Hawaiian Electric Industries Inc (HE) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the second quarter Hawaiian Electric Industries Incorporated earnings conference call. We will be facilitating a question-and-answer session toward the end of the conference. (OPERATOR INSTRUCTIONS) I would now like to send your call to Ms. Suzy Hollinger, Manager of Treasure Investor Relations.. Please proceed.

Aloha. Thank you for joining us on an update on HEI. Here with me from Senior Management and speaking today are Connie Lau, HEI and ASB President and CEO and Mike May, HECO President and CEO. Eric Yeaman, HI Financial Vice President, Treasurer and CFO, , Alvin Sakamoto, ASB Executive Vice President , finance, and Tayne Sekimura, HECO Financial Vice President are also on the call. In addition, American Savings Bank has a new Chief Operating Officer, Tim [Skool] who joins the bank from the South Financial Group, the largest publicly trading company headquartered in South Carolina where he most recently served as EEP and Chief Financial Officer. Tim is well-known to banking analysts on the street and created TFFGIR program which was recognized by Institutional Investor magazine as the leading IR program among all banks. less than $100 billion in total assets.

Connie will start today's presentation with a few comments on second quarter earnings and the Hawaii economy. Mike will follow with an update on the utility, and then Connie will come back to discuss the bank and make some closing remarks. At the end 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 IV of our second quarter form 10-Q that was filed yesterday for information about forward-looking statements. Now let me turn the call over to Connie to begin the

Thanks Suzy. Aloha and good afternoon. As anticipated when we last spoke with you in May, our operating subsidiaries continue to experience the challenges faced in the first quarter of 2007 and the last half of 2006. In the second quarter, our utilities saw rising O&M and depreciation expenses and our banks earnings were impacted by difficult interest rate environment and high non-interest expenses. These factors contributed to lower quarter-over-quarter earnings per share of $0.21 cents. The financial details of the quarter were included in the earnings release and form 10Q that Suzy mentioned were filed last night. I assume most of you had a chance to read through the release so we won't go through it, but would be happy to answer any questions you have at the end of the formal presentation. These financial challenges will be with us until our utility receives rate recovery of higher O&M expenses and capital investments and the interest rate environment becomes more favorable for our bank.

We continue to focus our efforts on 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. Mike and I will discuss our efforts in these areas in more detail. Let me now briefly update you on the Hawaii economy. As most of you know, Hawaii experienced solid growth over the last five years. State economists continue to expect moderate growth over the next several years in the 2 to 2.5% range. The outlook for continued growth is supported by the expectations for increases in real personal income, jobs and visitors as well as low levels of unemployment.

The visitor industry continues to perform well although visitor days are slightly off record 2005 levels, we continue to see growth in visitor expenditures which were up 1.2% through June, 2007 compared with the same period of 2006. That trend is expected to continue with growth in 2007, visitor expenditures projected at 3.3%. The construction sector showed strong job growth of 5.9% through June, compared with the same period of 2006. A significant increase in commercial construction, in part due to $854 million of government construction contracts is more than offsetting the decline in residential construction. Growth in government construction contracts is expected to continue. Announcements of three new entrants to the Hawaii marketplace, Walgreens, (inaudible) Foods, and Target will also support future commercial growth. Unlike real estate values in other parts of the country, Oahu real estate crisis continue to hold up increasing 2.4% for homes and 5.7% for condominiums, period over period.

Year-to-date volumes have slowed after record levels of growth in 2004 and 2005. As values have held, we continue to see near historic low delinquency trends in our bank's residential loan portfolio. In summary, the Hawaii economy is expected to grow at a moderate pace for the next several years. This growth will continue to impact the operations of our subsidiaries. Now let me ask Mike to update you on the utility.

Thanks Connie. Aloha and good afternoon. Growth in the state economy that Hawaii---- Connie just discussed has resulted in higher electric demand. We saw record growth in 2004 and have maintained those high levels. To meet these higher load levels our generating units are running more frequently and at higher levels of strain than in the past. We continue to focus our efforts to promote energy efficiency, energy conservation programs. These actions, along with aggressive implementation of load management programs are helping us during our peak load periods.

