yield is attractive at 4.7%, and we expect to maintain the dividend.

In summary, while several key factors will continue to affect our core businesses in the near term, the long term outlook for our Company is positive. We expect the trend of rising utility O & M expenses to continue and that utility returns will improve when rate relief is received. As Mike discussed, rate cases have been filed for all service territories and we are beginning to see some interim rate relief. At the banks, the difficult interest rate environment will continue to put pressure on net interest margins. Economists believe the environment should improve later this year, and if so, that could take some of the pressure off our net interest margin. With respect to the dividend, we intend to maintain the dividend through these near term challenges and are focused on the key strategies that will drive long term earnings growth.

This concludes our formal comments, and we'll be happy to answer any questions you may have.

Thank you. (OPERATOR INSTRUCTIONS) And your first question comes from the line of Doug Fischer with A.G. Edwards. Please go ahead.

Aloha.

Hi, Doug.

Hello, Connie and company. Two questions about expenses. Utility O & M was up, we were expecting it to be up quite frankly it was up more than we might have expected in the first quarter. When you say expenses are going to remain high, should we be looking for similar percentage increases in future quarters, or is there some timing issue in this first quarter that might result in lesser percentage increases through the balance of the year?

Doug, this is Mike. As we have been saying for the last several calls, we expect that our O & M expenses will continue to be at a high level until we get the additional capacity that we've been talking about as we've indicated, we've been short of reserve margins, and we're having to run our units harder. We're having to do more extensive work and that continues to be our plight until we get the 2009 unit in place and the additional capacities that we have scheduled for the neighbor islands as well, particularly Maui.

And what kind of, maybe you can talk to us a little bit about the overhauls, what kind of cycle they're on and whether there's any lumpiness to it during the year?

Well, the only lumpy comparison I can make is if you compare the first quarter of '06 with the first quarter of '07, there's always a change in mix. The one example I can cite is that AES had an overhaul in the first quarter of 06, which basically did not allow us to do overhauls in our units, so AES was not doing an overall in the first quarter of '07, which gave us the opportunity to do extensive overhauls on some of our units, so those kind of things occur from time to time in the business.

Is there any guidance you can give us for the balance of the year as to the timing of overhauls versus what you had in the first quarter?

The only thing I can tell you is that we will continue to make decisions around reliability and supporting the energy needs, and what we are working on in tandem with that is the rate case cycle to adequately recover the O & M cost and the capital investments that we're making to support that.

And then at the bank, the services expenses were up materially, and I guess was the bulk of that these legal and litigation expenses?

Yes, that's correct, Doug.

Could you provide some color around those? Were those abnormally high? I know you said that relatively high levels are going to continue.

Yes. The legal and litigation expenses were at an abnormally high level, and as I said in my prepared remarks, as those matters get resolved, we may see those costs come down; however, we have always had a philosophy of investing in the transformation and in the infrastructure necessary to support the transformation and you'll recall that often that services line has included significant consulting expenses and we would expect that the overall non-interest expense will remain at a relatively high level because this year, we're working on our risk management and compliance infrastructure.

Okay, thank you.

Your next question comes from the line of Dave Parker with Robert W. Baird. Please proceed.

Good morning and thanks for letting my call come through. Doug as usual took all the good questions so let me see if I can ask a few B ones. First off, an interesting component of the HELCO settlement was the, I guess for better terms call it sort of a tracker on retirement cost. If that was applied to all of the three utility systems, how could that help earnings performance I guess if I could try to put it in that context.

Dave, this is Tayne Sekimura. Hi, I'm going to respond to your question there. Again, I just want to remind everyone that the pension tracking mechanism was something that was included in the HELCO interim decision. If it were applied to the HECO and MECO cases, what the tracking mechanism allows for are changes outside of test year rate cases, changes in pension costs to be captured in a holding account and be booked at either a regulatory asset or a regulatory liability and that the next rate case become part of that case and brought into the pension cost for that test year.

Great. And any recollection, Tayne, on how much that's been a drag on earnings? Want to stick your neck out a little bit on that one? That could give us hopefully in 2008 if we got that applied with how much we could pick up on that?

Dave, this is Eric. For the change between 06 and '07, it's about 2.5 million.

Great. Thanks, Eric. Second question, I know it was really wet a year ago and vegetation control costs spiked substantially. Are we going to see any relief there, Mike, when we look at just maintenance costs year-over-year this year's comparison or does that remain pretty high?

Dave, the reports that I'm getting from operations continue to speak to the need for vegetation management. Some of our folks just did a flyover of the system and the report that I received is that there's continuing vegetation management in our corridors that needs to occur.

Okay, and it looked as if weather was probably in your favor yet. I didn't see that quite translate into sales growth as I expected. Is conservation or demand side management efforts that you've been aggressively going after helping here to keep the low growth at minimal levels?

