Hawaiian Electric Industries Inc (HE) 2008 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 2008 Hawaiian Electric Industries Inc. earnings conference call. My name is Josh and I will be your coordinator for today. At this time, all participants are in a listen only mode. We'll be facilitating a question and answer session towards the end of the conference. (Operator Instructions). I'd now like to turn the presentation over to your host for today's call, HEI Manager of Treasury and Investor Relations, Suzy Hollinger. You may proceed, ma'am.

Thank you. Aloha and good afternoon. Thanks for joining us for an update on Hawaiian Electric Industries. Here with me from our senior management team and speaking today are Connie Lau, HEI President and CEO; Jim Ajello, HEI CFO; Dick Rosenblum, HECO President and CEO; and Tim Schools, ASB President. Alvin Sakamoto, ASB Executive Vice President Finance; and Tayne Sekimura, HECO Senior Financial Vice President, are also on the call.

Connie will begin the presentation with a wrapup of 2008 accomplishments and Jim will take you through financial highlights. Connie will then discuss the outlook for 2009 and key strategic initiatives. Dick will provide some insight on the utility schedule for its regulatory initiative and Tim will provide some color on bank credit quality and accomplishments. Connie will end with closing remarks and then open it up for Q&A.

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 pages 2 and 3 of our 2008 annual report that was filed on 8-K this morning for information about forward-looking statements. Now let me turn the call over to Connie to begin the formal comments.

Aloha, everyone, and thanks for joining us on the call today. Before I begin formal comments, I'd like to formally introduce two new members of our senior management team. First, Dick Rosenblum, our new Utility President and CEO, who joined us on January 1. Dick comes to us from Southern California Edison, where he spent over 30 years in all areas of utility operations. We are very fortunate to have someone of Dick's experience and caliber leading our electric utilities. In late January, we also welcomed Jim Ajello as HEI Senior Financial Vice President, Treasurer, and Chief Financial Officer. Just prior to joining HEI, Jim spent eight years at Reliant Energy, where he led their effort to expand and grow competitive electricity markets across the country. Jim also has significant financial experience from his 14 years in various investment banking positions with UBS.

I'd like to start the formal presentation by addressing questions some of you have asked regarding the amount of credit risk in our bank's loan and securities portfolios and the maintenance of our dividends. In the fourth quarter, the bank increased its provision for loan losses, probably more than some of you expected, to reflect a rise in classifications of commercial loans and increases in non-performing residential loans, primarily vacant lot loans. Overall, the quality of our loan portfolio remains solid and net charge-offs remain low. For context, in the two loan categories in which we are seeing greater weakness as the economy slows, out of our $4 billion loan portfolio, $127 million are vacant residential lot loans and $597 million are commercial loans. I will note that our business plan does assume additional deterioration in credit as the economic and credit cycle proceeds.

The bank also recorded a $4.7 million net of tax writedown on two of its private mortgage related securities. While we estimated the economic loss of the securities to be relatively small and not occurring for some time as of year end, the accounting rules require a writedown to their very distressed values at year-end. In both cases, as long as the underlying loans continue to perform, the difference between the writedown and the expected loss will accrete back into interest income over the remaining lives of the securities. If conditions stay the same, we would not expect to see additional writedowns in this portfolio; however, as markets worsen, we could see additional writedowns.

Overall, while we experienced higher credit costs in the quarter, our bank's credit quality remains sound and the overall core franchise is profitable and growing. The securities writedowns are also a function of today's very distressed market valuations for mortgage related securities, and to the extent the securities continue to perform, that amount will accrete back into earnings over time. Finally, unlike most banks, our bank returned capital to HEI during 2008. I'll ask Tim to give you further color on these two items later in the presentation so you'll have a better feel for the risks going forward.

With a couple of recent dividend cuts in our industry, there also appears to be some speculation about whether our dividend would be cut. As you probably know by now, our Board declared a quarterly dividend of $0.31 per share to be paid on March 10 to holders of record on March 2. The next dividend date is February 26th. At an annualized rate of $1.24 per share, our dividend yield is now an attractive 7%.

Let me now spend a few minutes discussing the company's significant accomplishments in 2008. First off, in contrast to many companies, HEI's 2008 earnings improved over the prior year. In addition, we were one of five among the 59 EEI companies to deliver positive total returns to shareholders last year.

Over the last two years, we have been especially focused on improving the operating and financial performance of both our operating companies. While that may sound trite in today's environment, we fortunately got a head start on such activities. Accordingly, we're very pleased to be able to report that in 2008, our utility and bank both benefited from the achievement of several strategic initiatives, which also lay the groundwork for further shareholder value creation.

At our utility, we entered into a landmark agreement with our governor, Hawaii State Department of Business, Economic Development and Tourism, and our consumer advocate, which memorializes a shared vision of reducing our state's dependence on [a] quarry fossil fuels and provides for a new decoupled regulatory model for our utility, which should improve our ability to recover costs and earn our allowed return. We also benefited from a full year of rate relief which was granted at various times during 2007.

At American, the execution of a balance sheet restructuring in June successfully enabled the bank to maintain its earnings power on lower assets and a lower capital base. The restructuring improved profitability as the net interest margin increased from 3.13% at the end of the first quarter to 4.07% at the end of the fourth quarter, significantly above peer levels. It also enabled the bank to dividend excess capital to HEI. In addition, Tim and his team announced a comprehensive performance improvement initiative and have started to reduce the run rate of non-interest expenses.

