Hawaiian Electric Industries Inc (HE) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the second quarter 2012 Hawaiian Electric Industries, Inc. earnings conference call. My name is Jasmine and I'll be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's 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 and Strategic Planning. You may begin.

Thank you, Jasmine. Welcome to Hawaiian Electric Industries second-quarter 2012 earnings conference call. 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.

Connie will provide an overview of the quarter and an update on our strategies. Jim will then update you on Hawaii's economy, our financial results for the quarter, and outlook for the remainder of the year. Then we will conclude with questions and answers.

Forward-looking statements will be made on today's call. Please reference the accompanying disclosure to the Webcast slides located on our website.

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

Thanks, Shelee, and aloha to everyone. We closed the first half of the year with strong results, and consistent with our 2012 objectives. Many constructive regulatory milestones were achieved during the first half of the year. Most significantly, all three utilities are now decoupled under Hawaii's new regulatory framework. Our Bank continued to perform well in this very low interest rate environment, with steady loan growth for a seventh consecutive quarter. In addition, credit and asset quality continued to improve consistent with Hawaii's gradual economic recovery. We continued to make progress on our strategies. And believe we are well positioned to continue to deliver attractive and stable earnings growth to our investors.

Second-quarter 2012 earnings were $0.40 per share, consistent with $0.40 in the linked quarter and $0.28 per share in the same quarter last year. This increase from last year was largely driven by the recovery of costs for our Oahu utility, which commenced July of last year for its 2011 test year. As we close the first half of the year, we are pleased with the utility's strategic progress. During the second quarter, the Hawaii Public Utilities Commission rendered over 50 decisions that affected our Company, including issuing the 2011 Oahu Final Decision and Order, and Maui County's 2012 Interim Decision and Order. With these decisions, all three utilities are fully decoupled, and each will go in for a rate case once every three years. Under the new regulatory model our utilities receive annual revenue balancing account, RBA and RAM rate adjustment mechanism adjustments between rate cases, among other changes.

Our 2012 capital projects are on track for the year. In 2012 these continued to be routine capital expenditures critical to strengthening our grid and integrating more renewable sources. On the clean energy front, our adoption rate of additional renewable energy has continued to grow. Year-to-date through June 30, over 13% of our electric sales came from renewable sources, ahead of our projections. In addition, the procurement process for an additional 200 megawatts of renewable energy for Oahu from renewable developers is progressing and is scheduled to be launched in the second half of the year.

Turning to the Bank, we are on track to meet our 2012 performance targets. While margins are gradually eroding in a very low and challenging interest rate environment, we continue to grow our loan portfolio at a steady and disciplined rate. Year-to-date annualized return on assets was 1.22%. And year-to-date annualized ROE was 12.1%. While the Bank's efficiency ratio and non-interest expense rose in this quarter, this was largely due to timing of project expenses. The first-half run rate for expenses remains consistent with our annual target of $145 million. Year-to-date Bank earnings of $30 million is in line with our expectations. We continue to believe 2012 full-year earnings will be 3% to 5% lower than 2011, as this extremely low interest rate environment will continue to exert downward pressure on net interest margin during the second half of the year. Overall, the Bank continues to maintain its low risk profile, strong balance sheet, terrific funding base, and straightforward business model.

Jim will now discuss the details of our second-quarter results and drivers for the year.

Thanks, Connie. As a backdrop to our results and outlook, I'll briefly comment on Hawaii's economy, which continues its gradual improvement. The tourism industry, a significant driver of Hawaii's economy, posted record arrivals and spending for the month of June. Visitor spending has grown year-over-year for 26 consecutive months. Year-to-date, visitor arrivals were up 10.2%, and expenditures were up 21.4% compared to last year. And the 2012 outlook for the visitor industry remains very positive. Local economists expect construction to begin to recover in 2013 due to an increase in non-residential and public sector projects. Statewide, unemployment is at 6.4% in June, and remains very low compared to the national average of 8.3%. Overall, we continue to see gradual improvement in the Hawaii economy. However, the gains in the tourism sector have largely not spilled over to the rest of the economy.

