Hawaiian Electric Industries Inc Q2 FY2021 Earnings Call

Good day, and welcome to the Hawaiian Electric Industries Second Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Julie Smolinski, Vice President of Investor Relations and Corporate Sustainability. Please go ahead.

Thank you, Andrea. Welcome, everyone, to Hawaiian Electric Industries’ second quarter 2021 earnings call. Joining me today are Connie Lau, HEI’s President and CEO; Greg Hazelton, HEI’s Executive Vice President and CFO; Scott Seu, Hawaiian Electric President and CEO; Ann Teranishi, American Savings Bank President and CEO; and other members of senior management. Our press release and presentation are posted in the Investor Relations section of our website. As a reminder, forward-looking statements will be made on today’s call. Factors that could cause actual results to differ materially from expectations can be found in our presentation, our SEC filings and in the Investor Relations section of our website. Now, Connie will begin with her remarks.

Thank you, Julie, and aloha everyone. Mahalo, thank you for joining us today. Second quarter consolidated financial results were strong as Hawaii's economy improved and as we advanced key priorities across our enterprise. Our consolidated net income for the quarter was $63.9 million with EPS of $0.58, 31% and 29%, respectively above the same quarter last year. This followed a great first quarter. And for the first half of the year our consolidated net income and EPS were up 56% compared to the first half of 2020. At the utility, our year-to-date results have benefited from our focus on cost management and efficiency and from timing items expected to reverse in the balance of the year. We expect the utility to remain within its full year guidance range announced in February. The improved Hawaii economy and strengthened credit quality of our bank loan portfolio were key drivers of our results year-to-date and in the second quarter enabled the bank to release a portion of its reserves for credit losses, resulting in a negative provision for the quarter. We are again increasing our full year bank and consolidated guidance, which Greg will cover shortly. We've seen strengthening in Hawaii's economy with the reopening of our local economy and rebound of tourism. However, we are closely monitoring the recent increase in cases due to the delta variant, as well as how our community responds. More than 60% of Hawaii residents are now fully vaccinated and we expect that to increase as more employers, including state and county government, are requiring employees to be vaccinated or subject to frequent testing. Controlling virus levels will enable Hawaii to continue to be an attractive tourism destination and that will help us as our economy opens. Daily visitor arrivals have increased strongly over the last couple of months, approaching and sometimes exceeding pre-pandemic levels with most of our arrivals continuing to be from the US Mainland. In June, arrivals from the US West region were approximately 15% above June 2019 and their spending was 33% higher. Unemployment declined to 7.7% in June, the fifth month of improvement. Hawaii real estate values and activity remain robust. For July, median prices of Oahu single-family homes were up 22% and sales volume was up 12% over last year. For condos, prices were up 8% and sales were up 58%. As of the May forecast, UHERO, the University of Hawaii Economic Research Organization, expected state GDP to increase 4% in 2021, and 3.1% in 2022. While we've seen great progress on the economy, we're still taking a cautiously optimistic approach particularly with uncertainty due to the delta variant. At the utility, we remain focused on cost efficiencies as we make needed investments to continue to provide affordable, resilient and reliable electricity to reach Hawaii's climate goals. The new performance-based regulation or PBR framework is now fully in effect as of June 1 and we've begun returning cost savings to our customers under the management audit savings commitment and customer dividend component of the annual revenue adjustment mechanism. As we've discussed, in the past performance incentive mechanisms or PIMs are an important part of the PBR framework. In May, the Hawaii Public Utilities Commission approved the final details of a suite of PBR PIMs, which are now in effect. The commission has now started a process to consider and develop additional performance incentives. This includes PIMs and shared savings mechanisms relating to grid reliability, retirement of fossil fuel generation, interconnection of large renewable energy projects and cost control for fuel purchased power and other non-ARA costs. We don't yet know when additional performance mechanisms would come into effect or what the potential earnings impact could be. However, we always expected PBR would be a process of continued refinement and we look forward to collaborating with stakeholders to develop new ways to align incentives with customer interests. As we've always said, reaching our collective clean energy and decarbonization goals must be done in a way that is equitable and involves everyone working together. A lot of the progress we're seeing now across utility scale and distributed renewable energy additions, grid modernization and electrification of transportation are good examples of this. The Powering Past Coal Task Force, convened by our Governor Ige, has brought together a range of stakeholders to ensure commission-approved projects on Oahu are successfully brought online as we prepare for the retirement of Hawaii's only coal plant. We're pressing forward on Stage one and two renewable procurement projects with independent power producers. Three Stage one projects are now under construction, with others slated to start construction this year or early next year. Six of 12 Stage two projects now have approved Power Purchase Agreements. And the remaining six Stage two projects are pending approval. Last quarter, we saw a clarification from the commission regarding the interconnection docket and the Kapolei Energy Storage battery energy storage project. We appreciated the commission's work to respond quickly in both matters. In the interconnection docket, the commission clarified its intent for us to track costs to customers resulting from changes in project schedules rather than record such costs. And the commission revised the conditions to its approval of the Kapolei Storage Project, enabling us to now work with the developer to advance that project. We're working to accelerate the addition of more distributed energy resources and are advancing programs to benefit all customers. As of this June, we surpassed 90,000 cumulative installed customer-sited solar systems, which comprise most of the nearly one gigawatt of solar capacity on our grid. The Battery Bonus program launched last month incentivizes customers to add storage and benefit the overall system by allowing the utility to use energy from those systems in the evening hours. Grid modernization is also progressing well, with advanced meter deployment accelerating with the commission's approval to shift from an opt-in to an opt-out approach enabling greater operational efficiencies and more customer options. Finally, we're encouraged by recent developments that will accelerate electrification of transportation here in Hawaii and across the country. In June, the commission approved our eBus Make-Ready Infrastructure Pilot Project, which is projected to provide savings for bus fleet operators while decreasing greenhouse gas emissions. Governor Ige signed into law bills to replace the state's light-duty vehicles with a zero-emission fleet by 2035, consistent with our Utility's own fleet electrification goal and to allocate 3% of oil barrel tax revenues to finance construction of EV charging stations. President Biden's recently announced goal of 50% of vehicle sales being electric by 2030 will also help accelerate our electrification efforts, which will benefit our customers, our environment, and our clean energy transition. Turning to the Bank. American Savings Bank's strong results reflected the credit-driven reserve release and resulting negative provision for credit losses as the economy and credit quality improved. We believe our reserve levels are appropriate taking into account ongoing pandemic uncertainty. The Bank's margin improved compared to the first quarter, benefiting from fees related to American Savings Bank CARES or payment protection program loans, lower amortization of investment premiums and a continued record low cost of funds of seven basis points. We're still seeing margin pressures due to low asset yields and excess liquidity as strong deposit growth continues to outpace lending opportunities at present. Even so, earning asset growth is helping us grow net interest income consistent with our expectations and we're starting to see more in the loan pipeline with an uptick in home equity lines of credit as well as continued strength in residential mortgages and commercial real estate. As American Savings Bank's digital banking transformation continues, we're focused on strategic investments to keep the franchise strong and competitive, expand service levels and continue to deliver the personal touch that is a hallmark of who we are as a bank. Ann and the Bank team are upgrading the bank's technology, data analytics and operating model to allow our team members to transition away from processing tasks and focus more on customer relationships and satisfaction. We're getting great feedback from bank customers on our digital offerings so far. Nearly 50% of consumer deposits are now through our upgraded ATM fleet or mobile platform and customer satisfaction remains high. We've opened three digital centers to date with the fourth opening today, and are excited to see how this new concept, which merges our digital platforms with our warm in-person presence performs in the coming months. And now, Greg will discuss our financial results and our outlook.