As we previously mentioned, O&M expenses continued to increase as a result of the higher load levels. As Connie noted earlier, these increasing costs continue to challenge our results. We expect these costs will remain high given our current generation reserve situation. These higher O&M expenses are part of our pending rate cases which I will be covering shortly. To address these challenges, we are executing a strategic plan that focuses on making needed reliability investments and seeking recovery of costs through a rate making process. In line with this strategy, over the next five years we are forecasting approximately $1.2 billion in capital expenditures to increase generation capacity and maintain and improve reliable service for our customers. This slide shows the anticipated utility capital expenditures by year. One of the major large projects is a new 110 megawatt bio-fuel picking unit here on Oahu planned for 2009. I'm pleased to report that we have received both the PUC approval and APA air permit for this unit. This generating unit is one of many efforts underway to increase our renewable energy portfolio and support the stage energy policy of reducing our dependence on fossil fuels.

Our strategy also includes seeking rate relief at all three utilities to recover the cost of reliability investments and increased O&M expenses that I had mentioned earlier. Timely and adequate rate recovery of these costs is crucial to improve our earnings. As you know, we have four pending rate cases. Two for our Oahu utility and one each for our Hawaii island utility and our Maui county utilities. Interim decisions have been received for the 2005 test year Oahu case and the 2006 test year Hawaii island case. Interim decisions are expected later this year for the 2007 Oahu case and in early 2008 for the Maui case. Given the number of rate cases before I PUC it is important to note that the third PUC commissioner's seat, a seat which has been vacant since August of 2006 has recently been filled in July.

To sum up, we continue to see the effects of Hawaii's economic growth on electric sales. Tight generation reserves have resulted in higher O&M expenses. We are addressing these type generation reserves through increased capital expenditures or new generation capacity and other reliability investments. And, at the same time we are pushing DSM and load management programs to reduce demand, especially during peak times. To recover increasing costs and improve earnings, we have several rate cases in progress. With a focus on improving our earned rates of return. With timely and adequate rate relief, we expect to recover these higher costs and improve our earnings. Now I'd like to turn the call back to Connie to discuss the bank.

Thanks, Mike. An extended period of high short-term interest rates, combined with a flat yield curve has created a challenging operating environment for banks and especially thrifts. This environment has pressured net interest margins and caused a migration of lower cost transaction deposits into CDs and other higher paying accounts. In addition, the slowing economy has tempered loan demand.

While our bank is experiencing similar trends in many of these areas, we have managed relatively well through this difficult interest rate environment and importantly, we have not experienced a significant decline in asset quality as with many mainland banks. This chart highlights why the interest rate environment has challenged net interest margins for most banks and especially for ASB. When the Federal Reserve began increasing interest rates in mid-2004 we were able to withstand the margin pressure, largely because Hawaii deposit costs lagged the increase in short-term interest rates, while yields on our growing commercial and commercial real estate loans increased with market rates. When short-term rates plateaued in mid-2006; however, margin pressure significantly increased for American. This was because asset yields on our commercial and commercial real estate loans stopped increasing.

While Hawaii deposit rates, which had lagged overall market rates, continued to increase as depositors shifted funds into higher yielding alternatives. Since then, the persistent high, short-term interest rates have made it more and more difficult to attract and retain deposits. Hawaii market data for the 12 month ended March 2007, for the for major Hawaii banks, showed that deposits were essentially flat with the decline in lower cost transaction accounts and increases in higher cost CDs. This trend continued in the second quarter, leading to a decline in our total deposits. To counter these unfavorable market trends, we remain focused on building our franchise by targeting the full customer relationship with an emphasis on capturing the deposit relationship.

Our market research shows that customers value convenience and customer service and we are aiming to be the market leader in this area. Not only do we have the second largest branch network in Hawaii, we also have more extended hours than any other local bank. At the end of this month we are furthering our commitment to convenience in customer service by expanding branch hours. We have been gradually modifying our staffing model in anticipation of increasing operating hours. As a result, we should be able to implement this strategy with minimal increases in personnel costs. In our lending activities, outstanding loans grew about 1.8% during the quarter. In spite of the slowing residential real estate market, mortgage originations have remains good while repayments have slowed, resulting in moderate growth in residential loan balances.

