Good morning, and welcome to the Second Quarter 2019 Hawaiian Electric Industries Incorporated Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Julie Smolinski, Director of Investor Relations and Strategic Planning. Please go ahead.

Thank you, and welcome to Hawaiian Electric Industries' second quarter 2019 earnings conference call. Joining me today are Connie Lau, HEI President and Chief Executive Officer; Greg Hazelton, HEI Executive Vice President, Chief Financial Officer and Treasurer; Alan Oshima, 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 followed by Greg, who will update you on Hawaii's economy, our results for the first [ph] quarter and our outlook for the remainder of the year. Then, we'll conclude with questions and answers. During today's call, we'll be using non-GAAP financial measures to describe our operating performance. Our press release and webcast presentation are posted on HEI's Investor Relations website and contain reconciliations of these measures to the equivalent GAAP measures. Forward-looking statements will also be made on today's call. Factors that could cause actual results to differ materially from expectations can be found on our website slides, our filings with the SEC, and on the HEI website. I'll now ask our CEO, Connie Lau, to begin with an overview.

Thanks, Julie and aloha to everyone. We are making great strides on key strategies across our companies. And, in the second quarter, delivered consolidated net income of $42.5 million and $0.39 per share of earnings, in line with our expectations for the year. We remain on track with our 2019 plans. While we are reaffirming our earnings guidance range for the year, we do have some updates, which Greg will address shortly. Turning to our utility. Together with our commission and our stakeholders, we are working hard to reach our ambitious goals of 100% clean energy and a carbon neutral economy by 2045. We continue to look for the best ways to achieve these goals while providing greater customer value, including affordable, reliable, resilient energy, and more customer options. This requires a much more expansive and integrated approach. For example, our stage 2 renewable energy RFP and our grid services RFP are moving forward concurrently, allowing us to compare a range of generation, storage, load management, and other grid services solutions all at the same time. Similarly, our integrated grid planning process will enable us to simultaneously evaluate resources to meet generation, transmission and distribution, and resilience needs rather than in siloed processes. In line with this integrated approach, the commission denied two battery proposals that we had filed earlier last year. The West Loch PV battery denied in April and the CIP contingency and regulating reserve battery denied without prejudice this month. These storage projects were proposed before the results of our stage 1 renewable RFP and before the launch of integrated grid planning, and our stage 2 RFPs. Through these new processes, we have the ability to better assess alternatives and find the options that deliver the best value for our customers. The Commission has encouraged us to…

Thanks, Connie. Hawaii's economy remains healthy although we have seen some softening, particularly in the tourism spending, following last year's peak levels. Hawaii's unemployment rate has been relatively steady since the first quarter and stood at 2.8% in June. The fifth lowest in the nation and significantly below the national rate of 3.7%. Tourism arrivals have continued to grow, although we are seeing slight declines in total expenditures versus the record highs reached in the first half of last year. June year-to-date arrivals were up 4.2% compared to the same period last year, while visitor expenditures were down 2%. Some of the expenditure decline reflects dollar appreciation given the international tourism we have here in Hawaii. Hawaii real estate fundamentals remain sound, while sales volumes declined from the prior year by 3.7% for single-family homes and 8.8% for condos, median prices were relatively flat. We've had seven consecutive years of housing price appreciation for both single-family homes and condos, and the longer term trend remains positive despite slight declines in the first half of 2019. The state's economic outlook remains positive with Hawaii GDP expected to rise 1.2% in 2019. Turning to our results, consolidated Q2 earnings were $0.39 per share compared to $0.42 per share in the prior year’s quarter, as consolidated net income declined 8% versus last year. Year over year earnings grew at the utility while declining at the bank, and the holding company and other segments loss grew slightly for the quarter. Pacific Current’s operating portfolio continues to contribute positively to earnings, helping offset the cost of building out the platform. As highlighted on the right hand side of the page, HEI’s consolidated GAAP ROE for the last 12 months strengthened to 9.4%. Utility ROE for the last 12 months improved with new rates in place…