As a result of the bank's balance sheet restructuring, the return of capital was instrumental in strengthening the company's financial flexibility. Also key was the issuance of $115 million of common stock in December, which will enable HEI to help strengthen the utility's balance sheet and support its capital expenditure program. The timing of our common stock offering was important, given the uncertainty in the capital markets and the list of utilities that are now queuing up to go to market to finance their own capital projects.

Overall, 2008 was a good year for the company from both a financial and operational perspective, and I am pleased to be able to report the significant strides we made in the execution of our strategies in 2008. I'll pause here and let Jim discuss the financial highlights, comment on pension funding requirements, and our 2009 financings. I'll return to discuss our outlook and strategic opportunities.

Thanks, Connie. The company earned $90 million or $1.07 per share in 2008 compared with $85 million or $1.03 per share in 2007. Excluding the $35.6 million charge related to the bank's balance sheet restructuring, adjusted net income for the year was $126 million or $1.49 per share.

Tempering a positive year, however, was a 66% decline in fourth quarter earnings brought on by worsening economic conditions and the dislocation in the capital markets. Hawaii's visitor industry and related businesses were especially impacted. Visitor arrivals were down 14% in the quarter compared with the same quarter of 2007. Visitor expenditures were lower by 15% quarter-over-quarter. Unemployment was adversely affected by this trend, rising to 5.5% at year end. For relative comparison, unemployment levels for 2007 ranged between 2.4% and 3.1%.

Worsening economic conditions affected key quarter-over-quarter net income drivers. Kilowatt hour sales were 3.6% lower in the fourth quarter compared to the same quarter of 2007, lowering utility revenues by $24 million and causing full year kilowatt hour sales to decline 1.8% compared with 2007, which is more than we had expected at the end of the third quarter. Economic conditions also affected the bank and the mortgage related securities writedown and increase in the provision for loan losses that Connie discussed earlier. The significant impacts of economic and market conditions on these key earnings drivers lowered fourth quarter results to $14 million or $0.16 per share compared with $41 million or $0.49 per share in the fourth quarter of 2007.

Let me now update you on our pension funding requirements for 2009. Because of the deterioration in the financial markets, the funded status of our pension plan dropped from 91% at the end of 2007 to 64% at the end of 2008. Given the requirements of the Pension Protection Act, the company will make $21 million cash contribution to the plan in 2009. Details are included on pages 8 to 10 and 112 to 116 of our annual report that was filed on Form 8-K earlier today. Note our pension tracking mechanism which mitigates our pension expense exposure, as described in the 8-K.

Lastly, our financing plans. There are no long term debt maturities for HEI until 2011 or for HECO until 2012. Accordingly, no refinancings of debt are contemplated this year; however, utilities financing plans for 2009 include long term debt and additional equity from HEI. The equity infusion from HEI will be made from the proceeds of HEI's secondary stock offering that was completed in December 2008. As a reminder, the PUC must approve all long term security issuances by the utilities.

We believe our short-term borrowing capacities at both companies are adequate. HEI has a $100 million syndicated credit facility and HECO has two facilities totaling $250 million. There were no draws on any of the facilities at year end and there was no commercial paper outstanding for either HEI or HECO at year end. One of the HECO facilities for $75 million was a short-term facility that expires in September 2009. Now I'll hand the call back to Connie.

Thank you, Jim. We anticipate that the fourth quarter trends Jim discussed will continue into 2009. For that reason, 2009 looks to be a year of transition. We expect results will be impacted by 1% lower projected kilowatt hour sales, 13% higher utility O&M expenses, and higher levels of bank provisions for loan loss. The anticipated increase in O&M is due to the larger scope of planned work in 2009 to maintain system reliability -- new work related to [meetings] and Hawaii Clean Energy Initiative commitment to build a smarter, more robust grid that is able to integrate greater levels of renewable energy and an increase in staffing to support both. These cost increases are included as part of our 2009 Oahu rate case and will be included in later HELCO and MECO cases.

Earnings for the second half of the year are expected to improve, reflecting anticipated interim rate relief and revenue decoupling. Continued focus on strategic opportunities is helping the company mitigate some of the impacts of current economic conditions and lay the foundation for long term earnings growth. The key areas of focus are on rate relief in our 2009 Oahu rate case, implementation of the Hawaii Clean Energy Initiative. and the bank's performance improvement initiative. In the case of the utility, the groundbreaking Clean Energy Initiative puts Hawaii on a path to transform its energy future. The company has the opportunity to further broaden its strategic focus on renewable generation and energy efficiency. The agreement also recognizes the importance of a reliable grid and a financially sound utility to achieve these goals, and thus the need for a sound regulatory framework that enables timelier cost recovery and return on investments through new mechanisms.

That leads me to the utilities 2009 Oahu rate case. We expect to set the base for revenue decoupling from kilowatt hour sales on Oahu through this rate case. As discussed on our previous call, decoupling would remove the inherent disincentive for energy efficiency and conservation, as well as customer sided generation, while still allowing for the appropriate recovery of cost. Decoupling can also provide more stability in rates over the long term and was an important part of the Hawaii Clean Energy Initiative agreement. A separate decoupling docket is underway to work out the details of the revenue adjustment mechanism. We are scheduled to receive an interim decision on the Oahu case this summer, followed by a decision in the decoupling docket in early fall. As part of the Hawaii Clean Energy Initiative, we also agreed to file rate cases for HELCO and MECO to set the base for decoupling their revenues. The timing of those rate cases is still under review.

