Hawaiian Electric Industries Inc (HE) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2009 Hawaiian Electric Industries, Inc. earnings conference call. I will be your conference moderator for today. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Suzy Hollinger, Manager of Treasury and Investor Relations. Please proceed.

Thank you, Stacy. Aloha and good afternoon. Thank you for joining us for an update on HEI. Speaking today are Connie Lau, HEI President and CEO, and Jim Ajello, HEI's CFO. Dick Rosenblum, HECO President and CEO, and Tim Schools, ASB President and other members of our senior management team are also on the call today. Connie will begin the presentation with a strategic update and Jim will take you through the economic and financial highlights. Connie will then discuss key investment points and then open it up for your questions.

In today's presentation management will be using non-GAAP financial measures to describe the bank's operating performance. Management believes these measures provide a clearer picture of the bank's operating performance and are a better indicator of the bank's ongoing core operating activities. We have provided more detailed information about management's use of non-GAAP financial measures including detailed reconciliations from equivalent GAAP to the non-GAAP financial measures used in the presentation on A-1 through A-3 of the appendices to today's presentation slides that are posted on our website. Forward-looking statements will also be made on today's call. Please reference pages IV and V of our second quarter Form 10-Q that was filed this morning for information about forward-looking statements. You may also reference A-4 of the appendices of the webcast located on our website. Let me now ask Connie to begin the presentation.

Aloha, everyone, and thank you for joining us today. We continue to work hard to position our Company to weather this economic storm and emerge with stronger, improved performance and we are making good progress. However, the performance of our Company continues to be impacted by difficult economic conditions and delayed regulatory action.

In our year-end conference call we discussed our expectations that 2009 would be a transitional year as rate release and execution of Hawaii Clean Energy Initiative would take time to work their way in to earnings. We anticipated that a week Hawaii economy and higher O&M would depress earnings for the first half of the year and that earnings would improve beginning in the second half of 2009 with interim rate release and sales to decoupling. We also indicated that the bank would continue the focus it began in early 2008 to increase profitability which we believed could help offset higher expected credit-related provisions during this economic cycle. Year to date earnings were $0.39 per share, generally on track with our internal expectations for the first half of the year. At the bank -- for the second half of the year, we expect interim rate relief of $61.1 million in annualized revenues received beginning August 3, and expense controls at the utility should at least keep utility earnings at the same level as in the first half but still suppressed due to lower sales and regulatory lags. I'll speak in a moment about the interim decision and the schedule for additional possible recovery and regulatory reform late in the year.

At the bank, strong revenue and additional reductions in bank non-interest expenses are expected to further help offset elevated credit costs in the second half of the year. On August 3, the PUC granted approval to implement a partial interim increase in annualized revenue of $61.1 million. The partial interim rate increase did not include several significant items which had been stipulated to with the consumer advocate and Department of Defense which were deferred for consideration to proceedings later in the year. Chief among the deferred items was roughly $13 million of revenue requirements to cover the O&M expenses and return on our investment in our new Oahu unit, CT 1, which was not in service at the time of the interim order but which completed all utility requirements for system operation on August 3.

We will be seeking rate inclusion of the CT1 cost through the evidence hearings or possibly other mechanisms. The hearings are scheduled to commence October 26, 2009, on the items deferred from the interim increase, other items that were not settled as part of the stipulation between the parties in the rate case, and additional items identified be the PUC in its interim decision. There is no statutory deadline for a decision on this docket. The order also deferred a decision on establishment of a revenue balancing account to track the difference between sales included in rates and actual sales. The PUC will consider this issue in a separate decoupling docket it opened in the fall of 2008. It will also consider a revenue adjustment mechanism that would essentially adjust revenues to cover the cost of service via tracking mechanism. Hearings on the decoupling docket were completed on July 1, and the Company is now answering information requests. We hope to receive a decision on decoupling later this year, but there is no statutory deadline for a decision in the docket. Sales decoupling and the revenue adjustment mechanism are key to the utility's ability to earn its allowed rates of return. I'll speak to this in more detail later.

The economic environment, heavy work load, and the complexity of the issues under consideration are impacting the pace of PUC decisions in Hawaii. Although the pace of decision making is slowed, we continue to believe the Hawaii commission is supportive of our new regulatory initiatives. At the bank, we have made significant progress in our performance-improvement project. Compared to 2008, our adjusted pre-tax, preprovision income has increased approximately 14% or $15 million to $120 million. It is important to note the bank was able to achieve this on approximately $1.5 billion less in average assets.

In addition, we have recently identified $10 million to $15 million of additional opportunity to lower expenses, which I'll discuss in a minute. This should help increase pre-tax preprovision income to the $130 million to $135 million range, which would represent about a 25% to 30% improvement over the second quarter 2008 annualized level. We are showing adjusted pre-tax preprovision income because we believe it is the best indicator of the bank's core operating performance as it excludes the impact of provision related to the credit cycle and adjusts to eliminate certain costs associated with the performance-improvement project such as severance and the cost to exit leases which will not be in the bank's run rate going forward. However, we have provided a reconciliation of our adjustments from GAAP in the appendices.

We continue to feel good that the bank will remain sound and profitable during the credit cycle and will emerge are higher earnings when the economy improves. For our bank as well as the industry, the key uncertainty is around credit-related provisions. We believe our credit-risk profile is on the conservative side compared with other banks because of the high concentration of lower-risk, one to four family mortgage loans which historically have had lower default rates and a higher level of collateralization versus most alternative loan types. About two-thirds of our one to four family mortgages are on Oahu where the real estate values have held up relatively well compared with the neighbor islands.

