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Executives

Shelee Kimura – Manager, IR and Strategic Planning

Connie Lau – President and CEO

Jim Ajello – EVP, CFO and Treasurer

Tayne Sekimura – SVP and CFO, Hawaiian Electric Company, Inc.

Dick Rosenblum – President and CEO, Hawaiian Electric Company, Inc.

Analysts

Ashar Khan – Visium

James Krapfel – Morningstar

James Bellessa – DA Davidson

Hawaiian Electric Industries, Inc. (HE) Q1 2012 Earnings Call May 9, 2012 1:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2012 Hawaiian Electric Industries Earnings Conference Call. My name is Stacy, and I’ll be your conference moderator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this conference call is being recorded for replay purposes.

I would now like to turn the presentation over to Ms. Shelee Kimura, Manager of Investor Relations and Strategic Planning. Please proceed.

Shelee Kimura

Thank you, Stacy, and welcome to Hawaiian Electric Industries’ first quarter 2012 earnings conference call. Joining us this morning are Connie Lau, HEI President and Chief Executive Officer; Jim Ajello, HEI Executive Vice President, Chief Financial Officer and Treasurer; Dick Rosenblum, Hawaiian Electric Company President and Chief Executive Officer; and Rich Wacker, American Savings Bank President and Chief Executive Officer, as well as other members of senior management.

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

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

I’d now turn the call over to our CEO, Connie Lau.

Connie Lau

Thank you, Shelee, and aloha to everyone. We are off to a good start in 2012 with our performance tracking against 2012 objectives. At the utility, there were many constructive regulatory actions since the start of the year. With all three utilities now decoupled under Hawaii’s regulatory framework. Our bank continued to deliver solid performance. Profitability metrics remained strong, credit quality improved and our loan portfolio grew for the sixth consecutive quarter even as we remix the portfolio away from loan mortgages to control interest rate risks. Our bank remains one of the better performing banks in its class across the country.

Hawaii’s economy continues to improve albeit slowly and we remain cautiously optimistic about continued economic recovery going forward. We continue to make progress on our strategies and believe we are well positioned to continue to deliver attractive risk adjusted returns and earnings growth to our investors.

First quarter 2012 earnings were $0.40 per share, up from $0.30 per share in the same quarter last year primarily reflecting a recovery of cost approved for our Oahu utility in July of last year. As you can see on slide four, there has been positive momentum in our utility with numerous decisions rendered by the Hawaii Public Utilities Commission in just the few two months. Most notable were the final decisions in Hawaii Island and Maui County 2010 test year rate cases, which implemented decoupling. We are pleased to be able to report that all our utilities are now on the regulatory model. Jim will discuss the impact of our recent regulatory decision shortly.

On the clean energy front, out utility remained focused on integrated more renewable energy into our system, diversifying our fuel sources by adding renewable can stabilize customer bills in our jurisdiction, which increased approximately 40% in the last year, 90% of which would cause by higher oil prices. In the quarter the utilities added 16 megawatts of renewable energy contract. Renewable energy generation currently account for 12% of electric sales towards an RPS requirement of 15% by 2015 under Hawaiian law.

In addition HELCO filed a request with the PUC to acquire up to 50 megawatts of geothermal generation on the island of Hawaii through a competitive procurement process. On a broader note, our State achieved a clean energy milestone in a 2012 legislative session with the passage of a bill that establishes a framework for a future undersea cable project anticipated to be developed and owned by a third party.

Our utility continues to work towards contracting an additional 200 megawatt of renewable energy through the PUC ordered RFP which could include the cable.

Turning to bank, we had a solid first quarter, and we are on track to meet our 2012 performance target. We continue to track favorably with our high performing peers. We are consistently growing our loan portfolio at a steady rate in the low to mid single-digit range, while holding our operating cost down and we continue to post strong profitability metric in a difficult interest rate environment. The bank continues to maintain a slow risk profile, strong balance sheet, terrific funding base and straight forward business model.

Looking ahead we expect continued improvement in Hawaii’s economy which provides a constrictive contact for our businesses. The outlook for our company will be largely driven by our utilities facility to transitioned their operation that fully aligned with the new regulatory model and to manage the timely recovery of costs. We expect our Bank to continue to be a strong contributor to the consolidated enterprise and it should provide upside leverage as the economy recovers. Overall, the combination of our two companies continues to provide value for shareholders, with the Bank providing a strong and steady source of cash and capital and our utility investment to help recover these aggressive cost of goals to reduce our state dependent on oil

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

Jim Ajello

Thanks, Connie. As a backdrop to our results and outlook, I’ll briefly comment on Hawaii’s economy, which continues its gradual improvement. The tourism industry, a significant driver of Hawaii’s economy, maintained a positive growth trend that started almost two years ago. Year-to-date March, visitor arrivals were up 7.8% and expenditures were up 12.5% compared to last year. March was the 23rd consecutive month of a year-over-year growth and expenditures. And the 2012 outlook for the visitor industry remains positive. Local economists expect construction to begin its gradual recovery in 2012 due to an increase in non-residential and public sector projects. Overall, we continue to be cautiously optimistic about the continued recovery of Hawaii.

