Hawaiian Electric Industries Inc (HE) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2011 Hawaiian Electric Industries Incorporated earnings conference call. My name is Regina, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will be conducting a question-and-answer session. (Operator Instructions). Today's event is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Shelee Kimura, Manager of Investor Relations and Strategic Planning. Please go ahead, Ms. Kimura.

Thank you and welcome to Hawaiian Electric Industries' third-quarter earnings conference call. I am Shelee Kimura, and joining me today are Connie Lau, HEI President and Chief Executive Officer, Jim Ajello, HEI Executive Vice President, Chief Financial Officer and Treasurer, 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. Forward looking statements will be made on today's call. Please reference the accompanying disclosure to the webcast slides located on our web site. I'll now turn the call over to Connie Lau.

Thanks, Shelee, and aloha to everyone. First, I will provide an overview of the quarter and an update on our strategy. Jim will then provide more details on the economy, and our results for the quarter. Third-quarter earnings were $0.50 per share compared to $0.35 per share in 2010, reflecting improvement over last year's depressed levels, as a result of rate relief, decoupling implementation, continued cost management, and solid bank performance. Year-to-date results of $1.09 compared to $0.95 last year.

At the Utility, we continued to work towards full implementation of the Hawaii Clean Energy initiative. We aimed to be a leader in our state's effort to reduce its dependence on imported oil. This is not only critical for our environment, it is an economic imperative and an energy security imperative. This is a significant undertaking for an island utility system that is almost 80% dependent on imported oil. Integrating the amounts of renewable energy needed to achieve our RPS goals while maintaining reliability requires major strengthening of our grid and significant investments in both infrastructure and expanding operating and maintenance program.

We've been working to implement a new regulatory framework, including decoupling, to help us recover these expenditures and earn an adequate return on investment so that we can successfully fund these efforts. Major progress has been made, and we are now starting to show improvement in our earned returns. However, there is still a lot to be done. Last quarter, after receiving the PUC decision which delayed the revenues of the new RAM, or rate adjustment mechanism, by 5 months each year, and the July interim rate case decision for Oahu, we indicated that HECO Oahu's ROE goal of 9% in 2012 would be much more challenging to achieve, but we are not prepared to revise the goal, as we are evaluating mitigating strategies. Based on our detailed review of the new mechanisms, clean energy framework, and the mitigating strategies, we are revising our goal to 8.5% earned return in 2012 for Oahu. We will continue to work on further refinement to the new regulatory framework.

Our Bank continued to deliver excellent results in this difficult regulatory and economic environment. Our profitability metrics remain strong, and we achieved the fourth consecutive quarter of loan growth. As we show on slide 4, our utilities are well on their way to meet and likely exceed the next RPS goal of 15% renewables in 2015. Our utilities are focused on achieving as much cost-effective renewable energy as possible, as fast as we can. We are building a diversified portfolio of renewable sources, that both moderate our energy cost and reduce price volatility for our customers. We've achieved a lot this past quarter, including the execution of several new purchase contracts for renewable energy, and PUC approval of a purchase contract for the first utility-scale solar project on Oahu.

Turning to the Bank, we continued to show strong performance in the quarter. Beating or meeting almost all of our performance targets, and exceeding the average of our high-performing peers. Return on assets increased 2 basis points over the linked quarter to 1.26%. Net interest margin was 4.11%, remaining above our target and our peers'. Annualized non-interest expense was better than our target of $145 million, and our efficiency ratio improved slightly to 56%, and remains better than our high-performing peers. Annualized pretax pre-provision income was $108 million, $3 million higher than the linked quarter.

Jim will now provide additional insight to our results and our outlook for the remainder of 2011.

Thanks, Connie. I will first briefly address the Hawaii economy.

