Hawaiian Electric Industries Inc (HE) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Fourth Quarter 2007 Hawaiian Electric Industries Incorporated earnings conference call. My name is Lauren and I'll be your coordinator for today. At this time all participants are in listen only mode. (OPERATOR INSTRUCTIONS) I'd now like to turn the presentation over to your host for today's call, Ms. Suzy Hollinger, Manager of Treasury and Investor Relations.

Hello and good afternoon, thank you for joining us for an update on HEI. Here with me from senior management and speaking today are Connie Lau, HEI President and CEO; Mike May, HECO President and CEO; and Tim Schools, ASB President. Also on the call today are Curtis Harada, HEI's acting Financial Vice President, Treasurer and CFO; the Utilities COO, Eric Yeaman; and CFO Tayne Sekimura, and the Bank's CFO, Alvin Sakamoto. Connie will started today's presentation with a few comments on 2007 earnings and the Hawaii economy. Mike will follow with an update on the utility. Tim will then discuss the bank and Connie will make 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'd like to alert you that forward-looking statements will be made on today's call. Please reference Page 2 of our Annual Report filed on 8-K this morning for additional information about forward-looking statements. Now let me turn the call over to Connie to begin the formal comments.

Thanks, Suzy. Aloha and good afternoon. One of the key issues for HEI has been to obtain recovery of cost incurred at our utilities and earn a reasonable return on our investments and rate case. Beginning in mid 2006, we filed three rate cases for each of our utilities and began receiving $108 million additional annual revenues from interim decisions in these three cases in 2007. Mike will discuss more detail --

You may proceed.

Because much of this rate relief was received late in the year, 2007 net income was $85 million, down 22% compared to 2006. Bank net income was down 5% year-over-year, but the decline in bank net income was almost entirely offset by 10% lower holding company losses. The financial details of the quarter were included in last night's earnings release, and our 2007 Annual Report that was filed on 8-K this morning. I assume most of you had a chance to read through the release, so I won't go through it, but would be happy to answer any questions you have at the end of the formal presentation.

Let me now briefly update you on the Hawaii economy. This slide shows a snapshot of Hawaii's economy over the last five years. As you can see, Hawaii experienced robust growth over the 2004 to 2005 period, with growth moderating to a more sustainable pace of around 3% in the 2006 to 2007 period. Growth in 2007 reflected continued job growth, low unemployment, strength in commercial and military construction, and stable home prices. The visitor industry saw a modest decline in arrivals, but length of stays remained flat with 2006. Visitor expenditures were $12.2 billion, slightly higher than they were in 2006. Over the next three years, state economists expect growth to slow to about 2.5%.

Tempering Hawaii's growth rate projections are the effects of a weakening U.S. economy and persistent high fuel prices and their possible effects on tourism and consumer spending. While subprime loans were originated in Hawaii over the course of the last several years, the impacts of the subprime mortgage crisis have not had a significant impact in Hawaii as on the mainland. The foreclosure rate in Hawaii remains one of the lowest among all states. Although transaction levels have fallen off, overall prices had remained relatively stable, especially on Oahu. Several factors have contributed to the relatively strong performance of the housing market, including the stable economy, strong job market, and lack of excessive overbuilding in prior years.

In summary, Hawaii's economic growth rate is expected to moderate to about 2.5% in 2008 after several years of solid growth. Risks include a national economic recession and the timing and severity of its impact on the Hawaii economy and continued volatility in the national market and its effect on interest rates. Now I'd like to ask Mike to update you on the utility.

Thanks, Connie and good afternoon. As Connie mentioned, a key objective for the utilities in 2007 was to obtain recovery of cost and a return on investments we are making in the electrical system. Let me begin my discussions with that topic. In 2007, as summarized in this slide, we received interim rate relief for all three of our utilities. Most recently in December, we received an interim rate increase for our Maui County utility. I will discuss that decision in greater detail in a moment. In total, we recorded $32 million of additional revenues due to rate relief in 2007. Because the HECO and MECO decisions came later in the year, we expect to see incremental revenues of $76 million in 2008. These three rate cases will help our utilities to recover higher levels of O&M cost and a significant amount of capital projects completed in the last several years.

As I said earlier, in December, we received a $13.2 million or 3.7% interim increase for our Maui County utility. We began recording the additional revenue in late December. The interim decision reflects the terms of a settlement we reached with the Hawaii Consumer Advocate. Like the HELCO and HECO rate case decisions, the MECO decision also included a tracking mechanism for pension and post-retirement benefits. All three companies are also continuing to pursue a tiered rate structure to encourage residential conservation of energy.

The rate relief we received in 2007 was partially offset by two one-time charges. In April, we recorded a write-off of $12 million or $6.9 million net of taxes for costs related to the Keahole plant addition. In the third quarter we accrued reserves for a refund to Oahu rate payers due to the proposed final D&O for the HECO 2005 test year rate case. This totaled $16 million including interest or $9 million net of taxes. Although these charges had a significant impact on our 2007 results, they also resulted in needed closure for these items.

Looking ahead, we expect sales to remain relatively flat. Our customers are conserving and using energy more efficiently and we've been encouraging them to do so. The new commercial construction is substantially more energy efficient. And existing facilities being made more efficient through retrofits. However, despite relatively flat sales growth, overall demand for power remains high, near record levels set a few years ago. The need to meet these high demand levels continues to put pressure on our aging generating units, especially on Oahu. As a result, O&M expenses have increased and the rate relief received will help recover the majority of these costs. In 2008, we do expect some O&M increases due primarily to inflation and our continuing tight generation reserve margins.