The continued need and opportunity to invest in the reliability of the grid and an improvement to help integrate greater levels of renewable energy is reflected in the utility's capital expenditures budget, especially in the later years. The CapEx budget for 2009 increased $54 million, half of which were costs carried over from 2008. In addition to decoupling, the new business model and the clean energy agreement provides for a new clean energy infrastructure surcharge designed to expedite cost recovery, both capital and expense, supporting greater use of renewable energy within our utility system.

We have submitted a request for approval of the Clean Energy Infrastructure Surcharge mechanism to the PUC. Under the proposal, we will request approval to recover through the surcharge costs of qualifying projects as part of each project's individual PUC application. We recently made such a request for our AMI project, for which $40 million of costs are included in our five year plan. As we noted last quarter, we believe our regulators are open to these elements of the Clean Energy Agreement and we are hopeful that the participation of the state administration and the consumer advocate upfront in reaching the agreement will help facilitate implementation of these efforts through the regulatory process.

The bank's key focus remains on performance improvement, which seeks to optimize all areas of the bank, including utilizing technology, streamlining processes, reducing costs, and recasting staffing levels, while ensuring that enterprise risk is being managed appropriately and better products and services are delivered to customers. The goal is to reduce the bank's non-interest expenses from a 2008 run rate of $176 million to the $150 million to $155 million range over the next two years. The 2008 run rate represents 2008 bank non-interest expenses of $176 million, plus $40 million of gross loss on early extinguishment of debt related to the balance sheet restructuring.

Bank non-interest expenses for the quarter of about $45 million do not demonstrate the great progress that has been made through the year. The fourth quarter included $3 million for items such as severance, lease buyouts, determination of certain benefit programs, and expenses related to the partial sale of our insurance agency. Adjusting for the $3 million, expenses were about $43 million or $172 million annualized. Importantly, January, which was a relatively clean month, was $167 million annualized. This is particularly impressive as two new expenses totaling $5 million annually began in January. So on a comparative basis, the run rate would be $162 million versus the past couple of years in the $172 million to $176 million range and a good step towards our goal of $150 million to $165 million.

One final comment on expenses. Our bank team recently completed its review of its core processing selection. While we had originally thought that we would renegotiate with our current vendor, the team identified an alternative vendor which we believe offers a superior product at a reduced cost. This savings, absent other expense trends, would help reduce expenses another $5 million per year, taking the comparative expense level to $157 million. This savings will not begin until May of 2010 and will require us to spend $3 million this year in the conversion process.

On the reverse side, we're optimistic that the positive advancements we saw in the core banking franchise will continue in 2009. To cite just a few, consumer checking accounts increased 8.6%, core deposits increased almost $55 million, and the number of home equity loans increased 12% and balances about 40%. As you can see, we have a lot of positive initiatives going on that will strengthen the company in its prospects and we are proceeding full steam ahead.

Before we take questions, I'd like to ask Dick and Tim to address a few items I know are of specific interest to many of you. First I'd like to ask Dick to provide you with more detail on the schedule for some of the utilities regulatory initiatives this year. Tim will follow to give you more color around asset quality at the bank. I'll come back for some closing comments, and then we'll open it up for Q&A. Dick?

Thanks, Connie. We know there's a lot of interest in the schedule for the major clean energy initiatives. Here is a quick look at some key major dates for the major dockets. In the decoupling proceeding, final statements of position by all parties are due in May. After hearings, the procedural schedule allows for the PUC to be able to issue a decision in the fall of this year. In the feed-in tariffs docket, which would set standardized prices for specified quantities and types of renewable energy, all statements of position are due by the end of March with implementation targeted by late 2009.

Lastly, turning to the Clean Energy Infrastructure Surcharge, that mechanism is virtually the same as the renewable energy infrastructure surcharge we are already pursuing in an ongoing case. All parties in that case supported the surcharge in an October filing with the PUC. In November, we filed a joint letter with the consumer advocate that took the position that the Clean Energy Infrastructure Surcharge should be considered the replacement for the Renewable Energy Infrastructure Surcharge. The PUC is now doing its due diligence in this case. These major initiatives will help address the core issues to successfully execute on our strategic clean energy initiatives.

Now let me turn things over to Tim.

Thanks, Dick. As you are aware, the stellar credit environment of the last 10 to 15 years has turned. Nationally, provisions and loan charge-offs have elevated at a rapid pace. To this point, ASB and Hawaii have been rather immune. In fact, our charge-offs for 2008 were $4.7 million, down from $6.7 million in the prior year for 2007. As a percent of our loans, this remains well below peers.

However, in the fourth quarter of 2008 we began to see deterioration in our commercial loan portfolio and higher delinquency levels in our consumer and residential loan portfolios. Based on our allowance for loan loss methodology, this caused us to provide a higher provision for potential loan losses. Hawaii is largely dependent on tourism, and the effects of the global recession are now impacting Hawaii as evidenced by a growing number of layoffs. Therefore, we expect 2009 to be a challenging year that will require increasing provisions.

While our outlook is cautious and calls for increasing provisions, we believe we have a quality portfolio and will fare better than what you have observed nationally. Our portfolio is largely 30 year fixed rate mortgages to high quality borrowers. On a limited basis, ASB has offered stated income and loans above 80% on certain consumer and residential loans.