As we discussed in previous calls, a decline in commercial real estate loan balances was expected due to our shift in emphasis from construction lending to income property lending. In addition, the decline in commercial loan balances was due to both schedule and unscheduled pay downs. For the remainder of the year, we expect continued modest loan growth. Overall credit quality remained good during the quarter reflecting the strength of the local Hawaii economy. Our non-performing asset ratio remains well below industry averages. The increase in the non-performing asset ratio in the second quarter is attributable to one commercial borrower for which we increased the provision in the second quarter. Given the outlook for the Hawaii economy, credit quality is expected to remain good. However, situations with specific borrowers or changes in the economic outlook may cause credit costs to increase.

As discussed earlier, prices for local residential real estate remain stable and we have not experienced increases in foreclosures. We continue working to offset margin pressure by focusing on growing non-interest income and managing our non-interest expenses. One of our primary non-interest income initiatives is in the area of car payments. The work we have been doing to increase adoption and use of debit cards is showing results. Through June, income from debit card use is up 15% on a year-over-year basis. As I have discussed previously, we are strengthening our risk management and compliance infrastructure. The investment we are making in these areas is not uncommon in the industry and is necessary due to increased regulatory standards. We believe these enhancements will provide the infrastructure to support our future growth for some time. Overall, our outlook remains unchanged. We expect the difficult interest rate environment to persist through 2007 and possibly into 2008. Accordingly, we do not expect significant relief from margin pressure. Over the long-term, we remain optimistic about our ability to improve profitability and grow earnings through our transformation to a full service community bank. Although the yield curve changes constantly, the significant progress that we have made in transforming the bank over the past several years has helped tremendously in keeping the banks earnings stable in difficult market conditions.

Now let me wrap up the presentation with a few closing comments. First, a word about the dividend. At 5.4%, our dividend yield is attractive. We know that the dividend is key for our investors and we intend to maintain the dividend. While several key factors are currently impacting the earnings of our core businesses, the long-term outlook for our company is positive. To maintain reliable service we expect that O&M will continue to rise and have included these costs in our pending rate requests.

As Mike discussed we have interim rate relief for two of our cases and expect interim decisions on the HECO and MECO cases later this year and early next year to recover these rising costs. The bank is managing well through the difficult interest rate environment and is making necessary investments in its risk management and compliance infrastructure as it transitions to a full service community bank. This will put the bank in the best position to continue to compete and grow. We intend to maintain the dividend and are focused on key strategies in each of our core businesses to drive long-term earnings growth. This concludes our formal comments, and we'll be happy to answer any questions you have. Could you call for questions please?

(OPERATOR INSTRUCTIONS) Your first question will be from the line of Paul Patterson, please proceed.

Good morning, guys.

Morning, Paul.

Good morning, Paul.

Looking at the challenges that you're seeing in the second quarter which, as you said were a continuation of the first quarter, are you guys seeing anything that indicates that perhaps you guys didn't ask for enough in the original filings for the rate cases and that you might have to go in again. Obviously it depends on what you get, but can you give us more of a feeling as to what you're seeing with the trends with that?

I think Paul, as a general rule, what we are spending is consistent was what we're asking for in the test year rate case. And so, they're very much in parallel at this stage.

Okay, and then on the bank, it looked like the net reserve margin-- the net interest margin, excuse me-- had increased over the last two quarters. Do you think that's a trend? Is that an aberration? Could you give us a little bit more flavor for that?

Yes, the quarter linked and interest margin did increase. That is primarily due to the adjustment on the investment securities portfolio that we have, and I think, Paul, as you've seen over the quarter, that can tend to be fairly volatile because that is set really at quarter-end at a point in time.

Okay, and how much was that again? I can look it up in the 10Q. I don't want to-- I just was wondering, how much I guess-- that's contributed a significant amount I guess. I'll just try to back it out later.

It's usually you know, several basis points.

Okay, and then the bank-- , I guess you guys had no-- , I guess you guys grew your loans again, but no loan loss provision except for this $1.2 million from a commercial borrower, is

Yes, that's correct.

Okay, and then-- and then when we're looking at the higher non-interest income, it sounds like you're pretty optimistic that that could continue to grow, is that right?

Yes.

Okay, and then finally, the non-interest expense, which you mentioned it was sort of an investment in the future, should we expect this to continue? The risk management compliance infrastructure costs, I know there were litigation expenses last year-- last quarter, excuse me-- what should we think about in terms of this non-interest expense growth going forward?

