HAWAIIAN ELECTRIC CO INC - Annual Report: 2009 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

For the fiscal year ended December 31, 2009

OR

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Indicate by check mark if Registrant Hawaiian Electric Industries, Inc. is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No   ¨

Indicate by check mark if Registrant Hawaiian Electric Company, Inc. is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if Registrant Hawaiian Electric Industries, Inc. is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark if Registrant Hawaiian Electric Company, Inc. is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether Registrant Hawaiian Electric Industries, Inc. (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether Registrant Hawaiian Electric Company, Inc. (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No

Indicate by check mark whether Registrant Hawaiian Electric Industries, Inc. has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ¨    No  ¨

Indicate by check mark whether Registrant Hawaiian Electric Company, Inc. has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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Indicate by check mark whether Registrant Hawaiian Electric Industries, Inc. is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨ (Do not check if a smaller reporting company)    Smaller reporting company  ¨

Indicate by check mark whether Registrant Hawaiian Electric Company, Inc. is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x    (Do not check if a smaller reporting company)    Smaller reporting company  ¨

Indicate by check mark whether Registrant Hawaiian Electric Industries, Inc. is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate by check mark whether Registrant Hawaiian Electric Company, Inc. is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

DOCUMENTS INCORPORATED BY REFERENCE

HEI’s Annual Report to Shareholders (Selected Sections) for the fiscal year ended December 31, 2009—Parts I, II, III and IV

HEI and HECO’s Current Report on Form 8-K dated February 19, 2010—Parts I and II

HECO’s Consolidated Selected Financial Data—Part II

HECO’s Management’s Discussion and Analysis of Financial Condition and Results of Operations—Parts I and II

HECO’s Quantitative and Qualitative Disclosures about Market Risk— Parts I and II

HECO’s Consolidated 2009 Financial Statements—Parts I, II, III and IV

Selected sections of Proxy Statement of HEI for the 2010 Annual Meeting of Shareholders to be filed—Part III

This combined Form 10-K represents separate filings by Hawaiian Electric Industries, Inc. and Hawaiian Electric Company, Inc. Information contained herein relating to any individual registrant is filed by each registrant on its own behalf. HECO makes no representations as to any information not relating to itself.

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GLOSSARY OF TERMS

Defined below are certain terms used in this report:

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GLOSSARY OF TERMS (continued)

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GLOSSARY OF TERMS (continued)

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Forward-Looking Statements

This report and other presentations made by Hawaiian Electric Industries, Inc. (HEI) and Hawaiian Electric Company, Inc. (HECO) and their subsidiaries contain “forward-looking statements,” which include statements that are predictive in nature, depend upon or refer to future events or conditions, and usually include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “predicts,” “estimates” or similar expressions. In addition, any statements concerning future financial performance, ongoing business strategies or prospects or possible future actions are also forward-looking statements. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties and the accuracy of assumptions concerning HEI and its subsidiaries (collectively, the Company), the performance of the industries in which they do business and economic and market factors, among other things. These forward-looking statements are not guarantees of future performance.

Risks, uncertainties and other important factors that could cause actual results to differ materially from those in forward-looking statements and from historical results include, but are not limited to, the following:

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Forward-looking statements speak only as of the date of the report, presentation or filing in which they are made. Except to the extent required by the federal securities laws, HEI, HECO, ASB and their subsidiaries undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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PART I

HEI Consolidated

HEI and subsidiaries and lines of business.

HEI was incorporated in 1981 under the laws of the State of Hawaii and is a holding company with its principal subsidiaries engaged in electric utility, banking and other businesses operating primarily in the State of Hawaii. HEI’s predecessor, HECO, was incorporated under the laws of the Kingdom of Hawaii (now the State of Hawaii) on October 13, 1891. As a result of a 1983 corporate reorganization, HECO became an HEI subsidiary and common shareholders of HECO became common shareholders of HEI.