Another area that has caused a lot of pressure nationally is construction lending. We've always been very conservative in this area. In total, we have $315 million of commercial real estate loans -- but importantly, only $73 million is construction. On the residential side, we have about an additional $35 million of construction.

Investment securities and goodwill are two additional areas in which banks have begun to recognize charges over the past few years. Under the accounting rules, we monitor and evaluate each on a quarterly basis. While we determined that our annual goodwill impairment testing was satisfactory, we did conclude that two of our investment securities were impaired based on the accounting treatment for other than temporary impairment. These rules require you to evaluate securities whose market values fall below the book value to determine if the value is other than temporary. This is somewhat similar to provisioning for expected loan losses with the exception that if you deem that there is a possibility of not collecting your full principal amount, you are required to write the security down to its current market value, not the expected loss amount.

In our case, we had two bonds that, depending on the assumptions used, showed a likelihood that all principal would not be collected at maturity. However, the recorded charge was $7.8 million pre-tax while the estimated actual loss was approximately $500,000. Unlike provisioning for loan losses, if the economic environment improves and market values return to historical levels, you are not allowed to bring the recovered amount immediately back into earnings. In that case, the written down amount would accrete back into earnings over the remaining life of the bond. While we believe we have captured the bank's investment portfolio valuation exposure as of year-end, further deterioration in market conditions could contribute to additional writedowns of securities.

In our annual report that was filed on Form 8-K today, [note 4] of HEI's consolidated financial statements show a table summarizing the private issue mortgage securities by rating and vintage. This information should be helpful to you in assessing the quality of the portfolio.

While we are entering a challenging period and facing headwinds that our industry has not seen in some time, ASB is making great strides in improving its position in the market, strengthening our balance sheet, and reducing our operating cost structure. This year we introduced market leading consumer products which rewarded ASB with many new households that we can now cross-sell other financial services. Our goal is to be quick and nimble and to be recognized as the bank that looks out for the consumer from a value and service standpoint. The numbers on this slide, some of which Connie mentioned, are remarkable if we were operating in high growth markets like the Carolinas, Atlanta, or Florida, and demonstrates the opportunity we see for American in this market. 9% checking account growth is unheard of, especially in a market with little to no growth. The response was so good that within weeks, our competitors rolled out very similar products and marketing campaigns.

We have reduced our operating expenses from 2007 to the January annualized amount by $9 million. January includes increased FDIC insurance expense and pension costs of $5 million. Therefore, our team has really eliminated $14 million of annual operating expenses in only about 12 months' timeframe. That is an 8% reduction in one year. As Connie mentioned, we have also elected to change core processors, which we believe will bring us a stronger platform at a more competitive price. Barring no other movements, that would contribute another $5 million. That will be an 11% reduction. We believe there is more opportunity through better use of technology and more efficient use of real estate.

We also restructured our balance sheet which freed up capital that was not earning shareholders cost of equity. In addition to it being positive for shareholder value it allows ASB to focus on its core business of relationship banking and significantly increases our liquidity by reducing our FHLB line from a little over $1.5 billion to a couple hundred million.

The exciting thing to me is we honestly are just getting started. Effectively, our leadership team has only been in place since October. We are now just formulating our market strategies as well as really getting organized around efficiency improvements. We have a very well established brand and following in the market to build on. Higher credit costs will be an issue as we maneuver through this environment, but we are working quickly to add more revenue and reduce expenses to help absorb this cost and provide a stronger, more profitable earnings stream long term. Now I'll turn it back to Connie.

Thank you, Tim. In closing, while 2008 was a good year, yielding improved earnings, economic and financial market declines impacted fourth quarter's results and tempered full year results. As we've described, the environment will have continued implications for our company this year, especially in the first half of the year while our utilities await an interim decision in the Oahu rate case. However, with our senior management team now in place and full implementation of our strategic initiatives just getting underway, we believe we will weather this tumultuous period and be well positioned for long term earnings growth. Now I'd like to open it up for your questions.

(Operator Instructions). Our first question comes from the line of Paul Patterson from Glenrock Associates. Paul, you may proceed.

Good morning, guys.

Hi, Paul.

How you doing? Well, the loan loss reserve question I've always been asking, I guess the answer is that we were now beginning to see a significant increase in that. Should we take the Fourth Quarter number and extrapolate that into 2009? Or should we think of that, you mentioned that it might get a little bit tougher there with the economy. How should we think about that?

Paul, it's very difficult to extrapolate just one quarter's worth, because a lot of the provisioning relates to specific loans. And so every quarter, we have to look not only at pool rates for pieces of the portfolio, but also specifically loan by loan. So I think what we're saying is that the pickup that you saw in the fourth quarter is not unusual under these kinds of market conditions and it could remain about at that rate. It could be a little bit higher. It could be a little lower.

Okay, but when we look at the -- okay then, on the other side you guys are talking about a reduction in non-interest expense that's pretty substantial. And if I understood the $150 million to $155 million, I wasn't clear whether that included the $5 million benefit from the new vendor that you're seeing in May of 2010 I think it was? Or whether that was part of it or not.

Yes, it does.

It does include that?

Yes. The ultimate longer term target is the $150 million to $155 million, and so that will be included in that.

It sounds like because of some of the cost efforts that you're making that will be more likely next year, since it's a two year goal -- that will be happening later on than it will be this year. Is that a good way to think about it?

Yes, that's correct that 2009 is our conversion year for the system. And so we won't be able to convert onto the new system and realize the $5 million of cost savings until the middle of 2010, as I mentioned.