We are making capital investments to address the need for additional generation and transmission capacity, and to modernize our infrastructure. Over the next five years, we are forecasting $1.3 billion in gross capital expenditures for these reliability investments. The majority of our capital expenditures are expected to be financed with internal sources of funds; however, borrowing levels are projected to increase moderately to finance a portion of these projects. We'll continue to focus on the recovery of these increased investments and earning a reasonable return through a rate case process.

And before I wrap up, just a word about another aspect of our overall energy strategy. A critical component focuses on increasing our portfolio of renewable resources. So noteworthy examples of our efforts include our new combustion turbine which will be fueled by renewable biofuel. This unit will be 110 megawatts of firm, renewable power on our Oahu system. Also, on Oahu we've issued a request for proposals for up 100 megawatts of additional renewable energy. And on Maui, we've recently signed a memorandum of understanding with Oceanlinx of Australia to add a 2.7 megawatt wave energy demonstration project.

To sum up, 2007 was a year in which we gained significant interim rate relief for all three utilities. This will help recover higher O&M costs and significant investments in our electrical infrastructure completed in the last several years. However, inflation and tight generation reserves will continue, putting some pressure on O&M expenses. We are addressing this through the addition of new renewable energy generation and other reliability investments. At the same time, with we are encouraging energy efficiency and load management programs to reduce demand, especially during peak times. In the last quarter of 2007, we began to see the impact of rate relief on our utilities earnings, and we look forward to 2008 in which all three utilities will benefit from a full year's worth of rate relief. Now, I'd like to turn things over to Tim to discuss the bank.

Thanks, Mike. 2007 brought additional challenges to the Financial Services industry on top of what had already been for many a very difficult preceding two years. Since early 2005, the industry has been fighting off a rising and flattening interest rate environment and the negative effects it has on most net interest margins. After a prolonged period of historically low rates, depositors reacted by rotating their money in about the middle of 2006 into higher interest bearing accounts such as CDs. Further, those with a heavier reliance on interest rate risk for earnings, many of who levered up in excess securities, felt the pinch of a flattening yield curve. The more recent subprime mortgage issue has contributed to increasing delinquencies and foreclosures nationally. This created liquidity issues for many institutions throughout the fall, and has caused the banking system to tighten its credit standards, leading to increasing provision expense. Unfortunately, several companies took significant charges on top of already compressing earnings, with others having to either terminate business or, in the case of Countrywide, seek a partner to provide needed stability. While ASB's 2007 earnings declined 5% from the prior year, by all accounts, we fared very well on a relative basis. As you will see in a later slide, ASB has not experienced the level of net interest margin compression seen across much of the industry, and credit quality to this point has remained solid.

I would like to spend the next few minutes walking through our fourth quarter performance, highlighting each of our key ratios and then leave you with some of the key initiatives that we're working on. Net income in the Fourth Quarter increased to $17.2 million from $11.7 million in the third quarter. The increase was primarily due to the $8.8 million gain on the previously disclosed changes to the bank's defined benefit plan. Therefore, on an operating basis, our numbers and ratios would be more in line with the third quarter numbers presented in the slide. The numbers and ratios presented in the fourth quarter column, other than the net charge off ratio, are a good indication of what we would like to achieve on a continuous basis. Two things worth noting for the quarter are the expansion of our net interest margin and asset quality trends. As we mentioned in previous calls, we have been provisioning in prior periods for a single large commercial relationship. This quarter we actually charged that off, which resulted in a higher than normal net charge off, ratio and worked to lower our NPA ratio.

One of the primary key indicators in banking is the return on assets ratio. This slide shows that the we have actually proven to be more consistent over time, but are earning at lower levels than the average of both the bank and thrift industry. To me, this highlights the opportunity at ASB. If we achieved a 1% ROA, which is still below the historical average of the bank and thrift line shown here, we would earn about $70 million, an increase of $22 million in annualized net income or 45% annually from our current run rate. Alternatively, one might achieve a 1% ROA by shedding lower yielding assets that are not earning a cost to capital and returning the equity supporting those assets to investors, which in our case is our parent company HEI. We are evaluating plans at this time on how we can migrate ASB toward a 1% ROA. In all likelihood, our strategy would entail a combination of what I just described. The key to improving your ROA is knowing where the opportunity lies and where to spend your time. The forthcoming slides will help to point that out. As footnoted in this slide, 2004 includes a $20 million expense related to a tax settlement.

Net interest income in the fourth quarter increased to $49.1 million from $47.7 million in the third quarter. The increase was due to a seven basis point increase in the net interest margin and higher levels of earning assets. The seven basis point improvement in net interest margin was due to higher yields on earning assets while funding costs remain flat. We did see some relief from pressure on deposit rates in the fourth quarter, but our overall funding costs remained unchanged. We experienced a net outflow of deposits and made up for it with higher cost in wholesale borrowings. As you can see from the slide, we have some opportunity to improve our margin toward that of commercial banks, but it is in line with the thrift industry and actually has proven to be more consistent as I mentioned with our return on asset ratio.