Hawaii's tourism industry is a significant driver of Hawaii's economy, and continued to reflect a trend of positive growth from 2010. Tourism continues its strong recovery with September visitor arrivals up 4% and visitor expenditures up 19.7%, as compared to the same month last year. This marks the 17th straight month of increases in visitor expenditures. Year-to-date, visitor arrivals were up 2.7%, and expenditures were up 14.7%. Hawaii's Department of Business, Economic Development and Tourism expects total 2011 visitor arrivals to increase by 3% from last year and visitor spending to increase 12%. Economists believe visitor spending is currently on pace to approach the record levels set in 2007.

Hawaii's unemployment rate of 6.4% continues to track significantly better than the national rate of 9.1% in September. Statewide, residential home sales were up, but median home prices were down in September. Better inventory levels, the mix of homes being sold, and the elimination of the 2010 federal tax credit have often been cited as factors in the softer median prices. Overall, Hawaii's economy is expected to continue to grow modestly, as improvement spreads beyond the tourism sector.

At the Utility, net income for the third quarter of 2011 was $38 million compared to $22 million in the third quarter of 2010. The various after-tax components of the $16 million net income improvement are detailed here on slide 7. Overall, the increase was primarily driven by regulatory action, and continued cost management. We had $6 million of rate relief granted to all 3 utilities, and $5 million net decoupling adjustments recorded for Oahu. This included $7 million for sales decoupling and one month of revenue adjustment mechanism, offset by $2 million in lower fuel efficiency savings, attributable to the implementation to the heat rate dead band which became effective decoupling for Oahu.

We also benefited from $2 million in higher fuel efficiency savings at our Hawaii Island Maui County utility. O&M expense, excluding DSM was essentially flat compared to the same quarter last year. At the Bank, net income for the third quarter of 2011 was $15.5 million, essentially flat compared to $15.2 million in the second, or linked quarter and $15.3 million in the third quarter of 2010.

Now we'll look closer at the utility on slide 9. Slide 9 reflects key earnings drivers for the remainder of the year. 2011 interim rate relief, combined with sales decoupling at our Oahu utility will ensure that net revenues remain consistent to levels set in the rate case, excluding any variances from fuel efficiency. We have several rate case items pending further review, and written briefs will be filed in December on open issues. The timing and outcome of the PUC decisions will impact our ability to narrow the ROE gap. As for HELCO and MECO, we continue to await decoupling implementation, and maintain our forecast of flat kilowatt hour sales for those two utilities.

Due to higher bad debt and timing of PUC decisions, we expect consolidated annual O&M costs to be 3% higher than in 2010. We continue to expect the fourth quarter O&M to be lower than the fourth quarter last year. We expect 2011 CapEx to be approximately 10% below our forecast of $300 million, due to delays in EPA issuing environmental regulations, delays in the Inter-Island Wind Project, and delays in customer projects. We are now evaluating the 5-year CapEx plan and will provide an update with our year-end earnings call in February.

Slide 10 shows our actual ROEs for the trailing 12 months. The HECO Oahu ROE goal of 8.5% will require diligent cost controls to achieve. In order to successfully execute our clean energy and reliability strategies, it is essential we earn much closer to our allowed ROE. We continue to focus on further improvements in our regulatory model. Our priority focus is on the continuing regulatory lag inherent in the RAM. This includes the annual 5-month delay in recovery. In addition, the RAM does not address investments in software projects, so we are focused on the timely recovery of such costs.

Without the proposed refinements, the ROE gap will widen because -- in between rate cases as the rate-based investment increase and regulatory lag persists. We continued to assess how quickly we can get these regulatory refinements. We are focused on achieving the returns that support the increasing levels of capital we require in the future. HELCO's ROE includes about 100 basis points related to fuel-efficiency savings which may not continue when the heat rate dead band under decoupling is implemented.