Thanks, Greg. In summary, we continue to advance our mission of being a catalyst for a better Hawaii through our strategies across our enterprise. Our utilities have accelerated our pace towards our state's 100% clean energy and carbon neutral economy goals. As we do so, we're focused on delivering increased customer value, ensuring affordability and reliability, and strengthening resilience. Our bank provides a strong platform to continue delivering value for customers, shareholders, and our communities, and continues to focus on making banking easy, deepening relationships with customers and strengthening efficiency. [indiscernible] is optimizing existing assets and evaluating further sustainable investment opportunities. Our business model continues to provide the financial resources to invest in the strategic growth of our companies and our state's sustainable future, while supporting our dividend, which our board maintained at $0.32 per share this quarter, continuing our history of uninterrupted dividends since 1901 And now we look forward to hearing your questions

[Operator Instructions] And our first question comes from Eric Lee of Bank of America Merrill Lynch.

Maybe first off, could we just talk about a longer term CapEx opportunity? I know you've mentioned that there's more than plenty need for that since on a forward basis, mainly in light of the battery storage CapEx, which actually I know you've talked about being able to offset that for 2019 [indiscernible] but just in terms of the longer term opportunity here, where do you see the investment opportunities?

We'll turn that over to Tayne Sekimura, our CFO of the utility to respond.

Hi, Eric. In terms of our longer term forecast for 2020 and beyond, with our stage 2 renewable RFPs going out, there will be need for infrastructures to support integration of more renewables onto our system. We're also looking at more investments in the grids to provide more customer options. So with our grid modernization efforts, and that particular project on phase 1 is already underway, we're looking at how we can advance that more rapidly as well. We're also looking at, in addition to that other investments to address resilience, in light of climate change and looking at how we incorporate that into our planning models and what types of projects are necessary to address resilience. So those are, generally speaking, the kinds of things we're looking at for the future years.

And then maybe just touch upon stage 2 of the renewable RFPS. I mean, can we talk about, I mean, presumably, this is just -- would hypothetically be supportive of the ability to drive further renewable since, right, similar to the success with stage 1 on that front?

Yes, most definitely. Joe, do you want to talk about the schedule for the phase 2 renewable.

Yes. So, we've just recently -- we submitted our updated kind of proposed final RFP forms. The process now is that the commissioner will review those. Part of our proposal had requests for performance incentive mechanisms for both renewable energy acquisition and the grid services piece of that, but will be -- there's no specific deadlines for the commission to rule on those. But we expect that they will rule on those fairly soon.

Yeah. And if you recall, at stage 1, the commission did an amazing job of approving those in record time. So we're hopeful with our whole community wanting to move to renewable future quickly that that momentum will be able to be sustained.

And just briefly on the grid service RFP, with the proposal there for the 10s, would that be -- you would potentially be able to contract for safety capacity from an exit portfolio of like behind the meter solar plus storage assets and [indiscernible] just in terms of what the disposal is asking for. That's just what I started. That’s what it sounded like to me.

That’s right.

Yeah. IT does contemplate demand response aggregators behind the meter.

And then lastly, one more question before I see it to the queue. Can you just talk about expectations for implementation of PBR, given this protracted delay now to, I believe, you said a December 2020 decision, relative to expectations for about a first quarter ‘20 decision prior, and what might you be able to do to minimize regulatory lag in the meantime?

This is again Joe Viola, Vice President of regulatory affairs. I don't know that I'd say it’s a protracted delay. I think we were actually pretty supportive of a process that would allow all the parties in the commission to consider developing the details, as Connie mentioned earlier, which is going to be very important. So we think the commission has set forth a pretty reasonable process to allow us to do that. And the other part of the question was?

Mechanisms to make up for any lag.

Yeah, at least one of the proposals that the Commission seems supportive of, but we'll have to see how -- what's approved in phase 2, would be switching off of the current ramp to an annual adjustment mechanism that has a potential to reduce lag in our accrual of revenues in between rate cases.

