Hawaiian Electric and Its Subsidiary Bank

Grandfathered unitary SLHCs, the S&L crisis, a rejected energy company merger, and the rest of the backstory

Hawaiian Electric Industries, Inc. is Hawaii’s largest utility. The New York Times reports that, in the aftermath of the recent wildfires in Maui, Wall Street is beginning to speculate about the company’s potential liability:

It could take months for officials to identify what caused the fire in Maui last week. But some plaintiffs’ lawyers and investors have already begun to blame Hawaiian Electric, the state’s largest utility.

The utility’s power lines and equipment are one potential source of the fire that has claimed the lives of more than 100 people — a death toll that is expected to rise once the more than 1,000 missing people are accounted for.

Lawyers have filed at least four lawsuits against the company. The suits contend that the company was negligent in the operation and maintenance of its equipment. Among other things, lawyers say the utility should have shut off power to prevent its lines from starting fires during periods of high wind and drought, a practice employed in California.

Those lawsuits have spooked Wall Street traders who fear that the utility will not be able to shoulder liability claims that could add up to billions of dollars. Hawaiian Electric’s stock price has fallen around 68 percent since Aug. 7, the day before the wildfire started, to about $12 on Thursday.

Earlier today HEI filed an 8-K with an investor update. The investor update includes a short FAQ.

Is Hawai‘i an inverse condemnation state?

• Unlike in California, there is no precedent in Hawai‘i applying inverse condemnation to a private party like an investor-owned utility. It has only been applied to government entities.

• Also unlike in California, there is no precedent in Hawai‘i applying a theory of inverse condemnation to government entities based on damages that they’ve caused (as opposed to the taking of property). […]

Is Maui Electric Company ring-fenced from the rest of the utility?

• This is a complex legal question that will take time to work through.

• Maui Electric Company, Limited is its own corporation, wholly owned by Hawaiian Electric. […]

Have you retained restructuring advisors?

• Hawaiian Electric plays a unique and important role in Hawai‘i and for the people of Hawai‘i. Hawaiian Electric and HEI intend to be here for the long term, through the rebuilding effort and beyond. Like any company in this situation would do, and as we do in the normal course of business, we are seeking advice from various experts. This is part of prudent scenario planning. The goal is not to restructure the company but to endure as a financially strong utility that Maui and this state need. We look forward to working with the people of Hawai‘i to achieve this goal.

Obviously this is not even close to the most important thing about the horrible events in Maui, but as relevant to this blog Hawaiian Electric is also notable in that, in addition to operating a utility, the company also owns American Savings Bank, FSB. As of the end of 2022, ASB had roughly $9 billion in total assets and 38 branch offices across the Hawaiian islands. Bloomberg reports:

Hawaiian Electric Industries Inc. owns and operates American Savings Bank FSB, which has been grappling with this year’s turmoil in the regional-banking industry. Worse-than-expected results from the company’s banking division, which generates about 25% of operating income, led Hawaiian Electric to cut its earnings-per-share forecast for this year to $2.00 to $2.10, down from the $2.15 to $2.35 range it previously expected. 

The more pessimistic guidance was announced the day before fires claimed the lives of more than 100 people on Maui. 

As the Bloomberg story also notes, Hawaiian Electric Industries is “the only publicly traded US utility company to own a bank.” This post looks at how it got here.

Grandfathered Unitary Savings and Loan Holding Companies

The quotes in this section come from a late 1990s OTS report entitled "Historical Framework for Regulation of Activities of Unitary Savings and Loan Holding Companies," available here starting at page 846.

To understand the regulation of savings and loan holding companies, it is helpful to start by looking at the regulation of companies that own banks. Note that “bank” has a specific definition under the Bank Holding Company Act of 1956 and excludes certain deposit-taking entities one might ordinarily think of as banks. As relevant to this post, federal savings associations, federal savings banks, savings and loan associations and the like are generally not included in the definition of bank.