Now we'll look more closely at the Bank performance metrics. On slide 12, our net interest margin was 4.11%, 4 basis points above the linked quarter and well above our industry peers. Slight improvement in net interest margin from the linked quarter was primarily attributed to the recognition of deferred loan fees of loan pre-payment and slightly lower cost of funds, caused by the Federal Reserve's August 9th action. Going forward, we continue to expect NIM to decline modestly in a period of continued low interest rates, as portfolio yields ratchet down.

Compared to the third quarter of 2010, NIM is trending lower as we recognize a lower level of deferred loan fees from lower commercial loan repayments and lower mortgage refinancings, and growth in lower yielding assets such as commercial variable rate loans and home equity loans continue to mix the overall asset yield down, but should provide lift when interest rates rise. These impacts were partially offset by lower liability costs due to the decline in higher costing terms. Our liability cost of 33 basis points driven by our low-cost deposit base is a key differentiator for ASB.

The Bank recorded $3.8 million in provision for loan losses in the third quarter. This was up slightly over $1 million from the linked quarter, due to higher charge-offs in the third quarter. The Bank had continued loan growth for the fourth consecutive quarter, with an increase of $40 million in loans in the third quarter, driven primarily by increases in home equity lines of credit and commercial market portfolios, which more than offset the decline in residential mortgages. On an annualized basis, the third quarter growth rate was 4%, and in line with our goal for mid-single digit loan growth. Year-to-date, loans increased by $129 million or 3.6%.

Slide 15 is our balance sheet, which shows you the asset and funding mix of both ASB and our peer banks. Compared to ASB's September 30, 2011 balance sheet, the last complete available data set with our peers, which is as of June 30, 2011, 95% of our loan portfolio was funded with low-cost core deposits versus our peer banks at 82%. We reduced our higher costing CDs in the quarter, and grew our low-cost core deposits to $3.5 million, an increase of $35 million from the linked quarter and $258 million from the same quarter last year. This resulted in the additional reductions in cost of funds discussed earlier. We remained well capitalized with a Tier 1 leverage ratio of 9.1%, tangible common equity to total assets of 8.6%. Total risk-based capital of 13%, all on September 30, 2011. In addition, ASB continues to pay a healthy dividend to HEI. Third quarter, ASB paid $15 million of dividends and expects to pay annual dividends of almost $60 million to HEI in 2011.

Turning to credit quality, ASB's non-performing assets ratio was 1.94% in the third quarter. This increase from the linked quarter was primarily due to three commercial loans that remain payment current. Overall, the Bank's nonperforming assets ratio remains significantly better than its peers. Our primary credit risks continued to be in the three shrinking portfolios that we have described previously. Residential land loans, primarily on the neighbor island, neighbor island 1 to 4 family mortgages produced from 2005 to 2007, and the self-amortizing portfolio of mainland residential loans purchased. In aggregate, these are down $92 million or 19% over the last year, $403 million.

Our net loan charge-off ratio of 54 basis points also remains low compared to peers. The 9 basis points increase from the linked quarter was driven primarily due to partial charge-offs to commercial credit. The allowance for loan losses currently represents roughly 1% of outstanding loans, at $38.2 million, $1.1 million lower than the linked quarter and in line with the prior year level of $38.3 million. Going into the fourth quarter of 2011, we remain focused on modest organic net loan growth, and are on track for mid-single digit loan growth for the year. We continue to expect a modest decline in NIM in the forth quarter, given the current interest rate environment and expect to end the year at approximately 4%.

Based on our experience to date, we now expect overdraft fee income to be flat in the fourth quarter, 2011, compared to the same quarter last year, which was the first full quarter of Regulation E. Regulatory changes to debit card interchange fees have thus far not impacted our operations, but we continue to monitor the situation. Credit quality has improved slightly, and is stable. Hence, we expect provision to be the lower end of the range of $15 million to $20 million for 2011. We continue to expect 2011 pre-tax, pre-provision income to be in the range of $105 million to $110 million. Overall, we expect to continue to deliver strong results compared to our industry peers, with our low-cost funding base, efficient cost structure, and lower risk profile.

