Hawaiian Electric Industries Inc (HE) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter and year-end 2010 Hawaiian Electric Industries, Inc. earnings conference call. My name is Shantalay, and I will be your facilitator for today's call. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Ms. Shelee Kimura, Manager of Investor Relations. Please proceed, ma'am.

Thank you, Shantalay. Thank you, and welcome to Hawaiian Electric Industries' 2010 year-end and fourth quarter earnings conference call.

I'm Shelee Kimura, and joining me today are Connie Lau, HEI President and Chief Executive Officer; Jim Ajello, HEI Senior Financial Vice President, Treasurer, and Chief Financial Officer; Dick Rosenblum, Hawaiian Electric Company President and Chief Executive Officer; and Rich Wacker, American Savings Bank President and Chief Executive Officer; as well as other members of senior management.

On today's presentation, management will be using non-GAAP financial measures to describe the bank's operating performance. Our press release and the slides and appendices accompanying this webcast, which are posted on our Investor Relations website, contain additional disclosures regarding these non-GAAP measures, including reconciliations of these measures to the equivalent GAAP measures. Forward-looking statements will also be made on today's call. Please reference the accompanying disclosure to the webcast slides located on our website.

As shown here, GAAP earnings were $83 million or $0.91 per share in 2009. Excluding the $19.3 million or $0.21 per share after-tax loss related to the liquidation of the bank's private issue mortgage related securities, adjusted 2009 earnings were $102.3 million or $1.12 per share. Throughout this call, we will discuss earnings excluding the impact of this 2009 transaction.

I'll now turn the call over to Connie Lau.

Thanks, Shelee, and aloha to everyone.

2010 was a solid year for HE, with earnings per share of 8% and improved profitability and reduced risk. But the real story for 2010 was the achievement of major strategic milestones at both our operating Companies. Together, our unique combination of a utility and bank continues to provide our Company with a strong balance sheet and the financial resources to invest in the strategic growth of our Company while providing an attractive dividend for our investors. As a result, HE achieved a 15% total return to shareholders in 2010, more than double the 7% return of the EEI index.

Starting with the strategic milestones achieved in our utility, we recently received approval to implement our new regulatory model for our largest system on Oahu that facilitates meeting our state's goals to transition to a cleaner energy economy and achieve one of the most aggressive portfolio standards in the nation. At the same time, it provides for more timely cost recovery and a better opportunity to earn on our investments. The model, referred to as decoupling, de-links revenues from sales and includes annual revenue adjustments for O&M expenses and rate-based additions.

With the decoupled model, we should see the quality of our earnings improve significantly and become more predictable. We expect rate base to grow over time as we make investments to our electric system to accept increasing renewable generation and as we increase equipment replacement rates to address our aging infrastructure. In addition, we have the opportunity to stabilize and lower customer bills over time, as we become less dependent on costly oil for our generation.

During 2010, we also received a significant number of regulatory decisions, including PUC approvals for renewable projects and Clean Energy Initiatives. With so much accomplished in 2010, we believe our utility is well positioned to execute the state's clean energy strategy in 2011 and beyond.

At the bank, we successfully completed our multi-year performance improvement project in 2010. The many initiatives of this project resulted in substantially improved profitability and reduced risk and earnings volatility in 2010. In summary, we are well positioned to execute our strategy and deliver attractive risk-adjusted return and earnings growth to our investors in 2011 and beyond.

On slides four and five, you can see that the utility made significant progress in implementing its clean energy strategies. The Hawaii PUC issued a significant number of important regulatory decisions in 2010, all of which are key steps to support Hawaii's efforts to become -- to reduce its dependence on oil. Included in these decisions were a number of interim and final rate case decisions. Now, the only pending rate case decision are HECO Oahu's 2011 test year and HELCO's and MECO's 2010 final decisions, as we already received interim decisions in those cases in 2010.

The December 2010 final decision for the HECO 2009 rate case resolved several open issues and improved the implementation of decoupling for our largest system on Oahu, with an ROE of 10% effective with new rates requested for March 1. While the ROE is lower than our current ROE of 10.5%, decoupling will give us a better opportunity to earn our allowed rate of return and will be a significant improvement from our underearning situation over the last several years.

Lastly, our governor appointed State Representative Hermina Morita as the Chair of the Hawaii Public Utilities Commission last week. Her appointment requires confirmation by the state senate. She has been Chair of the House Energy Committee for many, many years and is very knowledgeable about the complexities of energy issues.

As for renewables, as noted on slide five, many actions have been taken and continue to be taken to execute our clean energy strategy. For example, in May 2010, the PUC approved HECO's power purchase agreement with First Wind Kahuku Wind Power. The project is expected to go online in the first quarter.

