Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Hawaiian Electric Industries, Inc. (NYSE:HE)

Q4 2009 Earnings Call

February 12, 2010 1:00 pm ET

Executives

Shelee M. T. Kimura – Manager Investor Relations & Strategic Planning

Constance H. Lau – President, Chief Executive Officer & Director

James A. Ajello – Chief Financial Officer, Senior Financial Vice President & Treasurer

Richard M. Rosenblum – President, Chief Executive Officer & Director of HELCO

Timothy K. Schools – President ASB

Tayne S. Y. Sekimura – Senior Vice President Finance & Chief Financial Officer

Analysts

Paul Patterson – Glenrock Associates

Robert Bohlen – KBW

[Chen Bokuda – Capital]

Michael Goldenberg – Luminous Management

Operator

Welcome to the Q4 2009 Hawaiian Electric Industries, Inc. earnings conference call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session towards the end of the conference. (Operator Instructions). I would now like to turn the call over to your host for today, Ms. Shelee Kimura, Manager of Investor Relations and Strategic Planning.

Shelee M. T. Kimura

Welcome everyone to Hawaiian Electric Industries 2009 yearend earnings release conference call. I’m Shelee Kimura and joining me today are Connie Lau, HEI President and Chief Executive Officer; Jim Ajello, HEI Senior Financial Vice President, Treasurer and Chief Financial Officer; Dick Rosenblum, Hawaiian Electric Company President and Chief Executive Officer; and Tim Schools, American Savings Bank President as well as other members of senior management. Connie will begin with an overview of 2009 and our strategic accomplishments and then Jim will take you through an update of the Hawaii economy and financial highlights. Connie will close with key investment points before opening it up for Q&A.

In today's presentation, management will be using non-GAAP financial measures to describe the banks operating performance. Our press release and a slide accompanying this webcast which are posted on our investor relations website, contain additional disclosures regarding these non-GAAP measures including reconciliation of these measures to the equivalent GAAP measure. Forward-looking statements will also be made on today's call. Please reference the accompanying disclosure to the webcast slides located on our website located at www.HEI.com.

Lastly, you will notice that yesterday's press release referenced GAAP earnings excluding losses from specific strategic transactions that management elected to execute at the bank for long-term performance benefit. As shown here, GAAP earnings were $83 million or $0.91 per share in 2009 and $90.3 million or $1.07 per share in 2008. In 2009, excluding the $19.3 million or $0.21 per share after tax loss related to the previously disclosed liquidation of the private issue mortgage related securities, adjusted earnings were $102.3 million or $1.12 per share.

In 2008, excluding the after-tax impact of the bank's previously disclosed balance sheet restructuring charge of $35.6 million, net income was $125.9 million or $1.49 per share. Management believes that these are significant transactions which we do not expect to recur in the future. As a result, throughout this call we will discuss earnings excluding the impacts of these transactions at the bank. I'll now turn the call over to Connie Lau.

Constance H. Lau

As you can see from the information we released yesterday we had a good quarter and a solid year considering the unprecedented economic challenges we faced at all companies and lower and later than expected rate release at the utility. Fourth quarter earnings were $0.36 per share compared to $0.16 per share in the fourth quarter of 2008. Full year earnings were $1.12 per year compared to $1.49 per share in 2008.

Given the headwinds we faced, we are pleased that we were able to preserve 2009 earnings through aggressive cost control and efficiency efforts across all companies. At the same time, we were able to continue to move forward on our key strategic initiatives, positioning us for improved performance in the future. At the outset of 2009, we anticipated a challenging year. We expected tough economic conditions and aggressive customer conservation efforts to reduce kilowatt hour sales at the utilities and we expected credit expenses to be elevated at the bank.

We also expected that O&M would be higher for the year and that utility earnings would be lower in the first half of the year as we awaited rate relief in the second half. At the utility, we ended the year with kilowatt hour sales down 2.5% compared to last year and while we received much needed rate relief, lower and later than expected responded promptly by competing and deferring spending to offset lower revenue. At the bank, we were impacted by the economic recession that dipped deeper than most anticipated. We experienced higher preserving for loan losses and other than temporary impairment or OTTI charges on our securities.

Fortunately, ongoing progress on the banks performance improvement projects provided additional cost savings to partially offset the negative impacts of the credit cycle and we strengthened our capital ratios over the course of the year. In addition, in the fourth quarter when we saw market opportunity, we made the strategic decision referenced earlier to liquidate the bank’s private issue mortgage related security, eliminating the risk of future OTTI charges from those securities.

Despite the many challenges in 2009, we stayed focused on executing our longer term strategies to improve the fundamental operating and financial performance of our operating company. We remain confident these are still the best strategies both for the near term and for the longer term health of the company. Before Jim goes through the economic update and financial results, I'd like to share some of the highlights of our strategic highlights throughout the year.