Turning to our financing and liquidity picture on slide 20, we expect to continue open market purchases to satisfy the dividend reinvestment plan through the end of 2011, and are currently conducting our annual forecast process to determine our plans thereafter. We will provide an update on our financing plan with our year-end earnings call. However, based on current assumptions, we do not expect to acquire additional equity other than possibly through the DRIP program, through the latter part of 2012. Now, I'd like to turn the call back to Connie.

Thanks, Jim. In summary, we continue to execute on our strategies, which are focused on creating fundamental value in our core Utility and community banking franchises. The Utility has made significant regulatory progress over the past few years. We continue to work on improvements in our existing regulatory mechanism. In order to successfully fulfill our clean energy role in our state, we are focused on achieving returns that support the increasing level of capital anticipated. At the Bank, despite the challenging interest rate and regulatory environment, we continue to be a high-performing community bank, and are focused on creating steady profitable growth.

Turning to our dividend, our dividend yield remains attractive and above the average for utility peers. As of yesterday's close, our dividend yield was 4.9%, and we're very proud that 2011 marked our 110th year of paying dividends continuously. Overall, we see solid opportunities to grow our business. We believe we are well positioned to deliver attractive earnings growth with reduced risk and volatility and an above-average dividend yield. With that, we look forward to hearing your questions.

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

Good morning, guys.

Hi, Paul.

The ROE change, in terms of now 8.5%, I gather that it's -- could you give us a little bit of a flavor as to what the biggest element of that is? You have timely software cost recovery and the five-month delay in RAM. Could you give us a flavor as for, is it the RAM delay that's the big deal?

Paul, this is Dick Rosenblum. Yes, I would say the RAM delay is our primary focus right now, although as we get into large software projects in the future, the software recovery becomes critical.

Okay, now the $100 million basis point issue, could you just elaborate a little bit on that? I'm taking about the heat rate dead band, how that could go away, and if you could just give us a little more flavor for that?

Again, this is Dick Rosenblum. At HELCO, we currently are recovering significant bonus because of our favorable heat rate. When decoupling is implemented, the heat rate mechanism gets a dead band around it. The nature of the dead band is to significantly reduce the bonus we recovered, because we're in a dead band, and therefore don't get anything inside that dead band.

Okay.

Because we put in place a very efficient steam unit.

Okay. Now when we talk about regulatory refinements, the PUC -- I'm just wondering, what would the timing be when we would maybe see the PUC -- what's the thought process in terms of how long that could take?

I think it's very difficult to predict when the PUC will issue any changes. We certainly see a PUC that is supportive of all the moves we're making, is supportive of the utility being financially whole, but as you well know, these are very, very significant changes in the regulatory model, and they take time. And there are no regulatory deadlines for when the various changes might come out.

Okay. And then finally, with the net interest margin, you said that you see it declining somewhat. Do you expect it to still be above 4% in 2012? Could you give us flavor for what your expectation is?

Hi, this is Rich. Yes, we -- for the year in total, we would expect it to be just north of 4%.

Okay.

It's quarter by quarter, it's a little bit challenging to call right now. For the year in total, we would expect it to be --

Next year, right. Okay.

Yes, Paul, I also suggest when you think about the net interest margin, there is some noise in that number from the refinancing waves that occur periodically so that's the thing that makes it more difficult to predict, because you don't know exactly what the interest rates are going to do, and any time there's a big refi wave, you get an acceleration of the pre-payment penalties or the deferred loan fees into the net interest margin.

Okay, great. Thanks for that. And finally, the Regulation E, it doesn't seem to be really impacting you guys. How would you say you see that going forward? It seems like things are okay, yes?

It impacted us quite a bit, year over year. Where we are -- since it took effect in August last year, we've reached the point of relative year over year stability on that now.