The growth in assets in the fourth quarter was primarily driven by growth in residential loans of $71 million and commercial loans of $18 million, partially offset by lower commercial real estate balances and lower investment balances. One of our financial objectives is to reduce our interest rate risk by reducing our exposure to longer duration, fixed rate, residential mortgages, and continuing to increase the percentage of higher spread, shorter duration loans, such as business banking, consumer, and certain types of commercial loans.

When you study all of our key ratios, efficiency appears to be the primary cause behind our lower ROA. This is the measure of your non-interest expense to total revenues or said differently, how much it costs you to generate $1 of revenue. If you were to adjust our fourth quarter items that appear to be one-time, our efficiency ratio would be in the 68 to 69% range. This is higher than many of our peers and we will be working to bring this ratio down. You can reduce your efficiency ratio by increasing revenues or reducing expenses. The tick down in the chart for the current period is primarily the result of the pension plan benefit. The economic conditions make it very challenging in the short-term to improve this ratio through increased revenue. Further, as we saw our net interest margin is already in line with the thrift industry and Hawaii is not a high growth economy. Therefore, we will take a hard look at reducing our expenses. I will caution that the results from this type of effort take time, but I'm optimistic that we can reduce expenses without hurting customer service levels or negatively impacting safety and soundness.

Overall, credit quality remained good in 2007. As a result of our stable housing prices, and historical focus on prime lending, our residential loan and home equity portfolio experienced low levels of delinquencies. Fortunately, foreclosure levels in general, Hawaii foreclosure levels in general remain one of the lowest in the country. We have had no residential net charge-offs since at least 2002. In 2007, we had only one home equity net charge off at about $80,000. Prior to this, the last year we actually had a home equity net charge off was 2002. Most of our provisions for loan losses in 2007 were associated with the single commercial credit I mentioned earlier. I will caution you that our and the industry's credit costs have been at historically low levels the past five to six years. So we expect to see a normalization of credit costs for both ourselves and the industry, especially as the growth rate of the economy begins to slow. We continue to feel good about our underwriting and the quality of our portfolio; however, we have begun to see some migration in our commercial watch and criticize categories. This is not unusual activity and it is in line with industry trends. We are watching these closely and at this time, do not expect any material losses, but it will require an increase in provisioning. Importantly, our NPAs remain at a very low absolute level and compared with the industry.

In closing, it is interesting times, but we have been able to operate fairly stable. We have a sizable position in the Hawaii market and we are working on several exciting initiatives that we believe will improve our performance over time. First and foremost, we are going to embark on becoming a more efficient organization. With continued margin pressure and industry provision expense increasing, it is critical that we make this a priority. Second, we have a number of exciting revenue projects targeted at our single product customers in order to deepen our share of wallet of existing customers. Third, we are focusing our retail and commercial teams on the acquisition of new customer checking, or core operating accounts. This is the key to owning the relationship long term. Now let me turn the presentation back to Connie for closing remarks.

Thanks, Tim. While 2007 was a difficult year from an earnings perspective, progress was made on many fronts. Rate relief, much of which was received late in 2007, helped partially offset increased operations, maintenance, and depreciation expenses and two charges related to the HECO 2005 and HELCO 2006 rate cases. These interim rate increases helped put the utility on a more solid financial footing for the future. Our utilities also made progress in getting Commission approvals for critical capital projects that are scheduled to come online in 2009 and 2010. Our bank earnings were down only 5% in 2007, despite a challenging environment for financial institutions. Margin compression continues, although as Tim mentioned, some relief was seen in the fourth quarter. Provisions for loan losses were higher primarily due to loans to a single borrower, and overall credit quality remained good. Non-interest expenses, excluding a pension change, were higher due to legal expenses and costs to strengthen compliance and risk management infrastructure. Non-interest income was higher and along with the gain on pension changes helped bank earnings.

At the holding and other companies, gains on sales of non-strategic assets helped dilute earnings and we no longer hold any significant non-strategic investment. In 2007, the Board maintained the dividend and yesterday, they declared a quarterly dividend of $0.31 per share, payable on March 11 to shareholders of record on March 3rd. At 5.5%, our dividend yield remains attractive.

Overall, we look forward to a better year financially in 2008 and remain focused on key strategies in each of our core businesses to drive long term earnings growth and increase shareholder value. While we expect to benefit from a full year of rate relief in 2008, expected increases in O&M and depreciation will offset some of that impact. Our utilities focus in 2008 is to put additional generation and transmission capacity in place. To earn on this growing rate base, we will need to seek recovery of cost and return on those investments. In addition, we continue to pursue renewable energy and conservation initiatives. At our bank, we expect that margin compression and loan loss provisions will continue. We will continue execution of the transformation strategy, paying particular attention to those areas with the best potential to drive future profitability and, as Tim mentioned, manage costs. This concludes our formal comments and we'll be happy to answer any questions you may have.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Paul Patterson with Glenrock Associates.

Good morning, guys.

Hi, Paul.

I want to touch base with you on a couple of things. On the utility, it sounded like you guys mentioned the $76 million of additional revenue benefit in 2008. Does that include the absence of the refund in Oahu, or is that just from the rate case, just from the annualization of the rate case?

The rate case refund was reserved in 2007.

Right, so in other words, would that be an additional amount of money we would expect, would that be part of the $76 million increase you're talking about?