At the utility, the Hawaii Clean Energy Initiative remains foundational to a fundamental change in our business model. The new model will provide us a better opportunity to earn appropriate returns on needed investments to strengthen our grid’s ability to accept high level of renewable resources helping to reduce our state's dependence on imported oil. In 2009, we moved forward on many fronts toward achieving one of the most aggressive clean energy goals in the nation.

Many of the first steps require regulatory approval and we have received the commission’s decisions on several components with others awaiting a decision. First, the commission approved the guidelines for new feed in tariffs which will provide standardized prices for various types of renewable energy sources, a critical component to building the renewable market in Hawaii. Near the end of 2009, we received a positive commission decision on a renewable energy infrastructure surcharge. You may have heard us refer to this as the Clean Energy Infrastructure Surcharge. This approval supports more timely cost recovery for renewable related projects and facilitates getting more renewable energy projects online faster to help us meet our [inaudible] goals.

With this surcharge framework in place, we can file requests project by project [inaudible] to include renewable projects that use this mechanism. The inner island wind or big wind project is a significant contributor to our state's future renewable energy resources. It is a collaborative effort with the independent power producers who are planning wind projects on the islands of Lanai and Molokai. The state of Hawaii is responsible for the undersea cable to transmit the wind power to Oahu and our utility is responsible for the related transmission and infrastructure to integrate those levels of wind power on Oahu.

Implementation studies are proceeding as planned and in a recent decision the PUC allowed for deferred treatment of inter-island wind study cost. As a result, we reclassified $2.4 million of 2009 expenses to a deferred regulatory asset. Once the studies are done, this will possibly be one of the first projects that will seek PUC approval to recover through the renewable energy infrastructure surcharge.

Next is our decoupling docket. Briefly, in October of 2009, our utility in the state Consumer Advocate completed all requirements for their joint proposal to the PUC. The docket is now complete and we are awaiting a decision. While we had anticipated getting a decision sooner on these mechanisms, these are major de novo decisions in our commission and we are hopeful that the commission will complete its review and support the joint proposal with a decision soon.

We have also been very busy with rate cases. As you know, we received approval to implement a partial interim rate increase in our Oahu 2009 rate case in August of 2009 and are seeking additional rate relief for our new combustion turbine CT-1 through a second interim decision. In the second half of 2009, we also filed 2010 rate cases for our other two utilities serving the tri-island county of Maui and the county of Hawaii. All of these rate cases are intended to set the base for sales decoupling as well as the associated revenue adjustment mechanism for both O&M and capital. Jim can walk you through the details of decoupling and our rate cases in a few minutes.

At the bank, we remained focused on the performance improvement project that we announced in 2008. This project is aimed at improving the bank's net income and profitability over a multi-year period concluding at the end of 2010 with full results anticipated in 2011. The first significant improvements were achieved as a result of the balance sheet restructuring in 2008 and we continue to build on those achievements through our focus on operating efficiencies and revenue growth.

I'll put our progress in to perspective for you. The original target we shared with you in the earlier stages of our performance improvement project are shown on this slide. As you can see, as of the fourth quarter and on the adjusted annualized basis we use to track the bank's quarterly progress, we exceeded our expectations by meeting or beating our targets in just a little over a year.

In addition, you can see that we produced significantly improved results over the first quarter of 2008, the last quarter before the balance sheet restructuring. Our success in this project is the culmination of many initiatives. It is not only the balance sheet restructuring, but our ongoing priority focus on operational efficiency for which you can see the specific benefit to non-interest expense on this slide.

In addition, we are building our core franchise value with market leading products resulting in double digit accounts and core deposit growth benefitting our net interest margin and fee income. At the same time, we were able to reduce our interest rate risk and improved our capital level. Last, but not least, we are very proud to be named one of the best places to work in Hawaii in an annual survey published in Hawaii Business Magazine. Our achievements in executing each of the components of our performance improvement project are allowing us to build more earnings through our core banking operations.

On a 28% smaller asset base and using less capital than we had two years ago, pretax pre-provision income is a measure we focus on to help gauge our progress on this front, removing the effects of the credit cycle. Over a two year period, we have driven our adjusted pretax pre-provision income from $92 million in the first quarter of 2008 to $120 million in the fourth quarter of 2009, a $28 million increase in the potential earnings power of the bank.

In the short-term, this improvement has been offset by rising credit provisions and the cost associated with the performance improvement project. Once the project is complete and the economic environment improves, we expect the banks earnings to benefit. And now let me break here and ask Jim to update you on the Hawaii economy financial results.