That's what I meant, I'm sorry. But -- what I mean is going forward, the fallout pretty much is we're not going to see much more of that, do you think, right?

Probably -- we probably have another $1 million of pressure year over year related to some changes we made in terms of payment posting orders and de minimus caps and daily caps based on the new guidance that's pending. But the big impact is absorbed.

Okay.

I said -- it will be flat to the fourth quarter, right.

So -- and I appreciate the clarification. I didn't mean to make it sound like you didn't have any impact. Thank you.

Yes, thanks. We worked hard to cover that.

Yes. We lost $8 million from it.

Thanks a lot.

Your next question comes from the line of David Paz with Bank of America-Merrill Lynch.

Hi, guys.

Hi, David.

Just wanted to confirm on the lower CapEx for the year, should we think of that as -- I think you said it was mostly timing. Should we be thinking about it being recovered in 2012?

You cut out. But I think you asked is that just timing and essentially pushing out -- And the answer is yes. By and large, these are associated with the things that we all know about, the EPA regulations coming in a little later than anybody anticipated, and the normal delays we see when customers ask for an upgrade and then say they really need it a little bit later.

Okay. Okay. But so timing, though, would still be -- we're still talking sometime in 2012?

Yes. For those costs, yes.

Okay. So -- all right. It shouldn't really impact for the most part your average rate base for 2012 at HECO. And then on -- just if we think of -- I was looking through your slides -- I know in the past you had slides where you talked about your goal for 2014 of earning -- I believe it was about 9.5% HECO or maybe the language was more like 50 basis points below your allowed ROE. Is there any impact on that target from what you did today regarding 2012?

David, this is Jim Ajello. The starting point here has been reset to the 8.5% level at HECO Oahu. What we said is we're working on refinements to the ROE goals. What we thought we'd do is take that slide out because it took you from a 9% starting point and a different couple -- we'll recast that when we have more clarity on the refinements that we're doing.

Got it, okay. And this may have been addressed -- I apologize. But on the fuel efficiency savings, how should we expect that going forward for like, say, 2012? Should we expect something similar to what you saw this year?

Yes. David, the fuel efficiency savings for HELCO and MECO when decoupling comes, that's when the heat rate dead band will go in. So it really depends on the timing of the interim decision, otherwise we would expect the operating conditions to continue.

Got it okay. And last question on the Bank, can you remind me why you lowered your pretax pre-provision income from $110 million to $120 million to $105 million to $110 million earlier this year, and what would get you back to that previous target for like 2012?

Yes. The principal change in the environment has been the yield curve outlook in the low flat interest rate environment. And so it's more of a net interest income view, combined with I think a challenging environment on raising the non-interest income level when you look at some of the headwinds and the regulatory environment.

Okay. So assuming no change in the yield curve, would $105 million, $110 million be similar -- would we see that in 2012? Are there other items, can you maneuver, can you move around your non-interest expense or other levers you can pull to get back to the higher range but for the yield curve?

Yes. Well, I think what the areas that we are -- that we've talked to you about is really trying to get the organic growth going that would help contribute more on that side. And so -- but I think the range that you talked about is probably realistic as we look forward a year. We continue to want to raise it above that, as we look beyond a year. But I think the range -- that slightly lower range is realistic.

David, the expense levels are at significantly lower levels than they were two years ago.

Right.

Liability costs are extremely low. So in a word, no.

Yes. And David, that's also assuming, again, we don't get another huge re-fi wave.

Yes. Yes.

Every time that happens it ratchets the portfolio yields downward.

Right. Thank you so much.

This concludes the question-and-answer portion of today's events. We have no other questioners, so I will go ahead and turn the call back to Ms. Kimura for some closing remarks.

Thank you, everyone, for joining us today. We look forward to seeing many of you at EEI next week. Thanks a lot.

Ladies and gentlemen, thank you for your participation in today's broadcast. This does conclude our presentation, and you may now disconnect. Have a great day.