But, Eric, right now that, if you are referring to lag because PBR, the PBR decision now will be expected in 2020. There's nothing that really changes, because as we move forward, the existing mechanisms, including the revenue balancing account and the beta adjustment mechanisms, the major project interim recovery mechanism, all of that still remains in place.

Our next question comes from Andrew Levi of ExodusPoint.

I want to be daring. I want to ask some questions on the bank.

All right. Rich is happy. He is touring.

Nothing too technical, but I was just kind of, I guess just first at a very high level, so obviously with interest rates dropping rapidly in the 10 year, 185 or something, and a flat yield curve, could you just kind of go into more detail on how that may affect the rest of the year.

Sure. So first, it affected second quarter fairly dramatically because of the premium amortization on the mortgage backed securities in the investment portfolio. So, as interest rates dropped, the assumption on the prepayment rates on those securities comes in, the timeframe shortens and so you have to amortize the premium more quickly. And so that was actually a $3 million swing from first quarter to second quarter on that interest income line. So it hit us now. We don't expect that they'll shorten like that much further as we go forward. So we'll get a little bit of relief there. But the new loan production will necessarily be priced lower as we come in, and so we're seeing new loan production coming on at lower than the existing book rates. And so that'll feather in some additional pressure. And then the new investments that we might make in the investment portfolio as we grow deposits will obviously come on at lower rates than we've been able to do up until now. So it just creates an opportunity cost, we had come into the year expecting one rate increase and maybe more. And so it’s a headwind against what might have been a tailwind coming into the year.

Yeah. I was expecting increases too. So it’s difficult for us.

Andy, let me just elaborate too on what Rich said at the very start about us not expecting that FAS 91 premium amortization would continue to get as bad as it was in this quarter because what’s happened on the prepayment side is that you'll get a big wave of prepayment upfront, but then you get to levels where there's just some people in a class that may be at a higher rate mortgage, but they don't have the capability to refinance or for various reasons. So that's why it's not a straight line curve on that.

Sorry, Andy, just one other point. The silver lining, I guess, you see is a little bit of a bump in mortgage refinance production and the potential for gains on sale on those, so we think that helps partially offset some of the pressure, so it's not all bad news. There's some bright spots around it.

Yeah. And if you also are looking at American on a comparative basis, we've always talked about one of their real huge advantages is the core deposit base and the cost of funds. And so some other banks that don't have as good of a deposit funding base might be seeing their cost of funds come down faster. But if you look at the base cost of funds of American, it's less than half that of the pure banks. So, it's what, 40 basis points now. So, that's a real benefit to keeping the stability of the earnings at the bank.

And just so I understand that first 3 million that you were talking about, I guess, that's almost like a true-up, so that you don't have a true-up every quarter.

That’s correct. You do, but it shouldn't be as dramatic as…

I got it. Okay. And that was marked as of what, June 30?

Yes.

Okay, so anything that happened in July, like the rate cut or kind of rates moving down in general, I guess, would be trued up again. But I guess at the end of June, I can look to see where we were.

Yeah. And the markets don't always wait for the rate cuts and it some of it gets priced in on a forward basis. Right.

Okay, so now I'm going to do some dumb math, because I'm good at dumb math. So if I look at kind of where you are year-to-date, and then actually, let me just step back before I do that, how is -- because you have built in $0.03 to $0.05 from the gain of campus, you're going to sell the campus, the old campus, can you give us just any idea of timing on that, could you get about five months to go in the year or how is the sale process going.

So we have -- we actually moved out of four different properties into one, into our new campus. And so, of those, two were leased and two were owned. The leased properties, we were out of one of them at the end of May from a cost standpoint and physical standpoint. The second lease property, we're out of physically but carried the cost through the end of third quarter. And then the two remaining properties are actively being marketed. One of them is very close and we are confident that that should happen this year. Which quarter, it's hard to call. But that is the property that contributes most to the gain and the other, we'll see. It's also in process, but it may slide to next year.

Okay. And you just have to get to close on it to recognize the gain or you just have to announce this.

We will only recognize the again when money's in the bank.