Paul, you should see a lot of cost savings this year. The number in 2007 was $176 million and there were one-time expenses and there were one-time benefits. They really net out to neutral. So 2007, the $176 million is a pretty solid number. 2008 was $176 million again, and I don't have all of the one-time items, but there probably was $2.5 million of severance charges. There was $2 million to write-off a software system. So the $176 million for 2008 -- it was $176 million but it was a lot of sort of clean up one-time expense to help get the run rate down. And then our January actual number with the new $5 million -- what happened was the FDIC raised pension insurance costs for the whole nation. That's going to hit us about $2.5 million this year. And then our pension that we talked about is going to cost us about an extra $2.5 million due to the change in market values. So my January number annualized was $167 million, so you should see material savings versus your 2008 run rate in our numbers this year. And it should get even better next year when we get in the new core processing system as well as we implement other things we've identified.

Right but the loan loss--

Paul, just a clarification, the FDIC is the increase in deposit insurance premiums, not the pension.

Okay. The loan loss reserves though, this will help offset the loan loss reserve, the increase in loan loss reserve?

Yes, without a doubt, so as I've been talking to the Board since I got here the last two years, and we've been talking about -- we're in the banking business. The banking business has gotten comfortable the last 10 to 15 years that this has not been an expense line. When you're in banking this is an expense line. So we've been talking the last 18 to 24 months that one of the reasons to do these expenses -- and we've been proactive, we really started over a year ago -- is that as they come in, they will be long term annuity savings. But in the short-term it maybe a give up to help fund some of the provisions. So I can't promise that it will be an exact offset, but it surely will help.

Paul, I'd just add that from the Board's perspective, we've decided that the longer term building of business is the way to go. And so that's the reason why you see us taking some of these near term charges in favor of that longer term growth.

An example, just so you guys can follow and understand and Connie mentioned one -- we had a branch that was about 0.25 mile, really two blocks from another branch. So we said -- Honolulu, for those of you that have been there, is an urban center. It's not suburban. It's very concentrated and dense. So we decided to consolidate that. And then you have the opportunity to reduce FTE, reduce electricity, and ATM, the servicing, a lot of duplication -- but that one branch we were leaving to go into the other had a three year lease lapse. So we paid one year off to pick up two additional years.

Okay, great. That makes a lot of sense. Now the securities writedown, what triggered the timing of that at this quarter as opposed to previously? Was there a specific event or something that caused the writedown of those securities?

What happens is it's the global environment. But under accounting rules you have to look at that every quarter. So the last 10 years, you look at it every quarter and it's just never been that securities are so far below. So once your securities fall below book value, you then have to monitor and study that to determine -- is it other than temporary? What is the potential that's going to come back? So it's something you do every quarter, and banks are having to do it much more so as well as insurance companies, anybody that owns bonds over the last 12 months. What happened in December is delinquency rates nationally -- most of these mortgage pools are national. Our securities, the mortgages are not from Hawaii. They are from all over the country. So delinquency rates really shot up in December. So you use two numbers to estimate your loss -- probability of default and loss given default. And the probabilities really went up because of the increased delinquencies, and then the loss rates that people -- servicers are seeing because of foreclosures, the loss rates are pretty high. I mean, if you have 30% market fall in a market and you got to pay 6% commission to a realtor, you've got to pay somebody to clean up the house and there's stresses from it being a foreclosure, people cherry picking -- it really pushes the prices down. So those two numbers you use in your model really peaked in December. We ran it against our whole portfolio, and as Connie said at December 31, we believe we've captured all the risk. Now, if delinquencies continue to rise and probability defaults go up and/or your loss given default goes up, there could be more. Maybe not.

And Paul, if you're thinking about third quarter versus fourth quarter, think about how different the markets were at September 30 versus December 31.

Right. Okay --

The credit slides we showed -- Suzy, I don't know if you can put them back up, I don't know how that works -- but if you look at this new slide we showed this time that has the four charts, that's a good example, you just ask what happened in fourth quarter. Look at the slides she just put up and look at the total loans past due and the total loans 90 days past due. Look how our delinquency shot up in the fourth quarter. That's also what happened nationally.

Okay, that's great, guys. Finally, just wondering, are there any -- what the limitations might be in terms of the bank returning capital to HEI and what that means in terms of the longer term implications for financing at the parent company?

Paul, the extra capital that was returned last year really came about because of the balance sheet restructuring project. And so we would not be expecting that there might be additional restructuring this year. I mean that really was a project. However, one of the things that we have been watching are conditions in the banking market and there was one point earlier in this year, if you recall, when the mortgage rates dropped significantly. And when those kinds of conditions occur, we have to really think about whether we want to book all of the production that we have onto the balance sheet or whether we want to sell that into the secondary market. And so we are making those kinds of decisions continually about whether we have the opportunity to grow the balance sheet in a profitable manner or whether it is better for us to take the fee income on making that loan and then selling it into the secondary market. But outside of some shrinkage that might come from a strategy shift like that, we're actually not looking for any major balance sheet restructuring this year.

But you're also really asking also what is the risk of shortfalls of the bank dividend to HEI due to higher credit risk?

You got it.

So we just ran three scenarios, and I guess Connie said it honestly is hard to determine what the provision could be. It's not like we're not wanting to tell you. It's companies deteriorate, certain companies lay off, they're in different businesses, you don't know -- we're monitoring our credits all the time.