Thank you, Connie. Let’s discuss our second quarter results. Consolidated earnings per share increased to $0.58 from $0.45 in the same quarter last year, marking a 29% rise quarter-over-quarter. Both the Utility and Bank showed strong performance, contributing positively to our consolidated results. The Utility maintained stable earnings despite higher operating and maintenance expenses due to anticipated increases in generation overhauls. The Bank achieved solid financial outcomes, aided by a reduction in reserves for credit losses, which resulted in a negative quarterly provision reflecting improvements in the credit quality of its loan portfolio. The holding company loss aligned with our expectations. In comparison to the previous year, our consolidated trailing 12-month return on equity improved by over 100 basis points to 10.5%, while the Utility’s return on equity rose by 100 basis points to 8.9%. As mentioned in our Q1 earnings call, we anticipated that the Utility's return on equity expectations for the latter half of 2021 would be influenced by the management audit savings commitment and customer dividends, as operating and maintenance reductions that benefited earnings in the first half of 2021 would be returned to customers under performance-based regulation starting June 1st. Additionally, the return on equity for the Bank, analyzed on an annualized basis, more than doubled to 16.8%. Utility net income stood at $41.9 million, similar to the $42.3 million from the second quarter of 2020. The primary variance resulted from $6 million in higher operating and maintenance expenses compared to the year-ago quarter, driven mainly by $3 million related to more generation facility overhauls that were delayed. There was also a $2 million impact from lower bad debt expenses in the prior year due to the recording of accrued amounts from a commission decision allowing deferral of COVID-19-related costs, as well as $1 million from the write-off of a terminated agreement linked to a combined heat and power unit, and another $1 million from an increased environmental reserve. Part of these operating and maintenance increases was offset by $1 million from reduced staffing levels and efficiency gains, along with an additional $1 million in higher depreciation. The rise in operating and maintenance costs and depreciation was counterbalanced by $5 million in increased revenues from the rate adjustment mechanism, which included $2 million associated with a timing change in revenue recognition within the year, while target revenues remained unchanged. A further $1 million benefit came from lower non-service pension costs, thanks to the reset of pension costs factored into rates as outlined in the final rate case decision, and another $1 million reduction in enterprise resource planning implementation expenses to be passed on to customers, as we have fully delivered on our commitment to provide savings under this program for Hawaiian Electric. Regarding the Utility's performance drivers for the remainder of the year, all performance-based regulation performance incentive mechanisms are now operational. We do not expect significant benefits from these mechanisms this year, and we are closely monitoring the potential for penalties related to reliability and expected downside sharing under the fuel cost risk-sharing mechanism. Some reliability challenges arose from prolonged repairs at one of our substations, but we have partially restored it, with full restoration anticipated soon. Additionally, fuel costs have risen since our January benchmark, leading to expected downside sharing under the fuel cost mechanism. Currently, we hold about $26 million in COVID-related costs, mainly estimated bad debt expenses in a deferred regulatory asset account. The moratorium on customer disconnections ended on May 31st, and we are requesting a continued deferral of COVID-related costs until the year’s end. We will seek recovery once we have a clearer assessment of actual bad debt or realized amounts as we assess our efforts with customers on payment plans and other bill assistance options. Our operating and maintenance expenses this quarter were influenced by increased overhauls, including those delayed from earlier periods, and we expect more overhaul expenses in the second half of the year, reflected in our guidance. The Utility's capacity to fulfill the accelerated management audit savings commitment is crucial for this year's results. To date, we have realized savings through improved efficiency and cost-management initiatives. The Utility is on track to achieve savings to honor its annual $6.6 million commitment, which we began returning to customers on June 1st. Utility capital investments thus far have been lower than initially planned due to productivity enhancements and efficiencies that reduced certain project costs, coupled with delays from ongoing repairs at one substation that restricted work on other system areas and some supply chain delays due to the pandemic. We now project capital expenditures to range between $310 million and $335 million for the year, down from our previous guidance of $335 million to $355 million. While this suggests a forecasted rate base growth of 3% to 4% from a 2020 base, we do not anticipate that this year's reduced capital expenditures will affect long-term earnings growth. This is because under performance-based regulation, earnings growth arises from three main sources: the annual revenue adjustment mechanism covering operating and maintenance and baseline capital expenditures; separate capital expenditure recovery mechanisms, like the Engineering Performance Rate Mechanism and exceptional project recovery mechanism; and our renewable energy recovery mechanism and performance incentives. We still project a Utility earnings growth of 4% to 5%, excluding potential upside from performance incentive mechanisms starting in 2022, which will represent the first full year of performance-based regulation. The recovery of electrification of transportation and resilience projects could lead to additional growth. Turning to the Bank, American Savings Bank's net income for the quarter was $30.3 million, compared to $29.6 million last quarter and $14 million in the second quarter of 2020. The negative provision for credit losses was the primary factor driving the higher income. American also saw an increase in net interest income, though non-interest income was lower than the same quarter last year, which had included higher gains from the sale of securities, including a $7 million after-tax gain from the sale of Visa Class B restricted shares. Now I'll elaborate on the specifics of these drivers.