In addition, we have significantly less exposure than other banks to higher risk, commercial real estate construction, residential construction, auto and credit loans. Year to date provisions have occurred in four key areas. One to four family mortgages due to the sheer size of the portfolio and a small pocket of mainland loans purchased in the summer of 2007 near the height of the real estate cycle. A small portfolio of residential lot loans, one large commercial credit. In addition, OTTI charges have related to our private mortgage-backed securities in our investment portfolio. Jim will have some detailed comments about credit quality and the Hawaii economy later in the presentation that can help inform your thinking about the magnitude and duration of the down side of the credit cycle on our future financial performance.

As I have mentioned, we are very pleased with the bank's progress on their performance improvement initiatives. You have heard us speak previously about our market-leading checking account which we introduced last year. Today, we have over 77,000 accounts and $131 million in free deposits related to this product. Our success has continued in to this year with core deposit increasing almost $200 million year to date and $109 million just in the second quarter. The associated fee income from these new deposits led to strong revenue growth, excluding this quarter's recognition of OTTI.

Bank management continues to identify opportunities to reduce the bank's cost structure largely through improved processes and procedures as opposed to large staff reduction. This is helping substantially to offset rising credit costs. Recently, the team identified and is now working on additional initiatives which we believe are lower our non-interest expenses another $10 million to $15 million from the $155 million current run rate by the end of 2010. At that point, our efficiency ratio should be approaching 50% and like our net interest margin will be in line with high-performing peers. Through our performance-improvement efforts, we also returned excess capital to HEI while growing our leverage ratio from 7.8% prior to our June 2008 balance sheet de-leveraging to 8.7% at the end of the second quarter of 2009. Let me break here and ask Jim to update you on the Hawaii economy, our key performance drivers and financial position.

Thanks, Connie. I'll start with an update of the state of our local economy, touch on earnings and move to an update of our expectations for key performance drivers and by discussing support for the dividend, liquidity and capital.

First, the economic backdrop. This slide shows historical visitor arrivals and visitor expenditures. You can see significant drop-off in 2008 and 12 months trailing June 2009 arrivals. We monitor achievements and expenditures because of the significance of tourism to the overall Hawaii economy as well as the impacts to one of our largest utility customer segments.

Unemployment rose dramatically in the first half of 2009 from 5.4% at the end -- at year end to 7.4% at the end of June, but still remains well below the national average of 9.5%, currently 9.4% with this morning's announcement of the June figure. The weakness in tourism is expected to impact the neighbor island economies more than Oahu because their economies rely more on tourism. Job losses in the accommodation and food service sectors are estimated to be 6% or greater on Maui and Kauai and nearly 9% on the big island. This compares to the estimated 2.5% decline for Oahu where approximately 70% of the state's population resides and where about two-thirds of our banks' residential mortgage loans are located.

The median resell price for Oahu homes was $570,000 year to date through July, down 9.1% from the same period in 2008. Sales volumes declined 22%. Local authorities, note that while the housing market is still weak, there are indications that the Oahu housing market way be past the bottom. July was the second consecutive month of increased home resales and median prices. Maui and Kauai are weaker than Oahu. For the first half of 2009, Maui and Kauai experienced home sales declines of 41% and 30% and price declines of 14% and 27% respectively. Foreclosures in Hawaii continue to rise and are at levels significantly higher than a year ago. The neighbor islands are experiencing foreclosure rates that are in line with the US average. Oahu's foreclosure rate is half that of the neighbor islands. This slide shows local economists' expectations for key economic indicators. Based on their projections, we expect the impacts of Hawaii's weak economic conditions on electric sales and bank credit-related provisions to persist. Given the economic backdrop, HEI earned $15.5 million or $0.17 a share in the quarter in line with our expectations, compared to $40.7 million, or $0.48 a share for the second quarter of 2008, adjusted to exclude the bank's balance sheet restructuring.

Let me now turn to an updated key earnings drivers. Starting with the utility. Sales for the quarter were 3.1% lower than the second quarter of 2008 and down 5.2% for the first half of the year. This quarter's decline was lower than the 7.4% decline experienced in the first quarter because there was little effect of weather in the second quarter sales decline. In general, sales have been declining for the last several quarters as a result of customer conservation and a declining Hawaii economy. Given the trends we have seen year to date, we expect sales to be down about 4% for the full year versus 2008. Absent sales decoupling, every 1% decline in sales represents about a $5 million annual decline in net income.

Operations and maintenance expenses. We revised our original forecast for expected O&M increases from an increase of 13% year-over-year to a 10% increase compared with 2008. This increase includes the cost of demand-side management programs for both years. Those programs were transferred to a third-party administrator on July 1. The expected increase in O&M is lower than previously anticipated and we have continued to pursue cost-reduction measures this year, including a general freeze on executive salary levels and an ongoing program to achieve cost savings and contracted services. Delays in renewable energy initiatives and other targeted reductions are currently being initiated in response to delays in regulatory recovery. Finally, we are also evaluating the timing and scope of our capital expenditure plans in light of the interim order.