The BHC Act has existed in one form or another since 1956. The exact scope of the prohibition has changed over the years, but since the very beginning the BHC Act has prohibited a company subject to that act from engaging in certain nonbanking activities.

One key thing that was different about the 1956 version of the BHC Act compared to its present version, however, is that the 1956 iteration of the act applied only to a company that owned two or more banks. Congress felt that a company that owned only one bank was not a serious concern.

As the Senate Banking Committee later observed, unitary bank holding company operations in the mid- 1950s were generally small and presented no serious supervisory problems. Additionally, since banks were at the time subject to sometimes stringent state branching laws, a multiple holding company provided a possible vehicle for circumventing the laws. Unitary holding companies could not, by definition, present such a risk. Congress also believed that blanket coverage by the BHCA would tend to discourage formation of new banks and force the sale of many existing banks. This Congressional decision that only multiple bank holding companies were to be covered by the BHCA of 1956 was not modified by amendments to the BHCA in 1966.

But the situation soon changed.

Twenty-three of the 51 banks in the United States with deposits of $1 billion or more, including the six largest in the country, holding over 20 percent of the deposits of the entire banking system, became subsidiaries of one-bank holding companies by 1970.

Furthermore:

Many one-bank holding companies engaged in commercial or industrial pursuits that had no discernible relation to their banking powers. These businesses included television broadcasting, the manufacture of furniture, yarns, carpets, lawnmowers, and shoes, and the operation of department stores, experimental farms, ranches, pizza parlors, and restaurants . The mixture of these operations with commercial banking, was, in the view of the chairman of the House committee, "clearly against the public interest.”

Thus, in 1970 amendments to the BHC Act, Congress determined that the act should extend to also cover companies that control only one bank. There were grandfather provisions for companies lawfully engaged in now-impermissible nonbanking activities as of June 30, 1968, but those provisions were fairly strict.¹ For this and other reasons, ultimately one-bank holding companies that were also engaged in commercial activities generally either divested their bank or kept their bank and wound down those of their non-banking activities that were now impermissible.

Savings and Loan Holding Companies

Like bank holding companies, savings and loan holding companies drew attention from Congress in the 1950s. Unlike BHCs, however, Congress viewed SLHCs as not of immediate concern.

When savings and loan holding companies first came to the attention of Congress in the late 1950s, their numbers were few and opportunities for growth limited. The subsidiary thrift in a savings and loan holding company structure had to be in the stock form of ownership. Most of the nation's savings institutions were organized as mutuals, but all federally chartered associations, which constituted the majority of savings institutions, were required by statute to be mutuals. In contrast to their banking counterparts, savings and loan associations were basically restricted to local residential home mortgage lending and ancillary activities. Indeed, there were statutory restrictions on the geographic areas in which insured thrifts could make home mortgage loans and rates on deposit accounts were fixed by regulation.

Congress ultimately did get around to enacting a comprehensive scheme for the regulation of SLHCs in 1967 but, unlike with the BHC Act amendments Congress would adopt a few years later in 1970, Congress permitted companies that owned only a single deposit-taking subsidiary to continue to engage in commercial activities.

Congress's decision in 1967 to grant the non-thrift business exemption to unitaries was made purposefully and deliberately. As the Senate Report indicates, Congress sought to encourage the acquisition of single thrifts by companies outside the savings and loan business and to free such acquirers from the activities limitations applicable to multiple holding companies. Contrary to the Congressional attitude towards bank holding companies, there were no serious concerns over the combination of single thrift institutions and other commercial enterprises under common control.

Skipping over some of the intermediate history, including the imposition of a “qualified thrift lender” test, the next key event happened in 1999 with the passage of the Gramm-Leach-Bliley Act, which bars new affiliations between SLHCs and firms engaged in commercial activities. The GLBA also, however, includes fairly robust grandfathering provisions saying that unitary SLHCs engaged in commercial activities as of May 4, 1999 may continue to engage in commercial activities. These firms are referred to as grandfathered unitary SLHCs.

