Hawaiian Electric Industries Inc (HE) 2018 Q3 法說會逐字稿

Good day, and welcome to the Hawaiian Electric Industries Third Quarter Earnings Conference Call. (Operator Instructions) Please note that this event is being recorded.

I would now like to turn the conference over to Julie Smolinski, Director of Investor Relations. Please go ahead.

Thank you, and welcome to Hawaiian Electric Industries' Third Quarter 2018 Earnings Conference Call. Joining me today are Connie Lau, HEI's President and Chief Executive Officer and Chairman of the Boards of Hawaiian Electric Company and American Savings Bank; Greg Hazelton, HEI Executive Vice President and Chief Financial Officer; and Rich Wacker, American Savings Bank President and Chief Executive Officer; as well as other members of senior management. Alan Oshima, Hawaiian Electric Company President and Chief Executive Officer, is traveling and unable to join us on today's call.

Connie will provide an overview, followed by Greg, who will update you on Hawaii's economy, our results for the third quarter and our outlook for the remainder of the year. Then we will conclude with questions and answers.

During today's call, we will be using non-GAAP financial measures to describe our operating performance. Our press release and webcast presentation are posted on HEI's Investor Relations website and contain reconciliations of these measures to the equivalent GAAP measures.

Forward-looking statements will also be made on today's call. Factors that could cause actual results to differ materially from expectations can be found in our webcast slides or filings with the SEC and on the HEI website.

I'll now ask our CEO, Connie Lau, to begin with an overview.

Thanks, Julie, and aloha to everyone. In the third quarter, we continued to make significant progress on our strategies across the enterprise and delivered solid results, with consolidated net income of $66 million and earnings per share of $0.60. Our utilities continued to work towards Hawaii's 100% renewable energy and carbon neutral goals. As we do so, we're focused on ensuring our communities move forward together and that all customers have access to renewable but also affordable and reliable energy.

American continued to perform well, achieving another consecutive quarter of strong net income growth as it remains focused on making banking easier for customers and improving operational efficiency. As we approach the end of the year, we are reaffirming our earnings guidance range, and Greg will go over that in more detail later.

Our energy transformation has moved very quickly over the past year. With the core policy frameworks established through commission acceptance of our Power Supply Improvement Plan and approval to proceed with our grid modernization strategy as well as our filing of our electrification of transportation road map, we have now been able to move forward more quickly on implementation.

We launched the state's largest ever renewable energy initiative and are now negotiating power purchase agreements in Phase 1 of that effort for 7 solar-plus-storage projects on 3 islands to add 260 megawatts of solar and over 1 gigawatt-hour of storage. If approved by our commission, these projects will displace another 1.2 million barrels of fossil fuel per year, provide renewable energy at some of the lowest prices we've seen to date and be eligible for performance incentive mechanisms.

This year, we also filed for approval to add 180 megawatt hours of grid-scale battery storage on Oahu and for Phase 1 of our grid modernization project.

We completed our biofuel-capable Schofield Generating Station in June, strengthening system resilience and helping incorporate more renewable energy. And we're building our 20-megawatt West Loch solar project and expanding demand response opportunities on our system.

Maui's first 2 large-scale solar facilities are now in service, and we look forward to the Honua Ola biomass facility coming online on Hawaii Island, bringing 21 megawatts to help fill the 38-megawatt renewable gap that was created when Puna Geothermal Venture's plant went out of service due to lava flows earlier this year.

We continue to offer more options for customers to participate in the clean energy transition, from our community-based renewable energy program to our recently launched NEM Plus program to enable existing net-energy metering customers to add nonexport technology, including storage, to their rooftop solar systems.

As we advance our renewable energy and grid transformations, we're also making progress on other clean utility initiatives. We continue to seek ways to increase efficiency and deliver even more benefits to our customers. Last month, the commission approved our agreement with Hawaiian Telcom to acquire their portion of jointly owned utility poles across our service territory. Our customers and communities will benefit from more efficient and effective management of pole infrastructure and faster deployment of new technologies like 5G and smart community initiatives that use wireless networks to improve public services. This acquisition also presents new revenue opportunities for our company.

Our new SAP Enterprise Resource Planning and Enterprise Asset Management system also went live last month. And we've committed to delivering $244 million in customer benefits from the project over 12 years. We've also reached a key milestone in our return to triennial rate cases, with new rates in effect at all 3 utilities following the commission's August interim decision in our Maui Electric 2018 test year rate case. While we have new rates in place, we are still working to return to the normal rate case filing schedule. Our Hawaii Electric Light rate case will be filed by year-end. With the resumption of triennial rate cases and the new major projects' interim recovery mechanism, and as we move towards earlier rate case filings, we look forward to continued ROE improvement in the next few years.

The performance-based regulation, or PBR docket, continues to proceed with collaborative examination of our regulatory framework and whether adjustments may be needed to better align utility incentives with customer expectations and state energy policy. We continue to see PBR as an opportunity to support achievement of our 100% clean energy goal and to continue to evolve our framework to include incentives to perform valuable services as well as to make prudent capital investments for our customers.

We're pleased that our utilities in the IBEW Local 1260 reached agreement. And in August, union members ratified a 3-year extension of their collective bargaining agreement. We're working together to develop a code of excellence that will apply to both management and union employees and focus on mutual goals such as enhanced accountability, shared values and vision and productivity.