HECO and its operating utility subsidiaries, Hawaii Electric Light Company, Inc. (HELCO) and Maui Electric Company, Limited (MECO), are regulated electric public utilities. HECO also owns all the common securities of HECO Capital Trust III (a Delaware statutory trust), which was formed to effect the issuance of $50 million of cumulative quarterly income preferred securities in 2004, for the benefit of HECO, HELCO and MECO. In December 2002, HECO formed a subsidiary, Renewable Hawaii, Inc., to invest in renewable energy projects. In September 2007, HECO formed another subsidiary, Uluwehiokama Biofuels Corp. (UBC), to invest in a biodiesel refining plant to be built on the island of Maui, which project has been terminated.

Besides HECO and its subsidiaries, HEI also currently owns directly or indirectly the following subsidiaries: American Savings Holdings, Inc. (ASHI) (a holding company) and its subsidiary, ASB, and the subsidiaries of ASB; Pacific Energy Conservation Services, Inc. (PECS); HEI Properties, Inc. (HEIPI); HEI Investments, Inc.; Hawaiian Electric Industries Capital Trusts II and III (formed in 1997 to be available for trust securities financings); and The Old Oahu Tug Service, Inc. (TOOTS).

ASB, acquired by HEI in 1988, is one of the largest financial institutions in the State of Hawaii with assets of $4.9 billion as of December 31, 2009.

HEIPI, whose predecessor company was formed in February 1998, holds venture capital investments (in companies based in Hawaii and on the U.S. mainland) with a carrying value of $1.3 million as of December 31, 2009.

HEI Investment Corp. (HEIIC), incorporated in May 1984 primarily to make passive investments in corporate securities and other long-term investments, changed its name to HEI Investments, Inc. (HEIII) in January 2000. HEIII is not an “investment company” regulated under the Investment Company Act of 1940. HEIII’s long-term investments previously consisted primarily of investments in leveraged leases, the last of which was sold in November 2007. HEIII filed articles of dissolution in 2008 and substantially completed winding up its affairs during 2009.

PECS was formed in 1994 and currently is a contract services company providing windfarm operational and maintenance services to an affiliated electric utility that will cease such services when the windfarm is dismantled in 2010.

In November 1999, Hawaiian Tug & Barge Corp. (HTB) sold substantially all of its operating assets and the stock of Young Brothers, Limited (YB) for a nominal gain, changed its name to TOOTS and ceased maritime freight transportation operations. TOOTS currently administers certain employee and retiree-related benefits programs and monitors matters related to its former operations and the operations of its former subsidiary.

For additional information about the Company required by this item, see HEI’s “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (HEI’s MD&A), HEI’s “Quantitative and Qualitative Disclosures about Market Risk” and HEI’s Consolidated Financial Statements (including Note 2, “Segment financial information”), which are incorporated by reference to HEI Exhibit 13 to HEI’s Current Report on Form 8-K dated February 19, 2010 (HEI’s Annual Report), and also see HECO’s “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (HECO’s MD&A) and HECO’s Consolidated Financial Statements and HECO’s “Quantitative and Qualitative Disclosures About Market Risk,” which are incorporated by reference to HECO Exhibit 99 to HECO’s Current Report on Form 8-K dated February 19, 2010.

The Company’s website address is www.hei.com. The information on the Company’s website is not incorporated by reference in this annual report on Form 10-K unless, and except to the extent, specifically incorporated herein by reference. HEI and HECO currently make available free of charge through this website their annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports (since 1994) as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.

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Recent developments and updates (to information incorporated by reference into this Form 10-K from HEI’s and HECO’s MD&As and HEI’s and HECO’s Consolidated Financial Statements in HEI Exhibit 13 and HECO Exhibit 99 to the Company’s Current Report on Form 8-K dated February 19, 2010) are included in the discussions below.

Commitments and contingencies.

See “HEI Consolidated–Selected contractual obligations and commitments” in HEI’s MD&A and HECO’s “Commitments and contingencies” below.

Regulation.

HEI and HECO are each holding companies within the meaning of the Public Utility Holding Company Act of 2005 and implementing regulations (2005 Act) and filed a required notification of that status on February 21, 2006. The 2005 Act requires holding companies and their subsidiaries to grant the Federal Energy Regulatory Commission (FERC) access to books and records relating to FERC’s jurisdictional rates, and also imposes certain record retention, accounting and reporting requirements. However, FERC granted the application of HEI and HECO for a waiver of these record retention, accounting and reporting requirements, effective May 2006.