No. The amount just reflects what we got in all the interim decisions, Paul.

So the other, the $16 million and the other I guess $12 million would be in addition to that? Year-over-year I would expect, right? Because those were one-timers?

Yes, and the amounts you're talking about are revenue numbers.

Right, pre-tax. Okay, and then the other question I have is on the O&M, it sounded like there was a $6.8 million timing issue in the fourth quarter. For the year is there any timing issue we should expect? I know there's normal O&M inflation, everything else you mentioned, but is there anything else we should think about in terms of impacting O&M, any more color you can give on that?

Well, there's always the unknown, Paul. Like the 2006 earthquake, it's hard for us to predict acts of God. We had a couple of storms last year that -- one in December, one earlier in the year. Those things are always difficult to predict but do have an impact on our O&M. So other than what we would characterize as inflation, we are seeing a run up in commodity cost. I think as you listen to other calls you're probably hearing the same comments. But one of the things that we're pleased to say is that we believe that the interim decisions that we received is in large part recovering or covering a lot of our O&M expenses.

Excellent. Now let me ask you about the gains of the holding company. It wasn't clear to me exactly from reading the press release how much in terms of -- there was some sale of I guess non-core stuff and also some investment gains. How much would you say there was at the holding company and how much should we expect going forward? How much of that was sort of the usual versus sort of unusual?

For the year, we had a $2.2 million gain from the sale of non-strategic assets versus last year, but last year, we made some adjustments to either writedown or write up assets. But essentially now all of those assets have been sold, and we really have no more material investments in any non-strategic assets.

So there was a $2.2 million sale that probably won't be recurring and also some investment gains mentioned as well in 2008? Is there any number associated with that?

All included in the $2.2 million.

Okay, great. And then with respect to the bank, just in terms of the loan loss provisions, you mentioned the single borrower but you also, which seemed a little unusual I guess, and then there is also sort of the mention that just in general we should expect higher loan loss provisions. Can you give us any flavor as to what we should be thinking about going forward with respect to that line item?

That's a tough one to answer because we're not, we don't offer guidance, but -- I guess one way I would think about it is if you just look at -- and this is going back awhile, but if you go, the chart I showed you, net charge-offs have been very low the last five or six years, if you look prior to that the period , I think ASB probably ran $2 million to $5 million a year in provision expense, so

You're now around $5 million, right?

What's that?

2007 was over $5 million if I'm correct, correct? $5.7 million?

Right. But that the provisioning was largely related to the one commercial customer.

Right, but now you have more loans than you had before the sort of abnormally low level of loan losses that you had for the last couple of years, right?

I don't know that more loans really, I don't know again being sort of new going back 10 years ago I'm not sure what the size of the bank was. But I don't think the bank is substantially larger from a loan portfolio. What's interesting is the mix of loans is different. So if you look today at the portfolio versus 8 to 10 years ago, there's a much larger commercial portfolio. So even if you benchmark next year provision expense to say 2001 or 2000, it's a little bit different risk profile. It's not high risk, but if you did a probability of default on a commercial loan and a probability of default on a residential first mortgage, it would be higher statistically. So I know that's not the exact answer you wanted, but --

Okay we'll take what we can get. Let me ask you this -- with the non-interest expense and with this $1.1 million and $8.8 million of [line] benefit, you're mentioning getting those costs down. And it would seem to me that that might be a little bit challenging with what seems to be non-recurring benefits to those, to that line item. I mean, I guess just sort of in the general thought here, Tim, on this getting to a 1% ROA, what kind of timeframe are you thinking about that actually occurring? I mean if you could just give us a little more flavor in terms of what kind of cost reductions on this non-interest expense item which has been rising. I mean I know it's not as [legal] and just what should we be thinking about that?

First of all let me just say to you and the folks on the phone, it's in its infancy and it's something we've been talking about for maybe the last two to three months. And so we don't have our action plans and timetables and milestones in place. So anything I mention to you, it's very much in its infancy and I'll share my thoughts on the topic. My thoughts are if you look at our efficiency ratio or another ratio that banks tend to look at, that takes out the impact of revenue, is non-interest expense as a percent of assets, and if you look at either of those ratios, we are above the median in the industry. And so there should be an opportunity to reduce expenses. Now, you can either go and just cut everybody's budget 10%, which really isn't a prudent way to manage a company, or you can take the time to search for where are you inefficient and do some benchmarking. That's going to make it take longer. So my personal ambition is if we cannot make material progress towards this goal over sort of a 24 month period, I personally am going to be disappointed. As you saw in those slides, an average thrift probably runs over an extended period, maybe a [1.10] ROA, and an average bank maybe [1.20 to 1.30] and we're trying to migrate from a thrift to a bank, so certainly, we should aspire to be at the average line. We should aspire to at least be at that the [1 to 1.10].

Okay, thank you.

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

Hi, good morning. Maybe just to follow on on your thought there, Tim, my recollection was there was a fair amount of investment at ASB into systems and et cetera. Is that also an opportunity here, those costs are dialed back for you to be able to hit the numbers you're looking for in the next year or two?