Finally, I am also pleased with our storm response to Lane and Olivia in August and September. Our crews restored service quickly, and our investments in resilience, including more than $800 million on Oahu from 2013 to 2017, paid off, limiting damages and outages. We've also restored services to customers in lava-affected areas on Hawaii Island, who authorities have allowed to return to their homes as lava activity has significantly decreased and there is currently no active flow. The financial impact of these weather and lava events has not been material to our company.

Turning to the bank. American achieved another consecutive quarter of strong net income growth, driven by expanding net interest margin and improving operational efficiency, with the bank continuing to benefit from lower tax rates from tax reform. American continues to maintain its low risk profile, strong balance sheet and low-cost funding base. The bank's new Honolulu campus is nearing completion, and we are excited for employees to begin moving in early next year. The consolidation of American's nonbranch employees into this new collaborative environment presents opportunities for greater efficiencies for both the bank and our customers.

At Pacific Current, we are pleased to announce the appointment of Scott Valentino as President. Scott has an extensive and diverse background in energy, infrastructure and finance, including at AltaGas, NRG and Stern Stewart and brings a wealth of relevant leadership experience and strategic insight to Pacific Current. As President, Scott's role will be -- will include building a team for Pacific Current, building and maintaining the company's portfolio of sustainable infrastructure projects in Hawaii and partnering with local developers and others in the community to bring new projects to fruition. Pacific Current's first 2 projects continue to proceed well, and cash flow from Hamakua Energy continues to fund the Pacific Current's start-up costs as we prudently build the organization.

I'll now ask Greg to cover Hawaii's economy, our third quarter financial results and 2018 outlook.

Thanks, Connie. Overall, Hawaii's economy remains healthy and continues to grow. Hawaii has maintained one of the nation's lowest unemployment rates at 2.2% in September, significantly below the national rate of 3.7%. Tourism has shown continued strength, with visitor expenditures up 9.8% and arrivals up 6.5% through the first 3 quarters compared to the same period last year.

Hawaii real estate fundamentals remain sound. While sales volumes declined from the prior year by 3.7% for single-family homes and 0.1% for condos, median prices continued to rise, with year-to-date September increases on Oahu of 4.2% for single-family homes and 5.5% for condos. Hawaii state GDP is expected to rise 1.8% in 2018, and the state's economic outlook remains positive.

Turning to our financial results. As shown on Slide 7, third quarter earnings increased to $0.60 per share compared to $0.55 per share in the third quarter of 2017 with solid performance across the enterprise. Earnings grew at both the utility and bank, while the holding company and other segment results were flat, given our efficient capital structure and net income growth translated into 9 -- over 9% EPS growth. Pacific Current, which is included in the holding company and other segment, has contributed positively to net income and operating cash flow for the year-to-date period, offsetting some of the holding company expenses and our investment in the new strategy.

On Slide 8, HEI's consolidated GAAP ROE for the last 12 months was 8.7%, with contributions of 7.2% from the utility and 12.7% from the bank. Excluding the onetime impacts of tax reform recorded in the fourth quarter of 2017, HEI's core consolidated ROE for the last 12 months strengthened approximately 90 basis points to 9.4% versus 8.5% for 2017.

Our utility ROE for the September 2018 LTM period reflects the ongoing transition back to a triennial rate case cycle after no base rate increases for 6 years. This includes a full 12 months of new rates at Hawaii Electric Light, 7.5 months of new rates at Hawaiian Electric, our largest utility, and just over 1 month of new rates at Maui Electric. We expect to benefit from the continuation of these new rates through the rest of the year.

As noted last quarter, under the MPIR mechanism, recovery for the Schofield Generation Station is limited to roughly half of the investment in the year the project goes into service, with recovery on the full investment of the -- amount of the plant investment beginning January 1 of the following year.

Our bank ROE for the last 12 months grew approximately 160 basis points compared to 2017 -- the 2017 last 12-month period, driven primarily by the tax reform, the bank's continued low-cost funding and strengthening yields on earning assets.

On Slide 9, utility earnings were $49.7 million in the third quarter of 2018 compared to $47.5 million in the third quarter of 2017. The most significant net income drivers were as follows: $8 million of rate relief from the now final Hawaiian Electric 2017 and Hawaii Electric Light 2016 test year cases and interim rate relief from the Maui Electric 2018 test year rate case; $4 million from higher RAM revenues as well as MPIR revenues for the Schofield Generation Station; $5 million higher net income from net favorable tax adjustments, primarily related to the difference between 2017 year-end tax accrual and the filing of the 2017 tax return, largely due to the acceleration of the 2018 pension contribution deductions into the 2017 tax year; also, $1 million higher net income representing the difference between the actual third quarter tax savings and the reduction in revenue requirement from tax reform, which was based on test year projections.

Year-to-date, the revenue requirement reduction from tax reform was approximately $3 million higher than the actual tax savings. The benefits of tax reform have been passed along to our customers.

These amounts were partially offset by $11 million higher O&M expenses compared to 2017, primarily due to the reset of pension costs as part of the rate case interim decisions and higher costs for unplanned underground circuit repair work, generating station operation and maintenance and workers compensation claims; $2 million higher depreciation expense due to increasing investments to integrate more renewable energy and improve reliability and system efficiency; $2 million lower allowance for funds used during construction; and $1 million higher interest expense from higher interest rates and increased borrowing.