We believe the Company has launched a very conscious and aggressive effort through a combination of conservation initiatives and demand side management, energy efficiency programs. We have implemented with the Public Utilities Commission support a number of both commercial and industrial demand side management programs, energy efficiency programs, and we've had additional support from the Public Utilities Commission to expand those programs and to further extend the effect of that on our system.

Of course, the benefit of that is it's a lot cheaper to save a kilowatt than it is to generate one, and the trueup time is obviously in the rate case when you try to balance out against the offset. There was, in the energy efficiency as you may recall the 2005 docket, our rate case was bifurcated and there was a separation of the rate case from the energy efficiency docket, and the PUC has continued to allow us to participate and also have a tiered reward system, if you will, as a result of that decision. So to answer your question more succinctly, there is some efficiency and conservation that are a product of our aggressive efforts and programs.

Is there any mismatch right now, Mike, between expenses and revenues collected or is that, are we experiencing any regulatory lag or are we pretty current on that?

I think to answer your question, I don't think so.

Okay. All right, thank you. Over to the Bank, maybe you could refresh my recollection, but the slowdown in the commercial real estate lending activity that's not by accident, wasn't that pretty much by design from my understanding?

Yes. Dave, you'll recall that in the commercial real estate line of business, it tends to be pretty cyclical according to the economy, and you actually have to be quite anticipatory and look out 2-3 years, particularly when you're doing construction projects, because it takes about two to three years from the time you first commit to make the loans to when approvals are received, construction actually begins, and we start funding those loans and products is delivered, and so actually, about a year and a half ago, we had started shifting our emphasis away from the construction lending area to income property lending, and so what's happening now is the construction loans that we made two years ago are starting to finish up those projects or delivering their product now to the buyers and so they're getting paid down, so yes, you're correct, and we will continue to see that through the year. We are looking to make up that volume through the emphasis on the income property lending and also through our commercial banking line of business.

Great. That's what I thought, and I know you're trying to fix the yield curve and good luck there, but --

Can you help us out on that, Dave?

I've tried. I've done everything I can. I'll leave it to the experts. And also, home values are hanging right in there in Hawaii and I think last call, you identified the average price of a home was pretty high. Could you refresh my memory, because obviously this has an important impact on just the allowance that you don't have to take is for the values to hang in there, why have home prices done so well in Hawaii?

Yes. It's really still, I mean, we are islands, and it takes awhile for approvals to be obtained on residential projects, and so our developers here try to watch the market pretty carefully in terms of balancing that off and so you're correct. The housing prices really have held in there and actually demand is still pretty strong. Now, we are seeing some differences across the islands. Certain markets are weakening somewhat, but overall, while the transaction volumes have been slowing, the prices really have been very stable.

Okay, good. And I just thought of one other question, back at the utility, with rate cases sort of pancaking up here and increases are anywhere from 5 to 6 to 7% a shot, are you starting to see any impact from rate payors or negative editorials, that kind of stuff where we get a sense of a rate payer result starting to line up?

To answer your question, Dave, we've not seen any indications of that at all. The process that we go through is before an application, after an application is filed, there are actually public comments sessions that are conducted by the Public Utilities Commission, and I think for the most part in all of our public comment sections or hearings, there has been little in the way of opposition.

Great. Thank you.

Your next question comes from the line of Paul Patterson with Glenrock Associates. Please go ahead.

Hi. Almost all my questions have been answered. Just one sort of follow-up on the shifting out of the construction loans to the income property loans, what is it that you guys are anticipating I guess specifically happening that's causing you guys to take that action now?

Just actually, Paul, we started taking that about two years ago, just the normal slowing of the cycle, and so while the cycle has slowed, actually as I've just stated, the housing prices are just hanging in there, and so what's happened with the Hawaii market is that we were really pretty much on fire after 9-11, there was a little dip, and then our economy really was quite strong, and many people really began to see Hawaii, particularly in the resort areas and the neighbor islands as really safe place to have a second, third, or fourth home, and so our real estate market has been very very strong, and we are coming off that very strong peak, and that's what we were foreseeing a couple of years ago when we made that strategy shift to emphasize the income property lending as we saw that construction might flow.

Right, but in other words, you guys were, the demand for construction loans has simply been falling. There hasn't been, you guys aren't actually shifting, is it because there's less demand for the construction loans or is it because you guys feel that the quality of those loans might be in question I guess?

Yes. Actually, demand for loans is still quite strong. It's more a strategy shift on our part that we want to put the income property loans into our portfolio at this point in the cycle. We are still doing construction lending but I think as we said when we first began doing the construction lending, we really only do selected construction lending.

Okay. Thanks a lot, guys.

Yes. .