In January 2011, HECO and Castle & Cooke Resorts announced agreement on pricing terms for power from a proposed Lanai wind farm. The agreement requires PUC approval and is another step forward for the inter-island wind project to transmit up to 400 megawatts of electricity to Oahu by an undersea cable from wind farms proposed for Lanai and Malukai. And we signed a 20-year contract with a local company to supply 16 million gallons of locally-produced biodiesel per year. The achievement of these strategic milestones puts us on the right path to continue to meet or exceed our clean energy goals and provide rate-based growth as we invest in our own system to support these renewables.

Under our new decoupling model, the most significant drivers for improving the ROE are managing O&M expenses relative to de-escalation rates, especially during periods of increasing demand; spending within PUC-approved amounts for major projects and completing projects on schedule; rate case outcomes that reset O&M requirements and rate base items not included in the RAM. For HECO Oahu, our goal is to achieve an ROE within 100 basis points of our allowed ROE by the end of 2012. The next big items to close our ROE gap are this year's HECO 2011 rate case and decoupling implementation for HELCO and MECO.

Turning to slide seven, we successfully completed the bank's multi-year performance improvement project, which we began in 2008. We reported a strong 1.2% return on assets and a 56% efficiency ratio for the year, and our profitability metrics are now in line or better than the average of our high-performing peers.

I'd like to take this opportunity to highlight the key drivers of this improved performance. We reduced non-interest expense significantly over the last two years, and we reduced our exposure to riskier non-core assets by shrinking wholesale assets and liabilities and selling private mortgage-related securities. We lowered funding costs through our market-leading free checking product and lower CD balances. We optimized our balance sheet and capital efficiency and improved our capital ratios by exercising great discipline through the downturn on what we selected to put on our balance sheet, favoring shorter-duration, higher-yielding assets, over low fixed-rate mortgages and carrying additional capital to hedge against the downside of the current credit cycle. And we achieved an annualized pre-tax pre-provision income within our target.

In addition, the Hawaii economy seems to have found the bottom, resulting in declines in non-performing assets and provision expense year-over-year. Importantly, our credit quality through this cycle has been better than average, due to our historic disciplined and conservative underwriting standards. As it has throughout the credit cycle, our bank continues to maintain its low risk profile, strong balance sheet, terrific funding base, and simple business models.

Going forward, Rich Wacker, a seasoned and talented bank executive who joined us in November as the bank's new President and CEO, is now working with his team to develop a new strategic plan that will solidify the gains from our recent successes and grow our bank franchise in Hawaii as the economy improves. We are focused on maintaining the bank as a high-performing community bank, with a targeted return on assets of 1.2%, net interest margin above 4%, and an efficiency ratio in the mid-50s. We reaffirm our pre-tax, pre-provision target range of $110 million to $120 million. With the delay in the recovery of the credit cycle, we expect the bank to produce annual earnings at $60 million-plus in the next 12 months to 24 months. As the economy improves further, we expect to benefit from lower provision expense.

We are encouraged that in the fourth quarter 2010, we began to see loan growth in the commercial markets and commercial real estate portfolios and would expect to see modest loan growth in 2011. In addition, as interest rates rise, we have the opportunity to selectively retain a larger portion of our mortgage production on our own balance sheet to help maintain our asset size, as opposed to our practice over the last two years of selling almost 100% of our production. While our targets have seen lower fees from Regulation E, they do not consider other regulatory changes such as the Durbin Amendment capping interchange fees.

I'll now ask Jim to provide additional detail and insight to these results and our outlook for 2011.

Thanks, Connie.

I will first briefly address the Hawaii economy as a backdrop for results and outlook. The positive economic trends that we are seeing here in Hawaii bode well for HEI. Hawaii's tourism industry, a significant driver of Hawaii's economy, continues to reflect a trend of positive growth, which we began to see at the end of 2009. Visitor arrivals were up in 2010 by 8.7% over 2009, and visitor expenditures were up 16.2% as compared to last year.

Hawaii's unemployment rate of 6.4% in December continues to track significantly better than the national rate. We are also seeing signs of recovery in Hawaii's housing market. On Oahu, where we're seeing the strongest signs of recovery, 2010 residential home sales were up 13% over last year, and median prices were up 3%. On the neighbor islands, sales volumes were up for the year for all islands compared to 2009, although prices have not yet begun to recover on a broad basis.

Hawaii's gradual recovery continues to be led by improved performance in the visitor industry and mostly on Oahu; however, the rest of the economy, including job creation, has lagged the visitor industry revival, other than federal government expenditures, which have remained strong throughout the financial crisis. Local economists, however, expect expansion throughout Hawaii in 2011. And we expect to see earnings benefit, particularly at the bank, as the Hawaii economy and credit environments improve.

Turning to slide 10, full-year 2010 earnings were $1.21 per share, up 8% compared to $1.12 per share in 2009. Fourth quarter earnings were $0.26 per share, compared to $0.36 per share in the same quarter last year. On a net income basis, HEI earned $113.5 million in 2010, $11 million higher than 2009.