At the utility, net income for the second quarter of 2012 was $29.4 million. Compared to $27.3 million in the linked quarter and $17 million in the second quarter of 2011. In looking at changes in utility revenues between periods, we focus on net revenues. The net revenues, as shown on this slide, refer to operating revenues net of fuel oil, purchase power and taxes, other than income taxes. In the quarter, net revenues after-tax were $9 million higher than the same quarter last year, largely driven by the recovery of costs for our reliability and clean energy investments on Oahu, which became effective in July 2011. Operations and maintenance expense after-tax was $2 million lower than the prior year. This was primarily due to $2 million lower A&G expense from a change associated with the capitalization of costs in July 2011. The deferral of inter-island wind project costs were offset by $1 million of higher customer servicing costs related to our new customer information system, which went into service in late May.

At the Bank, net income for the second quarter of 2012 was $14.2 million compared to $15.9 million in the first quarter of 2012. Net income declined by $1.7 million compared to the linked quarter, which included the release of tax-related reserves of approximately $1 million. The remainder of the decrease was largely due to higher non-interest expenses for new products and business projects, some of which were originally expected to be incurred in the first quarter. Partially offset by lower provision for loan losses from the continued improvement in credit quality and portfolio mix. Compared to the second quarter of 2011, Bank net income declined by $1 million, primarily due to $1 million of non-recurring insurance gain in the second quarter last year. Higher gains on sales of loans of $1 million after-tax were offset by higher non-interest expense.

Now we'll look more closely at the utility. Slide 9 shows our actual ROEs for the trailing 12 months as a percent of allowed ROE. As of June 2012, the utility's last 12 months consolidated ROE of 8.7% improved from 5.8% a year ago, significantly narrowing the gap to our allowed returns. Although our largest utility on Oahu earned 9.4% ROE over the last 12 months, we still expect the full-year 2012 ROE to be 8.5%. The expected decline is largely driven by the timing of O&M projects which are weighted to the second half of the year.

With regard to our Hawaii Island and Maui County utilities, we expect their combined ROE in the second half of 2012 to be generally in line with the first half, which was 6.4% annualized. While MECO should improve over the first half of this year due to the impact of the interim decision and order received in June, HELCO's returns are expected to be lower than the first half. HELCO's ROE will be negatively impacted by the elimination of heat rate savings and lower allowed ROE resulting from the implementation of decoupling in April. In addition, the timing of O&M projects is weighted to the second half of the year. We expect to file HELCO's 2013 best year rate case this month. The approval of the new regulatory model by the PUC has helped improve the timing of cost recovery. And will help our utility to gradually improve its consolidated ROE beyond 2012. This facilitates the ability to effectively raise capital for our needed infrastructure investments.

As we have stated before, however, we continue to expect on ongoing gap to our allowed returns. The timing of our general rate case decisions and the effective date of the revenue adjustment mechanisms, together with expenses that are consistently excluded from rates, are estimated to have a consolidated ROE impact of 120 to 150 basis points in a typical year. In addition, there are other items which are not covered by our annual revenue adjustment mechanisms that could also have an ongoing impact on our allowed returns. For example, investments in software projects, O&M in excess of indexed escalations, and changes in fuel inventory must be addressed in general rate case. While the specific magnitude of the impact can fluctuate, depending on size of projects and exogenous factors, we anticipate that these items could incrementally impact consolidated ROE by 50 to 75 basis points in each of the next two years.

On slide 10, we summarize for you the key utility earnings driver for the second half of 2012. Effective June 1, the PUC approved $13.1 million increase in annual revenues for our Maui County utility. The recovery of $32 million of costs for CT-1 and approximately $59 million for the customer information system is still pending regulatory audits. There has been no schedule as yet set for these audits. With all of the three utilities decoupled, kilowatt hour sales no longer impact revenues. 2012 revenue adjustment mechanisms, allowed under the decoupling model, were implemented in June at an annual revenue amount of $4.9 million.