James A. Ajello

First the economic backdrop; Hawaii saw continuing contraction in 2009 with weakness in one of our largest industries and one of our largest utility customer segments; tourism. You can see from this slide that we have experienced a significant decline in tourism since it peaked in 2007. However, arrivals appear to have stabilized near the 2002, 2003 level with an increase of 1.7% in the second half of the year over 2008. Hawaii unemployment is low at 6.9% in December 2009 compared with the national average of 10%. This statistic is for Hawaii as a whole. Oahu is relatively stronger which stands at 5.9% than the neighbor islands.

For all of 2009, the median home sales price declined 8% and volume declined 6%. January 2010 Oahu home sales were just released and are very encouraging. Oahu home sales volumes increased by 33% and the median price rose to 11% to $597,000 compared to January 2009. This slide shows local economist's expectations for peak economic indicators gradual recovery expected to begin in 2010. We predict the impacts of Hawaii's weak economic conditions on electric sales and bank credit related provisions to persist but modestly improve over the course of the year.

Turning to our financial results, HEI earned $102.3 million or $1.12 per share in 2009 compared to $125.9 million or $1.49 per share in 2008. Both operating company’s earnings were down for the year reflecting the impacts of the economic crisis and lower and later than expected bait relief at the utility. Although earnings were down for the year, earnings were up in the fourth quarter. In 2009, HEI earned $33 million or $0.36 per share compared to $13.9 million or $0.16 per share for the fourth quarter of 2008. Both operating company’s earnings reflected growth over 2008.

At the utility, net income was $23.3 million for the quarter compared to $14 million in the fourth quarter of 2008. The primary driver for the increase was $9 million of incremental interim rate relief. Kilowatt hour sales were 1.1% above the same quarter last year primarily due to soft sales in the fourth quarter of 2008, lower fuel prices and warmer weather this year partially offset by energy conservation. As a result of our aggressive cost containment and deferral efforts, we were able to hold O&M essentially flat for the quarter excluding the effects of DSM expenses which are recovered in a surcharge.

For the full year of 2009, the utility earned $79.4 million compared to $92 million in 2008. Primary drivers for the decline were $13 million in higher O&M and $13 million lower sales partially offset by $14 million for five months of interim rate relief for Oahu. Kilowatt hour sales for the year were 2.5% below the prior year. Absent the impact of weather, 2009 sales would have been about 1% below 2008. With continuing weakness in Hawaii's economy, rising fuel prices and positive efforts by Hawaii residents to conserve, we expect weather normalized kilowatt hour sales to decline about 0.9% in 2010.

Last quarter, we expected 2009 O&M expenses to be approximately 6% higher than 2008 including DSM. However, management was able to achieve greater cost containment in the quarter than anticipated. As a result, O&M expenses for the year were only 3% higher than 2008 including DSM or 7% excluding DSM. In 2010, we expect O&M expense to increase by 11% including DSM or 16% excluding DSM. This level of increase reflects multiple factors. The short-term nature of some of 2009's cost reductions, some 2009 cost deferred into 2010, increase levels of work to address our aging infrastructure, higher retirement benefit cost, and a full year of CT-1 costs.

On the regulatory front, I'll now update you on decoupling starting with a recap of the three main components of the company and Consumer Advocate's joint proposal. First is the revenue balancing accent which is the mechanism to de-link revenues from electricity usage and allow for a periodic true up of sales revenues. In other words, under this proposed mechanism, reported sales revenues would not be impacted by changes in kilowatt hour sales. This helps the utilities to support energy efficiency, conservation, and renewable distributed generation.

Second, is the revenue adjustment mechanism or RAM for expenses, which is the annual adjustment in rates to accent for indexed changes in costs. Last is the revenue adjustment mechanism for capital additions which adjust our rates in a more timely fashion to account for approved additions during the year. Due to the importance of our rate cases to the implementation of decoupling as proposed, let me first give you an overview of to timing of the rate cases we have in process and planned before I go into each one.

As you know, we received an interim decision on our 2009 Oahu rate case and we have requested a second interim decision for CT-1. We filed Maui and Hawaii Island 2010 rate cases in 2009 and we expect interim decisions on those in the latter part of this year. Lastly, consistent with our agreement with Consumer Advocate in the decoupling docket, we anticipate filing a 2011 Oahu rate case in the second half of this year with an interim decision in 2011. This case is required under decoupling to reset base revenues up or down.

On the 2009 Oahu rate case, the partial interim rate increase of $61.1 million that became effective in August 2009 did not include several significant items which have been included in a stipulation with the major parties. These items were instead considered in the evidentiary hearings that concluded in November 2009. The primary deferred item was roughly $13 million of revenue requirement for our new Oahu generating unit, CT-1. In December 2009 after initial operation of CT-1 on biofuels, we requested a second interim decision to include CT-1 in rates. There is no statutory schedule for this request.