Turning to the bank on Slide 10. American achieved another quarter of strong net income growth, reaching $21.2 million, $3.6 million higher than the third quarter of 2017 and $0.7 million higher than the second or linked quarter of 2018. Compared to the linked quarter, the increase was primarily driven by higher net interest income from higher yields on earning assets, higher bank-owned life insurance income and lower noninterest expense, which offset higher provision expense that was mainly due to additional loan loss reserves for the consumer loan portfolio.

Compared to the third quarter of 2017, the $3.6 million higher net income was primarily driven by higher net interest income and $3.6 million lower income tax expense from the lower federal tax rate, partially offset by higher provision for loan losses due to increased reserves for the loan growth -- for loan growth and additional loan loss reserves for the consumer loan portfolio. Our consumer loan portfolio expansion is a relatively new strategy added over the past few years. This higher-margin portfolio remains solidly profitable, despite the higher provision for the quarter. As the consumer portfolio seasons, we continue to adjust its parameters and are adding additional operational elements to reduce net charge-offs.

Turning to Slide 11. American's solid profitability continued in the third quarter with an increased return on assets and continued strong net interest margin. We achieved a return on assets of 122 basis points for the quarter, exceeding our second quarter 2018 return on assets of 120 basis points and our 110 basis point threshold for the year.

Net interest margin was 3.81% for the quarter and 3.78% year-to-date. Net interest margin for the third quarter was higher than the linked quarter at 3.76% in the high -- and at the high end of our guidance range of 3.7% to 3.8%. Our margin continues to perform well against our high-performing and Hawaii-based peers.

On Slide 12, American's net interest margin reflects higher yields on interest-earning assets and continued low-cost deposit growth that funded earning asset growth in the loan and investment portfolios. Our interest-earning asset yield increased 7 basis points over the linked quarter to 4.06%. We maintained our low-cost funding in the rising interest rate environment and continue to benefit from our disciplined approach and our focus on relationship banking. Our cost of funds was 26 basis points in the quarter, just 2 basis points above the linked quarter and well below peers.

On Slide 13, net interest income grew by approximately 3% compared to the linked quarter, driven primarily by higher yields on interest-earning assets discussed on the slide.

Total loans as of September 30, 2018, increased by $83 million or 2.4% annualized from December 31, 2017, driven mainly by the growth in our home equity lines of credit, commercial and consumer loan portfolios. We expect to see our target -- to meet our target of low to mid-single-digit earning asset growth for the year.

As of September 30, deposits increased by $240 million or 5.4% annualized from December 31, 2017, including approximately $100 million in repurchase agreements that were transferred into deposit accounts. Excluding such transfers, deposit growth was 3.1% annualized.

On Slide 14, credit quality remains sound due to prudent risk management and the healthy Hawaiian economic -- Hawaii economic environment. The credit quality of our residential portfolio remains very strong, and our commercial and commercial real estate portfolios are stable with improving trends. Provision for loan losses reflected additional reserves for the consumer loan portfolio, partially offset by the release of reserves due to improved credit quality in other portfolios.

Allowance for loan losses of $54 million was 1.14% of outstanding loans at quarter end compared to 1.11% in the linked quarter and 1.13% in the prior year's quarter.

Nonaccrual loans as a percentage of total loans receivable held for investment was 0.59% compared to 0.57% at the end of the linked quarter.

Our net charge-off ratio increased to 40 basis points for the third quarter compared to 32 basis points in the linked quarter, driven by the consumer loan portfolio, which, as previously mentioned, remains solidly profitable.

American's asset and funding mix, shown on the right side of Slide 15, remains attractive relative to peers. 100% of our loan portfolio was funded with low-cost core deposits versus the aggregate of our peer banks at 88%. In the third quarter, total deposits increased by $14 million, and our average cost of funds was 48 basis points lower than our peer median.

American also paid $14 million in dividends to HEI in the third quarter and $36 million year-to-date, a 28% increase over the prior year-to-date period, while remaining well capitalized at September 30 with a leverage ratio of 8.6%, tangible common equity to tangible asset ratio of 7.8% and a total capital ratio of 13.8%.

As we look to the calendar year, we've revised our 2018 utility rate base growth forecast to 6% to 7% from 7% to 9% previously. This is due to a clarification of tax reform rules, which enabled us to benefit from bonus depreciation on assets placed in service during the fourth quarter of 2017 and thus, provided $66 million of additional tax deductions and deferred -- and an increase in deferred taxes, which is an offset to rate base. That also increased cash flow for the period. Our utility 2018 CapEx forecast remains at $400 million, as discussed on last quarter's call.

As mentioned earlier, the successful go live of our SAP ERP system was completed as planned on October 1 and within the cost recovery cap for the project.

Turning to Slide 17. We are reaffirming HEI's 2018 consolidated earnings guidance of $1.80 to $2 per share while guiding towards the lower end of the utility range of $1.33 to $1.46 per share. While we achieved material savings at our utility over the course of the year while adequately resourcing our ERP project that went live last month, those savings have not been sufficient to offset the combined headwinds of lower revenues from customer benefits that were part of our rate case settlements, lower Schofield MPIR revenues due to the average rate base method for recovery during the first year in service and unplanned expenses and onetime costs. Due to additional onetime higher utility costs, we are revising the utility's 2018 O&M increase over 2017 to 5% from 4% previously.

We are guiding to the higher end of the bank earnings guidance range of $0.68 to $0.74 per share. Net interest margin is expected to be at the high end of the range of 3.7% to 3.8%, with provision also at the high end of the range of $14 million to $18 million due to consumer -- due to our consumer loan portfolio, which remains profitable.