HEI is subject to an agreement entered into with the PUC (the PUC Agreement) which, among other things, requires HEI to provide the PUC with periodic financial information and other reports concerning intercompany transactions and other matters. It also prohibits the electric utilities from loaning funds to HEI or its nonutility subsidiaries and from redeeming common stock of the electric utility subsidiaries without PUC approval. Further, the PUC could limit the ability of the electric utility subsidiaries to pay dividends on their common stock. See “Restrictions on dividends and other distributions” and “Electric utility—Regulation” below.

As a result of the acquisition of ASB, HEI and ASHI are subject to OTS registration, supervision and reporting requirements as savings and loan holding companies. In the event the OTS has reasonable cause to believe that any activity of HEI or ASHI constitutes a serious risk to the financial safety, soundness or stability of ASB, the OTS is authorized under the Home Owners’ Loan Act of 1933, as amended, to impose certain restrictions on HEI, ASHI and/or any of their subsidiaries. Possible restrictions include precluding or limiting: (i) the payment of dividends by ASB; (ii) transactions between ASB, HEI or ASHI, and their subsidiaries or affiliates; and (iii) the activities of ASB that might expose ASB to the liabilities of HEI and/or ASHI and their other affiliates. See “Restrictions on dividends and other distributions” below.

OTS regulations generally prohibit savings and loan holding companies and their nonthrift subsidiaries from engaging in activities other than those which are specifically enumerated in the regulations. However, the OTS regulations provide for an exemption which is available to HEI and ASHI if ASB satisfies the qualified thrift lender (QTL) test discussed under “Bank—Regulation—Qualified thrift lender test.” ASB met the QTL test at all times during 2009; however, the failure of ASB to satisfy the QTL test in the future could result in a need for HEI to divest ASB. In addition, currently proposed federal legislation could eliminate this exemption. See “Legislation and regulation” in HEI’s MD&A.

Restrictions on dividends and other distributions. HEI is a legal entity separate and distinct from its various subsidiaries. As a holding company with no significant operations of its own, HEI’s principal sources of funds are dividends or other distributions from its operating subsidiaries, borrowings and sales of equity. The rights of HEI and, consequently, its creditors and shareholders, to participate in any distribution of the assets of any of its subsidiaries are subject to the prior claims of the creditors and preferred stockholders of such subsidiary, except to the extent that claims of HEI in its capacity as a creditor are recognized as primary.

The abilities of certain of HEI’s subsidiaries to pay dividends or make other distributions to HEI are subject to contractual and regulatory restrictions. Under the PUC Agreement, in the event that the consolidated common stock equity of the electric utility subsidiaries falls below 35% of the total capitalization of the electric utilities (including the current maturities of long-term debt, but excluding short-term borrowings), the electric utility subsidiaries would, absent PUC approval, be restricted in their payment of cash dividends to 80% of the earnings available for the payment of dividends in the current fiscal year and preceding five years, less the amount of dividends paid during that period. The PUC Agreement also provides that the foregoing dividend restriction shall not be construed as relinquishing any right the PUC may have to review the dividend policies of the electric utility subsidiaries. As of December 31, 2009, the consolidated common stock equity of HEI’s electric utility subsidiaries was 54% of their total capitalization (as calculated for purposes of the PUC Agreement). As of December 31, 2009, HECO and its subsidiaries had common stock equity of $1.3 billion of which approximately $588 million was not available for transfer to HEI without regulatory approval.

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The ability of ASB to make capital distributions to HEI and other affiliates is restricted under federal law. Subject to a limited exception for stock redemptions that do not result in any decrease in ASB’s capital and would improve ASB’s financial condition, ASB is prohibited from declaring any dividends, making any other capital distributions, or paying a management fee to a controlling person if, following the distribution or payment, ASB would be deemed to be undercapitalized, significantly undercapitalized or critically undercapitalized. See “Bank—Regulation—Prompt corrective action.” All capital distributions are subject to a prior indication of no objection by the OTS. Also see Note 12 to HEI’s Consolidated Financial Statements.