Yes, you should-- , you should expect that the levels will continue. I think Paul, as you've tracked us for a very long period of time, the bank has had to continue to invest in infrastructure as we transform the bank so we began first with building the commercial banking lines of business and commercial real estate and I think you'll recall that we began last summer to look at the operational risk area and so we are full swing in the middle of building out the risk management and compliance

Okay and then you mentioned just finally the long-term-- the long-term outlook for the business you felt was good and that you, I think the term was, you plan to attempt to maintain the dividend. Could you just elaborate a little bit more on that in terms of what we should think about in terms of the dividend?

Yes, as we've said, the current earnings of the operating companies are depressed on the utilities side, primarily because we need rate relief and on the bank side primarily because of the shape of the yield curve. And, we believe that we can maintain the dividend through this difficult period and that when the utility receives rate relief and the operating environment for banks and risks is more normalized that the earnings will recover.

Great, thanks a lot.

Your next question comes from the line of James Bellessa, of D.A. Davidson & Company.

Paul asked several of those questions I had, but a couple remaining ones. How long does this difficult period remain? When do you get rate relief? And when does the shape of the yield curve change?

I wish I knew about the yield curve. And on the rate relief side, I think as Mike has telegraphed, we have a number of the rate cases pending. We should be looking at some interim increases for the 2007 cases later this year and in 2008. And, let me ask Mike if he has further comments on that.

Yes, Jim, I think the key is timing and adequacy of rate relief, very key here. We spending to deliver a reliable product and service to our customers and we need to be basically, covered in our costs and expenses to do so. The rate case as we've talked, we had a 2005 which we were seeing very timely, interim on. We had a 2006 HELCO which we received a very timely decision on, and we're right in the middle of expecting some closure on the HECO 07 rate case. These will be key determining factors. In terms of answering your question on the timing. One might also reasonably expect, that as I mentioned in my prepared remarks, we have a $1.2 billion CapEx plan, and, as we go forward with that, one could reasonably assume there would be other rate case activities associated with recovering our investments associated with that capital program.

With the dividend payout ratio like it is, are you facing any bond covenants or other issues that would cause you to have to reconsider your maintenance of the dividend?

Jim, not at this time.

And regarding this provision for loan losses, you never know when these-- you say one commercial borrower is going to have problems, why don't you just have a more even keel loan loss reserve provision every quarter and not have to wait until these hit problem after problem and just add a more even addition to your reserves?

Jim, I wish that we could, but under the accounting standards, we have to have a very elaborate methodology to calculate the loan loss reserve. And so, there are very specific quantitative measures that go into that model as well as qualitative measures that are really translated into quantitative measures. And so, many times we would like to increase that reserve, but we really cannot do so. We have to make sure that it is accurate for expected losses in the loan portfolio at a point in time.

Six months from now, what would cause you a nightmare in terms of what happens with the yield curve? What would be something that would be very difficult to go through? You're talking about waiting for the yield curve to improve in your favor, but what would cause it to go the opposite direction?

I think if short rates spiked, that would create more of an issue for us, although I do think that the current flat and somewhat inverted yield curve that we've been experienced for quite some time now actually will continue and , as I said in the prepared remarks, we're not expecting any near term relief from the shape of the yield curve. That's the reason why we're really focusing down on the fundamental strategies of growing the retail franchise and particularly the deposit

Thanks Connie and Mike.

Thank you, Jim.

Your next question comes from the line of Edward [Haight] of Catapult Partners.

Good morning.

Morning.

Just -- I just had a quick question to clarify on the dividend. I know you made some comments, but --- Just,-- if I look at the-- you're kind of trailing 12 months of earnings, it looks like on that basis you're actually earning below the dividend payout right now. Do you-- are your comments basically saying that if you do not kind of reach-- earning the dividend in 2007 you're going to continue to maintain that, even if it goes above 100% payout ratio in the near term. Is that where the board and management has kind of come out on that at least in the near term?

Yes, and we've gone through these periods before when the utility has been faced with the need to make capital investments to continue providing reliable electric service in Hawaii and we're now experiencing the lags to recover those costs through the rates and so-- this has happened before and that is the position of the management and board.