As we indicated last quarter, we do not expect Pacific Current to contribute meaningfully to 2018 earnings given start-up costs for the year as we build the platform and team.

Connie will now make her closing remarks.

Thanks, Greg. In summary, we continue to focus on our mission of being a catalyst for a better Hawaii. Now that we have the core policy frameworks in place, our utilities have quickly advanced our renewable energy and grid transformations. As we advance towards 100% clean energy, we're focused on ensuring our communities move forward together and that all customers have access to affordable, reliable, renewable energy.

Our bank's strong performance continues as it remains focused on making banking easy, deepening relationships with customers and strengthening efficiency, which the bank will be even better positioned to do with its move to its new campus.

We are excited to have Scott Valentino join us as Pacific Current President. We're confident he will help us build a strong team and position Pacific Current to advance Hawaii's environmental and economic goals through investments in sustainable infrastructure.

Our business model continues to provide the financial resources to invest in the strategic growth of our company and our state's sustainable future while supporting our dividend, which our Board maintained at $0.31 per share this quarter, continuing our history of uninterrupted dividends since 1901. The dividend yield continues to be attractive at 3.3% as of yesterday's market close.

As always, our companies will continue to focus on providing long-term value for our customers, communities, employees and shareholders.

And now we look forward to hearing your questions.

(Operator Instructions) And our first question comes from Julien Dumoulin-Smith with Bank of America Merrill Lynch.

Perhaps a first quick question, perhaps a little bit of a higher level. Connie, how do you think about some of the new investors in the stock? And are you evaluating any changes on the Board or from a governance perspective or even with respect to your investment strategy? Just wanted to hit that one out of the gate, if you don't mind.

Sure. Julien, we've always thought that Hawaii has been on the forefront of renewable energy and climate change and reducing emissions. Lots of good things have been happening in our state, and you've seen all the new policies that our lawmakers have put in place, both at the state level and at the county level. So it's really great that there are folks, there are investors, who have been taking note of the wonderful changes that have been happening in Hawaii. And so we are moving forward with our plans. And we don't have any major changes that we are looking at since a lot of what we've been doing is very consistent with those views, and we're just trying to move as fast as we can.

I would add a tagline to that. I think as most of you know, it's really important in a small community, in a small state like Hawaii, for all of us to move forward together. It can't only be the electric utility, particularly as we build out demand response markets and all the distributed energy resources, we have to all work together. And that includes all the way down to our communities that have to host the renewable projects. So we're really pleased that in this most recent RFP solicitation, we've been able to begin negotiations with 7 projects that will bring the most renewable energy onto our grids very shortly.

Excellent. Maybe to pick up off of that, how are you thinking about Pacific Current as sort of an alternative investment vehicle? And even in tandem with that, how would you think about financing that incrementally for -- given the capital plan that you already have underway?

Yes, sure. I think as we've explained before, one of the reasons that we formed Pacific Current was that we've got the 2 strong operating companies in both the utility and the bank, but both are very highly regulated. And we have seen opportunities here in Hawaii to help move the whole clean energy transformation forward more quickly, hence, the reason for starting this third kind of leg of the stool to allow us to do that. And as you've seen from the first 2 projects that Pacific Current has done, both of those were done with investment-grade credits on the other side. And so we've actually been able to finance those based on the credit of the project itself. And we would be looking to do that going forward. Having said that, we are looking -- Hawaii is a smaller market, and so there may be opportunities for us to do some of the smaller projects that other sources outside of the state might be less interested in, in which case, we would aggregate them and portfolio them and then finance them.

Got it. Excellent. Can you elaborate a little bit further on just the rate base changes looking out to '20? It looks like there's been a slight reduction as well even on '18. What's that driven by? Is that a regulatory change or a project change, a tax issue?

Yes, it was primarily a tax issue. During the fourth quarter, we were able to benefit from bonus depreciation that -- there was a clarification of the Tax Reform Act Law, which went into effect December 22, but it made the law effective as of the end of September. So it was unclear that we would have bonus depreciation during the fourth quarter. As a result of a clarification that came out in August by the treasury, we were able to take an additional $66 million of the tax deductions, which, as you know, that creates deferred taxes, which then is a reduction to rate base for those deferred taxes. But it also increased our cash flow. It was a net positive. We had increased cash flow overall but just a temporary impact or onetime impact from that. Going forward, we've got our rate base growth modeled based on the new Tax Reform Act going forward, which is still a higher level than it had been on -- from a pretax reform basis.

Got it. But just to clarify, though, on '20, was it the same thing?

'20, we're -- we stay with -- we've stayed within the -- yes, I'm not aware that we had changed. There's not really a change on the 2020 period from our prior guidance.

All right. I thought you pulled down the top end. Sorry about that.

No, we -- yes, no, we still continue to forecast our $400 million to $500 million. We will clarify that going forward now with our -- after our year-end in terms of our CapEx trajectory as well as our rate base growth as we complete our year-end reporting process and our forecasting process this year.

Got it. And just to make sure I heard the last question correctly, with respect to capital needs, as you're looking at Pacific Current or just in general into 2019, what are the expectations right now given the CapEx budget that you have already in front of you and some of these additional projects that you're contemplating?