The Dodd-Frank Act further narrowed (without fully eliminating) the differences between thrifts and commercial banks and between the regulation of SLHCs and BHCs, but the GLBA grandfathering provisions remained.

Long story short: although this was not always the case, the general rule now is that if you are a company that controls a deposit-taking institution, you are severely limited in the commercial activities in which you can engage, regardless of whether you are an SLHC that controls a thrift or a BHC that controls a bank.² But some companies, by virtue of acquisitions made decades ago, are not subject to those restrictions. Hawaiian Electric Industries is one such company.

Hawaiian Electric and American Savings Bank

Grow or Die

Dudley Pratt Jr. became head of Hawaiian Electric Company in 1981, having first joined the company in 1953. A 2016 special report by Honolulu Civil Beat described Pratt as following a “remorseless rule” - “You either grow or die.”

And so Hawaiian Electric grew.

In 1983, Pratt presided over the creation of Hawaiian Electric Industries, which has grown into the largest company in the state. It was started as a holding company that folded the 92-year-old HECO in as its first subsidiary and had visions of expanding into many different commercial sectors. […]

In 1984, the holding company established HEI Investments Inc., which was created largely to invest in corporate securities and other long-term investments. Its cash began to flow far beyond the shores of an isolated archipelago in the middle of the Pacific Ocean. […]

A wind farm operation. A North Shore real estate business. Investments in Arizona, New Mexico and elsewhere on the mainland.

In 1986, HEI invested in the interisland freight company, Young Brothers, and its sister company, Hawaiian Tug & Barge, which operated ocean-going as well as harbor tugs and barges. The revenues quickly proved better than expected.

1988 Bank Acquisition

A couple years later, Hawaiian Electric spotted an opportunity coming out of the S&L crisis.

In 1988, HEI purchased American Savings Bank’s branches in Hawaii for $113 million.

HEI had not planned to focus on financial services, but it couldn’t resist the chance to buy them from the American Savings and Loan Association in Salt Lake City, Utah. American Savings had gotten caught up in the $150 billion savings and loan crisis of the mid-1980s when risky investments led to the collapse of more than 1,000 thrifts nationwide and ensnared U.S. senators in schemes to help financiers like Charles Keating Jr.

To fund that purchase, HEI reached out to mainland and international investors. The company sold 2.5 million new holding company shares in the U.S., Europe and Japan, bringing in $77.2 million through the stock offering.

In connection with the acquisition, Hawaiian Electric was required to enter into a Regulatory Capital Maintenance Dividend/Agreement. The agreement, which is still in effect today (as subsequently modified), provides that HEI may be required to contribute additional capital to American Savings Bank in order to keep the bank’s capital at specified levels. The company in its most recent 10-K describes the current state of play.

At the time of HEI’s acquisition of ASB, HEI agreed with the Office of Thrift Supervision (OTS), Department of Treasury’s predecessor regulatory agency, that ASB’s regulatory capital would be maintained at a level of at least 6% of ASB’s total liabilities, or at such greater amount as may be required from time to time by regulation. Under the agreement, HEI’s obligation to contribute additional capital to ensure that ASB would have the capital level required by the OTS was limited to a maximum aggregate amount of approximately $65.1 million. As of December 31, 2022, as a result of certain HEI contributions of capital to ASB over the years, HEI’s maximum obligation under the agreement to contribute additional capital has been reduced to approximately $28.3 million.

ASB is subject to OCC regulations on dividends and other distributions and ASB must receive a letter from the FRB communicating the OCC’s and FRB’s non-objection to the payment of any dividend ASB proposes to declare and pay to ASB Hawaii and HEI.