At the utility, net income for the first quarter of 2012 was $27.3 million, compared to $19.2 million in the first quarter of 2011. The main driver of the net income improvement was $7 million attributable to the recovery of cost for our Oahu utilities reliability in clean energy investment.

Operations and maintenance expense was slightly lower in the prior year largely due to lower A&G expense of $2 million after tax from the change in the capitalization of costs which was effective with the July 2011 HECO interim position.

In addition, there were two unusual O&M items that net to $1 million after tax increase. An increase in the reserves for environmental cost of $2 million offset by the reversal of $1 million of deferred costs that were previously expensed in 2011. Our O&M outlook for the year remains at 6% higher than 2011.

At the Bank, net income for the first quarter of 2012 was $15.9 million compared to $13.9 million in the first quarter of 2011. The $2 million improvement was primarily due to $1 million higher non-interest income due to higher gains on sales which fluctuate depending up on interest rates in loan origination volumes. $1 million in lower provision for loan losses and $1 million due to the release of reserves for the tax position discussed earlier.

Compared to the linked quarter, Bank net income was up $500,000 higher primarily due to the aforementioned $1 million reserve release. $1 million in lower net interest income resulted from the continued loan interest rate environment, which was offset by lower non-interest expense and provision for loan losses.

Now we’ll look at the utility more closely. Slide nine shows our actual ROEs for the trailing twelve months as a percent of the allowed ROE. Our March 2012, consolidated utility ROE of 7.9% improved from 5.9%, in March 2011. Our largest utility on Oahu earned 7.7% ROE over the last year. Approximately 77% of its allowed return and we are on track to achieve an ROE of 8.5%, for 2012.

The implementation of the heat rate deadband associated with decoupling our Maui County and Hawaii Island utilities, we set their respective heat rate. As a result, about $3 million of annual heat rate savings for our Hawaii Island utility will be eliminated. This represents roughly 100 basis points of the Hawaii Island utilities ROE.

This quarter our customer information system which handles all three utilities is expected to go in service. The total estimated deferred and capital cost of this system and completion is approximately $60 million, and would normally be recovered for each utility in its next general rate case. But this timing could be affected by the pending regulatory audit. The recovery of $32 million of cost per CT-1 is also pending the regulatory audit.

We also expect the gap to our allowed returns to continue as a result of the timing of our general rate case vision or a non rate case years, the effective date of the revenue adjustment mechanism, both of which generally take place halfway through the year.

With respect to our capital expenditures forecast on slide 10, in the first quarter we invested $41 million in infrastructure, and are on track to invest approximately $300 million this year with (inaudible) weighted towards the second half of the year. We expect – we continue to expect rate base growth of 4% to 5% in 2012.

On slide 11, we summarize for you the key utility earnings drivers for 2012, some of which we have already covered. Last month our Maui utility entered into in a settlement agreement in its 2012 test year rate case. If approved it would result in an increase in annual revenues of $14.9 million. An interim decision is scheduled later this month.

Effective in the second quarter, HECO’s 2012 test year interim decision was increased by $5.5 million to recover the East Oahu Transmission Project cost. And HELCO’s and MECO’s 2010 final decisions resulted in annual revenue reduction totaling $4.4 million which reflects a lower ROE associated with decoupling and $2.3 million lowered depreciation expense.

Also all three utilities wowed for their 2012 revenue adjustment methods which together represent $5.7 million in annual consolidated revenues, of this amount $3.3 million is expected in 2012. Overall we are focused on effectively executing our new regulatory model and our clean energy and reliability CapEx program.

Now, we will look more closely at the bank’s strong performance metrics. On slide 13, our net interest margin was 4.04% in the first quarter of 2012 and it continues to exceed that are of our high performing peers. The 12 basis points decline in net interest margin from both the linked quarter and prior year was primarily due to lower yield on interest earning asset consistent with lower interest rate environment as this bank continue to reduce its exposure to long maturity fixed rate residential mortgages to control on favorable interest rate risk.