Yes. Well -- so relative to Pacific Current, we don't see ourselves capital constrained for incremental investments overall. That is -- it's a smaller company. We're continuing to look at projects, and we'll invest in those as the projects are adequately developed. Those tend to be less programmatic at this time as we review the marketplace, look at investment opportunities, partner with other partners here to do the development and other work. And we will fund those as those projects are mature and as the investment opportunity yields itself.

We have tended, as Connie had mentioned previously, to fund those projects within Pacific Current, contributing the equity from HEI and then project -- typically project -- financing those projects within the Pacific Current entity while maintaining an overall investment-grade profile. So we will -- Scott has just been brought on as President, he is responsible for driving that strategy. We'll be working closely with him to develop our projections for 2018 and beyond, and we'll have more on that as we come back to you at the year-end time and talk about our expectations going forward.

And our next question comes from Paul Patterson with Glenrock Associates.

I apologize, I think you might have gone over this with Julien. Just the bonus depreciation and its impact on rate base, what caused that to happen, I guess, this quarter, I guess? That's -- I'm a little bit confused as to how that -- why that impacted rate base, it seems, at this point in time.

Sure. It was nothing more than the clarification and the application of the Tax Reform Act. As you recall, last year, it went into law in December 22, I believe. It had specified that the application of that law was as of the end of September, I think September 27 prospectively. It was unclear. In fact, we believed that bonus depreciation from September 27 forward was no longer applicable, we were now under the Tax Reform Act. So at the utility, we did not forecast for bonus depreciation for project -- plant in service that was closed during the fourth quarter of last year.

With the clarification coming out from the treasury, this August, we were able to take bonus depreciation for the fourth quarter. That was a total of $66 million of additional tax deductions that resulted in 21% of that in deferred taxes -- additional deferred taxes that is a reduction to our rate base. And the benefit of all of that, despite the lower rate base growth for 2018 given the deferred tax portion of that, was that we saw increased cash flow as a result.

Okay. The -- just the PBR proceeding, it seems everything I've seen so far, I think, is interprocedural. Has there been anything else or any sort of feedback that you'd be getting in the process that you want to share with us or anything?

So, Paul, we actually have Joe Viola, who runs our regulatory group, with us today. And so I'm going to let Joe make some comments on that.

Paul, again, this is Joe. I think you're right. I mean, the way the commission

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And we've gone through the first step in the process was really a collective examination of what PBR is and what it offers. The second step, which took place and finished up in the October time frame, was an evaluation of our existing regulatory framework with an eye towards how it impacts potential prioritized outcomes. And we're moving into the next step, step 3, which will begin at the end of this month, and we'll start examining potential mechanisms or changes that might affect and further encourage prioritized outcomes.

So I think you're right. There's been a fair amount of kind of discussion and evaluation for the first part of this proceeding. I think we'll be getting into details starting pretty soon. And the second phase of the docket, it will take place in 2019. That's when we'll actually begin developing potential changes to our regulatory framework to support prioritized outcomes. Now those prioritized outcomes that we were still in the middle of actually examining what those should be. There are 10 interveners in the docket, along with the Hawaiian Electric companies and the consumer advocate, and really, we've been spending time -- the commission has been soliciting input on what the type of prioritized outcomes should be. Generally, those are consistent with what our plans are anyway. But the commission has acknowledged that it's in the process of trying to narrow what those outcomes will be. And those will be the focus of the Phase 2, as I mentioned earlier, in the docket.

Paul, I would also just add that, as you know, some of current performance incentive mechanisms that had begun to be put in place, actually starting as early as 2017 and a few more earlier in 2018, we're actually in the first year of implementation of the ones that went in place in 2017, and those were on reliability, safety and the customer service. So that's also playing out alongside of the docket as it goes forward.

And our next question comes from Charles Fishman with Morningstar Research.

If I could go over guidance again. I'm sorry, it was going faster, and I couldn't write it down. Utility -- it'd be Slide 17. Utility EPS, low end of range because of the higher O&M and there was a revenue impact. What was that again?

Well, what we were referring to is certain customer benefits that were part of the agreed settlements through the rate case processes for HECO and Maui, Hawaiian Electric and Maui. And what those essentially were, were agreed-upon reductions in a revenue requirement that we agreed to with unidentified and yet to be achieved savings through O&M and other measures at the utility to achieve and provide those consumer benefits. That, in addition to some of what I had referenced with some of the headwinds of some onetime costs during this year, some unplanned events, actually impacted the utility significantly enough that we've now moved our forecast to the lower end of the utility range or the lower half of the utility range.

Okay. And then -- and bank high end, I got that. And then consolidated stays the same.

Correct.

Okay. And then moving to Maui, the interim case. I see -- it was on one of the slides, you're using a 9.5% ROE. Was the settlement ROE for Maui?

Yes.

And is that -- I realize that the final has to be approved by the commission, but I guess that's a positive because weren't you -- or aren't you currently at a 9% ROE that's sort of a -- as I recall, is a punitive ROE for some problems that occurred at Maui a few years ago. I guess we're over that then, I guess, is what...

We're well -- that's well behind us in terms of the issue that caused that, a long time resolved. So it's good to see the ROE at a corresponding level to the other utilities.

Okay. And then last question. Besides Scott, how many full-time employees are at Pacific Current at this time?

Actually, Scott is the first.

Okay. That's what I thought might be the case.

Yes.