I think there's opportunity across-the-board, and again, we're just starting our benchmarking. There's a company out of Arizona called Cornerstone that -- and there's lots of benchmarking you can get, but they're one that's sort of well known and they have a population of about 60 banks and they probably have 200 variables and they benchmark every two years, stuff like how many auditors do you have per FTE, how many auditors do you have per assets, everything. How many online banking customers do you have per checking account? And we need to participate in that type survey and then just go across our company and I think we're going to find opportunities on contract renegotiations. I think we're going to find opportunities on data processing expense. I think we're going to find some opportunities in FTE, and it's just going to be across-the-board. In fact I don't think I answered the prior gentleman's question on size. One way I think about it is if you sort of try and commonsize the non-interest expense to total assets or an efficiency ratio simply by looking at expenses, about a $20 million reduction in pre-tax expenses would equate to about a 60% efficiency ratio roughly. It also equates to sort of our 2006 run rate which was just two years ago, so that doesn't seem irrational. If we were there just two years ago, we have not added a lot of branches, we have not added any branches. We're sort of net branch neutral if not a few closures -- same size company, seems like we could get back to a run rate from two years ago.

Great, and thanks. I appreciate your Southern Hawaii accent and how that brings good diversity to this call, Tim.

Well, I was telling them the other day like Ricky Bobby says in Talladega Nights, if you ain't first, you're last, so --

Exactly. One question -- we switch to the utility, I know there's been approval for more infrastructure spend and what's the strategies to get recovery of those costs during the next couple of years?

Well, the answer I guess in a plain and simple, Dave, is that you heard us talk about our capital expenditure plan and one might reasonably assume that as you're spending at the levels that we anticipate, $1.3 billion, one might reasonably expect that we would be filing rate cases to seek timely recovery of those investments.

Okay, so I'd assume there will be several more rate cases here in the next short while, I assume then?

One might assume that.

Okay, and one last question, I think I saw a headline about a potential, and this is probably for you, Mike, that by a potential Hawaii biodiesel provider looked as if they've backed off on their plans to build a facility on the islands. Any comment as far as source for biodiesel for the future or does that change your outlook on your plans?

Just for all of the callers, the supplier in question is Imperium. Imperium has 100 million gallon facility that they have in Washington. They have committed to us that if they lag on their facility development here that they will be supplying our biodiesel from their Washington facility. So we do not see anything based on their commitment that would lead to inability to reach supply. The fuel contract is still under review by the PUC as well.

Okay, great. Congratulations on a good quarter.

Thanks, Dave.

Your next question comes from the line of Neil Stein with Levin Capital.

I had a couple of questions if I could. First for '09, could you quantify or provide any guidance on what these O&M pressures might look like and also what the depreciation and a bump up in '08 might look like?

Well we don't give guidance. As I said in my earlier comments, we would expect that a fair amount of what we are spending on O&M, we're getting some relief through our recent interim rate decisions through the PUC. Aside from that, we're still expecting some normal inflation. We're seeing skyrocketing commodity prices and component prices on some of our systems. We would expect that to creep into our O&M, and we expect maintenance to continue. But again, we believe a lot of that has been taken into account in our recent interim rate decisions.

It looks like in the fourth quarter operations expense was up about $10 million year-over-year. Is that a good run rate?

Well, there were events that contributed to that. For example, things that don't hit the newspapers probably on a national basis but certainly give us havoc is we had a fluke storm in the early part of the quarter, early part of December that reeked havoc on our system. We had hurricane gust winds that just appeared overnight and took out a fair number or a fair part of our distribution, and subtransmission system. Those things you never can anticipate creeping into your costs. That was something that was just one example of a cost creep in our system.

And to [answer] one more question related to depreciation expense, based on the items that went into service, looking forward, we can expect about a $5 million to $6 million increase in depreciation expense.

Per year? Or for 2008?

Probably, yes, for 2008.

And then regarding the maintenance expense, that was $7 million lower year-over-year because of timing. What was that -- by commenting it was lower due to timing, does that mean it's going to occur next quarter or was it delayed or something?

Well if you look at -- quarter to quarter year-over-year, keep in mind in '06, we had two back to back earthquakes in the fourth quarter of '06 that again goes to the storm and unusual events. Those factors figured into our fourth quarter of '06 which wasn't quite as dramatic in our fourth quarter '07.

So it was more timing related as to what happened last year as opposed to anything happening this year?

Yes.

And then the $76 million of extra revenue, what's the tax rate we should be applying to that?

Well if you take a look at the $76 million, that's incremental revenues that the rate cases deliver. It asks you the bottom line of about $42 million.

$42 million. Okay.

Net of tax.

And before increases in O&M and depreciation.

When we look at the income statement for the utility, it looks like revenue net of fuel was up like $35 million year-over-year which struck me as kind of high relative to the rate increases you got. Is there anything else that goes into that gross margin?

The demand side management program is one factor.

But those incentives were $2 million?

That was net of taxes.

Okay.

Before gross. And Neil, the revenue piece for the interim decisions in '07 was about $32 million.

Okay.

So that's pretty close.

On top of that, the DSM of $4 million.

Okay. With those DSM incentives, is that saying you'll get on a regular basis, should we see some of that show up every quarter?

No. The State passed a law that will, effective 1/1/09, change the DSM program to a third party administrator. We will be able to participate in the DSM program, but we will not have single point accountability for the DSM program.