In addition existing adjustable rate commercial loan also repriced down in line with lower market indices and new loans were funded at lower than average portfolio rate. This pressures NIM in the near term but we are managing our interest rate portfolio mix to be well positioned when interest rates rise. There are other dynamics that cause an interest margin volatility quarter-to-quarter such as the recognition of income on loan prepayment which were elevated in the fourth quarter of 2011.

Normalizing these variables and interest margin compression has been in line with our expectation and we continue to expect 2012 net interest margin to be about 4%. Rates on interest bearing deposits have declined over the last year or two to offset some of the decline in asset deal.

Our liability cost of 28 basis points in the first quarter is extremely low by industry comparison and is driven by our low cost deposit phase. The bank recorded $3.5 million in provision for loan losses in the first quarter of 2012 down from the prior year quarter of $4.6 million and the linked quarter of $4.1 million. The decline in provision was due to lower net charge offs particularly in the residential portfolio and improved credit quality associated with the gradual improvement of Hawaii’s economy.

As shown on slide 15, loans have been growing steadily over the last six quarters. In the first quarter of 2012 loans grew by $30 million or a 3.2% annualized. This is in line with our expectation. Growth was driven primarily from home equity lines of credit, commercial real estate, commercial lending which more than offset as deliberate decline in residential mortgages.

Although our residential loan production increased by approximately 73%, or $70 million in the first quarter of 2012 compared to the prior year quarter, we still those that and do not meet our portfolio yield threshold and that was over 50% of our loan production in the quarter. In addition to quarterly loan growth, the Bank reported a return on assets of 1.29% and a return on equity of 12.9%, while these metrics benefited from the $1 million in tax related reserves discussed earlier, they are still quite strong.

Slide 16 is our balance sheet, which shows you the asset and funding mix of both Americans and our peer banks. 97% of our loan portfolio was funded with low cost deposits versus our peer banks at 85%. Core deposits increased a healthy $62 million in the quarter to $3.6 billion, which helped to fund our loan growth while maintaining a very low average cost of fund. We remain well capitalized with a Tier 1 leverage ratio of 9.1%, tangible common equity to total assets of 8.5% and total risk-based capital ratio of 12.9%, all at March 31, 2012.

In addition, American continues to pay healthy dividend to HEI. In first quarter, American paid $10 million of dividend to HEI and expects an annual dividend of $45 million. The Bank will retain a portion of its earnings in 2012 to fund its planned loan growth while maintaining its capital ratios at 9% Tier 1 leverage and 13% total risk-based.

Turning to credit quality, American’s non-performing asset ratio remained relatively flat at 2.02% at the end of the first quarter versus the linked quarter and remains better than its performing peers. The $900,000 increase in non-performing assets was primarily due to one commercial borrower that is payment current and a modest increase in residential mortgages partially offset by a sustained run off in the vacant land loans.

Our primary credit risks are in the three rapidly shrinking loan portfolios. First, the residential land loan, second neighbor island one to four family mortgages produced from 2005, 2007 and thirdly our purchase to Mainland residential loans. These three portfolios totaling $354 million were down $29 million or approximately 8% from December 31, 2011.

On slide 18, our net loan charge off ratio of 0.28% remains low and improved by 20 basis points from 0.48% in the linked quarter primarily due to higher recoveries and lower charge offs in the residential mortgage portfolio. The allowance for loan losses currently represents 1.05% of outstanding loan at $38.8 million relatively unchanged from 1.03% as of December 31st, 2011.

Looking forward there are no changes to our expectations consistent with what we’ve said previously, we expect they continue downward pressure on net interest margins quarter-over-quarter. We expect full year NIM around 4.4%, slightly higher than first half of below that in the second half.

Non-interest income will be impacted by gains on sales of loans, which will fluctuate depending on interest rates and loan origination volumes. We continue to expect at least $1 million in lower interchange revenues in 2012 compared to last year due to changes from our interchange network firstly offset by volume increases from account growth.

Our expectations for 2012 net income will be approximately 3% to 5% lower compared to 2011 remains unchanged. Overall, we are targeting to deliver strong results with our low cost lending base, efficient cost structure and lower risk profile.

Turning to our financing and liquidity picture, on April 19 all three utilities issued a combined total of $417 million of taxable unsecured senior notes through a private placement with interest rates ranging from 3.79% to 5.39%. $267 million of notes were used to redeem utility special purpose revenue bond with higher interest rates ranging from 5.45% to 6.20%. The remainder of $150 million was used to fund capital expenditure.

HEI continues to remain – maintain a strong capital structure with 51% consolidated equity to total capitalization and based on our current assumptions we do not require additional equity other than through our dividend reinvestment program through 2012. From our dividend policy we will consider an increase we consistently maintain a 65% payout ratio.