HEI and its subsidiaries are also subject to debt covenants, preferred stock resolutions and the terms of guarantees that could limit their respective abilities to pay dividends. The Company does not expect that the regulatory and contractual restrictions applicable to HEI and/or its subsidiaries will significantly affect the operations of HEI or its ability to pay dividends on its common stock.

Environmental regulation. HEI and its subsidiaries are subject to federal and state statutes and governmental regulations pertaining to water quality, air quality and other environmental factors. See the “Environmental regulation” discussions in the “Electric utility” and “Bank” sections below.

Under the terms of the agreement for the sale of YB, HEI and TOOTS had certain environmental obligations arising from conditions existing prior to the sale of YB, including potential obligations regarding petroleum releases in the Honolulu Harbor area. In 2003, TOOTS paid $250,000 to fund response activities related to the Honolulu Harbor area as a one-time cash-out payment in lieu of continuing with further response activities.

Securities ratings.

See the Standard & Poor’s (S&P) and Moody’s Investors Service’s (Moody’s) ratings of HEI’s and HECO’s securities and discussion under “Liquidity and capital resources” (both “HEI Consolidated” and “Electric utility”) in HEI’s MD&A. These ratings reflect only the view, at the time the ratings are issued, of the applicable rating agency from whom an explanation of the significance of such ratings may be obtained. There is no assurance that any such credit rating will remain in effect for any given period of time or that such rating will not be lowered, suspended or withdrawn entirely by the applicable rating agency if, in such rating agency’s judgment, circumstances so warrant. Any such lowering, suspension or withdrawal of any rating may have an adverse effect on the market price or marketability of HEI’s and/or HECO’s securities, which could increase the cost of capital of HEI and HECO. Neither HEI nor HECO management can predict future rating agency actions or their effects on the future cost of capital of HEI or HECO.

Revenue bonds are issued by the Department of Budget and Finance of the State of Hawaii for the benefit of HECO and its subsidiaries, but the source of their repayment are the unsecured obligations of HECO and its subsidiaries under loan agreements and notes issued to the Department, including HECO’s guarantees of its subsidiaries’ obligations. The payment of principal and interest due on revenue bonds currently outstanding and issued prior to 2009 are insured either by Ambac Assurance Corporation, Financial Guaranty Insurance Company, MBIA Insurance Corporation (which bonds have been reinsured by National Public Finance Guarantee Corp.) or Syncora Guarantee Inc. See the discussion of the downgrades of the ratings of these insurers under “Electric Utility—Liquidity and capital resources” in HEI’s MD&A.

Moody’s, in an issuer comment dated February 23, 2010, indicated that it views recent regulatory decisions by the PUC as being credit supportive for the ratings of HEI and HECO, but will not result in any change in ratings or rating outlooks at this time. The issuer comment references the PUC’s February 19, 2010 second interim decision in the HECO 2009 test year rate case and the PUC order approving a joint final statement of position that if implemented would introduce a decoupling mechanism into rates for HECO’s customers (see “Generating reliability and reserve margin” and “Regulation,” respectively, below). The issuer comment states:

Moody’s considers both actions to have positive credit implications for the companies’ near-term and intermediate-term credit profiles. The $12.7 million rate increase for CT1 will have an immediate positive impact on HEI’s and HECO’s earnings and cash flow in 2010 as both companies’ credit metrics remain weak for their current rating due in part to the impact that the Hawaiian economy has had on financial results. Moreover, the Order on decoupling, while not affecting near-term financial results, is an important first step in beginning to address the regulatory lag that has historically affected HEI’s and HECO’s financial results negatively and helps to advance statewide objectives contemplated under the Hawaii Clean Energy Initiative.

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S&P, in a bulletin dated February 25, 2010, indicated that the two recent rulings by the PUC mentioned above do not affect the ratings on HECO or HEI. S&P stated that “the rulings demonstrate progress in managing the full regulatory docket for HECO, but that the ongoing need for timely rate relief remains a factor in the negative outlook assigned to the utility and its parent.” The bulletin further states:

While we view the orders as constructive, delays in rulings are contributing to regulatory lag. The negative outlook also reflects a weak island economy, the parent’s reliance on the utility for distributions given HECO’s growing capital program, and deteriorating credit metrics.

Employees.