In addition, HELCO's heat rate savings, which were $1.5 million in the second half of 2011, are expected to be eliminated in the second half of 2012 with the new heat rate debt plan implemented when HELCO was decoupled. With respect to O&M, because initiatives are weighted to the second half of the year, we expect the second half O&M expenses to be 15% higher than the same period last year. This will result in full-year 2012 O&M to be 6% higher than last year, consistent with our original expectations. There is no change to our expectations for a 4% to 5% rate base growth for the year. Overall, we continue to be focused on effectively executing our new regulatory model and our clean energy and reliability CapEx programs.

Now we'll look closely at the Bank's strong performance net interest margin. Our net interest margin was 3.97% in the second quarter of 2012. The 7 basis decline from the linked quarter was due to lower yields on interest-earning assets due to the low interest rate environment. And the shift in the portfolio mix in favor of shorter duration adjustable rate products. Our liability cost of 27 basis points in the second quarter of 2012 is extremely low by industry comparison. And is driven by our stable, low-cost deposit base. Note that there can be volatility in net interest margin between quarters as a result of the accounting recognition of fee income on loan and investment prepayments and other factors. However, it had no significant impact between the first and second quarters of 2012.

The Bank recorded $2.4 million provisioned for loan losses in the second quarter of 2012, down from $3.5 million in the linked quarter. The decline in provision was due to lower net charge-offs, particularly in the residential, land and commercial market portfolios. And improved consumer credit quality associated with the gradual improvement in Hawaii's economy.

As shown on slide 14, loans have been growing steadily for seven consecutive quarters. In the second quarter of 2012, loans grew by $23 million, or 2.5% annualized. And year-to-date loans increased by $53 million or 2.9% annualized. Growth continued to be driven by American's home equity lines of credit and commercial real estate.

Slide 15 is our balance sheet, which shows you the attractive asset and funding mix of American relative to our peer banks. 97% of the loan portfolio was funded with low-cost deposits versus our peer banks at 86%. Our core deposits increased by $25 million in the quarter to $3.6 billion, which helped fund our loan growth, while maintaining a very low average cost of funds of 27 basis points. American remains well-capitalized with a Tier 1 leverage ratio of 9.2%, tangible common equity to total assets of 8.6%, and total risk-based capital of 12.8%, all at June 30, 2012. Year-to-date, American paid $20 million in dividends to HEI. And expects to pay an additional $25 million by year end, while maintaining its capital ratio of 9% Tier 1 leverage and 13% total risk-based capital.

Turning to credit quality, American's non-performing assets ratio declined to 1.84% at the end of the second quarter. Versus 2.02% at the end of the first quarter. And remains better than its high-performing peers. The $6.3 million decrease in non-performing assets was primarily due to the reduction of the residential loan portfolio, land loan portfolio. And the pay-off of one large non-performing commercial loan.

Consistent with the improvement in non-performing assets, our net loan charge-off ratio declined to 0.19% from 0.28% in the linked quarter. The decline is primarily due to lower charge-offs in the commercial markets portfolio and the rapidly shrinking residential land portfolio. Provisions exceeded net charge-offs for the quarter and year-to-date. As a result, the allowance for loan losses is up slightly of 1.06% of outstanding loans compared to 1.05% at the end of the first quarter and 1.03% at year-end.

Looking forward, our 2012 expectations for the Bank remain unchanged. We continue to expect 2012 net income to be approximately 3% to 5% lower than 2011. As explained last quarter, we expect to see continued downward pressure on net interest margins quarter-over-quarter. Full-year NIM is expected to be close to 4%, With the first half of the year slightly higher and the second half of the year slightly lower than 4%. Non-interest income will be impacted by gains on sales of loans, which will fluctuate depending upon interest rates and loan origination volumes.