Continuing with our rate cases, Maui Electric filed a 2010 rate case on September 30th requesting an overall revenue increase of 9.7% or $28.2 million. The request is based on a 10.75% return on common equity and an 8.57% return on rate base. This case is intended to set the base for sales decoupling for Maui County. Without a decoupling mechanism, our requested return on common equity is 25 basis points higher at 11%. The statutory deadline for an interim PUC decision is August 2010.

Hawaii Electric Light Company also filed a 2010 test year rate case on December 9th requesting an overall revenue increase of 6% or $20.9 million. This request is based on a 10.75% return on common equity and an 8.73% return on rate base. Like the Maui rate case, this case is also intended to set the base for sales decoupling for Hawaii Island. Without a decoupling mechanism, our requested return on common equity is 25 basis points higher at 11%. Statutory deadline for an interim PUC decision is November 2010.

Total gross capital expenditures remain at historically high levels with $1.6 billion planned for the next five years providing attractive opportunities for growth in rate base. Clean energy related expenditures are included in this forecast and may span over the categories shown here. In addition, this forecast does not include the cost of the Oahu infrastructure and support of the inter island wind as the state begins to develop plans for the undersea cable.

Now I'll sum up the key earnings drivers for 2010 for the utility. The regulatory outcomes and their timing will drive our financial results in 2010 and beyond. Getting requested decisions on our rate cases is important not only because of the rate relief itself but because they provide the basis for sales decoupling. A secondary driver is sales levels pending approval and full implementation of decoupling as we are forecasting an additional .9% decline. O&M is expected to be up 11% in 2010 including DSM or 16% excluding DSM. The revenue adjustment mechanism proposed in the decoupling docket, if approved will provide a partial offset to the O&M increases in 2010.

Turning to the bank; fourth quarter 2009 earnings were $14.9 million versus $5.9 million in 2008. The primary driver for the increase was $5 million of OTTI charges in the fourth quarter of 2008 which we did not have in the fourth quarter of 2009 due to the liquidation of the private issue mortgage related securities portfolio. 2009 earnings were $41.1 million approximately $12 million lower than last year. The major drivers were $13 million higher provision for loan losses, $3 million lower net interest income, and $5 million higher OTTI partially offset by lower non-interest expense of $5 million.

The company's net interest margin expanded in the fourth quarter to 4.27% and remains above our high performing peer bank averages. Our margin is driven by our large, high quality deposit funding base. At the end of the fourth quarter, over 25% of assets were funded with free or low cost checking accounts. This is an extremely strong number in the banking industry. Equally strong, 63% of our assets are funded with core deposits and 85% are funded with customer deposits. When you consider our equity levels, we essentially have very little wholesale funding which increases our margin in markedly reduces the liquidity risk of the bank.

Core deposits increased $393 million in 2009 and $144 million in the fourth quarter. Much of it due to our continued success with our market leading checking account introduced last year. In addition, funding costs remained very low with core deposits of 16 basis points and total deposits at 52 basis points down one and 18 basis points respectively from the third quarter. Because of the historically low interest rate environment, at the end of 2008 the bank began selling its originations of one to four family mortgages. Booking these loans would increase interest rate risk and credit risk.

Along with the normal cash flows from payments on other loans and limited investment opportunities, our decision to sell the recent mortgage production as well as our private issue mortgage related securities portfolio has resulted in large amounts of cash on hand compared to normal periods. High cash levels are a consistent occurrence across the industry and will likely put temporary downward pressure on net interest margins and income in 2010.

To mitigate some of these effects to date, management has been proactive in reducing higher costing CD balances putting the banks cash to use without taking additional credit risk. We continue to monitor the interest rate environment and will redeploy our cash to higher earning asset categories when we think it is appropriate in light of our interest rate risk parameters.

Moving on to non-interest income 2009 includes $15.4 million of OTTI charges we took through the third quarter of 2009 on the private issue mortgage related securities portfolio. This is up $7.6 million for the year. Because we liquidated this portfolio in the fourth quarter of 2009 we do not have these types of charges in the quarter and we eliminated the risk of future charges from these securities. Excluding OTTI, non-interest income was up $4 million for the year and $3 million for the quarter.

In the fourth quarter, the bank recorded $5 million provisions for loan losses, essentially even with the third quarter. This brings the 2009 annual provision to $32 million of which $10 million is one commercial credit. The remainder was largely due to an increase in non-performing residential lot loans and one to four family mortgages primarily on the neighbor islands. The fourth quarter provision was primarily due to increases in historical loss ratios used in computing the allowance for loan losses on commercial market loans and home equity lines of credit caused by a change in the timing of the charge offs which I'll explain further in a moment.