At the utility, net income for the quarter of -- fourth quarter of 2010 was $18.9 million compared, to $23.3 million in the fourth quarter of 2009. The decrease was primarily attributed -- attributable to $10 million higher O&M and $3 million lower kilowatt hour sales resulting from the cooler and less humid weather, partially offset by a non-recurring tax settlement items of [$6.6 million]. The O&M increase in 2010 was significantly weighted to the fourth quarter due to the timing of generation unit overhauls, which is typically skewed to the fourth quarter, due to the seasonality of demand and higher transmission and distribution maintenance. In addition, the increase reflects management's action to defer work in the fourth quarter of 2009 to 2010.

For the full year 2010, the utility earned $76.6 million, compared to $79.4 million in 2009. The decline was primarily due to $6 million in lower kilowatt hour sales, which was in line with last quarters guidance, $23 million or 12% higher O&M expense, just under our expectation of 13%, and $11 million in higher financing costs, primarily due to generation units put into service in the latter part of 2009. These factors were partially offset by $26 million higher rate relief and $6 million from the non-recurring tax settlement items.

At the bank, net income for the fourth quarter of 2010 was $13.3 million versus $14.9 million in 2009. The $1.6 million decrease compared to the fourth quarter 2009 is attributable to $2 million in lower net interest income, $2 million in lower non-interest income, and $2 million higher provision for loan losses. These factors were largely offset by $4 million in lower non-interest expense.

For the full year, bank net income was $58.5 million, compared to $41.1 million. The $17 million or 42% increase over last year was primarily the result of lower non-interest expenses and lower credit-related costs, including the non-recurrence of impairment charges on the private issue mortgage-related securities portfolio liquidated in 2009 and lower provision expense.

Let's take a closer look at the utility. Slide 13 reflects earnings drivers at utility this year. Most significant are the regulatory outcomes and their timing. Based on the HECO 2009 final decision, decoupling will be effective with the approval of the final rate tariffs. We requested an effective date of March 1. If that date is approved, the RBA and RAM revenues should commence at that time.

While we expect implementation of these mechanisms to improve our earned ROE, the most significant driver of earnings in 2011 is the HECO 2011 rate case. It will reset base rate -- base sales revenues, O&M, and rate base with the decoupling mechanisms going forward. Kilowatt hour sales will no longer be a key driver of earnings for HECO Oahu but will continue to be a key driver for HELCO and MECO as they will await decoupling implementation.

We expect 2011 O&M expenses to increase by about 7%, excluding DSM, primarily reflecting higher costs to execute our clean energy plan. 2011 O&M increase is largely included in the O&M RAM and HECO's 2011 rate request. I will discuss our CapEx plan and rate base growth shortly.

Slide 14, we show our actual versus allowed ROEs for 2010. We have a significant opportunity to narrow the gap between our earned and allowed rates of return. With the implementation of decoupling and a PUC decision in the HECO 2011 rate case, we are targeting to achieve an ROE within 100 basis points of our allowed by the end of 2012.

Slide 15, we demonstrate HEI's earnings sensitivity to changes in HECO's consolidated ROE and the potential growth opportunities in the future. Every 100 basis points change in the HECO consolidated ROE is equal to approximately $0.14 and does not include rate-based growth. For HECO Oahu, the EPS sensitivity is $0.09.

Capital expenditures remain at high levels, and as we continue to make investments to support reliability and achieve the long-term benefits of a clean energy future, we have increased our five-year forecast to $2.2 billion, investing at more than two times depreciation each year. Based on this forecast, we expect the compounded annual growth rate for rate base to be approximately 5% over the next five years. Many of the major initiatives within this forecast are expected to be completed beyond this five-year period.

Four major initiatives comprise approximately 40% of the five-year plan -- replacing aging infrastructure, environmental compliance, fuel infrastructure investments, and infrastructure investments to integrate renewables into our system. Estimates for these projects could change with time, based on external factors. For example, we do not have clarity on the timing and technical requirements for environmental compliance. The timing of fuel infrastructure and inter-island wind is depending on permitting and third-party activities.

Based on these CapEx plans, we expect the change in bonus depreciation rules to yield at least $75 million in positive cash benefits over the next two years. However, the specifics of the 2011 impact continue to be assessed, in part because the transition rules related to the definition of qualified property are still unclear. Therefore, the net amount of cash generated and its application continues to be evaluated. Even without taking into account the potential cash benefits of bonus depreciation, we do not expect to issue equity beyond the dividend reinvestment program for the next two years to fund this healthy CapEx plan.

Now we'll look more closely at the bank's performance metrics. On slide 18, our net interest margin was 4.21% and continues to exceed the average of our high-performing peers. The decline from last quarter was due to the higher third quarter recognition of deferred loan fees related to a significant increase in loan prepayments. In the fourth quarter, we also reduced the level of excess cash in the quarter from $230 million to $100 million. Most of the excess was redeployed to the investment portfolio while maintaining a short-term duration profile and flexibility for when the economy improves. This was an improvement over the 25 basis points earned previously.