Okay, so now back to my dumb math. So if you look at where you are year-to-date, and then, we'll throw in $0.04 for the gain, you have to do like 43 million or something like that in net income the second half of the year, again, assuming the gain to get to kind of the low end of the bank guidance. And then kind of looking at the 17 million you did in a quarter and then the 20.8 million you did in the first quarter and I think you did about the same in the fourth quarter. How do you get to that number? Is it possible, I guess is what I’m asking?

Of course, we would not have made that statement. No, it is -- the biggest contributor will be some normalization of the provision line. We have been hot in the first and second quarters related to that one commercial property principally. There are other factors inside but the rate that you've seen for the year to date is hotter than we would expect for the second half.

Have you ever done $43 million in two quarters? That would be, I don't recall.

So if you took fourth quarter and first quarter, we were 20 each quarter and those didn't have gains on properties in it.

Yeah. But I’m including the gain in that 43 million. So I add the stripping out at the beginning. So I'm giving you the gain plus where you are year to date, you still need to be at 43 million?

Right.

Our next question comes from Paul Patterson of Glenrock Associates.

So, I just wanted to go back to the phase 1 PBR order and, as we all know, not everything, you never get everything you want in a regulatory decision, but there were a number of things that didn't go the company's way. And I realized that you guys are expecting, phase 2 to be sort of the where the implications financially might be. But I just wanted to sort of follow up about how you guys see that. I mean, there were several items that they just didn't seem to go along with your positions, and they still seem to be big on this day one savings or customer dividend thing. And I just was wondering if you could just elaborate a little bit more in terms of how you guys are feeling about this order.

Hi. This is Joe. Yeah, I can't say that we feel like that the phase 1 order didn't go our way. I think we're actually pretty pleased with the phase 1 decision order. It was consistent with the discussion throughout the docket, consistent with the [indiscernible]. The things that commission said they weren't going to pursue at this present time are things that we agreed with a little bit more, they'll take a little bit more time to develop, the things they're intending to focus on in phase 2, I think, are the right elements of our regulatory framework. So I can’t say that we think it went against us.

Okay. Well, I mean, what I'm referring to is the five year MRP, you guys wanted to take a three year one, the day one or the customer dividend, I don't think that went your way. Also, the initial period of which the MRP would take place. I can go through others. I mean, those are the things I thought were sort of like, they didn't seem to be buying into that. And again, they seem to want this day one savings thing. I mean, to sort of follow up on that, when the discussion previously about sort of like the grid mod and everything else, it seems like there is this big desire for lower rates as well as grid mod and environmental, do you follow what I'm saying, and I guess when I'm reading the order, it's not clear to me how these things might be reconciled.

So just to take a couple of those, the difference between the three to five years, a company's position was that we would consider going to five years, we were just, we need to know what the change would be. So we were conditionally supportive of going to a five year so long as other elements of the multi-array plan were adjusted, in a manner that allows us to pursue the outcome, achieve the outcomes in the interim period. In terms of the customer dividend, yes, this will be, again, this is a comprehensive approach, we will need to see what the other elements are decided for regulatory framework, there is a productivity factor. There are other factors involved, and we’ll have to see what revenue opportunities will be attributable to achieving the thing. So, it really is, I think, the verdict is out on it, and I think we feel pretty good, at least the Commission has in their guiding principles and the factors they're going to look as it says what's a reasonable approach? Yes, there's a desire for lower rates, we share that desire as well. So, again, a lot of pieces that will need to be determined for us to see how this will work.

Hey, Paul, this is Alan. I think from my level, I think people have to realize that, not only is the regulatory side transforming, but the company has been transforming for a couple of years now. We just haven't realized all the benefits of the transformation yet internally. But we expect to realize operational savings, new products and services, other lines of revenues. So it's not the utility of the past. And I think we just have to discard looking at it through a lens of the old utility business model. And that's what we're preaching in house. And I think that's where PBR will assist us in getting to.