HEI is also subject to a statutory source of strength obligation:

In addition to OCC oversight, federal law and Federal Reserve Board policy require that HEI, as a savings and loan holding company, serve as a source of financial and managerial strength for any FDIC-insured depository institution that it controls. Accordingly, if ASB were to be in financial distress or to otherwise be viewed by the regulators as in unsatisfactory condition, HEI could be required to provide additional capital or liquidity support or take other action, in support of ASB.

Abandoned Spin-Off Plans

In December 2014 Hawaiian Electric Industries announced that it had reached a $4.3 billion merger agreement with NextEra Energy. In connection with the transaction, American Savings Bank would be spun off to existing HEI shareholders in a transaction valuing the bank at around $800 million, or 1.7-1.8x book value. The deal announcement press release specifically noted that one benefit the bank expected to realize from the deal was “higher year-over-year fee income due to regaining its exemption from regulatory limits on interchange fees (Durbin Amendment).” (The bank itself is below the $10 billion Durbin threshold, but HEI on a consolidated basis has more than $10 billion in total assets.)

Reactions to the bank spin-off plans were positive. The Honolulu Star Advertiser’s initial headline takeaway was that the split was “expected to benefit both” the bank and its electric company parent.

"That combination of a utility and bank, that’s always been a bit unique and so typically what happens is you have two different entities and you sort of struggle with where to best allocate capital," said Nashville, Tenn.-based banking analyst Brett Rabatin of brokerage firm Sterne Agee. "You have different people clamoring for the same dollars, so eventually it makes sense to separate the two things. It’ll be a good thing for the Hawaiian market over time for that spinoff to happen. It’ll change things a little bit, I’m sure. It’s something that probably needed to happen at some point anyway. It’s not like a shocking thing."

American Savings’ separation from HEI is a good move for both the shareholders and the community because it "unlocks value," said retired banker Walter Dods, former CEO of First Hawaiian Bank.

"When you split them up you just have a lot more focus on the specific industry," said Dods, who was chairman of Alexander & Baldwin Inc. when it split with subsidiary Matson in 2012. "The fact of the matter is at the parent level you have to decide where to best employ your capital. We in Hawaii are always capital short. We need money as a community so we want a healthy financial industry. Having a separate American Savings is good for the community."

Reaction to the overall transaction, however, was not as positive, at least among some members of the public and, crucially, Hawaii’s Public Utilities Commission. The PUC voted in July 2016 to dismiss the parties’ application for regulatory approval, finding that the purported benefits of the transaction were “inadequate and uncertain.”

Rejection of the HEI-NextEra merger also doomed any immediate plans for the bank spin-off.

New York-based analyst Andrew Weisel, who covers HEI, said he doesn’t think a future spinoff would occur without the stipulations that were part of NextEra’s offer.

“Though utility investors would absolutely love to see Hawaiian Electric without the bank, we view it as extremely unlikely without the NextEra merger,” Weisel, of Macquarie Capital USA Inc., said in an email. “HEI has been trying for years to divest it, but has struggled to do so without a huge tax bill to be paid by shareholders. The only reason it would have been tax-free for HEI shareholders under the NextEra offer is that the buyer was to assume a $165 million tax liability as part of the deal.

This was also disappointing to those at the bank who thought they might have access to additional capital or the ability to pursue an expanded business model.

Another benefit ASB would have realized from a spinoff: It would have no longer had to pay dividends to HEI. Right now ASB pays about 70 percent of its net income to HEI to fund the utility’s capital expenditures. As an independent, ASB would pay a dividend to shareholders of only 30 to 40 percent. So the bank would have had more free cash to invest excess capital in the bank and conduct buybacks. The additional income would have given the bank more options and free it from providing capital to holding company HEI and the utility. Besides giving dividends to ASB shareholders, the bank would have been able to invest excess capital in the bank and conduct buybacks.

ASB Today

Since 2016, HEI’s future plans for the bank have continued to occasionally be subject to questions from utility-focused analysts who see a pile of capital that could otherwise be devoted to the company’s utility operations.³ So far though nothing has materialized.