Now, I will turn the call back over to Connie.

Connie Lau

Thanks, Jim. We are pleased with the strategies we adopted in 2008 to focus on instituting fundamental changes and our two operating businesses are working well and delivering improved results. Our utility continues to focus on successfully fulfilling it’s clean energy role in our state and achieving returns that will enable us to compete for capital and fund the upfront investments necessary to support Hawaii’s move to clean energy. And all three of our utilities are now fully decoupled under our state new regulatory model to encourage this transition to clean energy.

At the Bank, we maintained gains from our performance improvement project and continue to deliver high performing results and we are on track to meet our 2012 target. Our dividend yield remains attractive and above the average for utility peers. As of yesterday’s close our dividend yield was 4.6% and 2012 will mark our 111th year of paying continuous dividend.

We believe we are well positioned to continue to deliver a unique investment combination of attractive earnings growth with reduced risk and volatility and an above average dividend yield.

And now we look forward to hearing your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Asshar Khan with Visium. Please proceed.

Ashar Khan – Visium

Hi. Good morning. I just wanted to go over this slide 11, if I can, I guess, I am just trying to get a sense of the positives and the negatives for the rest of the kind of the year. So I’m right, the 6% higher O&M right, we had flat O&M for the first quarter is that still expected in the remaining three quarters, is that equal to something like $24 million or something or could you quantify that?

Jim Ajello

Sure. It’s Jim Ajello. I will start by saying that yes, the short answer is that we expect to have a 6% O&M increase year-over-year.

Ashar Khan – Visium

Okay. And Jim is that equate to like $24 million or my number wrong?

Jim Ajello

It is very close to that number, yes. You’re correct on that.

Ashar Khan – Visium

Okay. And then we would have the MECO rate case right that would be in effect starting like July 1, like so you would get something more than half of that in additional revenues in the last half of the year, is that correct?

Jim Ajello

That is correct.

Ashar Khan – Visium

So that’s not in one of these bullets or am I might missing it somewhere or it’s in the top bullet. Is that what is the MECO...?

Connie Lau

The reference on slide 11 to the very first point is the MECO.

Ashar Khan – Visium

Okay, the MECO thing. Okay. Okay, and is this the update interim the $5.5 million is that incremental or is that just the same of what we had before?

Connie Lau

This has changed its likely $5 million is incremental.

Ashar Khan – Visium

So that’s incremental that’s what I thought, so that’s incremental this year, and that started when January 1, or when did that start?

Tayne Sekimura

That started in the beginning of the second quarter.

Ashar Khan – Visium

So that’s...

Tayne Sekimura

$5.5 million this obtained release to the recovery of remaining cost for the East Oahu transmission project. It was the second quarter item.

Ashar Khan – Visium

That’s second. Okay. So that will show up in the second quarter going forward?

Jim Ajello

Correct.

Tayne Sekimura

Correct.

Ashar Khan – Visium

Okay. Okay. And then next bullet if I can just follow through is the, you said there is revenue reduction of $4.4 million, but $2.3 million is depreciation. So from earnings perspective, it’s only a negative $2 million, is that correct?

Tayne Sekimura

This is Tayne. In terms of how to look at that, it’s really offsetting, it’s not a negative because lower rate increase is equal to the lower depreciation expense. In other words, we didn’t need the revenue to cover that lower depreciation expense. So it’s a net income item. And then also the other piece of that is the lower ROE, as decoupling begins, so yes, it does go down by about $2 million, but then we do have decoupling mechanism that will kick in.

Ashar Khan – Visium

That will make the kick in. Okay. Okay. Okay. So the RAMs are all positive, right, the 5.7% is like a positive, starting from June, right, that’s additional revenue, right?

Tayne Sekimura

Yes. That’s right.

Ashar Khan – Visium

Okay. Okay. So if one and then if am I right the higher CapEx that should lead to higher AFUDC or no?

Jim Ajello

Yes, as we build out the project there is FEVC on that.

Ashar Khan – Visium

On that. Okay, okay. So I am just trying to get a sense as we look at I guess the last three quarters we do an additional subtraction. It seems like you told earnings should still be able to go up, am I missing something or wrong?

Jim Ajello

I think what you are missing there is a couple of items write-off and then (inaudible) to add anything. As you know on that slide 11, in the – now that we have the HELCO’s final decision that will reset the heat rate and we had been getting heat rate savings previously because we had installed the theme unit, that was very efficient since the last rate case. So those heat rate savings will go away with the rest of the heat rate in the rate case.