And we take additional collateral.

Yes. So we just ran three scenarios over the past couple weeks. What we did, we got in a room with a bunch of people, what do we think a low stress, a moderate stress, and a high stress is. And they're estimates. You estimate probability of defaults and loss given defaults and we have different ranges and each one presents different challenges. And so I'm working with Jim and those different scenarios, what would be our contingency plans and it looks like in all three, based on the assumptions we used, that the bank would be satisfactory and that HEI would have various strategies to maintain our operations.

So we integrate that in our entire cash planning function and we look at under these scenarios which funds are available from dividends. We look at our liquidity sources and we make sure under all these scenarios that we have adequate capital regardless of the risk posture that Tim talked about. So I would say under all these scenarios, the bank would be in very good shape and the corporation as a whole would be able to fund under virtually any scenario that we've run. There's always a possibility that it could be even more stressful or there could be certain spikes in time, but we rather think we have it well covered.

Okay. Thanks a lot guys.

Sure.

Our next question comes from the line of Steve [Vugarza]. Steve, you may proceed.

Good afternoon.

Hi, Steve.

Hi, Steve.

I just had a question on the loan loss provisions and I guess this kind of dovetails into the scenario planning you just did. The roughly $6 million with the provision in the fourth quarter -- and I appreciate you analyzing the entire portfolio on a facts and circumstances basis so it's hard to give forecasts -- but in terms of what you view to be a downside case, what would that provision look like under a kind of protracted weak economy? What would run through the P&L in 2009?

It's hard to tell. First thing I always do is look back at history, and when you look, the last stress cycle the banking system had was the late 80's, early 90's. And you look at ASB -- our portfolio is modestly different. Not greatly different, but modestly different. I'll explain that in a minute. But in the early 90's our provision ran about $13.5 million to $14 million a year, which last year, which we just reported, was a total of I think about $10.7 million. Now the fourth quarter run rate of 6 times 4 is 24. So that one quarter is higher, the year was lower -- but that gives you some indication.

How big was the loan? Is the loan portfolio two to three times the size what it was back then?

The bank was roughly the same size -- the bank really has not grown tremendously.

So the fourth quarter run rate would then be -- if you could look at the $24 million run rate, that would be a pretty conservative, that would be a fairly -- relative to economic history that would be pretty conservative provisioning?

Well, here is the key difference. The key difference is over the last 10 years a commercial portfolio has been built. So back in that cycle, that mainly was our mortgages, any consumer loans, and commercial real estate. We did have a modest amount of commercial real estate. Our commercial's really been built the last 10 years, so it hasn't been tested. Our total commercial portfolio is close to $600 million. So it's a little bit of a mix shift, so it's hard to estimate -- that was $13 million to $14 million, we do have this new sort of portfolio and we'll have to see how that plays into it.

Could you comment on how concentrated your commercial portfolio is? Like is there, is it the top five loans -- is it some large percentage of that?

I think our top, I mean you can look at top whatever, but our top -- I mean our top 60 loans is ironically is about the same amount. It's about 60%. So the top 60 are fairly sizable, but I mean -- and then the rest, the other 40% would be $400,000, $1 million credits.

Okay, and so is it fair to say then that scenario, if you had a situation where the Q4 run rate in provisioning was extrapolated through 2009 that that would be consistent with some of the scenarios you've run?

Yes.

And in which case -- ?

Right. We all see in the news, gosh, who would have ever imagined that Lehman, Washington Mutual, Countrywide, people totally out of business. We're in unprecedented territory, so I don't know that it will exactly be horrible but I don't know it will be the $13 million from the 90's. What I'm trying to do as a prudent person is okay, how does it look if it is two years like the 90's, how does it look if it's twice that? How does it look if it's three times that? And in general, the bank specifically looks fine and safe if that happens, and Jim working through his cash needs if that were to lower my dividend to him, his planning looks adequate. So one thing to point out specifically for the bank, unlike other situations, is our capital ratio has gone from, I forget the numbers, I think it's 7.78% the end of last year to 8.48% at the end of this year. So we actually have increased capital percentage relative to our balance sheet versus the prior year. So we built up capital, we have less wholesale risk, we got rid of FHLB stuff so we don't really have liquidity risk, and we're getting our expenses down to help pay for some of the credit.

Okay, if I could just switch to the utility for a moment. On the decoupling that would presumably -- the decoupling in your Oahu case would that hit in the fourth quarter of 2009 -- is that what's planned, is that right?

Yes, that's the likely time, Steve.

And will there be any forward-looking, I know you do have an ability to project expenses to some degree currently, but in this current round of rate cases, or the next round of rate cases that you're going to have, do you expect to have any ability to have a better matching between your expense levels and your rates?

Yes. Definitely as we mentioned some of the increases that we experienced in fourth quarter and are running at now are in the 2009 Oahu rate case and will be going into the HECO and MECO cases. Plus when we decouple there will also be rate adjustment mechanisms as well that should help with all kinds of increases.

But I guess my question is, will you be using improved -- like is it the same test year structure you'll be using in these cases?

Yes, that's correct.

Okay, so --

But Steve, I'll just add -- the but is that once we -- we will use the same rate case structure to set the base rate. But then once we set that and then we decouple, with the decision coming in the fall, then that's when we would have the rate adjustment mechanisms that would carry us going forward and the plan would be that once that system is in place, we would only have a rate case which would be in the nature more of a trueup rate case about once every three years.