A key profitability driver for the bank is efficiency. Over the last year we have achieved improvements in both revenue as well as expense. The largest impact has been a lower expense base. As you can see, fourth quarter 2009 adjusted non-interest expenses are running at about $38 million for the quarter or $152 million annualized and the adjusted efficiency ratio is 56%. The slight uptick in the fourth quarter is primarily due to $1 million of yearend adjustments in non-interest expense and the effect of annualizing that increase.

In either case, fourth quarter adjusted results reflect nice progress since we started this initiative and are approaching the bank's goal of $140 to $145 million annualized adjusted non-interest expense by the end of 2010. However, we are planning to expand our mortgage banking business. If it is successful, it will generate additional non-interest expense over time primarily related to commissions. Thus, any increase should be more than offset by the corresponding revenues.

For our bank and the banking industry as a whole, the key uncertainty continues to be around asset] quality. We believe our credit risk profile is on the conservative side compared with other banks because we have a high concentration of lower risk, one to four family mortgage loans and significantly less exposure than other banks to higher risk commercial real estate construction, residential construction, auto and credit card loans. We continue to believe in the quality of our assets and that our primary credit risks are in the $343 million in neighbor island, one to four family mortgages reduced from 2005 to 2007, $120 million of mainland residential loans purchased in 2007, and $96 million of lot loans which have a three year life.

In total, the non-performing assets ratio increased 24 basis points in the fourth quarter to 185 basis points reflecting a rise in non-performing residential lot and commercial market loans. However, this is more than 40% better than the industry fourth quarter 2009 median rate of 323 basis points recently cited by KBW for a sample of 154 banking institutions. We continue to believe in the overall good quality of our loan portfolio.

Our net loan charge off ratio was 98 basis points in the fourth quarter compared to 19 basis points in the third quarter. In the fourth quarter of 2009, the bank recorded charge offs of $9.2 million related to residential one to four family, residential, lot, and home equity lines of credit. This is primarily due to the timing of taking these charge offs. Starting in the fourth quarter, we elected charge offs, specific loan loss reserves at the time of provisioning. The increase in the fourth quarter primarily reflects an adjustment of the amounts for which we reserved and provisioned for earlier in the year. Absent the adjustment, net charge offs would have been 36 basis points for the quarter. On a full year basis, our net charge off ratio remains low at 66 basis points. This is over 50% lower than the industry which was recently reported at 148 basis points by KBW for 154 banks.

I'll now sum up the bank's earnings drivers for 2010. As with all banks across the country, we are keeping a close eye on the economy, the credit cycle, and interest rates. Our net interest margin, given the current interest rate environment, we are preserving our long term performance opportunities by not choosing yield for short term earnings benefits. On the funding side, we have been fortunate to have a low cost and loyal customer base relative to the industry and we expect that to continue.

Based on the economic outlook for a gradual recovery starting in 2010, we expect provision expense to remain high with measured improvement over the year. The execution of the final year of the performance improvement project will continue to be key with some expenses expected for 2010 for the implementation of long term cost efficiencies. The largest reduction opportunity remaining is an additional $6 million in annual savings expected from the Fiserv conversion that is expected to be complete on June 1. Once the project is completed this year, we expect to reach our target of an annualized non-interest expense run rate of $140 to $145 million subject to an increase as we build our mortgage banking business. But this commission expense will be covered with increased revenues.

The company has a strong capital base with both operating companies solidly capitalized. Our overall consolidated common equity to total capitalization is 50% at the end of the fourth quarter. Utilities common equity layer is 55%. At the bank, we increased our capital ratios throughout 2009 to further strengthen its financial soundness in a difficult economic environment. At the end of 2008, we maintained a tier-1 leverage ratio of 8.5% and ended 2009 50 basis points higher at 9%. We brought up our total risk base capital ratio from 12.8% at the end of 2008 to 14.1% at the end of 2009 after paying $50 million in dividends to HEI in 2009.

As planned, HEI contributed $93 million to the utility in the fourth quarter of 2009 and expects to contribute $55 million in 2010 to support the utility's cap ex program. With respect to short term borrowing capacity between the holding company and the utility, we have $233 million of remaining capacity at year end. In addition, utility had $94 million of cash and equivalents. Our $275 million extended [inaudible] credit facilities expire in 2011 and we are in the process of putting new multiyear credit facilities in place by the end of the second quarter of this year. At this time and based on our current assumptions, we do not anticipate any equity requirements beyond our dividend reinvestment plan for at least the next three years. We continue to have very good access to liquidity in the capital markets.

I'll now update you on support of the dividend. This slide shows simple sources in use of the cash at the holding company. As you can see, we expect primary support for the dividend to come from the operating companies. We will be financing uncovered portions in holding company expenses with equity issuances through our dividend reinvestment program and via short term borrowing.

In 2011, we expect dividends from the operating companies to increase as the economy improves and the utility completes its rate case cycle. That brings me to the fourth quarter dividend. The board declared the dividend payable on March 10th to holders of record on February 22nd at $1.31 a share for the year and $0.31 for the quarter. The next dividend date is February 18th. Now I'll turn the call back over to Connie.