We expect approximately $750,000 of lower interchange revenues in the second half of 2012 compared to last year, due to changes from our interchange network. We expect this to be partially offset by volume increases from account growth. We expect provision expense to be between $13 million to $16 million for the year, as provision will increase with loan growth. Commercial charge-offs may be lumpy throughout the year but we remain cautiously optimistic about the continued improvement in the Hawaii economy. Overall, we are targeting to deliver strong results with our low-cost funding base, efficient cost structure and lower risk profile.

I'll wrap up my comments with views on consolidated earnings and capital. We expect second-half earnings to be generally in line with the first half of 2012, subject to the earnings drivers we have discussed, primarily utility O&M and lower Bank net income. This is in contrast to many years in which the annual earnings distribution was significantly more weighted to the second half of the year. We continue to maintain a strong capital structure with consolidated common equity to total capitalization of 50%. And based on our current assumptions, we will not require any equity issuances beyond our dividend reinvestment plan through 2012.

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

Thanks, Jim. In summary, we have made significant progress on our strategies. Out utility continues to focus on fulfilling its clean energy mandate for Hawaii, while achieving returns that will enable us to attract capital for our clean energy investments. At the Bank, we've continued to deliver solid results. And through the first half of the year are on track to meet our 2012 targets. Our dividend yield remains attractive relative to the average for our utility peers. And as of yesterday's close, our dividend yield was 4.4%, with 2012 marking our 111th year of paying continuous dividends. We believe we are well-positioned to continue to deliver a unique investment combination of attractive earnings growth with reduced risk and volatility. And an above average dividend yield.

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

(Operator Instructions) Paul Patterson with Glenrock Associates.

Brutal earnings season we've had this week. But just wanted to touch base with you on a few things. I might have missed this. I think you did say what the outlook for provisions for loan losses was. And I think it was improved, is that right, going forward?

We had given some guidance between $13 million and $16 million. And actually, that remains our guidance, although the second-quarter provision was a little lower than the first.

Okay. And then just in terms of the Hawaiian economy, I noticed on slide 43 that the University of Hawaii, it looks to me, if I'm reading it right, really decreased their outlook. And I'm really not sure. You did mention how strong the visitor numbers were. And it looks like there's some sort of decoupling between the tourism economy. So I was wondering if you could elaborate a little bit on that. And how that strikes you in terms of your cautious feeling, the positive outlook you have for the Hawaiian economy. It just seems like a big revision that they've had here.

Yes, I don't know the real ins and outs of their modeling. But I can tell you that, from my observations of what they do in their forecasting, is they tend to be very influenced by national economic projections. And also, because we draw a lot of tourism from the Asian economies, as well, from that area. And some of the other economies that tend to feed us tourism. And I think right now, because of all of the uncertainty that's being felt from a global perspective, that seems to also be bleeding into their forecast. As you heard Jim talk about, Hawaii's tourism numbers have been pretty amazing. But we're not seeing that generally translate into the rest of the economy yet.

Not too get too much into this but I'm wondering why is that? In fact, the University of Hawaii sees the numbers increasing substantially, it appears, for the next couple years, for this year and next, for visitors, if I'm reading it right. But, yet, still see the gross state product going down by almost half the growth rate that it had before. Is there something in particular that's happening with the economy that's making that? Is it lower spending tourism? I'm just wondering briefly what that might be.

No, I don't think we noticed anything particular to Hawaii itself. I really think it's being influenced more by the views of what's happening generally in the world and the markets from which the tourists are coming.

Okay. And then just Dodd-Frank, anything that you're seeing out of the promulgation of the rule making there that you have any update in terms of how that might financially impact you guys?