So I guess I'm confused, I understand how decoupling helps you on the volume, but if your O&M expense is growing 10% every year, how does decoupling help you to deal with that issue?

It's not the decoupling. It's the rate adjustment mechanism.

So the rate adjustment mechanism will adjust to your expense level?

Correct.

So it's essentially a forward-looking mechanism with a trueup?

No, it is not a forward-looking mechanism but it will look at various kinds of indices for different kinds of costs. And then once we agree on the types of indices that go into the rate adjustment mechanism, then the rates will adjust according to those indices.

Maybe add to Connie's comments there, Steve, this is Tayne. We are still working through the process with the parties, the consumer advocate. But just in summary what we're trying to do is the cost of services established in a rate case and years after that, we would use indices to true up or down from that base, and then it gets reset in base rates in the next rate case. So --

Why don't you give them an example? Give Steve an example of the kind of rate adjustment.

So one of the things we're looking at for example is, you set a level of O&M expenses in a rate case. And based on whatever index you use to trueup in the following year, based on something that we agree on, it would true up say 2% at the beginning of the year, based on the base set in the rate case. And we would have other trackers such as we're looking at rate based growth. And this would be for both the return on the investment as well as some of the expenses.

Great. Well, thank you very much.

And our next question comes from the line of Bobby Bohlen from KBW. Bobby, you may proceed.

Thanks for taking my question. I think this question will be for Tim. Looking at the deposit growth that you saw in the quarter, I was wondering if you could talk about that a little more. Because we did see from both of your public competitors, they also both produced fairly significant deposit growth in the quarter. So I was wondering if you could give a little background on -- is it higher balances, net new accounts, etc.?

I haven't really followed their numbers. For us, I think it's both. I think we've rolled out two new checking accounts this year that as I mentioned everybody quickly followed and there was commercials within a couple weeks, everybody was copying them. But we increased our checking accounts 16,000 for the year, which is a 9% checking account growth, and that really came from rolling out -- we introduced free checking to Hawaii. Free checking has never really come to Hawaii in the way we know it on the mainland, and then we introduced -- we are really simplifying our product set. We have seven checking accounts and we're going to two. So we have free checking and then interest checking which is just the free checking with on top of that you get one or two extra features. And it's been well received, they are simple. Products here tend to be a little bit complex, and it's just been welcomed. And so ours has come from a lot of new account growth, but also we've benefited from people being shy of the equity markets or CD rates are very low. So a lot of people that had CD rates nationally either in the mainland or here across Hawaii are putting those into depository accounts. So the pro of that is great, we got deposits. The con of that kind of money is likely when rates go up, that money moves back out.

Right. Now I'm not sure if you can tell this or not, but are you seeing movement in from any of the credit unions? Or is that hard to tell?

To be honest, we've had good acquisition. I mean, I was shocked. This was my fourth bank and this was probably as good of an individual year I've seen any of the banks I've worked at to grow net checking accounts 9%. Our market only grows about 1% a year, and there's only about 1 million people that live in Hawaii, so you're really stealing share from others. All those accounts weren't people that just moved here to Hawaii. So they are really coming. If you look at where they are coming from and we do track that, it's not any one source. It's really from all over.

Okay. That's helpful. Thank you.

(Operator Instructions). Our next question comes from the line of Vik Ghei from Owl Creek Asset Management. You may proceed.

Thanks for taking the question. This question is probably actually for Tim as well. Just had a few quick questions. The first I guess was by the way, commendable that you gave so much disclosure on the private mortgage backed security book. It was something which is what we have been looking at. And also congratulations on the cost cutting that you've been doing. The first question just on the MBS book. I noticed that you took like a $37 million temporary charge on that which didn't flow through the income statement. And when I, if that actually was a real charge, I guess you would have had like a negative $30 million loss for the bank. But why is that only temporary? And do you think that your book that's marked to $0.94 when you consider only the full, so the non-temporary charges -- do you think that's an accurate number?

Again, the fair value accounting rules are weird. I've always felt they were weird, and when you think about a bank balance sheet of securities and loans on the asset side and deposits and debt and equity on the liability side, you only mark-to-market one category of your whole balance sheet. And if you are doing prudent interest rate risk management, in theory, if the values of your assets go up and down and you really are managing interest rate risk, the values of your liabilities side should offset that. So if you're really calculating what's called economic value of equity, and in theory, good interest rate risk management, it should net to zero. So what's unfortunate about the accounting rules on what you're talking about -- other comprehensive income -- is two things happen on securities. You are required to mark them to market -- the ones that are held -- available for sale, held that way, not held to maturity, and whether the values go up, you put the gain in your equity. The values go down, you put the loss in your equity. We have stuff on the other side, our deposits would be much more valuable today. But we don't get to recognize the gain of that in our equity to offset that. So what you see there is just the change in the publicly traded prices of those securities that we have to reflect in there until we realize a loss, number one.

But why do you, why were you so much more optimistic than the market? Clearly the market is pricing these down. You think that you won't lose as much as the market is saying. But wouldn't the market be a fairly good judge of -- a better judge than you?

No, not necessarily, because that's trading value. That's what somebody is willing to buy today that may not be willing to hold it until the end or lots of different situations. It's not just credit risk. It's liquidity risk also, and we have the ability and the intent to hold it until maturity. We've got a lot of capital and we can hold it until the very end, and so we can wait it out. We don't really have the liquidity needs, and so I'd say the answer is no.