As recently as November of last year HEI’s CEO stated on an earnings call that “as long as the inflation environment is high and the interest rates are high, then the bank will continue to see benefit” and that HEI would continue to benefit from its diversified holdings.

As far as the bank is concerned, as long as the inflation environment is high and the interest rates are high, then the bank will continue to see benefit. So that's to my earlier point, having the bank and the utility as part of the HEI enterprise does help to really mitigate the pressures that any one company has seen in these varying economic situation. So that's what we expect to see continue going forward.

***

I have no idea what options might be on the cards, and it seems like HEI is also not sure what comes next. But to the extent that one’s mind goes to a sale of the bank as a potential outcome, in terms of market share the Federal Reserve’s CASSIDI tool indicates that ASB has operations in five defined banking markets:⁴ Hilo, HI; Honolulu, HI; Kailua-Kona, HI; Kauai, HI; and West Maui, HI.

In all but Kauai, where it is third, ASB ranks fourth in deposit market share behind (in some order) First Hawaiian Bank, Bank of Hawaii, and Central Pacific Bank. As CNN observed in a 2012 article, larger banks have generally stayed away.⁵

1. A 1971 speech by the President of the Federal Reserve Bank of New York explained:

The Congress did not see fit to provide to existing one-bank holding companies an ironclad exemption allowing them to retain any previously acquired or established nonbank subsidiaries. True, bank holding companies which come under regulation for the first time may continue to engage in nonbank activities which would otherwise be prohibited, provided they have been continuously engaged in them since June 30, 1968. But the Board has the power to terminate a company's authority to engage in such an activity if it finds such action is necessary to prevent undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices. The Board is required to make this determination by the year-end 1972 for those newly regulated companies with banking assets exceeding $60 million. The Board also has discretion to take similar action with respect to the other newly regulated holding companies whose banks have assets of $60 million or less, if it believes the so-called "grandfather" exemption is not justified.

2. The prohibitions on nonbanking activities are still not completely congruent between BHCs and SLHCs — see the discussion of insurance agency and “1987 list” activities here, for example.

3. See for example this exchange on a February 2017 earnings call.

Tim Winter

I have a big-picture question. Given the strong performance of the banks, ongoing capital needs at the utility, and you guys were close to spinning the Bank with the NextEra merger, what are some of the factors that are keeping you from monetizing the Bank and recycling capital back into the utility?

Tayne Sekimura

Tim, I think you know that we continually run that analysis and our board has actually charged us with doing so. But in that analysis there are many, many factors that go into that discussion, including the fact that Hawaii as a state that has a stakeholder statute and so we have to make sure that we consider all factors not just the financial factors but community based factors in those kinds of analysis.

Having said that, we'll continue to look at it going forward, you probably know that some of the factors obviously have shifted recently with the running the bank, that would do things like increase the tax bill for the bank on a spin. With interest rates rising, financing costs for an acquirer are going to be changing. So there is multitude of those kind of factors that we continue to look at and our current view is that we've not seen a compelling case for our shareholders to move ahead with any different structure in the company.

4. Banking markets can be sort of tricky in Hawaii, as the Board has previously explained.

In Hawaii, the Board has paid particular attention to an analysis of relevant commuting data, the state’s mountainous island geography, the economic integration of the local areas, and evidence of where customers conduct their banking business.

In applying these principles in Hawaii, the Board previously has identified five local geographic markets in which effects of bank expansion proposals on competition must be analyzed. Based on these and all other facts of record in this case, the Board continues to believe that Hawaii is comprised of five local banking markets and that the record in this case supports a competitive analysis based on these five local markets.

That quote is fairly dated as it comes from a 2003 order, but for what it’s worth the FRBSF in 2019 identified the same five banking markets.

5. That CNN article describes First Hawaiian as a subsidiary of BNP Paribas, but the bank was partially spun out in 2016 and BNP Paribas fully exited its stake in 2019.