HE

Business Context and Reporting Period

Company: Hawaiian Electric Industries, Inc. (HEI) and principal subsidiary Hawaiian Electric Company, Inc. (HECO).
Reporting Period: Quarterly report (Form 10-Q) for the period ended June 30, 2007.
Operations: HEI operates through three primary segments: Electric Utilities (HECO, HELCO, MECO), Bank (American Savings Bank, F.S.B. or ASB), and Other (investments and holding companies). The utilities provide electric service to approximately 95% of Hawaii's population.

Key Financial Metrics (Six Months Ended June 30, 2007)

Segment Performance (Six Months)

• Electric Utility: Revenues of $940.4 million; Net Income of $11.1 million (down 71% from prior year). Decline driven by higher O&M expenses, a $12 million plant write-off, and discontinued DSM incentives.
• Bank (ASB): Revenues of $212.0 million; Net Income of $24.2 million (down 27% from prior year). Decline attributed to net interest margin compression due to a flat/inverted yield curve and higher noninterest expenses.
• Other: Net Loss of $11.0 million. Improved from prior year due to a gain on the sale of Hoku Scientific shares.

Material Changes vs. Prior Period

• Significant Earnings Decline: Consolidated net income dropped 59% year-over-year. The electric utility segment saw a 71% drop in net income, and the bank segment saw a 27% drop.
• Utility Plant Write-off: HELCO recorded an after-tax charge of approximately $7 million in the first quarter related to the write-off of CT-4 and CT-5 plant costs following a settlement in its 2006 rate case.
• Rate Relief: HELCO received interim rate relief of 7.58% (implemented April 2007). HECO received interim relief in September 2005, but final approval for its 2005 test year case remains pending.
• Bank Margin Compression: ASB's net interest margin decreased to 3.14% for the six months ended June 30, 2007, from 3.30% in the prior year, due to higher funding costs and lower investment balances.
• Debt Issuance: In March 2007, the State of Hawaii issued $265 million in Special Purpose Revenue Bonds (SPRBs) loaned to the utilities to finance capital expenditures and refund prior debt.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Utility Expenses: Management expects higher operation and maintenance (O&M) expenses to continue in 2007 due to aging infrastructure, increased maintenance of generating units, and higher employee benefit costs.
• Reliability Concerns: HECO faces strained generation reserve margins on Oahu, increasing the risk of outages until a new 110 MW combustion turbine is installed in 2009.
• Bank Environment: ASB earnings remain dependent on interest rates and the yield curve. The bank faces challenges in retaining deposits and controlling funding costs in the current rate environment.
• Dividends: HEI maintained the quarterly dividend at $0.31 per share. The payout ratio for the first six months of 2007 was 207%, significantly higher than the historical target of 65% or lower, due to low net income.

Risks and Contingencies

• Regulatory Lag: Future earnings are heavily dependent on the timing and amount of rate relief granted by the Public Utilities Commission (PUC) to cover rising costs.
• Environmental Compliance: Potential costs associated with the Regional Haze Rule, Clean Water Act cooling water intake requirements, and new state greenhouse gas emission reduction mandates.
• Legal Proceedings: Ongoing PUC investigation into the October 2006 island-wide power outages caused by earthquakes; potential penalties or required corrective actions remain uncertain.
• Interest Rate Risk: ASB is exposed to interest rate risk; rising rates could reduce the market value of its investment portfolio and compress net interest margins.

Investor Verification Checklist

• Rate Case Outcomes: Monitor the final decisions on HECO's 2005 test year rate case and HELCO's 2006 test year rate case, as interim increases are subject to refund.
• Plant Write-offs: Verify if additional write-offs of CT-4/CT-5 costs or other capital projects (e.g., East Oahu Transmission Project) are required if the PUC disallows costs in final orders.
• Bank Asset Quality: Review ASB's allowance for loan losses and nonperforming assets, noting the recent provision for loan losses driven by a single commercial borrower.
• Capital Expenditures: Track the funding and progress of the 2009 Campbell Industrial Park (CIP) generating unit and other reliability projects.
• Regulatory Changes: Assess the impact of new Hawaii state legislation regarding renewable portfolio standards (RPS), greenhouse gas emissions, and net energy metering caps.