Turning to the bank, the Company's net interest margin expanded in the quarter to 4.16% as among high-performing tier banks. Our margin is driven by our large high-quality funding base. At the end of the first quarter over 25% of our assets were funded with free or low-cost checking accounts. This is an extremely strong number in the banking industry. Equally strong, 58% of our assets are funded with core deposits and 85% are funded with customer deposits. When you consider our equity levels, we essentially have very little wholesale funding which increases our margin and markedly reduces the liquidity risk of the bank.

Because of the historically low interest rate environment, the bank elected last year to begin selling its originations of one to four-family mortgages. Booking these loans would not only hurt the net interest margin but would more importantly increase interest rate risk. Along with the normal cash flows from payments on other loans and limited investment opportunities, our decision to sell the recent mortgage production has increased cash balances which likely will put temporary downward pressure on net interest margin and income.

In the second quarter, the bank recorded $13.5 million of provisions for loan losses and $5.6 million for other than temporary impairment. This quarter's provision for loan losses reflected additional provision for the single commercial credit we began providing for in the first quarter which accounted for account 37% of the provision in the quarter. Higher delinquencies in the one to four-family mortgages and lot loans comprised the majority of the remainder.

In total, non-performing assets ratio increased from 48 basis points at December 31, 2008, to 137 basis points at the end of the first quarter and then to 155 basis points at the end of the second quarter. Excluding the single commercial credit, non-performing assets ratio at the quarter end was 130 basis points, reflecting a rise in residential lot loans and residential one to four-family delinquencies especially on neighbor island mortgages. Our net loan charge-off ratio grew to 131 basis points in the second quarter compared to 20 basis points in the linked quarter and 13 basis points in the second quarter of last year.

The loan charge-off ratio grew in large part due to the charge-off of half of the principal of a single commercial credit resulting from the annual shared national credit exam which accounted for 76% of the second quarter net charge-offs. We continue to monitor this credit and believe the prospects of some recovery from our current principle balance is good. This situation is in bankruptcy and we are monitoring this process as well as the opportunity to sell exposure to determine the course of action that will return the maximum amount possible to the bank. We believe we are quality assets and that our primary risks are in the $389 million of outer island one to four-family mortgages produced from 2005 to 2007, $137 million of mainland residential loans purchased in 2007, $116 million of lot loans which have a three-year life and $275 million of private mortgage-related securities.

A key profitability driver for the bank that we have been focused on, efficiency. Over the last year we have seen improvements in both revenue as well as expense. The largest impact has been a lower expense base driven by improved processes and procedures. As you can see, on an adjusted basis, Q2 2009, non-interest expenses are running at about $39 million for the quarter, or $155 million annualized and the efficiency ratio is at 56%. Bank management is implementing $10 million to $15 million of new process improvement opportunities that we expect will reduce non-interest expenses to $140 million to $145 million on an annualized basis by the end of 2010.

Now let me turn to support for the dividend. This slide shows simple sources and uses of the holding company. As you can see, we expect primary support for the dividend in 2009 to come from the subsidiary companies and that we will be financing uncovered portions and holding company expenses with equity issuances to our dividend reinvestment plan and via short-term borrowings. We're currently evaluating the resumption of issuances of shares through [drip], which has been closed for four months.

We continue to have very good access to liquidity in capital markets. HEI and HECO have $350 million of syndicated credit facilities of which $295 million is available at quarter end. I should note that $75 million of HECO facilities terminated on August 4. The facility was a bridge until HECO could close on its $150 million revenue bond offering, which it did, on July 30. Revenue bond proceeds were to reimburse HECO from previously incurred capital expenditures and are expected to be used principally to repay short-term borrowings.

The bank's liquidity has been strong with good core deposit growth of $109 million in the quarter. Access to $1.6 billion of unused borrowing capacity and the FHLB of Seattle and inflows from repayments of mortgages and securities and loan sales. The Company has a strong capital base with both operating companies solidly capitalized. Our overall consolidated equity, including preferred stock to total capitalization, is 52% at the end of the second quarter. The utility's equity layer is at 53% and the bank remains, "well capitalized" with a tier 1 core leverage ratio of 8.7% at the end of the second quarter. With that, let me turn the call back over to Connie.

Thanks, Jim. We continue to see the opportunity for investment in our Company as multi-fold. Let me take a moment to frame the primary points before opening it up for your questions. At our utility, we are working hard with the consumer advocate, the Public Utilities Commission and their staff to implement the Hawaii Clean Energy Initiative, including a new regulatory model which will help us significantly close the gap between our earned and allowed rates of return. The new model will also ensure a financially viable utility which can help reduce Hawaii's dependence on oil. Meanwhile, until a new regulatory model is implemented, we will continue to seek recovery of cost and return on investments through the traditional rate case process.

You may have seen that we recently filed notices of intent to submit rate cases for HELCO and MECO. We expect to file these cases this fall with 2010 test years. Filing these cases is also consistent with the Hawaii Clean Energy Initiative agreement which would allow these cases to be used to set the base for decoupling for HELCO and MECO. Details will be announced at the time the cases are filed with the commission. We are also evaluating a 2010 test-year rate case for Oahu.

As I mentioned previously, the bank's core business is performing very well. Adjusted pre-tax preprovision income has been rising over the last several years and net interest margins are high performing at 4.16%. Our current adjusted non-interest expense run rate of $155 million is expected to be lowered to $140 million to $145 million by the end of 2010. When credit costs normalize with improved economic conditions, the bank has the possibility to go from earning roughly $50 million per year as it did in 2007 and on an adjusted basis in 2008, to $65 million to $70 million of annual earnings when the credit environment improves. In addition, this estimate is subject to no material changes in the yield curve which could affect net interest income.