Thanks, Greg. To wrap-up, the second quarter was strong financially and operationally for our companies and we're positioned well to continue delivering value for all our stakeholders for the rest of this year and beyond. As we've always said, ESG is in our DNA and as we work to integrate ESG further into our strategies, business planning, risk management practices and reporting, we're very focused on ensuring linkage to value for all stakeholders. And with that, we look forward to your questions.

We’ll now begin the question-and-answer session. And our first question will come from Eric Lee of Bank of America. Please go ahead.

Good afternoon. Thanks for taking the questions, and congratulations on the quarter.

Thanks, Eric.

Thanks, Eric.

Yes. Just had a few questions on the Utility. Given the use of 2022 as your baseline 4% to 5% utility EPS guidance, could you speak to your earned ROE expectations for 2022, recognizing you'll have greater second half 2021 ROE pressures but first half earned ROEs have been particularly strong if you can comment to that. Thank you.

Well, we haven't provided specific guidance yet on our 2022 ROE and specific earnings. We did talk about our long-term earnings growth trajectory, given the stability of the revenues and certainty of the cost recoveries or the cost recovery mechanisms that we have under our new PBR program. We'll come back to that. We have seen significant improvement this year. And as you know that's largely driven by the utility's ability to manage within the budget of those recovery mechanisms. And so we anticipate more of that going forward. Tayne do you have any comments?

Yes. Thanks, Greg. Eric, I would also add a couple of points here. Earlier in the year in our February 2021 webcast, we did note that at the midpoint of our guidance range, the realized ROE would be at 7.8% for 2021. Now going forward in 2022, a couple of things to remember. One, the elimination of the RAM our ARA lag, so that is one element. The other thing to think about is under the EPRM, we're getting the full first year recovery which eliminates another issue of lag. The third element I would point out is what Greg mentioned and that is managing our expenses within the ARA formula through our continued cost efficiency program. So that's how we would think about 2022.