The bank recorded $8.6 million of provision for loan losses in the fourth quarter, which was $2.6 million higher than the third quarter provision and $3.6 million higher than the expectation of approximately $5 million per quarter. The fourth quarter increase in the provision is primarily due to a $1.2 million specific commercial loan that was charged off and approximately $1.4 million related to a one-time adjustment for enhancements to our reserve methodology for our declining portfolio of residential lot loans.

For the year, however, provision was $20.9 million, a 35% improvement over 2009. As we said last quarter, provision may be lumpy, especially as we wait for the economic improvements in the tourism industry to spill over into the rest of the economy. We expect the 2011 provision for loan losses to be in the range of $15 million to $20 million as the economy improves, especially the neighbor island economies.

On slide 20, our efficiency ratio of 54% on a GAAP basis remains ahead of our high-performing peer benchmark. In the fourth quarter, non-interest expense on a GAAP basis declined by $1.3 million, compared to the last quarter to $35 million, the lowest level since the start of the performance improvement project in the first quarter of 2008.

We're pleased to show you the snapshot of our balance sheet at the bank. Here we show you our peer banks in ASB in terms of asset and funding mix. Since the last complete available data for our peers is as of September 30, 2010, we used that data here and compare it to ASB's December 31, 2010 balance sheet. A key differentiator for ASB the and Hawaii banking market versus the industry is our low-cost deposit base. Our average cost of funds of 41 basis points in the fourth quarter and 45 basis points in the third quarter is very low compared to the average of 111 basis points for the industry in the third quarter.

Fourth quarter cost of funds declined further as we grew core deposits and higher-costing CDs were reduced. At the end of the year, 94% of our loan portfolio was funded with core deposits, an increase from 86% at the end of last year. As you saw on previous slides, this enhances our margin relative to peers. We also remain strongly capitalized with a Tier 1 leverage ratio of 9.2%, tangible common equity of total assets of 8.6%, and total risk-based capital of 13.9% at December 31, 2010.

In addition, the bank has been able to manage its balance sheet and return capital to HEI in excess of its earnings. ASB paid dividends of $62 million in 2010, and over the past three years, the benefits of performance improvement have allowed ASB to generate over $220 million of dividends to HEI while maintaining its strong capital ratios.

Looking at non-performing assets, we saw another quarter of lower non-performing assets. A 10 basis points decrease in non-performing assets ratio was due primarily to the declines in residential lot loans. Our primary credit risk continued to be in three loan portfolios that now total $466 million, which is down $93 million or 17% over last year. They include $66 million of residential lot loans, primarily on the neighbor islands, $301 million in neighbor island one-to-four family mortgages produced from 2005 to 2007, and $99 million of mainland residential loans purchased.

Our net loan charge off ratio for the year remains low at 61 basis points, which is an improvement from 66 basis points in 2009 and better than our high-performing peers. The increase in the fourth quarter net charge-off ratio to 0.72% from the third quarter was due to a charge-off of one commercial loan previously discussed. In 2011, we expect short-term downward pressure on net interest margin and income consistent with the banking industry; however, even with ongoing loan repayments and assets repricing downward, we expect that our already low cost of funds will support better than industry margins. Thus, we expect our net interest margin will remain slightly above 4%.

In addition to expense management, we will focus on loan growth as the economy improves and we seek to gain market share in interest-friendly asset categories. In 2011, fee income may be impacted by regulatory changes to interchange fees; however, at this point in time, we are uncertain what impact, if any, these charges may have on the bank. Provision may continue to be lumpy, but we estimate provision expense at approximately $15 million to $20 million for the year. We expect modest and gradual improvement in 2011 and 2012, noting that our credit quality remains strong throughout the cycle relative to the industry.

On non-interest expense, we have reached our performance improvement project target this quarter and expect to maintain our run rate of approximately $145 million in 2011. Despite the revenue pressures across the industry, we expect our low-cost funding base, reduced cost structure, and lower risk profile to continue to deliver strong performance compared to industry peers.

Now I'll turn the call back over to Connie.

Thanks, Jim.

First, our dividends. The Board was pleased with the strategic milestones achieved by our Company in 2010 and declared the dividend payable on March 10 to holders of record on February 22. Our dividend yield remains attractive and above the average for utility peers. As of yesterday's close, our dividend yield was 4.9%.

Lastly, our ongoing commitment to excellence has earned us endorsements and awards in 2010. For example, for the fifth year in a row, HE has been recognized by Forbes as one of the 100 most trustworthy companies that have proven over time to have the most transparent accounting practices and prudent governance and management. Our three utilities claim three of the top 10 spots in the national ranking to be used as solar power, as determined by the Solar Electric Power Association. This is a testament to our ongoing efforts to be a leader in the use of renewable energy, and our bank was voted Hawaii's best bank or credit union in our daily newspaper's 2010 People's Choice Awards.