As an employee, but we do have a number -- he gets a sufficient support from others from the back office, accounting, structuring, tax and others. But there, he also -- we also have some contract employees that are effectively supporting the efforts there as well as we carefully make hiring decisions.

Yes, okay. But it's a signal that -- the fact that you're -- you have one now would be a signal that there's potentially a bright future for Pacific Current with respect to growth. Correct?

Yes. Charles, what we had done was to incubate that strategy here at the holding company. And you're correct, we have now reached the point where we believe that, that strategy is viable and that we should stand up a separate dedicated team at that subsidiary. And so that's -- Scott's first order of business is get that subsidiary completed. And he's got all kinds of things he has to do with separate HR systems and a separate facility, separate technology and the like. So he's going to be focusing on some of those issues as well as continuing to look at projects that are now, frankly, finding us in the marketplace.

And the next question comes from Jonathan Reeder with Wells Fargo.

My questions have actually been asked already and answered, so appreciate that and see you guys in a couple days.

And the next question comes with Jackie Bohlen with KBW.

I wanted to switch gears and change over to the bank. A couple questions for you, Rich. Just looking at the provision first would be -- I understand that the consumer portfolio is the driver of that. But just wondering if it's a change in anything within that portfolio or if it was driven by growth?

It's driven by growth and it's driven by a couple of vintages where as we test out different pricing and response models, we got a little bit higher yield and a little bit higher loss rate on those vintages than the rest of the book. And so those will move through the system. And then we learn from those, and we make some adjustments. So that's why you see both the yields at the high end and you see the loss rate moving up a little bit.

Okay. So as you go forward to the extent you continue to pick more consumer generation, is it fair to say that the provision would be a little closer to the current quarter's level rather than historical levels?

Pluses and minuses on that depending on whether you're talking the rate or the dollar level because that will affect the volumes and the mix that we bring on. So I think you'd be in the range in between them.

Okay. That's helpful. And then as the consumer book does continue to grow assuming that funding costs, you've done an excellent job in keeping that steady despite the rising rates, is it fair to say we could see a little bit more of margin expansion from here if those rates stay pretty flat and the consumer book continues to be stepped to loan yield side?

We probably -- we're -- appetite-wise, as we've grown it, we've grown it to a proportion of the book that we kind of like. So I wouldn't expect to see it grow too much more relative to the overall book proportion-wise. So I think we're kind of approaching a steady state on that.

Okay. Are there any more composition shifts within the book that you're working towards?

We've got -- as you know, our product set is a little bit narrower than some of our peers, and so we're looking at things all the time. We'll -- as we get them, we'll let you know about them. But we would expect over the coming year or 2 to continue to introduce some new things, but nothing imminent that would affect the next quarter or 2.

Okay. And how was payoff activity in the quarter versus where it's been previously?

Pretty consistent, I think. The -- which lines are you looking at?

I guess mainly either commercial or commercial real estate. I know those both had declines in the quarter. But just in general, if you're seeing any elevated payoff activity overall.

Everything is pretty consistent. The C&I and CRE are a little bit lumpier, right? And we've had -- on the CRE side, there's been construction

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Sorry, we got an accidental hit of the mute button. So we were saying -- I don't know where I cut out. But the C&I and CRE are a little bit lumpier. And the construction component of CRE has been more of our recent additions than, say, the investor exposure. And so as those have paid off, you've seen a little bit more volatility in the CRE piece. In C&I, the payoffs have generally been related to credit quality resolving, either criticized assets or the like. On the retail side, it's been pretty consistent. So we'll get Julie to get you some of the numbers. There's nothing particularly notable to point out on the rate of payoffs other than that, that normal lumpiness. And as you can tell from our margins, we've done pretty well on the production versus the portfolio rate. So that's contributed across the board, except for res due to higher yields.

Okay. Yes, I know that. That definitely shows through in the results. And then just one last one. The BOLI income in the quarter, did that include any insurance proceeds?

Yes. There was one death benefit of about $1.3 million that we realized in the quarter.

Okay. Great. That's all for me, and congrats on getting closer to moving into your new building. I'm sure that must be exciting.

Yes, we're very excited about it. It's -- I'm going to move in with milk cartons and a cardboard box, I think, to get in there and help everybody else get moved in.

And the next question comes from Andrew Levi with ExodusPoint.

Just a few questions to make sure that I heard everything. So just on the guidance, so you're going to be at the low end of the utility guidance and at the high end of the bank guidance. And then how should we think about the fourth quarter? Will there be growth over last year?

Well, we have a couple of moving parts. We would expect continued growth because of new revenues at the utility and with the settlement of the rate cases. I had mentioned that with those rate cases behind us, we'll continue to benefit from higher revenues, higher recoveries. Again, obviously, those rate cases also come with a reset of some of the underlying costs, including pension and so forth. But on a period -- quarter-over-quarter, period-over-period, you would expect to see continued improvement. On the bank, again, it'll be a quarter over -- we would anticipate strength in -- from a net interest margin perspective, but we haven't forecasted that in detail. But we continue to see strong benefits at the bank from tax reform, strong net interest margin and a well-managed and well-performing bank. And I do want to clarify as we talked about the lower end of the range, I would say that's the lower half of the range for the utility, not providing really a point estimate on that.

Okay. So you're at $1.39 year-to-date, right? So if you come in like around $0.45, which is like $0.04 growth or something over last year's fourth quarter, you're probably kind of trending around the $1.85 or something like that. I know you can't give the exact number, but that's by looking at kind of the low to midpoint for the consolidated number. Is that kind of the way to think about it on an annual basis?