As of December 31, 2009, 2008, 2007, 2006 and 2005 the Company had full-time employees as follows:

The utilities’ employee count increased in 2009 due in part to new positions to meet increased workload, to provide staffing for Campbell Industrial Park Combustion Turbine No. 1 (CIP CT-1) and to carry out strategies such as the Hawaii Clean Energy Initiative (HCEI) and related Energy Agreement. ASB’s employee count decreased in 2009 due primarily to staff reductions resulting from ASB’s performance improvement project and the Bishop Insurance Agency closure.

The employees of HEI and its direct and indirect subsidiaries, other than the electric utilities, are not covered by any collective bargaining agreement. As of December 31, 2009, 56% of HECO and its subsidiaries’ employees were covered by collective bargaining agreements. See the discussion of “Collective bargaining agreements” in Note 3 to HEI’s Consolidated Financial Statements.

Properties.

HEI leases office space from nonaffiliated lessors in downtown Honolulu under leases that expire in May 2011. HEI also subleases office space in a downtown Honolulu building leased by HECO under a lease that expires in November 2021, with an option to extend to November 2024.

Electric utility

HECO and subsidiaries and service areas.

HECO, HELCO and MECO are regulated operating electric public utilities engaged in the production, purchase, transmission, distribution and sale of electricity on the islands of Oahu; Hawaii; and Maui, Lanai and Molokai, respectively. HECO acquired MECO in 1968 and HELCO in 1970. In 2009, the electric utilities’ revenues and net income amounted to approximately 88% and 96%, respectively, of HEI’s consolidated revenues and net income, compared to approximately 89% and 102% in 2008 and approximately 83% and 62% in 2007, respectively.

The islands of Oahu, Maui, Lanai, Molokai and Hawaii have a combined population estimated at 1.2 million, or approximately 95% of the Hawaii population, and comprise a service area of 5,766 square miles. The principal communities served include Honolulu (on Oahu), Wailuku and Kahului (on Maui) and Hilo and Kona (on Hawaii). The service areas also include numerous suburban communities, resorts, U.S. Armed Forces installations and agricultural operations. The state has granted HECO, MECO and HELCO nonexclusive franchises, which authorize the utilities to construct, operate and maintain facilities over and under public streets and sidewalks. Each of these franchises will continue in effect for an indefinite period of time until forfeited, altered, amended or repealed.

For additional information about HECO, see HECO’s MD&A, HECO’s “Quantitative and Qualitative Disclosures about Market Risk” and HECO’s Consolidated Financial Statements, which are incorporated by reference into Part II of this Form 10-K.

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Sales of electricity.

The following table sets forth the number of electric customer accounts as of December 31, 2009, 2008 and 2007 and electric sales revenues by company for each of the years then ended:

Seasonality. Kilowatthour (KWH) sales of HECO and its subsidiaries follow a seasonal pattern, but they do not experience the extreme seasonal variation due to extreme weather variations like some electric utilities on the U.S. mainland. KWH sales in Hawaii tend to increase in the warmer summer months, probably as a result of increased demand for air conditioning.

Significant customers. HECO and its subsidiaries derived approximately 10% in 2009, 10% in 2008 and 9% in 2007 of their operating revenues from the sale of electricity to various federal government agencies.

Under a Basic Ordering Agreement (BOA) with the federal Department of Defense (DOD) entered into in 2007, which expires in 2012, and earlier BOAs and other agreements, HECO has completed energy conservation and other projects for federal agencies over the years, although the number of projects completed has decreased through the years.

The Energy Policy Act of 2005 mandated that federal buildings reduce energy consumption by up to 20% by fiscal year 2015 relative to base fiscal year 2003 consumption to the extent that these measures are cost effective. The Act also establishes energy conservation goals at the state level for federally funded programs, stricter conservation measures for a variety of large energy-consuming products and tax credits for energy efficient homes, solar energy, fuel cells and microturbine power plants; and includes other energy-related provisions. Executive Order 13514, adopted in 2009, expanded upon energy reduction and environmental performance requirements set forth in Executive Orders 13123, 13149 and 13423. The Order sets the framework for sustainability goals for Federal agencies including making improvements in environmental, energy, and economic performance. The Order requires agencies to set agency-defined targets for the reduction of greenhouse gas emissions, as well as measure and manage steps to meet those targets. HECO continues to work with various federal agencies to implement measures that will help them achieve their energy reduction objectives.