In 2008, we initiated aggressive strategies to set both of our operating Companies on a new course. Our utility entered into an agreement with the State of Hawaii to create a clean energy future for Hawaii, and our bank set new performance standards while continuing our commitment to help our communities grow and prosper. In 2010, we saw major progress on these initiatives and demonstrated improved profitability, earnings, and reduced risk. While we have more to accomplish, I am confident that we are on the right course to make a difference in creating a better tomorrow for our shareholders, customers, and other stakeholders.

And with that, we look forward to hearing your questions.

(Operator Instructions). Your first question comes from the line of Paul Patterson of Glenrock Associates. Please proceed.

Good morning, guys.

Good morning.

Hi, Paul.

Hi. Just on the utility, the hundred, the -- I think it sounded like you guys were looking at 100 basis points off of the HECO Oahu in 2012. Is that how we should think about sort of I guess around 9%, is that sort of what the thought process is?

Paul, we're thinking about all three utilities on a consolidated basis.

Okay, so all of them, basically. They are -- some of them not being fully trued up for the right, I guess is how we should think about it.

How would we think about it for HECO Oahu, though? I mean, in terms of when you guys are running on all four cylinders, how should we think about the differential that you guys are beginning to look at here when you're -- when, assuming that everybody was running, I don't know if that will happen, but do you know what I'm saying? If all of the utilities had sort of caught up with decoupling and everything, how should we think about the differential between your allowed and earned ROE?

So Paul, it's Jim.

So let me just clarify. The notion that we provided here just now indicates that for the HECO Oahu, the goal is to get within 100 basis points by the end of 2012 because we have the implementation order for HECO Oahu. The other implementation orders are not yet in effect for the two smaller utilities, so we're -- 2012 for HECO Oahu.

In terms of the other utilities, or when all three utilities are operating, as you say, on full cylinders, there will be some leakage going into the structural mechanisms that we've discussed in the past. And those will be on the order of 40 to 50 basis points as of when all utilities get implementation going.

Okay, great.

Also, the tax settlement of $6 million, how should we think about that going forward? Is that a one-timer for the most part? Are you going to see something like that again in 2011?

Those are non-recurring items, Paul.

One of them had to do with a cost allocation method at the utility that was settled out after a number of years, and we received interest owed from that in the fourth quarter of 2010, a one-time situation. The other item had to do with a deferred tax asset that was written off also in the fourth quarter of 2010, owing to an independent power business that the Company formerly had over 10 years back. We had argued that -- with the service that this should be an ordinary loss. The service viewed it as a capital loss, and we did not have the offsetting capital gains, so we actually wrote off that deferred asset in the fourth quarter.

Okay, and then you're thinking of retaining more loans. You've mentioned this, I think, in the past. Just any update on that and any sense we should get as to what the size of that might be and how you guys are managing the risk associated with keeping the loan?

This is Rich, Paul.

We are optimistic that as the long end rises a bit, then we'll have mortgages that are priced in a way that we can actually retain more of them on the balance sheet. And fourth quarter, we retained about half of our origination, and we'll watch that as we go forward. It will depend on the level of originations that we have, and those will come down a little bit as the interest rates rise because the refinancing will be a little bit lower. But we're hoping to see over the course of the year an opportunity to sort of mitigate that run-off of the real estate book as we go, and we'll see how the interest rates play out for that.

Okay. There is some discussion about a mortgage moratorium, I think, in the state legislature.

Right.

I guess could you comment -- I don't think of you guys as having that many mortgage foreclosures, specifically with your Company, but just in general, is that an issue that you're thinking about? Is there anything we should think about with regards to that legislation?

You know, there's a lot of different bills that are being proposed at this time. Most of them -- the driver behind it tends to be national servicers and issues that they're having on foreclosures in the state here, rather than an issue with the local institutions. That said, the proposed regulations would affect everybody. They're primarily targeted, and most of the bills that are being offered at the non-judicial foreclosure piece, because the judicial foreclosure tends to have the legal procedures in the court that will protect the borrower adequately, we think.

Non-judicial for us are pretty small, about 5% of the foreclosures that we have, so not really a material issue for us. We've got to watch how the legislation moves, but -- and we're watching that closely and trying to communicate about the consequences of the different considerations that are being looked at by the legislature. But right now, we're -- we don't see any need to raise a big red flag for you.

Okay.

Finally, I can't let you guys get away without sort of at least potentially addressing this -- news reports about an offer to buy your Company, sort of an aggressive renewable agenda. Just in general, are you guys in talks with this individual? What can you tell us, anything more about that situation?

Paul, we haven't, we really can't tell you any more than what we already had said, which is basically, we don't comment on these kinds of issues. We believe that our own combination of the bank and the utility are actually providing very good value for shareholders today and the other stakeholders in the state. But of course, the Board does have a fiduciary responsibility, so if a valid proposal came in, we would look at it.

Okay, you can't tell us anything more about discussions with this group of people?

No.

Okay, I had to try. Okay. Thanks a lot.