We acknowledge that these opportunities are on the horizon, but to some extent they depend on forces outside of management's control, and that they may not come to fruition or all be optimized at the same time. However, we believe we are making good progress and our extremely attractive dividend yield of 6.9% should help compensate investors for some of these down-side risks. You may have seen that the Board declared the dividend yesterday payable on September 10 to holders of record on August 24, the ex-dividend date is August 20. Thanks very much for your attention, and I'll now open it up for your questions.

(Operator instructions). Your first question comes from the line of Paul Paterson with Glenrock Associates. Please proceed.

Good morning.

Hi, Paul.

First of all with the provision of loan losses, just looking at slide 19, and you mentioned the single credit -- commercial credit, as I guess being provisioned for in the first quarter of 2009, is that correct?

Yes.

Yes.

And at what level was that provision for, I guess? I mean, it doesn't look like it was provision for much at all.

It was half provisioned in first quarter and it was half provisioned in second quarter and then what happened is the shared national credit exam came out and they do a rating of all shared national credits and they suggested from their examine that it should be written down 50%, a charge-off. So what happened was the $10 million that was in the provision actually got charged off, so your provision goes down because you don't have that risk anymore. So it went in and then it came out.

Okay. And then when we're talking about the 2011 picture for the bank, I think you guys said $65 million to $70 million. What should we think about in terms of what the provision for loan losses should be? I mean you mentioned the credit cycle and obviously that's causing some issues, but on the other hand it sounds like real estate prices have sort of held up pretty well and one wonders what the situation would be if we didn't have resilient real estate prices in terms of the impact on provisions for loan losses.

Great question.

A Paul -- Tim, before you start. Paul, let me just comment that the $65 million to $70 million was when we get through this credit cycle, too. So whether that comes by the end of 2011 or not, that will be an open question, so Tim, maybe you can comment further.

Yes, great question, Paul, and here is the way I would think about it, and it's a lot, but our Company historically pretax preprovision has run $90 million to $95 million. That's what it has been historically, and we have had very little credit -- the whole industry has had very little credit in the last 15 years, so that's starter number one. And that translated in to about $50 million of net income. So where we're at now is we're already in second quarter where that pretax preprovision is at $120 million. So it has gone from 90 to 95 to 120, so it is already up 33%. We have 33% more earnings power in second quarter than we have historically. Okay?

We see -- we have a hard $10 million to $15 million already identified -- it's not, hey, let's go find 10 to 15. I have a project sheet that has the 10 to 15 and it's underway, so our pretax preprovision will go from about $130 million, $135 million, $140 million by the end of next year. We will have gone from an earnings power of $90 million to, say, $135 million. That's a 50% increase in earnings power. The real wild card is what you're asking is how high can credit get and how long will it sustain and that's very difficult to answer. I wouldn't want to propose something to you because I wouldn't be honest. What I would tell you from my experience is I truly believe that ASB has a lower risk portfolio and right now, knock on wood, our provisions are really isolated in those key areas that Connie talked about. So we have got about $4 billion of loans and it appears to be about $600 million of assets where we bought some mortgages in the summer of 2007, it was unfortunate timing. At the time you didn't know, but that was the peak of the market so those tend to have less equity than maybe a mortgage you've had for five years where people pay down principle.

Our private mortgage-backed securities we have been talking about for several calls, our lot loans. We have about $110 million, maybe left, but 20% are delinquent. Now you are not going to lose 100% of those loans. I mean those loans do have equity in them. So of that 20% that's delinquent, let's say half of those go bad, and let's say you take a 40% loss on those, that's not a big number. Really -- I hate to exclude stuff, but right now the big dingy this year is that commercial credit where we had a $20 million exposure in a company, and I'll be honest with you, in hindsight that probably was a little bit of an exposure for our size Company, and I'll tell you we don't have a lot of those. So $20 million in one credit like that probably is a little much, but that has been charged off. That loan -- those are trading right now in the open market at $0.65 on the dollar. We actually could sell our position today and get $3 million to $4 million back in income today. So we're actively monitoring that credit to see if it improves. I know that's a lot but the real story at the bank it is will be earning about 50% pretax preprovision in about 12 months. In my opinion, being an investor, I would gauge on maybe a first quarter level of provision for the coming quarters. I don't think it will be as high as second quarter because of that big commercial credit, but I would be conservative and bake in, at least for the next three quarters for now, a second quarter level.

Okay. If --

Excuse me. Corrected me. First quarter. First quarter.

Okay. First quarter. Okay. Now -- yes, that makes -- okay. Yes. On the -- on Slide 33 you guys have broken out sort of the adjusted from non-GAAP -- from GAAP to non-GAAP here. And I guess you guys are basically using the GAAP numbers when you are reporting your earnings essentially, these are not reflective, correct?

It's -- the reason we're doing that obviously is -- it's investment, right. In order to get this lower run rate, our expenses in 2007 and 2008 when you cut through all of the stuff was about $176 million. That was one our run rate two years in a row.

Yes.