Constance H. Lau

We continue to see the opportunities for investment and improved returns in our company as multifold. At our utility, we continue to pursue a comprehensive redesign of our regulatory model to ensure a financially viable utility strong enough to attract the capital necessary to execute our state's public policy of reducing Hawaii dependence on imported oil. We expect to narrow the gap between our earned and allowed rates of return as the model is implemented over the next two years.

In addition, we expect rate base to grow over time as we strengthen our system to accept increasing renewable generation and increase equipment replacement rate to address our aging infrastructure. The core business is performing very well and strengthening every day. Our bank has a low risk profile and a simple business model. Given our profitability improvements to date and expectations over the next year, the bank is close to finalizing a business model whereby we can achieve pretax pre-provision income of $120 million to $130 million per year on the current asset base.

This would be an improvement in the range of 30% to 40% over the equivalent run rate for the first quarter of 2008. This estimate is subject to no material changes in the yield curve which could affect net interest income. We expect to realize this value in earnings as the Hawaii economy and credit environment improve. Both operating companies are well along in implementing their strategies and are strongly positioned to benefit when the Hawaii economy recovers. I will now open the call up to questions and ask Jim, Dick, and Tim and also Tayne, our CFO at the utility to join me in answering your question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Paul Patterson – Glenrock Associates.

Paul Patterson – Glenrock Associates

I wanted to ask you about a couple of things. First of all, O&M at the utility, I think you guys are saying it's an 11% increase. What's driving that?

Constance H. Lau

The increase in the O&M in 2009 is really related to bringing on CT-1 and also increases that we implemented in the replacement of our aging infrastructure. So it's really very much the same story we've had all along Paul.

Paul Patterson – Glenrock Associates

I thought you guys were expecting an increase in O&M by up to 11%?

Paul Patterson – Glenrock Associates

Yes, that's correct. Let me ask Tayne are Dick to go over the O&M numbers because it is somewhat confusing because of the DSM impacts and if you recall the DSM programs were transferred over to the third party administrator in the beginning of 2009 so that makes some of the numbers a little more difficult to explain. So, either Dick or Tim, Tayne?

Timothy K. Schools

I wanted to clarify your question, you're asking about the increase ‘09 versus ‘08 or are you asking about -

Paul Patterson – Glenrock Associates

No, 2010 drivers on slide 26, you guys said that O&M levels are expected to be up 11%, 16% excluding DSM.

Timothy K. Schools

That's correct. Okay so, in addition to what Connie mentioned about the full cost of CT-1 and higher O&M for aging infrastructure, the other thing that's happening is we had some costs that were deferred in 2009 as part of our cost reduction measure that we will need to incur in 2010 so that's also a driver of our increase in 2010.

Paul Patterson – Glenrock Associates

How much of that would you say, because it's sort of a large jump here, how much would you say is because it's been deferred?

Constance H. Lau

Yeah and let me just break in here Tayne. It might be helpful to Paul if you would give him some proportions as to what relates to things like the deferred overhauls or short term initiatives that we don't expect to continue.

Timothy K. Schools

In general, if you take a look at the cost reduction measures, the large majority of those measures are not sustainable. Roughly two-thirds of those costs are deferral in nature such as some of our overhaul work that was deferred as a result of lower operating hours as we saw lower sales. We also deferred some of our software project work and we have a total IT strategy that we're looking at going forward and that's part of the increase as well. In addition, we also used very judicious use of our overtime hours in 2009 and that will also come back in 2010. The overtime hours that I'm speaking of is we reduced hours in our call center and those hours will come back in 2010.

Paul Patterson – Glenrock Associates

Now, with respect to the decoupling case, I know there's a statutory time frame, I know you guys are awaiting it but it does seem like it's taking some time here. Do we have any sort of flavor as to when we might see this finely be, I mean you've got a settlement and everything else, it seems like it's taking a little bit longer than one would think.

Constance H. Lau

First of all Paul, the decoupling docket doesn't have a statutory timeline. The only statutory deadlines are on the rate cases for interim decisions. But we believe that everything has been filed with the commission now and so it's just a matter of them coming out with a decision and we are expecting the decision for decoupling as well as CT-1 very shortly. Both decisions are, or both dockets are ready for decision by the commission but they really need to go through their process to ensure that they are comfortable with the dockets before they issue the decision.

Paul Patterson – Glenrock Associates

Then on the non-interest expense, the $140 to $145 million run rate, you guys have some expenses that you've mentioned here in terms of the Fiserv and what have you, I guess the implementation expenses I guess of about $2.3 million. But is there anything else we should be thinking about here? I mean are we winding down now to the point where when we look at the bank it should be I guess for 2010 about $140 to $145 or are we still going to be incurring some expenses other than the $2.3 million one that you guys mentioned?