Paul, I should have let you answer the question.

Your next question comes from the line of Ashar Khan of Visium. Please proceed.

Good morning.

Just wanted to get, are you saying that by 2012 all the three, like if you were reporting 2012 results, all the three subs would be within 100 basis points of their allowed ROE? Is that what you're indicating?

We were indicating, Ashar, that by the end of 2012, we would be within 100 basis points of HECO Oahu. That was our statement.

Okay, not at the other two subs?

Yes. That's right, because we don't have the implementation orders that begin the other two subs yet, so it's very hard to put a date on when those would be within those -- that range.

Okay. And then could you just tell us, you gave us rate base numbers for 2010, and then you've given us CapEx for '11 and '12. Could you give us what the rate base numbers are projected at the end of 2012 for HECO Oahu?

Ashar, this is Tayne Sekimura.

Just to give you a feel -- as Jim reported earlier, you can take a look at rate base for 2010, and we are projecting a 5% compounded annual growth rate over the five-year period.

So the ending 2010 rate base would be $2.272 billion, without being too specific, and you should assume a 5% on top of that, and then a CAGR going forward at the same rate.

At the same rate. Okay.

And Ashar, I want to just clarify on your first question. As Jim said, we are targeting to be within 100 basis points for Oahu. The only reason we are not doing that for the other utilities is because we haven't yet received those decoupling implementation decisions.

Yes, but if I was trying to see if we get them this year, would you be able to achieve a similar target for them in 2012, or no?

Yes, if the decisions come through and they're similar to Oahu, then yes, we would be expecting that, but we can't give you that assurance at this time until those decisions come in.

Okay.

And then can I just ask you, any feedback you can give us regarding settlement on the HECO case, what the time frame of such a settlement could be and if there are any talks happening. Are you optimistic? Any kind of flavor on that, please?

This is Tayne.

In terms of the HECO 2011 rate case, an interim decision is expected around the end off June per the procedural schedule. So as we normally do, we try to have discussions with the consumer advocate to settle the case, and that would precede that date.

Okay.

Some time during the Summer.

So it's too early right now? Is that a fair point?

Right now, but that's as best we can tell, based on the schedule.

So I guess timing is more like May, is that what we should be shooting for in terms of if any settlement achieves, like a month before or something?

Give us a moment, Ashar. We're discussing that. We're -- right now, we're in the phase where there's a tremendous amount of exchange of IRs and answering of IRs. Oh, again, as I mentioned, the end date being the expectation of the interim decision being at the end of June, we would expect some kind of settlement to start prior to that date.

Okay. Thank you so much.

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

Good morning.

Hi, Jim.

Yes, what is the approximate percentage in absolute rate increase required to achieve a 9% ROE on Oahu?

Jim, we're probably going to have to get back to you on that.

What I'm trying to assess is the ability of the residents of Oahu to absorb a rate increase.

Oh, the amount of the rate increase.

And trying to assess politically if it's feasible that you're going to be able to receive the rate increase and it would get your ROE up to where you're saying it may be.

Jim, while Tayne's looking at the numbers, I'll just remind you that we have said in the past that we believe that the overall increases to the rate payer or the customers will be reasonable. And the primary reason for that is, if you recall, over half of the bills here in Hawaii are based on oil prices. It's a straight flow through from our fuel adjustment clause, and so the volatility in fuel prices actually tends to be a much bigger impact on the customer from a day-to-day basis.

When Connie was talking about the bank and the pre-tax, pre-provision target range of $110 million to $120 million, the subject then went on to say there was something like $60 million over the next 24 months. And I didn't understand what the $60 million tied to.

Bottom line. Net income earnings, Jim.

You're looking at $60 million earnings from the bank in the next two years, is that what you've said?

Yes. We're projecting 12 monthsto 24 months that are factors for you. The pre-tax, pre-provision number is provided to help folks that decycle or take the cycle out of the numbers and to show you where our target is. And the $60 million was a reference to the net earnings, the equivalent of $58.5 million this year.

So Jim, we're expecting a good solid $60 million to be coming from the bank. What we can't predict for you is when the credit cycle will turn, so that's, as Jim says, that's the reason we give the pre-tax, pre-provision number. And as the cycle improves, the bank will benefit from that.

And we said we expect that in 2011, the $20.9 million of provision that we recorded in 2010 should be in the range of $15 million to $20 million, but again that's just our guess.

In your press release, you have a footnote about the demand side management cost. Do you expect that the annual DSM costs would be $4 million in 2011, as it was in 2010?

Yes, we do.

Yes, we would expect that.

And is it lumpy, evenly spread over the years, or is the fourth quarter half of the total for the year?

It's evenly distributed, Jim.

Why did the fourth quarter of the most recent year get $2 million, approximately half of the full year? I'm reading that footnote correctly.

Yes. You know, Jim, as a reminder, as we publish these numbers, we publish the O&M, we provide information net of DSM, and that is because we get recovery of those costs through our surcharge.