Our internal budgets had that going up in future years --

This is helpful though. I guess what I want to ask you, though, is when we're looking at this, right -- I mean, we're looking at these numbers and there are all of these little items which add up to a significant amount, actually, when do those little items go away?

Probably second quarter next year. I mean they are significant and they are not, right? You are going to get about $40 million a year perpetuity of lower expense levels for the next 10 years, so you have got to spend, say, $10 million to get $40 million times 10, you are going to spend 10 to get 400. Let me just give you an example. We had 338,000 square feet of non-branch real estate. Okay? 338,000 square feet. A bank our size probably operates with 100,000 to 125,000 non-branch real estate. So I have not got a lot of extra space and leases I don't need. So I can either keep paying that for the next five or ten years or I can go to those people and say, look, I got five years left. Are you willing for me to pay you 18 months now if you let me out of five years, and that person that is leasing to me gets 18 extra months and hopefully they can go and sublease it again and we both win. So we are just having to spend some investments to get out. Another 125,000 extra.

I guess what I'm wondering -- all I'm trying to get an idea of is that when -- we're now looking at an appendix and same thing that you sort of have to do with the earnings statement -- with the earnings release, what I'm saying is that these numbers will eventually go away, but I'm just trying to get scenes as to the timing of that, when that is going to be more or less reflected because you already seem to be at a run rate of the 150, but that's not really being reflected right now in earnings if I understand it correctly because of the --

Right. Right. Correct.

And when might you see that?

I would say, again, like I just said, second quarter. Second quarter is when our [five star] will be converted. We're pegging the middle of May, so June 1 is when the five star savings will come in. So when you start third quarter next year, it will be, I would say 98% clean of where we're going to be by July 1, next year.

Yes, Paul, I mean, clearly we're very deep in to the program, and a lot has been quantified and earned so far so to speak. That is the impression that I think the the appropriate one for the numbers.

Paul, if you remember we had said it would be approximately an 18 to 24-month project and so that's why you would be looking at it some time in 2010 either in the middle or slightly after that. But, as Tim said, the bulk of the projects will be in place by the middle of 2010 and particularly things like the re-evaluation of the branch network and the real estate. Those are under way right now and I think the team is through a good portion of that.

And it looks like if you look at the adjusted item, it looks like the numbers are actually moving down --

Frankly, as Tim got in to it, the team identified additional opportunities and so that's why as you said we basically already reached the original target that we put out there and particularly since the credit costs are running so high, the team looked and said, geez, maybe we can get even more, and that's the reason why we just announced today the new run rate target.

That's great. And just finally on the utility. The decoupling on the rate cases, just so understand how this is going to work, you are going to try to get decoupling by the end of the year, but you still need to have base rate cases to set the final number and then after that we're going to be getting adjustments to -- basically it would appear to me if I understand it correctly, if all goes well, so that we don't have near as many rate cases and as much regulatory lag. Is that the right way to think about it, A? And then, B, with the interim relief that you guys got, which was less than the settlement, has there been any change in the regulatory environment with respect to the perception of decoupling or anything else that you're encountering either because of the economy or something else?

Yes. In short, no, but let me ask Dick to give you a little more color around the regulatory situation because clearly that is one of the key questions about where the Company is going to head and whether we're going to get this reset.

This is Dick Rosenblum. Your recitation of how decoupling works is essentially correct. As a consequence of decoupling we would anticipate rate cases less frequently, basically probably every other year, perhaps even a little bit less if we had a stable cost environment. The -- we haven't seen any pullback from the policy issues at the commission. What we're seeing, our best judgment, is simply a delay in -- which is understandable in this regulatory environment, this economic environment, and given the significance of the issues. We -- as an analyst, I'm sure you are seeing this at other places in the country, too. It's very difficult for commissions to make their way through these decisions in this environment.

Okay. So, really, we'll see what happens the decoupling but then after that we still have to see what happens with these rate cases and then hopefully we'll be finished with the transition period?

Correct.

And when would we be finished with like the rate cases -- I'm sorry, you did tell us -- but what time in 2010 should we get some decision with respect to them? 11 months, is that right?

Yes, we would expect it in the last half of the year in 2010. Late third quarter most likely.

Okay. Great. Thanks a lot.

Your next question comes from the line of Jim Bellessa with D.A. Davidson & Company. Please proceed.

Good morning. Paul asked most of the questions that I had, so I'll ask a few additional ones on the same subject. The single commercial credit, I hear that it's a national credit so it's not a -- tied to the Hawaiian islands at all?

They do have large operations here, but it's a national company.

And is -- because they had local operations, is that why you made the loan?

Well, that's partial, but as I have said before, Hawaii is interesting from my experience coming from the East Coast, banks struggle to find deposits, and there are so many loans because people are moving to North Carolina, Georgia, Florida and you struggle to find funding. In Hawaii I found the opposite. There are so many deposit it is unbelievable, but you can't find any loans. The banks out here -- this market is not a commercial market. It's not Dallas, St. Louis, San Francisco, Phoenix. There's not a lot of companies, so that's why -- even if you look at Bank of Hawaii, and First Hawaiian versus their peers on the mainland, they have an unusual level of residential mortgages. If you look at Zion, South Trust, BB&T, they likely wouldn't have that level of mortgage so it's a function of our market and so you can either have all mortgages or you can have some of the small businesses here, but eventually you have to reach out and find other assets, so I think that the Hawaii banks probably have maybe a little bit more shared national credits than you would find on a mainland bank.