And then as I look going back to the $32 million that benefited you this quarter from rate increases, because I guess there was a $70 million interim rate increase awarded October 22 in April, there was one for $24 million, and then you had the smaller one in December. It seems like that's a large chunk of those --

Actually the number I gave you was an annual number.

Oh, I see.

Not for the quarter.

Okay. That's fine. I'll move on to something else. Going back to your 1% ROA goal and you made the comment if over a 24 month period if that goes by and you haven't made any progress then you would be disappointed. Does that mean you hope to hit that the 1% ROA in two years or you kind of hope to have a program to figure out how to do it in two years?

Well, I think both. I mean we're not just going to pray, so we're going to, that's my personal target and again like I said it's in its infancy. So we're going to gather a team and develop initiatives and it's not going to all be on the cost side. I don't want to mislead you. There's some great need things we can do on the revenue side. One of the interesting things in comparing Hawaii banks -- and I've studied Bank of Hawaii and I've studied First Hawaiian and CPV and us, very very different model. Our biggest engine for our bank is the balance sheet, right, and so the two key numbers -- or the biggest numbers is net interest margin percentage and Bank of Hawaii and First Hawaiian have healthy margins. Their margins are about 4%. Ours is 3%. So when you look at how Hawaii banks get there versus mainland banks, our earning asset yield on the asset side is about 5.50. That's very low compared to mainland institutions and it's about 70 basis points lower than Bank of Hawaii. So we have an opportunity to get an improved asset mix which would drive revenue. Bank of Hawaii is about a 6.20 earning asset yield last I saw it, didn't study their numbers this quarter. Mainland banks -- probably their earning asset yield would be 7.50; however, when you look at the value of the deposits in Hawaii. I was really blown away when I came to Hawaii. Whether you look at us, Bank of Hawaii or First Hawaiian, our cost of funding, we have a $7 billion bank and we're funding it at about 2.6%. That's pretty cheap. If you looked at mainland institutions or what I'm used to, the cost of funds would be 4 to 4.50. So we have a real funding advantage in Hawaii, the challenge is how can we look for that asset mix to help drive revenues. So we'll do exciting things on the side.

And in the absence of getting there, you said you implied you would liquidate a portion of the business and bring it up to the parent?

No, there's two ways to improve, no, in getting a 1% ROA, think about this. If you have, I've seen this in a lot of banks, if you have some lower yielding assets that aren't really earning a cost of equity, one thing I analyzed is what if we shrunk the assets, how much net income would you really give up? And as a trade off, how much equity could you free up and then I could dividend to the parent. And so you just have to play with the numbers. There's levers all around.

Neil, I think one of the things we have -- opportunities that we have on our consolidated basis is as Tim was describing on the bank side, we have investment portfolio that's really funded by a lot of wholesale borrowing. So there is an opportunity to perhaps reduce asset size and dividend that capital to the holding company at a time when our utilities actually need the capital to invest in rate base. So there's some neat opportunities that we're all exploring here.

The last company i was at had a similar situation in balance sheet, and I worked a lot the with capital research. Their bank equity analyst or investor there, and he was a big proponent of you shouldn't pay a price to book premium or PE premium for excess securities that are funded by wholesale. There's no real customer supporting those earnings. So he was a very big proponent. He was one of our Top 10 shareholders was -- shrink the institution I was at, you're not going to give up that much income and you'll be able to dividend a lot of equity to the investor. At that time he would have been one of the investors. Our investor is HEI.

Okay, thank you very much.

Sure.

Your next question comes from the line of James Bellessa with D.A. Davidson.

Good morning.

Good morning, James.

First of all, about the O&M and expenses, there was a number of questions but I'm going to ask it from a different direction. The year ago maintenance expense was explained partially by the earthquakes; is that right?

That is a partial effect, that's correct.

So let's just remove that, but for the first three quarters, maintenance expense per quarter has been averaging $28.6 million, and all of a sudden it drops to be below $20 million in the fourth quarter. So I'm just trying to understand, is that a new level that we can expect in the future, or will it be going back to this $28 million level?

No. I think, Jim, one of the factors again I've mentioned, it seems like we seem to have been blessed with two really bizarre fourth quarter events. The earthquake last year which lead to a lot of investigative work and reporting work which showed up in O&M, when we had the fluke storms that occurred, the wind storms, the hurricane-like storms that occurred, the 2nd and 3rd of December -- those diverted a lot of our assets from O&M to capital replacement to restore the system. So I think you see sort of a redeployment of assets. You've got the same amount of money being spent but you're seeing part of that being diverted to capital.

And here you just said the fluke storm occurred in December 2 and 3rd and that's 2007, right?

That's correct.

Now, that means that two-thirds of the quarter were up, and in fact if you break out or take away Christmas vacation, you're well into 80% of the quarter had been completed. How can you switch gears so fast? Between O&M?

Well, I think the message I would want to leave you with is that we're not expecting this to be the new level, Jim. We expect a running rate, one which I said earlier, we are expecting a lot of the costs that we've been experiencing in O&M to be compensated for in the interim rate reliefs that we have had absent the inflation and the commodity prices that we have talked about. It seems like, Jim, post-Katrina and post events that have occurred, not unlike the events that have happened here, we've seen a huge run up in commodity prices. Everything from copper to transformers, to conductors, to poles -- all of our component prices have run up substantially. The only thing we can explain it, it's due to the number of catastrophic events that have been happening around the country.