And then in the utility in the fourth quarter, there was this other interest charge that turned into a benefit. What happened? Is that something that's going to continue, or is it a one-time event?

That's a one-time event related to taxes.

Jim, that was what I mentioned earlier, the one-time event from -- with the service on interest owed from past tax cases.

So other interest charges went to your benefit. I thought that when you were explaining that, that you were explaining the other income line item where the tax settlement amount came into. Of the other net of $9.556 million in the fourth quarter, you indicate that $6 million after-tax is a tax settlement. How much was that pre-tax? Was that the pre-tax figure as well, was the $6 million, both pre-tax and after-tax?

That $6 million is the after-tax number.

So you have more than one item, maybe, and it gets into more than one line item?

That's right. And remember the write-off of the deferred tax asset as well.

And that was the parent company, was it not?

That's right. That was from an investment that went back at least 10 years ago, for which we retained a deferred tax asset, in effect an NOL that expired after five years.

So what I was asking about was the income statement of the utility. And so that $2 million after-tax for the parent Company wouldn't be in either those line items?

That's correct.

Those are entirely separate. The $2 million at the parent, the $6 million at the utility. That's right.

And the $6 million at the utility would have been both pre-tax and after-tax?

The $6 million is the after-tax number. That's tax affected.

Okay, thank you very much.

Jim, just one second.We've got your answer on the rate increase.

Yes, this is Tayne.

I'm using the 2011 rate case as a basis for answering your question, Jim. Just to give you a feel for rate increase, in that application we had requested $114 million, which is about a 5% increase, requesting a return on equity of 10.75%. That application was filed last summer, and so we're going to have to revisit that ROE number, given what -- the decision that came out in the HECO 2009 rate case.

Which was 10%, was it?

Right.

Including the implementation of decoupling.

Suggesting -- saying that the 5% is on the higher side.

So one would have to assume, perhaps, that the rate increase on Oahu could be less than $100 million to be able to allow you to achieve a 9% ROE?

Yes, that's correct.

And again, Jim, I'd just remind you, the volatility in the bills from just the change in oil prices can actually be much greater than that.

Thank you very much.

Your next question comes from the line of Matt Fallon of Talon Capital. Please proceed.

Hi, guys.

I was just wondering if you could quantify the tax -- I'm sorry, the cash flow impact from bonus depreciation and the effect on rate base, just in regards to your 5% growth in rate base.

Yes, this is Tayne.

In terms of the cash impact, what we project for 2011 and '12 is $55 million and $30 million. In terms of the 5% compound and annual growth rate for rate base, that does consider the effects of bonus depreciation.

Okay, great. And then just in terms of the interchange fees, I realize that you haven't quantified the impact for '11 from the new legislation, but could you give us a sense of how much you collected in '10 for interchange fees?

Yes. We're at about $0.52 a transaction right now, and in 2010, that turned into about $11.5 million. So if you took us to the $0.12, you can do the math on that impact. e obviously need to see how that plays out in terms of the final implementation of the proposals and how the market dynamic plays out for banks smaller than $10 billion like we are. So that's why it's a little bit difficult for us to quantify what we expect the impact to be, and we've got to see how things develop over the next couple of months.

Matt, just to be clear as Rich mentioned, the Durbin Amendment was intended to exempt banks of our size, under $10 billion. So that is what the -- if you believe that the market would allow, basically, two-tier pricing, there would be no impact. What's hard to judge is, you don't know what's going to happen in the market. The legislation can say that smaller banks like us don't have to cap fees, but our estimate is that the market will levelize things.

Okay, great. And then can you just remind me what the annual dividend reinvestment plan is for issuance?

Right. We typically have about $44 million or $45 million of proceeds that come in through the drip. And that's in fact about the number that we had this year, about $43 million, in fact. That represents about a 2% dilution, so in 2011, what we've estimated is $44 million of proceeds from the drip. And as I said earlier on the call, this is the extent of the equity issuance that we can foresee in the next two years, '11 and '12, so that gives you an idea.

All right, great. Thanks a lot.

Sure.

Your next question comes from the line of Rudy Tolentino of Morgan Stanley. Please proceed.

My question was asked and been answered. Thank you very much.

Okay, Rudy.

Your next question comes from the line of Greg Reiss of Catapult. Please proceed.

Hi, guys. Just a real quick question.

On the 7% O&M increase, is there any way to be able to break out what is going to be going through the RAM and what is actually still has to get approved in the rate case?

So the 7% -- this is Tayne. Of the 7% increase, most of it is going to be addressed in the HECO 2011 rate case.

Okay. And in terms of the RAM, I guess, what is the escalation factor? Is there maybe some sort of rule of thumb that you could use for what kind of escalation factor will be going on that?

The O&M one is GDPPI for the non-labor, and that runs about 1.4% to 1.5%.

Okay, got it. Thank you guys.