You transformed from a thrift to a community bank. Community banks don't go too heavily in to commercial real estate. How far do you want to increase the position in commercial real estate?

I don't think much more than we have. Out of our $5 billion of assets today and $4 billion of loans, we only have $300 million of commercial real estate. Of the $300 million, only $50 million is commercial real estate construction, the rest is commercial mortgages where -- we're a community bank so our commercial mortgages are typically with someone who may own a strip center or someone that may own two or three little offices that they are renting out to a dentist. That's typically our commercial real estate but when you look all banks are different and having a thrift legacy background, we are primarily a retail organization and so I see our future really have a very nice commercial unit and Gabe Lee does a wonderful job, he is $700 million of our $5 billion of assets. Our future really is as a consumer bank.

And most of those commercial loans that you anticipate for the future would be local Hawaiian loans, is that correct?

Well, yes -- I mean, we have $700 million. I don't have the exact numbers in front of me but I want to say out of the $700 million, probably $200 -- maybe $200 million is shared national credits and they try and stay in A names, Verizon -- I don't really know all of the names. We don't really try and take on a lot of credit risk, you are just looking for a commensurate return with a high-quality asset. This one happened to be a very high quality Company and it's really more of a liquidity situation than credit situation and they just released their earnings and they didn't look that bad in the second quarter, it's just a liquidity issue where a lot of their funding is coming due at once and everybody is nervous and not wanting to renew, so it's a unique situation.

And Jim, you are correct that the shared national credit that we have done have had some nexus to Hawaii or have been some company that we know that -- it's not the policy of the Company to go out and just look for shared national credits, generally.

But the -- the profit of Hawaii financial institutions definitely is the deposits. We have about $4 billion of deposit that we pay about 70 basis points on, so the fortunate thing for Hawaii is Hawaii banks like -- the reason they all perform well is they don't have to stretch for credit, so First Hawaiian, Bank of Hawaii, unbelievable credit, and high-quality institutions, and it's just because of our strong core funding.

Answers and your responses to my question, but I got confused a little there, Tim, when you said that you saw this national real estate -- or national commercial credit that is in default, have a good or solid -- and -- you didn't say solid -- second quarter report with earnings, and then you are saying they are in bankruptcy? I'm misunderstanding.

They are in bankruptcy because -- I don't know the whole side of it -- it's about $2.5 billion, I think -- I don't have the specific numbers -- of debt coming due and people do do not want to renew, and so they don't have the ability to pay back all $2.5 billion at once, but their current earnings is enough to service the debt obligation.

I see.

If everybody was willing to extend and renew, really -- I'm not -- being their treasurer, but being in a former industrial company like HECO, you need to ladder your funding so it does not come all due at once but they have a lot coming due at once and they just can't -- it's like our lot loans. Our lot loan customers are able to service their debt, but they are maturing, and they don't have enough money to pay us off. It's really a liquidity situation where if the bankruptcy judge can get this debt extended, their core operations can service the debt.

And my final question is about this opportunity for non-interest expense reductions and your -- in your slide it has a little bullet that says, this helps to offset rising provisions for loan losses. That kind of suggests future looking, and in response to Paul's question you said that you ought to be anticipating something in the order of magnitude of $8 million that you had as a loan loss in the first quarter and continuing this year. How far in the future does this help offset rise progress visions for loan losses have to be extrapolated in your mind?

Well first point, I can promise you that was not the intent of the language, to indicate increased provisions. I just want to be clear on that. The intent of the language is that just think if we had not taken out this $20 million to $30 million of expense. Right now the bank would be earning $30 million less than it is reporting, right? So the intent of the language is that it's very fortunate that we have these opportunities to offset this credit. That was the intended language. Being conservative, that's what I would do. I would do that times 4, 8 times 4 is 32 and I would just assume that is the run rate and I would do that at least through -- Connie asked me the other day -- and I would say at least through June and that's just a guess because there are a lot of mixed singles right there -- right now. You hear these reportings coming out that housing starts are coming back out positive, surprising. And then the next someday you hear a something bad. We are in uncertain territory. Hawaii lags being conservative at least through next June. It could be a little lower. Could be a little higher. Could be a little shorter, could be a little longer but I think that's a conservative number.

Jim, when Tim and I have talked about it, the other thing that you have to consider is that the bank's portfolio is primarily consumer related, so things like unemployment, personal income will tend to lag and so that's the reason why we would say that you would probably want to go through at least middle of the summer next year.

Let me just give you -- and we're on a public conference call, so my run rate is about $60 million -- if you take month, about $60 million. Okay? If you take month, and my provisions on a monthly basis are about $28 million so right now I'm earning enough on $28 million per provision, I'm earning about $60 million. The wild card is if one of these things pops in like the large commercial credit that happened in second quarter. But on a normalized -- when you look at though last six months on a normal month I'm running about $60 million and covering about $28 million of provision.

Or you get OTTI coming out of the securities portfolio.

Thank you very much.

Your next question comes from the line of (inaudible) with Incremental Capital. Please proceed.

Good morning. Connie, I was just trying to get a little bit of sense of the statement that you made regarding utility earnings. Are you saying that earnings for the last half of the year are going to be flat versus last year? So the impact of the increment increase is going to be, I guess curtailed by the O&M and the loss of sales? Is that what your comment was?

No, the comment was relative to the first half earnings, not year-over-year.