And let me add one more thing to Mike's comments. We take a look at the fourth quarter of 2007 versus the fourth quarter of 2006. We actually had more overhauls in 2006, and that is largely due to timing. But if I were to just compare quarter-over-quarter, there were more overhauls in the last year -- 2006.

Jim, I would also add maybe from a run rate standpoint, it's probably better to look at it on an annual basis, and taking into consideration the comments that Mike made about inflation and other things, because it can be lumpy quarter to quarter, just depending upon what overhauls we have in the scope of the specific overhauls.

Jim, one event that occurs, for example, particularly here on Oahu, we have a large concentration of purchase power. When our purchase power units decide to take overhauls, we delay our overhauls. And so what happens is there is a, when they declare that they're going to take, and just take for example, AES and [Kaleloa]. They're each 180 megawatt plants. When they announce that they're going to take an overhaul, we defer our overhaul and we'll have to pick that up in another year. So there's always this timing event that is not a normalized event. It's usually triggered by some anomalies like that that enters into our planning equation. So that's why I wouldn't want you to get sort of caught up in a one quarter event and do a linear extrapolation.

On the depreciation, we heard that perhaps the run rate will be increased by $5 million to $6 million. And you reset that in the first quarter every year, is that right?

That's correct.

And then you've talked about some conservation by some of your commercial customers who are your kilowatt hour sales are flat to down slightly.

That is correct.

Is there still a continuing trend then in that? Are you encouraging renewables like solar power that goes in Wal-Mart and therefore they generate their own electricity and reduce the demand from your grid?

Yes. We're seeing a host of things -- the programs range from residential commercial demand side management, load management programs, i'll just give you one example. A couple of years ago the Commission granted us the opportunity to do what we call an Energy Scout Program. Energy Scout is a wireless remote ability to cut off hot water heaters during a peak period of time. In other words, we can go into right now 30,000 homes and remotely cut off their hot water heater which will create 17 megawatts of peak shaving during a peak period of time. We pay our customers $3 a month to have that ability and that is a hugely successful program. We've been promoting compact fluorescent lighting and offering rebates. We had in the third and fourth quarter last year over 1 million compact fluorescent bulbs sold to our customers to encourage reduction of lighting. We have the most successful solar water heating program in the nation. We have one out of four of our customers that have solar water heating systems on their homes, which if you look at a typical residential bill, about one third of the residential bill is for solar water heating or for water heating. So that program has been in effect since 1996. And we estimate that we have been able to take about 35 megawatts of load out of our system by installing these solar water heating programs. So yes, we're very actively encouraging energy efficiency and conservation.

Now, they give you an incentive to do that and therefore, your margins aren't getting squeezed or should we build in some margin squeeze?

We are getting incentivized. As a matter of fact, as I mentioned earlier, we earned $4 million in incentives by hitting our DSM goals last year.

And if you don't meet your goals, is there a penalty?

No. We just don't get rewarded. At least under the current structure of the system.

Over on the bank side, you had of course your compensation employee benefit expense went down by $8.8 million, I think due to the change in your -- I guess defined benefit plan, your discontinuance of that. So is this the -- if I back that back into the compensation employee benefit line, is that kind of the run rate for that expense? Or is there, is it lumpy because of the quarters where you give I guess bonuses and so forth?

No. Because they would be accrued through the year, but there would be a small adjustment. And I'll have Alvin speak up and correct me if I'm wrong, but if you're looking like link quarter, the chart I had, third quarter, fourth quarter or if it's year-over-year, it depends on which time period you're looking at. Because as we came through the year, you accrue for your bonuses and you accrue for our long term incentive plan. And at such point that you see that you are not on the trajectory to hit your goals, under GAAP accounting you have reverse those accruals that you made or lower them to a level to the target you think you're going to hit. So we had some accrual reversals in third quarter, which is where the largest adjustment was, and then we had a minor less amount in fourth quarter. Point being when you start first quarter 2008, you're going to establish new accruals for bonuses and so forth this year. So your run rate, if you adjust it for that pension plan back in the fourth quarter run rate, your first quarter could be modestly higher because you're going to start your bonus accruals again and there would not have been any in the fourth quarter. But it should not be a substantial large number.

Was that benefit or that gain, $8.8 million exactly or was there a figure different than $8.8 million and you just rounded it?

No, the gain is $8.8 million, pre-tax.

And then the tax benefit or the tax cost of that was $3.5 million exactly?

I believe so.

Because when I do the arithmetic, I'm getting the overall earnings going from $0.49 down to $0.42, and yet, when we do it on a stand alone basis, using your numbers, it's like a $0.06 delta as a result of that gain. And I would imagine going forward, most analysts back that out because of its non-recurring nature, so just wondering is it $0.06 a share, or $0.07 a share?

It's $0.06 a share.

Jim, did you hear Suzy? $0.06 a share.

And I understand that, but when I put it into the model, the number comes down to $0.42 a share, and that's why I'm asking about the exactness of those two numbers, $8.8 million and $3.5 million in tax.

Jim, I'll follow-up with you later, but what the difference is the shares outstanding in the quarter when we book the adjustment versus what was outstanding for the year, so it's just kind of a rounding difference. It's really $0.06.