Your next question comes from the line of [Prydee Modee] of Prudential. Please proceed.

Hello. It's [Preethee]. Can you comment on the general environment and coordination efforts that are being undertaken to meet the RPS standards between the PUC and yourselves?

I'm going to ask Robbie to address that, because there's a huge amount of work that goes on within our state. As you know, the Clean Energy Initiative really is a community-wide effort, so there are many, many parties that we are involved with.

This is Robbie Alm. I think the coordination to date has been very strong. The consumer advocate is a strong supporter of Clean Energy Initiatives and has stated publicly that, while their job is to watch costs, you have to look at costs in the long run, given the likely oil price scenarios over the years. So, locally based renewable energy is critical to our future. And the Commission has also tended to take that same long view, that the state's goals of getting off oil and being less dependent on that commodity and focusing in on local renewable energy being in the long run interest, all three of us remain on the same page. The newly elected Governor is clearly there, and the newly appointed Chair of the Public Utilities Commission is also there, so I think at this point, we have a very strong agreement on basic principles. That still means that every single proposal for fuel purchase of renewable fuel or for power purchase agreements will be fully examined. But at this point, the overall goals, there's no real gap. And I think the number of decisions that came out last year really reflects the fact that we're all on the same page.

Right. Can you also give me a better understanding of what the technology mix is envisioned to meet the clean energy plan outlined in the presentation?

Oh, sure. The low-hanging fruit, if you will, is solar and wind, both of which are mature technologies, and we have lots of wind and sun in Hawaii. The capacity factors of our wind farms have been huge, 30% and on up to 50% and even 60% in some cases, so we really have great world-class wind here. We've just announced additional expansion of geothermal energy on the Big Island. We're looking at expansion of waste to energy, particularly on Oahu, which is significant. We've just announced the first of our biofuels contracts, and we hope to have more. We are working on OTAC and some ocean-related ones that are a little farther out. So we see it sort of coming in waves. You do solar and wind because you clearly have them right now as you have waste to energy. Then we move to hopefully more biomass, more geothermal, and ultimately, we would hope that some of the ocean-based ones, especially ocean thermal energy conversion, would really pay off for Hawaii. So take what we can now, and then keep expanding the base of technologies available. They are all available in Hawaii. The other thing we're going to need ultimately is the inter-island cable system, because the load here this year on Oahu -- three quarters of the load is here on this island, and yet this island doesn't have the strength of renewables that the neighbor islands have, and they have relatively low loads.So we're going to be working hard on that movement of the power around the state.

Thank you.

And just to edify Robbie's point, the Big Island now already has upwards of 29%, of maybe close to a third in terms of renewable generation, and Maui is 25%, 26%. So a lot of progress has been made around the state.

Great. Thank you.

Your next question comes from the line of Bryce Rowe of Robert Baird. Please proceed.

Thanks, hello.

Hi.

You guys mentioned the mortgage production, retaining half of it here in the fourth quarter. Can you tell us what the mortgage production level was and then kind of what the pipeline looks like now, given the recent increase in interest rates over the last two or three months?

Yes. So total production was a little over $200 million in the third -- in the fourth quarter to between $210 million and $220 million. Like we said, we sold a little bit less, close to half of that, a little bit less than half of that. The production levels have tapered off. A lot of that actual production was stuff that was committed in the third quarter during the lower interest rate period, and as the long end has moved up, we've soon a drop in the new commitment, new origination volume. Some of that is seasonal as well, because December and January are typically lower commitment months, and so we're watching that. But we would be down 25% or something in terms of that production level as we've come into the start of the year. And we'll see. But we also have a similar reduction in the pre-payment pace as well, so they net off a little bit in terms of the impact on the balance sheet overall.

Okay, that's helpful. And then a follow-up on the margin guidance, maintaining 4% or higher type of rate. What do you see the components doing from earning asset yield and then deposit cost perspective? How is that going to play out over the next year if we kind of, if we see interest rates maintain kind of a steady level where they are now?

If we maintain at a steady level where we are now, we can maintain reasonably steady performance on the components. We don't see a lot more -- you aren't going to see significant reductions on the liability side. We've already built a pretty good position there and a pretty low cost base. We'll continue to grow the free checking and non-interest bearing component. We think we still have some opportunity in that space, so we can offset some pressure on interest bearing.

And overall, while the new assets coming on are a little bit lower, we're also mixing a little bit better in terms of some of the consumer lending that we're doing. Some of the EDX, the home equity products that we brought on will hit repricing from the introductory rates, and so that will help offset. So there's puts and takes on both of them as we go.

Okay, thank you. Appreciate it.

You've also got the commercial portfolio, which tends to be more floating rate. So it depends on what happens to short end of the curve.

Okay, thanks.

At this time, there are no further questions in the queue. I would like to turn the conference over to Ms. Shelee Kimura for closing.

Thank you, everyone, for joining us today, and as always, feel free to give me a call if you have questions. Thanks so much. Bye.

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