Okay. So do you see earnings going in the utility business -- in the first half, they have been coming down, right? So you still first utility earnings coming down in the second half of the year?

Yes, because we have the lower sales this year, that's a big part of what is impacting utility results, and then higher O&M as we are putting in to new units.

Okay. So --

Just for clarity, because I think we're using terms that can be unclear, we would project the second half earnings at the utility to be consistent with the first half earnings, so flat through the year with the second half looking very much like the first half.

Okay. Flat through the year. Okay. Okay. Okay. So that would imply, Connie, if you take that assumption, you would be earning, I guess, if you look at the last half somewhere below the dividend level, and -- so I'm just trying to see as you look out when do you start -- and this goes back to what Paul said, if this -- you get this decoupling, do you pick up all of these lost sales earnings immediately once the decoupling order comes out at the end of the year. So next year if you are down 4% and it's $5 million for each percent we pick up $20 million in earnings next year automatically for the lost sales? Is that how it will work?

Well, just like on the bank side where you can't really predict what the provision is going to be or what OTTI might be coming out of the securities portfolio. On the utility side, most of it relates to the regulatory either rate relief or regulatory reform, and so that's the reason why it's very difficult to forecast what the earnings might be because you, in essence, have to forecast exactly when you are going to get that kind of relief, but you are correct that when the relief comes in, it would increase by whatever that amount is. In this case we had a stipulation for just under $80 million and the commission gave us the $61 million in the interim and now it is scheduled to go to hearings on the balance. On the decoupling it is when the decoupling mechanism is put in place that we can then adjust for sales. But I don't know -- Dick, if you want to add anything to that.

If I can just --- if the decoupling is approved, does the decoupling mechanism, say it is approved at the end of the year, does it start January 1, 2010, or do you have to wait for the rate cases for the decoupling mechanism to be effective?

This is Dick Rosenblum. It would be effective, presumably as of the date of the decision.

Okay. Okay.

The decision was December 1, presumably it would start December 1. It's possible they might approve it December 1 and say start it January 1, but that would depend on the decision. Generally speaking, it would be effective as of the date of the decision.

And can you tell us based on what you have filed how much lost sales there would be by the time end of the year? I'm assuming it's more after that 4%, right? I don't know what the starting point was.

This is Dick Rosenblum. Our best guess as we sit here at mid year is right at the 4% stage.

So there would be a 4% pickup in that decoupling mechanism?

The -- you also have to -- you are correct, you have to relate it to what the base of sales is in the rate case and so, for example, on Oahu we did forecast some decline in sales and keep in mind that when we filed this case this was in the middle of last summer before the financial crisis.

Sure.

So we were expects sales down I think about 1.1%, so what has actually occurred is significantly more than that, we said in the prepared remarks we're expecting it to be down about 4%, so it's a 3% differential.

Okay. Just going back to my question, I guess as you said, right, the bank starts improving second half really going to gun second half rate cases taken to impact everything. Will you be able to earn your dividend next year or is that something for 2011 as you look at things right now?

Well, again, there are so many assumptions and much of it is driven externally. We would expect that at we should be able to get relief in a reasonable period of time, and certainly when that comes in we should -- we would be earning the dividend and then some.

Okay.

I would add -- this is Jim here. I would add that we put forward the slide 21 to demonstrate to you that of the requirements that we have for the dividend -- assuming the dividend at the Board level is confirmed at the rate of $0.31 a quarter as it was yesterday, that the operating subsidiaries can cover essentially most of the dividend right now in relatively weak economic conditions and given these pending regulatory matters, so it's really a function of when the economy clarifies on these regulatory matters come to fruition, but I think $108 million out of the $113 million requirement is there even in these conditions. Now that's the way I would think about that.

No, I understand you have the cash. I don't have an issue is on you guys not having the cash, but I'm just trying to understand from a trajectory of earnings and all of that, it seems like as we go through the cycle, expectations should be that it's really in 2011 where we should be earning more than -- I'm just trying to set expectations as each call comes in, people get anxious whether the dividend is going to get cut or not because the earnings are below but I guess if we can clear the expectations as to when we would be earning above the dividend and everything, that takes away that uneasiness regarding the dividend cut away from every call. And I'm trying to get a timing of that and if I'm right, it seems like it would be more like 2011.

I understand the question. It is a fair question. So we'll commence at the end of the summer our budgeting cycle. We'll take in to account all of the factors that we have been discussing at that point in time, and have more to say about 2011 as we get closer to that right now, but this is basically where we wanted to leave it at the moment given the conditions we're in.

Thank you.

I would comment that we were always looking at 2011, complete reset, because we still have the two neighborhood island subsidiaries to reset. So while a lot of the discuss has been on Oahu, we also have to go through the cases for Maui and the big island.

Yes, Connie, I'm just trying to set up expectations, because as I was mentioning it, not to belabor it, we should just be ready for it and watch those cases and then everything should pick up by 2011?

Yes.

This is Dick Rosenblum. Your comment that we need to watch those cases carefully is spot on. The decoupling case and another case which we haven't mentioned which is a clean energy surcharge case, and the inclusion of our newly commissioned CT in to rates are the three big issues, and those we are watching very carefully and those are the keys to improving financial performance at the utility.

Thank you very much.

There's still things to do after that, but those are the key issues.

Understood.

Your next question comes from the line of [David Post] with (inaudible). Please proceed.