Well, that's awesome. And that's what I sort of wanted to sort of follow-up on. I mean, so when you're talking about all this opportunity for grid mod, the RFPs and everything else, how should we think about the impact on rates. So some utilities have sort of come up with in some cases and not the majority, in which they're doing CapEx, there is certain fuel savings or something that come about which actually lead to net decreases in rates or something of the sort. How should we think when we're hearing about this grid mod and in these investments, what you guys are, what your expectations are in terms of the rate impact, given sort of the unique situation that you guys are that you guys have in Hawaii?

So, Paul, good question. It's very complicated, because there's so many moving parts. And we're updating all of our rate models to see the impact. When you move one thing, you add another thing and then how does it fall out to a customer bill. So we're updating all of those things as PBR moves forward, as grid transformation moves forward, as we get new renewables online, and we should be seeing the results as some of these dockets reach more final stage, so we can have the inputs to give that analysis.

And Paul, I think you remember, in general, just on the energy side, obviously, as we move off of fossil generation to renewables, which has no fuel costs, that is a big savings to our customer and the energy.

It’s a levelized cost at about $0.08 on the new RFPs that will be coming in relative to our fall. So which is significantly higher based on $0.18.

Which is all the good news, right, that's on the energy, and we have to maintain capacity and resilience. And then we have to weigh out the savings we're doing on fuel, which is a good thing, reduces our fuel burn, and then we have to -- then after have the investments to give customer choice, and there are all significant investments in the grid to allow all of this to be integrated and to do what we intended to do. So that's the model that we're developing and updating.

Okay, and we'll get some sort of quantification, I guess, as these dockets progress, as you said. And that'll be interesting to see what it comes up with. Just to sort of follow up, on I guess, Andy's bank question, I apologize if I missed this, but you talked about what the 2019 impact would be through the yield curve, et cetera. How should we think about the longer term impact if these yield curve conditions so to speak, continue? How should we think about the impact on the bank’s situation if we keep seeing this kind of weird yield curve?

I think it's a little bit hard to tell right now and we see how the curve settles out and the volatility settles out, we'll be able to give you more guidance. Obviously, lower and flatter is challenging for banks. Lower and steep is not bad, because we can make money on the difference of over time on the steepness of the yield curve. Lower stimulates activity and you generally produce more loan growth, it also maybe creates a little bit less pressure on deposit costs, because the money flows back into banks, if the markets aren't performing. So there's a lot of variables in it. And I think, we'll watch how it plays out and we'll give you a little more guidance as we get to the end of the year.

Paul, I'd add from my perspective, until the last year or so when everybody started thinking that rates were going to rise, if you remember the period before that, that was a period which was low for longer, right? And if we all kept saying jeez, when are rates going to rise, when are rates going to rise, and they didn't, which is low for a long period of time. So I think we're kind of back in that situation. And if you remember the bank's earnings during that timeframe, again, because they've got a great funding base, through the deposits, they continued to perform well, with quite solid earnings throughout that period.

Our next question comes from Charles Fishman of Morningstar.

And yes, I'm coming from a same direction Paul Patterson has and he asked a lot of questions I was going to ask them. Let me, I have one more. A custom customer centric approach to the utilities financial health does not give me a lot of comfort. There's a big gap between what a customer might think is a healthy fine utility and what a shareholder and a bondholder thinks is a healthy utility. In phase 2, are there any working groups that try to establish benchmarks for what that might be? In other words, having a peer group of utilities, other US utilities and their financial metrics to establish what it means to be a financially healthy utility?

So this is Joe, again. The customer centric approach is, again, it's one of the three guiding principles, right. Financial integrity is one of the other two. And, customer centric approach, I think, is broad, and includes customer value as well. But to get to your specific question, I understand that the Commission is established in November, we'll have a workshop on financial modeling. So that decision is made, we’ll be informed by some type of financial analysis. So I think that's where we're starting out next week really to kick off phase 2, there would be a series of at least seven workshops over the next couple of months. And certainly setting benchmarks and understanding the financial implications of proposed changes will be part of that process.