Constance H. Lau

You know as Jim said in the remarks, we believe that apples-to-apples would be at the $140 to $145 run rate as of the end of 2010 which is when the performance improvement project was always intended to complete but we are beginning to build a mortgage banking line of business that would have commission expense associated with that that may bump up the reported GAAP numbers when you actually see them within 2010 or 2011.

Paul Patterson – Glenrock Associates

So when we're looking at this, so we're going to see still some more expenses? You guys were around $160 something million on a non-adjusted basis and about $152 million on an adjusted basis. So should we think that it would be I mean when we look at this, other than the $2.3 million that you're mentioning for implementation, is there anything else we should be thinking about?

Constance H. Lau

No and I'll let Tim comment in just a moment but I should also mention that as Jim did in the prepared, remarks that although you might see non-interest expense go up because of the commission expense from mortgage banking, you would also see revenues go up as well because obviously we wouldn't be paying commission if we weren't getting revenue from building that line of business as well. But let me give Tim a chance to comment on the run rate.

Timothy K. Schools

Anytime we're doing a big change like this in 18 months, it's hard to sort of get at stuff because we're spending money to make money. Our current run rate, you know we have to show certain things for the quarter and everything, our current run rate is about $145 right now. So as Jim said, we'll have another $6 million coming in when we convert from Metavante to Fiserv. So that's sort of the underlying core run rate right now. Then on top of that you need to lay - this year we have about $2.3 million at least to convert and finish the Fiserv and then there is still likely some potential for some real estate buyout cost and some level of severance.

It's hard to determine and we don't have a set number. We started with 338,000 of sort of non-branch space square feet and we estimate that we need about 140,000 square feet. So as we whittle that down to the appropriate number, we need to buyout the leases. I just had a presentation given to me about two weeks ago that if we, you know it takes a while to get there right, we have to move people around. But if we can get down to our 140,000 square feet, it's about a onetime expense of $3 million to break all those leases but it saves $1.75 million a year going forward. So it's an 18 month payback. We don't have a lot of those types of projects left but as Connie and Jim said we should be done all that kind of stuff by the end of this year.

Operator

Your next question comes from Robert Bohlen – KBW.

Robert Bohlen – KBW

I have another question for Tim, if I'm looking at the balance sheet and I'm trying to figure out where do you stand on asset sensitivity as short term interest rates move, it looks like your borrowings are down significantly year-over-year and your security portfolio's down pretty significantly, you have a big cash drag. But I guess, how nimble can you be to reinvest that cash when rates start to, when short rates start moving up by kind of year end or early next year?

Timothy K. Schools

Well good question. In general, just in isolation ASB would generally have more interest rate risk than a typical commercial bank. So I would imagine as an example in our market that our interest rate risk, it's not magnitudes higher but, I would imagine that our interest rate risk is modestly more higher than like a first line in a bank of Hawaii. That's due to our heritage of being a thrift and we've got say 47% of our loans in 30 year fixed rate mortgages. So it's a trade off, that benefits us on a credit risk side and it hurts you a little bit on the interest risk side.

We've done a lot of stuff over the last year to improve our interest rate risk. We look at it two ways, we look at sort of an economic value of equity where you discount the value of your asset and your liabilities and you sort of get a net present value position and then you shock that on rates and does that net present value go up are down. Then we look at the impact of just changes in net interest income. Both measures have come in a lot over the last 12 months and we've gotten a lot of compliments from the OTS on doing that.

So what we've done is a couple things one is, tremendous core deposit growth over the last year, replacing wholesale funds, that's number one. Number two, is I think our 30 year fixed rate mortgages peaked at about $3 billion, I don't remember the number. It's at about $2.4 billion now so we've drastically reduced our 30 year fixed rate assets and then the third thing is that our cash levels have increased significantly. We need probably $100 million of general cash on hand to run the bank and right now I've got $425 million. So I have $325 million that I can reinvest when rates come up and we're really trying to reinvest that.

I could generate you guys, if you owned our stock, I could generate you $10 million more of earnings this year by going and spending that today and you're going to hate me in three years when rates go up. So we're trying to be really patent and do the right thing, long term for the bank. So one of the opportunities we see is home equity. Our bank has been late to that game. There's $1.9 billion worth of earning balances at Bank of Hawaii, CPD, and First Hawaiian. We only have $300 million. So we want to try and get our share of that, that's prudently underwritten, that's 70% LTV, high FICO score. That's a way, Bobby that we could put that cash to work and then when rates go up, that asset reprices because it's a variable rate product. So we're going at that on all fronts.

Robert Bohlen – KBW

Could you talk about, you know I would assume that we're pretty close to being finished with the securities repositioning. Could you talk about where the duration currently stands on that?