Hi. Thanks for taking my call. I guess the first question is just on the dividend. Have you discussed internally whether to keep the dividend, given the I think Moody's and S&P had it -- moved you guys to negative watch, so I'm just wondering if that -- if the dividend at all was part of that discussion, and if they had had any comments on that?

Well, the Board that rates the dividend every quarter, but specifically to what the rating agency actions were, that was relating more to the question we have all been talking about which is when is the regulatory relief going to actually come through? So I think that's the primary uncertainty that they were looking at and, in addition, the overall Hawaii economy as it would impact sales on the utility's side and the credit provisions on the bank side, and the over all environment for regulation.

Got it. And then you have done a good job discussing the credit book, but on the securities portfolio I was just wondering if we should expect more OTTI charges going forward in the securities portfolio?

Yes, Tim, maybe you can give color on that.

I don't know that I'd use the word expect, I definitely would use the world possible. And we have got these private mortgage-backed securities are probably from 2003 vintage to 2007 vintage and we tracked at 30, 60, 90 day delinquency for all of them and the most troublesome by far is the 2007 and 2006 which we've already taken some OTTI. And when we look at it, there's about eight bonds that we flag that appear to be the most likely candidates if it were to happen, and when I try to frame it from memory, those bonds totaled maybe about $75 million of principal value on our books, and it's hard to judge with where the delinquencies is coming, and a lot of the modelling is subjective. You put it Bloomberg and run some vectors and assumptions on what you think the losses may be, doesn't mean they will be, it's like a loan provision and, again, just like the last question, we talk about this with our Board, and I would earmark it that is it probably possible of $5 million to $18 million out of that group of eight. I'm not saying likely, and in an extreme situation if it got really worse, it could be higher. But I think with the way that delinquencies are trending right now, every month it's just modestly higher in delinquencies. The last three, four, five months we have not seen a huge spike up in any one mont on any of our bonds. I would say possible $5 million to $15 million, but I wouldn't use as strong of a word as expect.

It looked like there was a $40 million, maybe a little bit more than $40 million unrealized loss position. I'm just trying to rectify that with the fact that you are saying it might only be $5 million to $15 million. Is unrealized loss -- is not reflective of the losses that could be taken.

Not at all. We have about $600 million or $700 million worth of bonds and the way that works the accounting if it's unrealized gain it goes in your equity, if it's unrealized loss it goes in your equity. And there are a lot of things that causes a bond to trade above or below it's book value. Credit is one of the large pieces that would cause it but there is liquidity, there's lack of demand, there are a lot of reasons but it's not all related to credit risk.

And looking at the 10-Q it looks like, maybe -- I'm just giving rough numbers but 30% to 35% were AAA, and it looked like $60 million or so that were trip CCC or below at least recently. How does that -- I'm just wondering, are the losses mostly on the CCC bonds or are they on -- are they just across the board?

Yes, hold on one second. I got it right here. When you look at the mortgage-backed securities, as an example, the -- we have one that was a 2007 vintage. We have already taken some OTTI on it. We have $13 million of book value left on that and the current market price as it's trading is $0.70 on the dollar. Okay. Then when you look at my 2006, it looks like I have got maybe, I'm just ballparking, looks like 10 to 12 deals here and each one ranges from $3 million to, say, $14 million and when I'm looking at the prices they, on average, look like they are trading at about $0.80 on the dollar, the 2006s, and there are two that are lower than that. When I look at my 2005s, there is about 10 deals and they are about $4 million to $20 million in size. And just for doing my finger down it there is one trading $0.94 on the dollar, $0.92, $0.93, and the remaining seven at about $0.85 on the dollar. Then when you go to 2004, they're almost all trading at $0.99 on the dollar and when you go to $0.03 they're almost all $0.99 on the dollar. So it's definitely the most recent vintages.

Sorry to interrupt. I just didn't know -- when I looked at CCC bonds it looked like they were all trading below $0.30, and CCC was between 0 and $0.30 I thought --

I have got on my sheet. This is the June 30 one, so it's changed a little bit for July, but on my June 30 sheet I have four CCC bonds here one is at $0.82, one is at $0.81, one is at $0.84, and one is at $0.42.

Okay. Got it. That's helpful.

Real quick. Just -- I want to make sure we get this in before the call is over. But in fair disclosure the question earlier from Paul or somebody on the investment expenses to get expenses down there are two known ones between now and in May. One is unrelated to all of this, and that is the expect -- the expectation is that there will be another FDIC special assessment. That's something that hits everybody, has nothing to do with our performance improvement project. Ours in second quarter was about $2.3 million.

It's a function of your level of deposits, and so it hadn't been confirmed but the industry world is there will likely be another one of that same level in fourth quarter. So just count on that. And as it relates to [Fisor] we said since the beginning that our guy that runs operations technology, he has converted a lot of banks. He estimates the total conversion one-time cost with training, extra support people to be about $3 million. We expect to spend about $700,000 of that in this calendar year and we expect to spend about $2.3 million of that from January 1 to May. So just mark that down as far as doing your planning .

I'm sorry. That was my last question. Thank you.

(Operator instructions). With no further questions at this time, I would like to turn the call over to Ms. Hollinger for closing remarks.

Thanks for being on the call today. As always, if have you have any further questions you can call me at 808-543-7385. Thanks a lot. Bye-bye.

We thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect connect, and have a great day.