Yes. Well, you're the analyst. You have a pretty good sense of getting it. I love how you think out loud. But unfortunately, I can't give you a point estimate on that. But I would approach it...

Can't confirm or deny..

Yes. It's kind of -- it is a little bit on the sum of the parts as you look at the bank dynamics, the utility dynamics. And we've provided specific guidance around the dynamics for each of those as well as the consolidated range.

Okay. And then like in '20, you look at the changes in rate base, I just want to make sure that I heard it correctly. So the reduction in rate base, as you get out to like 2020, that all relates to the tax change. Is that correct?

Yes. Remember, we went from -- originally from $450 million estimate of CapEx for 2018 to $400 million, so that does impact the base at which you grow from as well, in addition to the impact of the tax reform benefit that we received, which reduced the underlying rate base growth in '18 and also a lower base to start from as you project forward.

Okay. So the combo of lower CapEx and the tax has changed rate base by about $100 million as you get to...

Yes. And remember that lower CapEx is really signaling just for 2018. We haven't revised our forecast or provided any additional revisions as we extend out.

Okay. And then I also want to make sure that I heard something correctly. So I think you had gotten a question relative to the activists that have come in and pushing you to do more renewables or whatever it may be. But I guess what you're saying is, which I agree with, if I heard it correctly, that's kind of been your strategy already. Is that correct?

Yes, that's correct. And it's also reflecting the whole environment in Hawaii.

Right, right. Okay. That's what I thought when I first saw it announced. And then relative to Pacific Current, what type of risk are you willing to take there? Or will it be kind of utility-type contracts and projects? Or how will that work? How do you envision that, I guess, is a better way to put it?

Yes. Probably the best way for me to explain that, Andy, is we are very conscious of maintaining investment-grade ratings for the utility and for the holding company. And as you know, the bank is not rated. But if it were, actually, and when it was, it was actually rated higher than both the utility and the bank. So we are not looking to develop a strategy that would significantly change that overall profile of our company because I think that is what investors look to and depend upon. And so as we develop it, we're going to be very conscious of that overall principle.

As I mentioned earlier, the first 2 projects are investment-grade credits on the other side. So as Greg mentioned, we were able to project finance most of that on the debt side with a small amount of equity coming in from the holding company. But as we go forward, there may be some opportunities where we see the need in our local market to finance smaller projects, in which case, we might then aggregate and portfolio them and then finance them.

Okay. So just to understand, so these -- mainly these smaller projects with contracts, is that what you're basically saying or...?

Yes, possibly. I don't want to be too specific because there's so much happening here in Hawaii that can give opportunities. And our ultimate objective is to help accelerate the transformations here in the island. And so that could very much include not just the energy side but very much the transportation side as well.

And then the last question I have, obviously; you've said very clearly, no equity for this year and the year is over. But as you look out to '19 and '20 and '21 and then with the addition of Pacific Current, obviously, we don't know -- or you don't know how much you're going to be spending there. How should we think about equity needs going forward in conjunction with Pacific Current and, obviously, your CapEx program at the utility?

Well, as you're doing this on a model basis, we continue to maintain our regulatory capital structure at the utility at 57% equity capitalization. We continue to target and will maintain investment-grade ratings at the holding company, which currently is essentially 51% equity capitalization on a consolidated basis. And those are -- and we have clear dialogue with our rating agencies as we talk about our plans, and those are -- and our investment-grade ratings are fresh, and we have ongoing dialogues. So we'll continue to target those -- that type of capitalization structure.

As you've seen at Pacific Current, and as Connie mentioned, we've put in place nonrecourse financing, arranged for nonrecourse financing both of the investment projects that we have currently, and we'll continue to look for an appropriate credit profile of our investments going forward that will ensure that we maintain that investment-grade profile. So as you think about it on a -- as you model out your earnings growth, your dividends and so forth, we'll continue to maintain those targets. The good thing is that we've seen increasing dividends from the bank in the post tax reform this year, which continues to provide capital to the holding company for incremental investments, offsetting the need for external equity to keep our capital structure in balance. We have now been through a full rate case cycle, and we'll be starting our new triennial rate case cycle again here with the next Hawaii Electric Light rate case filing in process in 2019. So with the anticipation of earnings improvement going forward, that also drives additional retained earnings for investment at the utility as well. So as you've seen, our external equity needs have been relatively modest. We also -- as we consider how we raise equity capital, we have a very strong -- continued strong demand through our dividend reinvestment program, which we're currently using open-market purchases to meet that demand, but that provides a very low-cost access to equity over time. Somewhere between $30 million, $35 million annually is what we'd anticipate. So those are the components as we model this out. Now we'll come back to you with further clarification of our capital expenditure program, a little more clarity at year-end around Pacific Current and what we see on the horizon for that as well as the utility performance going forward. And we'll clarify what our equity needs will be going into '19 and beyond.

And, Andy, I'd just add on the triennial rate case cycle. We -- Greg mentioned the HELCO case that we will file by year-end. And I think if you remember our cycle from before, typically, we would file at mid-year. So we would have normally filed that case in July of this year. But with the big SAP conversion on the Enterprise Resource Planning and Enterprise Asset Management, we did delay that until after the go live that was October 1. So that's a little delayed. We would hope to be back on schedule next July with the big Hawaiian Electric case for Oahu.