On October 20, 2008, the Governor of the State of Hawaii, the State of Hawaii Department of Business, Economic Development and Tourism, the Division of Consumer Advocacy of the State of Hawaii Department of Commerce and Consumer Affairs, and HECO, on behalf of itself and its subsidiaries, HELCO and MECO, signed an Energy Agreement, a comprehensive road map that moves Hawaii towards a future where 70% of its electricity and ground transportation needs will come from clean sources by the year 2030. Several facets of the HCEI, such as energy efficiency, advanced metering infrastructure, pricing principles and new programs, are designed to assist all classes of customers in conserving energy, including HECO’s largest customers. See “Hawaii Clean Energy Initiative” in Note 3 to HEI’s Consolidated Financial Statements.

Neither HEI nor HECO management can predict with certainty the impact of these or other governmental mandates or the HCEI on HEI’s or HECO’s future financial condition, results of operations, or liquidity.

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Selected consolidated electric utility operating statistics.

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Generation statistics.

The following table contains certain generation statistics as of, and for the year ended, December 31, 2009. The net generating and firm purchased capability available for operation at any given time may be more or less than shown because of capability restrictions or temporary outages for inspection, maintenance, repairs or unforeseen circumstances.

Generating reliability and reserve margin.

HECO serves the island of Oahu and HELCO serves the island of Hawaii. MECO has three separate electrical systems—one each on the islands of Maui, Molokai and Lanai. HECO, HELCO and MECO have isolated electrical systems that are not currently interconnected to each other or to any other electrical grid and, thus, each maintains a higher level of reserve generation than is typically carried by interconnected mainland U.S. utilities, which are able to share reserve capacity. These higher levels of reserve margins are required to meet peak electric demands, to provide for scheduled maintenance of generating units (including the units operated by IPPs relied upon for firm capacity) and to allow for the forced outage of the largest generating unit in the system.

HECO’s CIP CT-1 was completed and placed into service (i.e., tied into the electrical grid and producing power) on August 3, 2009. With CIP CT-1, HECO’s reserve capacity is sufficient to meet its generating system reliability guideline. See “Clean energy scenario planning, integrated resource planning, requirements for additional generating capacity and adequacy of supply” in HEI’s MD&A under “Electric utility.”

On February 19, 2010, the PUC issued a second interim decision and order (D&O) in the HECO 2009 test year rate case granting HECO an additional increase of $12.7 million in annual revenues. This change was implemented effective February 20, 2010. The second interim increase is to recover the costs related to the CIP CT-1 and related transmission improvements, and is based on a return on average common equity of 10.50%, which was agreed to by the parties for purposes of an interim D&O, and a rate of return of 8.45% on an average rate base of $1.251 billion. In the second interim D&O, the PUC stated that, pending receipt of an operational supply of biodiesel, it will allow HECO to operate CIP CT-1 as a traditional diesel peaking unit, which is more fuel efficient than running the unit only on an emergency basis. HECO will provide a report to the PUC quarterly so the PUC can confirm HECO is making adequate progress in securing an operational supply of biodiesel. The generating unit has been successfully tested on biodiesel, and in December 2009, HECO entered into a two-year contract with Renewable Energy Group Marketing and Logistics, LLC (REG) to supply biodiesel for the unit, subject to PUC approval which is pending. The total of interim increases granted in the 2009 test year rate case amount to $73.8 million or 5.7% in annual revenues over effective rates at the time of the first interim increase, which granted HECO $61.1 million on August 3, 2009. If the amounts collected pursuant to interim decisions exceed the amount of increase ultimately approved in the final D&O,

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then the excess will have to be refunded to HECO’s customers with interest. Management cannot predict the timing, or the ultimate outcome, of a final D&O in this rate case.

Integrated resource planning and clean energy scenario planning.