Timothy K. Schools

On our securities portfolio?

Robert Bohlen – KBW

Yes.

Timothy K. Schools

It's low. It's like two years. It's low and it's all pretty much now in agency mortgage backed securities.

Operator

Your next question comes from [Chen Bokuda – Capital].

[Chen Bokuda – Capital]

Just a quick question on the potential cap ex for the HELCO utilities from the inter island wind projects that you were mentioning earlier.

Constance H. Lau

Your full question is how much capital expenditure is in there for the wind projects?

[Chen Bokuda – Capital]

I guess in your cap ex forecast that you laid out there 2014, you said that any spending related to the inter island wind project was excluded?

[Chen Bokuda – Capital]

Yes.

[Chen Bokuda – Capital]

I'm just trying to get a gauge of what the potential cap ex is from the project itself.

Richard M. Rosenblum

Right now the anticipation is that the wind projects will be PPAs so we would not have any cap ex associated with them. The cable itself is anticipated to be a state infrastructure project because the state can get we anticipate far better financing and therefore lower customer cost than we could. So, at least for those two pieces, we do not anticipate any cap ex at the utility. It is possible that we could step in in some position on the cable if we view that as in our customer's interest and an attractive investment for the utility. But it's far too early to see that today.

Constance H. Lau

Dick, I think there's also the transmission facility that we would, the part of the project that we would be responsible for [Chen] is taking the power from the cable then integrating it into our system and that's where our capital expenditures would go in. Maybe Dick can help you with some very rough estimates on that. It's pretty far out at this time.

Richard M. Rosenblum

Yes, Connie is exactly correct. The integration side of it would involve both transmission upgrades as well as potentially some capital investment elsewhere including in our generating assets in the system. But we do not yet have sufficient identification of those to have a forecast of how large those investments might be.

Constance H. Lau

[Chen], I think the way that we view it is that, now we're talking about 2015 and out, is that that's part of the major benefit that we see to the whole Hawaii clean initiative for us is that by the time we get out in that time frame, and by then we should have all the pieces of this new regulatory model in place that that actually creates great investment opportunity for us as we do improve in our system in order to take those renewable resources. But currently, no number is in the capital plan today.

[Chen Bokuda – Capital]

Right and I know we're looking a few years out now but any sort of spending related to this would be covered under the clean energy surcharge if my understanding is correct and that does not require rate cases, s that right?

Constance H. Lau

That's correct. What it requires is that we file for approval of each project for inclusion in the renewable energy infrastructure surcharge.

[Chen Bokuda – Capital]

So you would have a pre-approval process and then once you start spending on the project you would get more immediate returns on your capital.

Constance H. Lau

Well the timing is not necessarily pre-approval for example, as we said in the remarks, the commission approved deferral of the cost of the big wind study and when those studies are complete, we would be anticipating filing for now surcharging them through the clean energy infrastructure surcharge. So we’re incurring costs and deferring them

Operator

Your next question comes from Michael Goldenberg – Luminous Management.

Michael Goldenberg – Luminous Management

I had a question on the decoupling process so you and the CA have reached an agreement on all three points of the coupling? Is that correct?

Constance H. Lau

Yes, there is a joint proposal.

MM

Now given that last time during HELCO settlement commission still went ahead and decided for themselves what's appropriate and what's not, do you feel like a commission will be taking the decoupling order as a whole or they're likely to take each one of the three major points by itself and rule whether each one of them makes sense or not? And if that's the case, how would you rank them from what you believe to be the least riskiest and the most safe and likely to be adopted to one that's more likely to get some scrutiny in you from the commission?

Constance H. Lau

Ah, Michael I love your question. You know, I wish I could always anticipate what the commission would do and that's a very difficult thing because it really is what’s in their purview to study all the elements and then make independent decisions. So let me just with that prefatory comment ask Tayne or Dick if they have some comments on this issue.

Richard M. Rosenblum

I believe the commission understands the importance of all three pieces decoupling. Having said that, the commission needs to make its own decision. I would expect them to make their own decision and in the fine detail, some parts of what was proposed certainly might change. I wouldn't attempt to handicap what might change.

Michael Goldenberg – Luminous Management

Well, would you at least be willing to venture and say whether commissions likely to look at it as one proposal or three individual ones?

Richard M. Rosenblum

My anticipation is that it will be a single decision but certainly they could do something different than I anticipate.

Operator

With no further questions in the queue, I would now like to turn the call back over to Shelee Kimura for final remarks.

Shelee M. T. Kimura

Thank you for joining us today. If you have additional questions, please call me at 808-543-7384. Aloha everyone.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Hawaiian Electric Industries, Inc. Q4 2009 Earnings Call Transcript
This Transcript
All Transcripts