Generally, we have not had much impact from Dodd-Frank. Of course, Dodd-Frank did implement the Consumer Finance Protection Bureau, CFPB. And they are coming out with promulgations, particularly around consumer protection and consumer lending. So, undoubtedly, some of that will filter through to all of the banks. But thus far, it hasn't been unusually so. I think that we talked previously about the Durbin Amendment, that American is exempt because it is a smaller bank of $10 billion in assets or less. However, we are seeing, as we had telegraphed previously, changes in the marketplace that are somewhat of a drag on American's interchange income, as we have seen the interchange networks begin to change pricing according to the market. But in general, I think we feel that we've been able to adjust to the regulatory environment, even under Dodd-Frank.

I think you also know, under Dodd-Frank, we changed regulators because our old regulator was actually abolished in Dodd-Frank. And that was the Office of Thrift Supervision. So we are now under OCC at the Bank level, and the Federal Reserve at the Holding Company level. And we've filed new style reports with both agencies over the last year, and it all seems to be going pretty smoothly.

Great. And then, net interest margin, just any outlook here for 2013, how we might think about that, how that might be trending. We're in August now. I'm just trying to get a sense as to how this trend might be continuing with the current interest rate environment that we see.

Yes, let me start that answer and then I'll turn it over to Rich to give you his thoughts. From a targeting perspective, we've really wanted Rich and his team to target about 4%. But the very low interest rate environment that has just gone on for a prolonged period, I think way longer than anyone had expected, has really impacted that net interest margin. You can already see the deterioration in the second quarter to slightly below 4%. I think Rich and the team have been running really hard to build the loan book to make some of that margin up. But it's really quite a challenging environment. You also have to watch your expenses quite closely because it's very hard to grow revenues. So let me just ask Rich if he might share some of his thoughts on that.

Yes, I think, as Connie mentioned earlier in the call, we expect the continued drip, drip, drip of erosion. Probably in the neighborhood of 5 to 7 basis points a quarter, as we go. And that's a combination of lower yields on the things that are coming on in this environment, just lower than what's on the book. Plus we continue to be on what we've described as our controlled glide path on the mix of the portfolio taking a lower composition of residential mortgages. Because we don't really like holding 30-year fixed mortgages at these rates. And so we've mixed into HELOCs and more C&I and other adjustable rate products that just today have lower nominal rates. So you have a combination of the line-by-line erosion in the yields with that mix dynamic, too. So you wrap it all together, we think about 5 to 7 a quarter right now.

And how do you offset that? Is there anything that we should be thinking about in terms of additional non-interest expense cuts or something? Or how should we think about that?

Over time, you control expenses, as Connie said. But consistent -- we've said we think the total result for the year will be 3% to 5% lower than last year, and part of that's attributable to that dynamic.

Okay. But the trend doesn't look like its changing, in the near term at least, next year or so?

Not unless you've got some good news for me.

Okay, thanks a lot.

And, of course, as I mentioned, Paul, Rich and the team have really got to run hard and put more loans on the books so that we can keep the earnings up there, too. And that's not easy because, of course, that's impacted by the economy, as well.

James Bellessa with D.A. Davidson & Company.

I'm looking at this loan loss provision guidance of $13 million to $16 million. And you're indicating that partly that's a function of going forward loan growth, that you'll be increasing that some for loan growth. What is your target for loan growth?

I think as we've said before, it's in the mid single digits range. So we're year-to-date just under 3%.

And when you say year-to-date, how do you measure that year-to-date? Six months versus six months a year ago?

Yes, correct.

Thank you very much.

(Operator Instructions) Charles Fishman with Morningstar.

Thank you. I'm looking at slide 23 in the appendix. And what struck me is that it looks like your typical rate case cycle is about two to three years. Do you anticipate that changing with the decoupling?

Actually, the decoupling establishes the rate case cycle at three years. So once every three years, each utility will go in for a rate case.

Got it. Thank you for educating me on that. That was it.

At this time we have no further questions. I'd like to turn the call back to management for closing remarks.

Hi, everyone. This is Shelee. Thank you so much for joining us today. And as always, if you have any other questions about today's Webcast, please feel free to contact me. Have a great weekend.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.