And then as we talked about before we have a very large customer information system that is going in for all three utilities. The actual cut over gate is scheduled for a Memorial Day weekend and once that goes into service we then would have to recover those costs through the normal rate case process which now is every three years on a segregate for each utility. So that will be a dragon so we can get it into each rate case.

I would just say or clarify (inaudible) Jim that the – we estimate the reduction in the heat rate associated with the deadband is about a $3 million item just to put a number on that. And then to add to what Connie said, both the CIS system and the $32 million of CT-1 expense are still pending regulatory audit or review so the timing of the recovery of those has been uncertain now because there is no precise schedule for those review yet set up.

Jim Ajello

And CIS is a $60 million figure.

Ashar Khan – Visium

Okay, okay. Connie, now you’ve gotten I guess decoupling in all three jurisdictions if I am right? You had mentioned that you would think about giving – introducing guidance once you achieve that. Any thought on that process?

Connie Lau

Ashar, because we just got the final decisions in last week. We actually don’t have an update for you today. And that is something that we are looking at doing. And we will likely talk about in the next webcast.

Ashar Khan – Visium

Okay, okay. Thank you so much.

Operator

Your next question comes from the line of Jim Krapfel with Morningstar. Please proceed.

James Krapfel – Morningstar

Hi, good morning to you there in Hawaii.

Connie Lau

Good morning.

James Krapfel – Morningstar

It looks like 12 month trailing ROE at MECO declined about 130 basis points quarter-over-quarter. What drove that and then where do you expect ROEs to trend at MECO once the new rate case revenues go into seg later this year.

Tayne Sekimura

This is Tayne. In terms of the ROE it’s a lower trending and you see that downward that’s not because we are awaiting the MECO 2012 rate increase decision that we talked about expected sometime later this month, so that’s main reason for that. Thereafter we do except the ROE to popup a bit in 2012.

James Krapfel – Morningstar

Okay. Maybe what rate do you expect? Monsoon rates are into effect, what ROE you can generate?

Jim Ajello

It’s Jim Ajello. We don’t provide that particular information, but the allowed ROE is now across all three utility units are at 10%. So our goal is to obviously achieve as much as we possibly can of those allowed ROE.

James Krapfel – Morningstar

Okay. Great, thanks.

Operator

(Operator Instructions) Your next question comes from the line of James Bellessa with DA Davidson. Please proceed.

James Bellessa – DA Davidson

Good morning.

Jim Ajello

Good morning Jim.

James Bellessa – DA Davidson

The key HECO lease setting of the heat rate that savings was found in what line item up to now?

Jim Ajello

Jim, that was in HELCO of Hawaii Electric Light on the bigger Island.

James Bellessa – DA Davidson

Right. And what line item does that savings show-up, and is it a revenue item or its opposite to expense item?

Jim Ajello

It shows as an opposite to an expense item, your fuel expense.

James Bellessa – DA Davidson

And there is customary information system going in on September a total cost of $60 million was it is there an expense of operating that system that isn’t building your numbers?

Connie Lau

Just a correction, Jim it’s actually going to go into use after Memorial Day weekend so that will be June and then I will let Tayne talk about the operating cost of that.

Jim Ajello

The operating cost is associated with a system where not included in the 2011 rate case and so those costs are part of the costs that we are in terms of the increase for the remainder of the year. When we talk about – as part of that 6% increase.

James Bellessa – DA Davidson

Is it an all NIM expense built in and not built into the $145 million that you guys are putting up.

Jim Ajello

Jim, I am sorry – 145 million.

James Bellessa – DA Davidson

I thought you have an expense – excuse me – with the 6.6% increase in O&M expenses for the utility is what you were talking about.

Jim Ajello

Yes. That was the approximate $24 million figure we talked about earlier.

Dick Rosenblum

This is Dick Rosenblum, that extra O&M for our customer information system is in that 6%, it is not incremental to the 6%.

James Bellessa – DA Davidson

Thanks for that clarification. The slide number 17 talks about non-performing assets and non-performing asset ratio. I went through your Q, didn’t even find that concept in your Q, isn’t that required at that point and need to be put in to discuss the Bank’s operations.

Jim Ajello

Jim, I am sure we must have that in there and we can give you the reference to that.

James Bellessa – DA Davidson

Thank you very much.

Connie Lau

Sure.

Operator

And with no further questions in the queue. I would like to turn the call back to management for closing remarks.

Connie Lau

Thank you, everyone for joining us today and if you have any follow-up questions, as always please feel free to reach out to me. Thanks so much. Bye.

Operator

We thank you for your participation in today’s conference. This does conclude your presentation. You may now disconnect and have a great day.

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