Charles, this is Tayne. I also wanted to add as part of our phase 1 workshops, the commission did bring on board an advisor that represented the capital markets to talk about the importance of the utility’s financial integrity in a time where there needs to be access to the markets, due to a lot of the renewables coming on and the infrastructure needed to support that. And so that advisor came to one of the workshops to actually have a discussion about that.

So and continued access to low cost funding and capital is in the customers’ interest. It’s the quickest way to get to 100% renewable and facilitate the integration of all of the renewable projects. So as they have stated about the access to low cost capital, that is consistent with investment grade metrics, and appropriate returns to capital, so that capital can be priced appropriately.

Let me just add one more element because it's so important in our jurisdiction. I think there's an increasing awareness as we move to third party providers in getting to our renewable future, how important it is for those providers to get access to their capital needs, based upon our financial integrity. So the third parties are all behind the utility in preserving our financial integrity, otherwise, they can get access to low cost capital for their projects.

Yeah, that's a very good point on the PPAs. I mean, they really are leaning on your balance sheet.

Absolutely. And not many people understood that. And I think there's a growing realization of that, and it's coming through the PBR docket and other means.

Will this consultants, a financial consultant will he still be part of the process during phase 2?

We're not sure what the commission plans in terms of their support or who they'll invite.

Hey, Charles, this is Connie. I just point out that, on our slide five, which gives you the high level on the phase 1 D&O where it talks about advanced societal outcomes and capital formation. That's really the point that Alan was referring to the recognition that if we're going to go to a renewable future, and make it affordable for customers, cost of capital is important in that calculation for the utility, but also for third party providers. We're now moving in a way just from IP piece to the whole demand response area which has third party aggregators. So, that's a very important piece.

Okay, good point. I didn't see that capital formation there in that box. Good point.

Our next question comes from Michael Weinstein of Credit Suisse.

Yeah, actually, I'll respond briefly to Charles, I was in that workshop in PBR 1, phase 1, and to represent the interests of the and, at least the equity investors and Moody’s was there also for the dead investors. So, and I just had a conversation with Chairman Jay Griffin, he seems very interested in making sure that investor interests are represented in these PBR workshops. So we'll see where that goes. The question I had, I wanted to ask, I was actually also going to ask the same thing that Paul Patterson asked, which is, what do you think that means by customer dividend? Like, do you, I'm sure you guys have maybe some of your own ideas about what kinds of dividends can be provided to customers that might satisfy their requirement. And just wondering if you have any?

So this is Joe, again. Actually, the customer dividend, I understand that to be part of the regulatory framework, and I think it's in Massachusetts right now. So it's not something entirely new. I think the notion is that the part of the PBR framework will incentivize cost control and actually will benefit the utility’s expenses, realizing cost control in between read cases. So there'll be a little bit of a payment upfront to benefit customers, there is a little bit of a down payment on the realization of those benefits. And again, during the interim period, the utility will benefit by achieving those cost containment as well.

Another question I have is the -- are you seeing any impact on the economy or on tourism or anything else from the trade wars, as they start to rear their ugly head once again, at this point?

So far, for Hawaii, being the major driver here is tourism, and then also federal government expenditures. Greg had gone over what's happening in the tourism numbers and from the standpoint of arrivals, it's still holding up, expenditures are down a little bit, but we've not seen it come through to impact the economy, yeah.

Great. And I understood kind of your basically what you're kind of saying about the bank is that it's the customer deposit base insulates it from a flat yield curve or inverted yield curve.

Yeah, I don't know that.

Yeah. I wouldn't say insulated. But it helps us in all markets, actually. Because we've been able to have that kind of a cushion on our deposit costs and funding costs compared to our peers. So it helps us in all markets and the more room you have there and the better you're going to weather the flight yield curve, then if you had higher costs.

Yeah, an example that might help you think about it is that they have a very strong checking base that is non-interest bearing and so not impacted by changes in interest rates.

This concludes our question-and-answer session. I would like to turn the conference back over to Julie Smolinski for any closing remarks.

Thank you, everyone, for joining us today and have a great weekend. Happy aloha Friday.

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