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August 31, 2007 |
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Hawaiian Electric Industries blamed the yield curve for poor results at the bank and increasing O&M expenses for poor results at the utility in 2Q07. After suggesting it would do so in the 10K (pg. 56), the company acknowledged that as of March 2007 approximately 50% of dividend was being funded by issuing shares for the DRIP (previously shares were purchased on the open market).
How Many Bad Loans? Don’t Ask When bad debts at American Savings Bank (ASB) arise – like the $1.2 million hit in 2Q07 – investors start to question the company’s low loss reserves. Asked why loss reserves are not being raised HE’s CEO, Ms. Constance Lau, offered these comments during the latest conference call: “…under the accounting standards, we have to have a very elaborate methodology to calculate the loan loss reserve. And so, there are very specific quantitative measures that go into that model as well as some qualitative measures that are really translated into quantitative measures. And so, many times we would like to increase that reserve but we really can not do so. We have to make sure that it is accurate for expected losses in the loan portfolio at a point in time.” In other words, even if HE management had a hunch that loan quality was at risk of serious deterioration in the future, there is no way for accounting standards to accurately forecast and/or calculate appropriate reserve levels today. Notwithstanding the ‘very elaborate methodology’ being used, the simple fact is that bad loans turn bad when they turn bad... Added to Ms. Lau’s evasive comments should be the following: Even quality underwriting standards can not prevent some loans from going bad, and after periods of freakishly low default rates common sense says some negative surprises are due. Accordingly, see if you can follow the trend: * From 1988-1995 ASB always produced a ratio of net charge-offs of less than 0.05%. * From 1996-2004 ASB never produced a ratio of net charge-off of less than 0.05%. * Net charge-offs were at 0.02% and <0.01% in 2006 and 2005 respectively From a reserve perspective ASB could cope with another year like 1999 – when net charge-offs rose as high as 0.66%. However, it is worth remembering that declining loss reserves help the company’s financials, while rising loss reserves are burdensome. Although ASB has historically booked excellent business and no one knows exactly how many bad loans are lurking, simple mathematics suggests that there will be more bad loans going forward than there was over the last two years. Rising loss reserves/allowances are a negative.
Dividend Speculations & Conclusions Assuming no major blowups at the bank, the company could be covering the dividend more comfortably by mid-2008, or after some of the four pending rate cases are pushed through. Conversely, any combination of continued operational weakness or negative rate case developments could easily force the company to reduce the dividend. An outright suspension of the dividend is highly unlikely. On a more positive note, it is possible that negative business developments today will serve as a bargaining chip to help procure more favorable rate case results tomorrow. HE remains a potential dividend/turnaround candidate. Disclosure: No one at or associated with FallStreet.com has any investment position in HE. |
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