Andy, before we leave you, I just wanted to make one small correction. The S&P does actually rate our bank. They haven't published here since, I think, November of last year, but they've got a BBB. And we have an investment-grade rating at the bank. They just haven't published recently.

Right. And higher than the utility rating.

Yes.

And I apologize. I actually have one more question because it's hard to try to get you guys off the hill, why not. But -- so just -- you were talking about the -- if I remember correctly, when we met in New York, there were some regulatory issues that caused a little bit of a drag in the year, and you mentioned that, which I understand. And we went over those in New York. But then you also mentioned on the call that there were some other operational issues. I don't know if that was related to the hurricane or the volcano or something separate that also caused a little bit of a drag for this year. If you can kind of just give us some details on that.

Well, yes, there's been a number, and we've disclosed some of the operation and maintenance expenses, some of which had been unplanned for the year that have caused headwinds and has actually moved our guidance to the lower half of the range for the utility. And part of this is doing the right thing. We had some underground circuits that had some failures in our -- the core downtown Kakaako area, and we accelerated some of the repair work there. None of that -- which was not budgeted, which caused about $3 million of additional expenses reported through O&M. We had the writeoff of some smart grid costs along with the rate case settlement of a couple of million. We've -- we had some onetime rent expense. I think some of this we talked about on the last quarter's earnings call as well. The team -- or the utility has been doing their best to offset a lot of these onetime items as well as some of the customer benefit concessions that we made. But cumulatively, they've impacted our earnings guidance for 2018.

And not lava and storm response. That actually -- the companies came through very well in their response efforts there.

And our next question comes from Ashar Khan with Verition.

I just want to -- most of my questions have been answered, but I just want to clarify, you said that higher O&M was onetime in nature. So as we build for next year, we should think that these onetime costs should not repeat next year and you would have, under normal circumstances, been at the midpoint of the utility guidance. Is that a fair assumption?

Well, here's I would say, is the higher year-over-year O&M expense is a mixture of things. As you go through rate cases and you get certain other recovery mechanism reset, including our pension recovery costs, that in and of itself increased O&M, but we also had increased revenue to offset that O&M, so there was no compression of operating margin. So some of the increases that you see is as a result of the new rate case cycle. But we have had, and I think we disclosed it in our 10-Q, the list of the O&M increases, Slide 69 -- or Page 69 of our 10-Q. And what we've highlighted are some of the onetime and the unplanned activities in 2018 that increased that. And you're looking at $8 million, Tayne, approximately or so?

Approximately $8 million of that.

Yes, which we would consider -- which we would anticipate as onetime and/or not expect those to be reoccurring, those specific items.

This will be in pretax, right? Am I correct?

Yes. That's some...

That's about $0.05 or so, right? So okay.

And our next question comes from Frank Gordon (sic) [Greg Gordon] with Evercore.

It's Greg Gordon, but Frank's okay, too. So Ashar, I think, he just sort of kind of asked my question. I'm looking at Slide 21, and I'm looking at the core ROE LTM, this should be at 7.7%. So as I'm thinking about where you think you are on a run rate basis, as you exit this year going into next year, first and foremost, we should be $8 million -- all things equal, $8 million better on O&M run rate at the utility. Is that fair?

Yes. I think those...

I think that's fair because those were attributable as onetime. Yes, so that would be a fair statement.

And I guess, why I'm asking, as you think about the lay of the land today, and I kind of ask this question every time we talk, whether it's on the phone or in person, what is the runway that you would hope under a constructive engagement with your regulators over the next several years that you can get to that -- eliminate these lag items and get to that sustainable ROE in the mid- to high 8% range that you should, by all rights, be allowed to earn that they're not letting you earn before structural offsets?

Yes. As you know, our triennial -- part of closing and addressing some of those issues is the continuation of the rate case cycle that -- some of the lag, even some of the customer benefits that were part of our rate case settlements will continue on until the new rate cases as well. We've tried to be pretty clear about what we think are the peer structural items, which you tend not to get recovery of through the rate case process and those that can be cured through rate case processes. So...

Can I add to that? This is...

Well, Tayne is elbowing me here. I'll let our utility CFO to answer the question.

This is Tayne. So, Greg, I would look at it as the -- persistent item would be the structural items that you've seen is roughly 70 basis points. In addition to that, we're expecting also some drags there from the West Loch PV project that will be placed into service in the early part of Q2 next year. And under that mechanism, as you've seen in Schofield, the first year that, that project is in service, the recovery is on the half of that investment. And that is cured in the following year where the full investment is folded in, in terms of recovery. So we'll see some drag there with the West Loch project. In addition to that, with the Hawaii Electric rate case filing happening towards the end of this year, there's going to be some leakage there just due to having working through the rate case and expecting an interim later in 2019. As Connie mentioned, as -- moving forward with these triennial -- next set of triennial rate cases and as we move towards filing our rate cases in the middle part of the year, we should see some of that drag go away. But with the implementation of our new ERP system, we did delay the Hawaii Electric Light filing to later this year.

So, Andy, if you looked on your Slide 21 under the structural items, you're looking at about 70 basis points, plus you see that MPIR related to Schofield, that, of course, will go away in 2019, but will be replaced by the one that Tayne mentioned for West Loch because that project will be coming online.

And this concludes our question-and-answer session. I'd like to turn the conference back over to Julie for any closing remarks.

Thank you all for your questions and for joining us today. Have a great rest of the week.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.