Okay, and then when do -- is that looked at on a quarterly basis about whether-- , what to do with the

Yes, actually we continuously look at the situation of the companies.

Okay, great, thank you very much.

Your next question comes from the line of Peter Hart. of DeLong Capital

Hi Connie, it's actually Mark [Luniberg]. so, my question's not going to be as astute as Peter's usually is. Just, if you can give flavor, we're looking at the queue here about the loan portfolio, I see 74% of your portfolio is residential loans. Could you give quality matrix giving everything that's going on in the market relative to delinquencies, loan values, sub prime, what kind of loans you've been making to give comfort on that?

Sure I'm looking over at Alvin for the statistics. Let me give you an overall. The loan portfolio, that residential loan portfolio still is that traditional loan portfolio that we inherited as a thrift and so this Hawaii market has primarily been a fixed rate,long market. So most of what's in that portfolio is 30 year fixed rate mortgages and some 15 year fixed rate mortgages. And on the sub- prime area, this institution has never made sub-prime loans, and so we do not, we are not affected by that particular problem. And let me see if Alvin has anymore--

How about average loan to value, or delinquencies, 90 days, anything you might have to give some color?

Right now delinquencies are very low. Almost at historic lows. And. if it was not for that one commercial borrower, it would probably be at an historic low as far as the allowance. And again, as Connie had mentioned, really, you hear a lot of things about sub-prime lending and in our residential portfolio we do not have any sub-prime lending programs and so that affects whatever you see on the mainland, it's not happening here at ASB. As far as the other loans, the commercial and, the commercial real estate loans, they're-- right now I don't believe there're any delinquencies really in the commercial real estate loans, it's really a good portfolio. Asset quality is still relatively high and as we mentioned in prepared remarks that really, on the commercial side, it really depends on-- there could be a borrower that had specific issues and reasons for them to incur any issues.

Okay and if I remember right, historically your loan to value ratio has been very low in the overall portfolio?

Yes that's correct.

Okay, great, thank you very much.

Your last question comes from the line of James Heckler.of Levitt Capital Strategies

Good morning.

Morning.

My question's also regarding the dividend. And, I was wondering if you could just talk a little bit about the composition of where the cash is coming from to fund the dividend. I guess more specifically-- when I look at the cash flows from the utility operations, is there sufficient cash flow from operations there to fund the operations capital expenditures and the dividend? Or, is it the--- is the dividend--- is the cash that's being created at the utility actually staying there?

Hi Jim, this is Eric Yeaman, great question. Just to sort of give you an overall perspective. The dividend is about $100 million a year and about half of that is funded through our dividend reinvestment program with the other half being funded by the bank. The bank is at a point where it has-- it's reached its target capital levels, and so over the last several quarters has been dividing 100% of its earnings to the holding company to support the external dividend. That is anticipated to continue.

Okay, thank you.

And you have a question from the line of Steve [Gambudra\ of Long Bow Capital.

Good morning.

Hi Steve.

Hi Steve.

Did you say that 50% of the common dividend is--- is kind of-- of a pay in kind dividend or you issue shares to cover $50 million dividend payment?

That's correct, approximately 50% based upon our historical experience on the dividend reinvestment program.

That's just based on people-- they subscribe to that program essentially.

They basically reinvestment, right-- dividends so you don't have to pay out the cash. We began issuing new shares on that program in early March and just prior to that we were purchasing shares on the open market to fund it. But given the need for capital investment at the utility, we reinstituted in early March issuing these shares under that program.

Okay, so when I look at the consolidated cash flow statement historically, there has been every year kind of some marginal issuance, that represents the drip and you'd--

No, not every year. Again we reinstituted issuing new shares in March of this year and for the two years prior to that, we were purchasing shares on the open market. But it you go back beyond the two years from March you will see what the trend was relative to issuance of new shares under the dividend reinvestment program.

See the marginal amount that you were seeing likely is from the stock option exercises.

Okay, you have no more questions at this time. I would like to turn the call back over to Miss Suzy Hollinger for closing remarks.

Thanks everyone for being on the call. If you have further questions, please contact me at 808-543-7385 and have a nice day.

Thank you for your participation in today's conference. This concludes the presentation and You may now disconnect. Have a great day.