Okay --

Also, the part of our portfolio is agency mortgage backed securities, which are guaranteed by the government.

And I'd just add that we actually looked very closely at the securities portfolio last summer when we restructured the balance sheet and we made some conscious decisions about those that we would keep or not keep -- and as Tim said, depending on what the market valuations were versus our views on what the true value was to the bank over time.

No, no, that makes a lot of sense and, well, thanks for the disclosure. It is very, very useful. And I guess the second question I had related to -- I saw in your 10-Q, on the last 10-Q that you filed that about I guess 6% of your residential loan book was not originated by you guys in Hawaii. Suzy confirmed it was broker originated mortgages at various parts of the US and I guess that comes out according to my calculations of like $220 million which [at] 60% of your tangible equity. Could you provide some disclosure on that?

Yes, what happened was the summer of 2007 the company purchased two loan pools that totaled about $200 million and they were just national loans. And so our guidelines on one to four family mortgages have been fairly conservative here. And so at that time during the summer, they went out and built a filter of our underwriting credit profile and went out and said let's find similar ones with geographic distribution across the country. So they are 30 year fixed rate mortgages with high FICO scores in similar characteristics, but they are all geographies. They aren't concentrated in any one state.

But can you give a breakdown of what are the biggest states and where they are located?

Actually, I don't have that right in front of me, but I actually did pull that about a month or two ago and the largest state in that one from memory was Maryland.

Okay, and but just --

They all differ. All these mortgage securities we have, if you pull every one off, the largest state is different.

In fact, some of the limitations were that we would not have, that we put limitations on for states like California or Florida.

From memory, I could be off, don't hold me to this -- I was thinking that -- this has been a month or two, I think Maryland was like 13% or something.

Got it. Okay, that's pretty good. Thanks, and just the last question I guess was I noticed reading your 10-K and I saw you filed an 8-K about a year ago, the OTS gave you a cease and desist order, was related to something about money laundering. Has all that issue been cleared up and what is that about?

What happens is under banking regulation, there's something called the Bank Secrecy Act and it came into place full force five years or so ago. Companies have been building programs, and any time new legislation or new regulation comes out like that, it's infrastructure and learning. And I guess it was in the '06 timeframe it was found that there could be some improvements in ASB's process. It was not any fraud that was going on or anything. It was more around the process and the reporting that was happening. And so really nationally what happened was you saw a wave of cease and desist orders around BSA for banks nationally, because the regulators were like hey, this program has been out for four or five years. It's time we get this wrapped up and get everybody on par together. And it's basically a way to put a finite timeline on, you have until here to get it done. That's really what it was so. Fortunately for us we got ours done in less than nine months and the OTS removed it. And our exam is every fall for six weeks. So they came in, starting around September 1 last year for six weeks. And at that point, they removed it.

Okay, thanks, that's really helpful. And the last question I guess relates to just -- I was under the impression that the OTS and you had an agreement that if the Tier 1 fell below 8%, you wouldn't upstream any more money. And so I guess right now you're at 8.3%, but if you actually took that temporary charge that ends up being real, then you're probably below 8%. Does that effectively mean that you can't dividend more than your positive net income, and if you actually started losing money that you can't dividend upstream at all?

That's not determined. Right now what we're doing is it's not any, it was not a mandate or anything from the OTS. We have an agreement with them that we've told them we're going to during these times manage to 8% leverage ratio, which basically is just equity assets which are backing out your goodwill in essence, and your unrealized loss. So that -- we've been dividending out everything above 8%. There actually was -- more than you want to know, but there actually was a definition change to the OTS's leverage ratio calculation in the fourth quarter that just the definition change created $16 million of additional capital for us and took that 8% ratio to 8.28%. Just out of prudency, we've elected to just leave that in the bank, and so we're going to run now closer to 8.28%. That's just a management decision. We haven't even told the OTS that yet. So we'll just run at 8.28% through this time because we want to make sure the bank remains healthy. And it provides an extra $16 million of capital in your math. And then if such unfortunate events happen, that charge-offs either OTTI or just regular provisioning took it below 8%, we would have to cross that bridge to see whether we could work with the OTS to just earn back to the 8% or whether they would require a capital infusion from HEI.

Okay, thank you very much.

Let me just add one other thing is that when you talk about the valuation of the security, the market valuation runs through the balance sheet through AOCI. So that has already been reflected on the balance sheet, but it's not affected in the capital, the regulatory capital calculation. So unless we sell those securities, you wouldn't see it hitting the capital.

Or unless you deem that they aren't temporary.

Correct. Right.

Okay, thank you.

Our next question comes from the line of Paul Patterson from Glenrock Associates. Paul, you may proceed.

You're back, Paul!

I know. Can't get enough. Really actually a really simple question I think and I apologize if I missed it, but where are the ROE's at the utilities? What are the most recent ROE's that you guys are earning there?

Paul, this is Tayne. The most recent ROE's are as follows -- for HECO, HELCO, and MECO, we are at 8.07% for HECO, 9.39% for HELCO, and 8.54% for MECO. And this is compared to the allowance per the most recent interim decision of 10.7%.

Okay, great, and this is as of what date? Was this the end of the year?

This is as of the end of the year.

Okay, great. Thanks a lot, guys.

(Operator Instructions). At this time we are showing no more questions available. Suzy Hollinger, you may proceed.

Thanks, everyone for being on the call today. If you have further questions, please call me. 808-543-7385 and I'll be sure to get back to you. Thanks.

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