And now I'd like to ask about the charge off. You got a good portfolio and it doesn't look like there's problems overall, but there had been one customer. What did you learn from serving that one customer? You want to go into more of these kind of loans, but this one customer cost you quite a bit. What have you learned, what will you do differently?

Yes, you can lose money different ways, right? One is unfortunately, there's a bad economy or the customer has issues. This was an interesting one and it actually developed before I got here and I'm probably not the most appropriate person to comment what happened. Maybe Connie could. But this was an interesting one in that it was really more operational. So there was some stuff on this one that we could learn that in the future, we could probably prevent or limit this type of chargeoff and I'll ask Connie maybe if she could describe it.

Jim, this one did start before Tim arrived, and it was a problem that was specific to that particular borrower having to do with contracts that they had entered into, and so it really didn't have anything to do with general economic conditions. And as Tim noted, we have reviewed the underwriting of that credit several times to look at the process for the underwriting and there are some changes that we have made, although not large.

And interestingly, the health of the borrower is good. It's really a weird situation where it's a contractor and it's one project that he was working on and I don't want to say who it's with but very large organization that it was for. And whether it was miscommunication or what, but the project had some environmental issues, and had been stalled, and then apparently the contractor got notification or felt he got notification -- it was verbal notification that the contractor could continue with the project. So the contractor restarted and kept building and then the person that it was for said, wait a minute, we didn't tell you to go forward. So it was sort of a "He said, she said" and now that person the project was for doesn't want to pay the contractor. Now, from our side as a lender, we should be monitoring and should have insured that a written, instead of verbal, that a written communication was signed and documented before we released funds for future buildings. So that's where operationally in our procedures we could probably learn and tighten that up and not that they were loose, accidents happen, but we did learn a lesson from that one.

Now, is it true then in the fourth quarter of last year and for the last three quarters of this year, you've written off that full amount?

Almost a full amount. We do have a small portion remaining, but that's more than adequately collateralized by property.

And then I'm looking at the numbers in the net charge off runs by quarter, the first quarter was $700,000 and then $400,000 and then $300,000 and all of a sudden, the net charge off in the fourth quarter jumps to $5.3 million. Why weren't you charging this off as you went or you just waited until you really knew it was completely bad, or almost completely bad?

You're not allowed to under GAAP accounting and I'll let Alvin explain, but you have to wait until there is evidence of some state before you can actually charge it off. The way you do it under the GAAP accounting is through the provisioning. That's the way in theory you're charging it off, but I'll let Alvin explain.

Yes, as we had booked the provisioning on this one particular credit, we did do it in phases as information became available, and we did notice that it was deteriorating, we did what we could under the GAAP accounting. And when it was determined that the collectability of this particular loan was doubtful, and that's when we charged it off.

Thank you very much.

Your next question is a follow-up from the line of Paul Patterson with Glenrock Associates.

Hi, guys, how are you? Can you hear me?

Hi, Paul.

Just I was wondering, Connie if you could just comment a little bit about the dividend. It does look like you have a improved situation with the utility, obviously, there's some potential issues at the bank and what have you. But just wondering if you could comment on the outlook for the dividend given what you guys are planning long term for the bank and what you're seeing at the utility?

Well, I think Paul, you're right. We have always looked at whether we have the fundamental earnings stream to support the dividend, and so the earnings for the utility should improve, although as Mike indicated, we still have continuing investments going in. And there is still pressures on [M] costs and we need to get new generation in before we can relieve some of those pressures. So the dividend is an issue that we discuss continuously with the Board and every quarter make a recommendation to them. So that is something that of course we just did, and they reaffirm the current policy. And then we'll continue to do that on a go forward basis.

Okay, but do you see anything other than obviously your capital requirements and what you're looking, is it just pretty much a quarter by quarter event here, or anything longer term that we should be thinking about?

No, not, there are no changes at this time.

Okay, thanks a lot, guys.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Edward [Wallbridge] with with [RAA Corp].

You are managing well in a difficult environment and I congratulate you on that.

Thank you.

I have a question about the renewable energy program. You mentioned wave energy, a demonstration program and biofuel effort. But do you have any plans for a solar energy planned, either a photovoltaic or solar thermal that would be a major generating plant as opposed to solar at residences? Or wind energy or geothermal?

Well -- to start backwards, we have a geothermal plant on the Big Islands. Matter of fact, it's one of the largest resources that we have on the Big Island. That resource has been there since the early 90's. Photovoltaic, we recently announced adding a 12 acre PV park out in an area of our island called Kapulei, and there are a couple others on the drawing board. So we're looking at a whole host of programs. And interestingly enough, as we're looking at renewable energy, we're expanding that beyond the electric envelope and are looking to plug hybrid vehicles as a way to take advantage of our offpeak energy. So, in other words, we could convert every automobile in Hawaii to a plug hybrid without adding 1 kilowatt of power, if we could find the right kind of inducements to get our community move that way. The reason that's important is two-thirds of the oil consumed in our state is consumed for transportation, so if you convert our entire portfolio of electric sources into renewable sources, you still have two-third dependent on oil because of transportation. So that is the next frontier that the we're working on very aggressively.

Thank you.

There are no further questions in the queue. I'll now turn the call back to management for closing remarks.

Thank you, everyone for being on the call. If you have any additional questions, or anything you wanted to follow-up on, please call me. My number is 808-543-7385. And thanks again for being on the call today.

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