Your next question comes from the line of Steve Gambuzza with long bow capital. Please proceed.

Hi. I was wondering if you could just review the issue of prepaid pension asset and rate base if you wouldn't mind just kind of going through each of the utilities where you have, how much of prepaid pension asset you have on the balance sheet and how much you are seeking to get into rate base and what the status of that request is.

This is Tayne Sekimura. Right now, because of the charge we took for AOCI as of 12 -31-06, we don't have a prepaid pension asset on our balance sheet. That was the result of implementing FAS 158 on how we account for our pension costs. So right now, nothing on the balance sheet.

Okay. How about in rate base?

But in terms from a regulatory perspective, we have included that amount in our rate base, and just as a reminder, the prepaid pension asset is really the result of an accumulation of all your expenses over the years and how much we've contributed to the fund, and there for, we do require a return on that asset and have included it in rate base, in our rate cases. Okay can you just review for each utility how much is in rate base? Can I come back to that question?

Sure.

I'll check that right now.

While Tayne looks at that number let me just add something to Paul's question on the whole construction cycle. In our commercial real estate line of business, what we really do is try to follow the cycles really to anticipate the cycles in the real estate market, and so for example, on the construction lending side is part of the market that we began looking at whether we should shift emphasis is really the residential because we were having a lot of residential construction, so as I mentioned, we are still doing selected construction lending and right now, in fact we're looking at a large retail complex, so our construction lending will shift according to the cycles here in the market because we really, as it was said earlier, have to be anticipatory ust as our customers have to be as to where the market will be two or three years out for these projects when the product will actually deliver. I'll see if Tayne has her answer.

Yes, I do. The amounts and these are approximate amounts that we have in rate base, for the prepaid pension item, for HECO, it's about $60 million. For HELCO, it's $12 million and for MECO, it's $3 million.

3 million you said?

Yes.

And those amounts have all been approved and regulatory filings or they are requests?

No. For the HELCO case, that has been included in its interim but for HECO and for MECO, they are included in our request, and those cases are still pending.

Okay.

And ongoing.

Thank you and finally just want to understand the issue of what's going to happen from a GAAP standpoint on the prepaid pension asset? Is it you wrote it off last quarter and now you've been authorized to reestablish that asset and so you're going to take that back to equity?

Yes. Let me explain that. The prepaid pension tracking mechanism allows us reverse the charge that we took to equity and establish a regulatory asset, that's for the HELCO case. Assuming that a similar tracking mechanism is approved for HE CO and MECO that will allow us reverse the charge that was taken as of December 2006.

Okay and when would you expect to have at least interim orders on those two cases?

Well on the HECO case, we expect an interim later in 2007 and for the MECO Maui case, we do expect an interim some time in early 2008.

And are there any like I guess my question would be are there any differences in the requests on this issue for the three utilities or the facts and circumstances are essentially the same such as if the Commission chooses to apply a similar logic you'd expect a similar decision you got in HELCO for the other two utilities?

Well on our positions we are going to take similar positions for the Company. The Commission still needs to go through its process of evaluating each utility separately, and so we do need to see what they will say in each of those cases separately.

Okay, thanks very much.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of James Bellessa with D.A. Davidson & Company. Please go ahead.

Afternoon.

Hi, James.

It seems to me that you've seen this struggle that you're facing right now in the utility for a long time, and I'm wondering why you didn't start earlier in trying to build new plant and equipment and get rate basing or is it a situation where you have to be hemorrhaging in that state before you get adequate rate relief?

Jim, This is Mike. Good question. We have actually had in our plans for a number of years to add generation. We have known since 2002 that we had the need. We've had the applications and the process under way, and it just takes awhile to site and build a power plant in Hawaii. That's also true I think probably for most utilities around the country. Siting, infrastructure whether it be transmission or generation assets have a higher level of scrutiny and involvement by everyone from the community to the regulators, all of the environmental it's and that is probably more indicative of our times than it is unique to Hawaii.

When you get the new plant and equipment up and running, will you not still have this older plant and need it as part of your core assets and therefore, you still have O & M expenses on it?

Well, keep in mind, Jim, that the real crunch that we are experiencing isn't during our peak period. We don't have a problem over our normal load. It's in the peak period so this 2009 unit is actually a peeking unit, so what we're having to do is keep all of our units because of the tight reserve margin during peak period that the finest level of reliability as we possibly can, hence the O & M expenses. When we get the peaking unit in 2009, it should provide some relief from that situation we find ourselves in.

Thank you very much.

And at this time we have no more questions in queue. I would now like to turn the call back over to Ms. Suzi Hollinger for closing remarks.

Thanks, everyone for participating on the call. If you have further questions please call me at 808-543-7385. Aloha.

Thank you for attending today's conference. This concludes the presentation. You may now disconnect and have a great day.