The PUC issued an order in 1992 requiring the energy utilities in Hawaii to develop integrated resource plans (IRPs), which may be approved, rejected or modified by the PUC. The goal of integrated resource planning is to identify demand- and supply-side resources and integrate these resources for meeting near- and long-term consumer energy needs in an efficient and reliable manner at the lowest reasonable cost. In November 2008, the parties to the Energy Agreement filed requests with the PUC to move from the IRP process to a new Clean Energy Scenario Planning (CESP) process intended to be used to determine future investments in transmission, distribution and generation that will be necessary to facilitate high levels of renewable energy production. In November and December 2008, the PUC closed the utilities’ IRP dockets and directed them to suspend all activities pursuant to the IRP framework to allow for resources to be diverted to the development of CESP frameworks. In May 2009, the PUC opened an investigative proceeding to examine the proposed CESP framework. See “Clean energy scenario planning, integrated resource planning, requirements for additional generating capacity and adequacy of supply” in HEI’s MD&A under “Electric utility.”

Nonutility generation.

The Company has supported state and federal energy policies which encourage the development of renewable energy sources that reduce the use of fuel oil. The Company’s renewable energy sources and potential sources range from wind, solar, photovoltaic, geothermal, wave and hydroelectric power to energy produced by the burning of bagasse (sugarcane waste), municipal waste and other biofuels.

HECO PPAs. HECO currently has three major PPAs. In March 1988, HECO entered into a PPA with AES Barbers Point, Inc. (now known as AES Hawaii, Inc. (AES Hawaii)), a Hawaii-based, indirect subsidiary of The AES Corporation. The agreement with AES Hawaii, as amended, provides that, for a period of 30 years beginning September 1992, HECO will purchase 180 megawatts (MW) of firm capacity. The AES Hawaii 180 MW coal-fired cogeneration plant utilizes a “clean coal” technology and is designed to sell sufficient steam to be a “Qualifying Facility” (QF) under the Public Utility Regulatory Policies Act of 1978 (PURPA). On December 28, 2007, AES Hawaii filed an application with the FERC for a limited waiver of FERC’s operating standard for a qualifying cogeneration facility for 2007 because it determined that it will be unable to meet the QF operating standard for 2007. Under the PPA between HECO and AES Hawaii, any change in QF status does not affect either HECO’s or AES Hawaii’s obligations. In 2003, HECO consented to AES Hawaii’s proposed refinancing and received consideration for its consent, primarily in the form of a PPA amendment that reduced the cost of firm capacity retroactive to June 1, 2003, which benefit is being passed on to ratepayers through a reduction in rates. AES Hawaii also granted HECO an option, subject to certain conditions, to acquire an interest in portions of the AES Hawaii facility site that are not needed for the existing plant operations, and which potentially could be used for the development of another coal-fired facility.

In October 1988, HECO entered into an agreement with Kalaeloa Partners, L.P. (Kalaeloa), a limited partnership, which, through affiliates, contracted to design, build, operate and maintain a QF. The agreement with Kalaeloa, as amended, provided that HECO would purchase 180 MW of firm capacity for a period of 25 years beginning in May 1991. The Kalaeloa facility is a combined-cycle operation, consisting of two oil-fired combustion turbines burning low sulfur fuel oil (LSFO) and a steam turbine that utilizes waste heat from the combustion turbines, and is designed to sell sufficient steam to be a QF. Following two additional amendments, effective in 2005, Kalaeloa currently supplies HECO with 208 MW of firm capacity.

HECO also entered into a PPA in March 1986 and a firm capacity amendment in April 1991 with the City and County of Honolulu with respect to a refuse-fired plant (HPower). The HPower facility currently supplies HECO with 46 MW of firm capacity. Under the amendment, HECO will purchase firm capacity until mid-2015. HPOWER is proposing an expansion to their facility which will provide an additional 27 MW net to HECO beginning in 2012.

HECO purchases energy on an as-available basis from two nonutility generators, which are qualifying cogeneration facilities at two oil refineries, Chevron USA, Inc. (10 MW) and Tesoro Hawaii Corporation (19 MW). Both contracts continue unless a party elects to terminate upon 90 days notice.

The PUC has allowed rate recovery for the purchased energy costs related to HECO’s as-available energy PPAs and for the firm capacity and purchased energy costs related to HECO’s three major PPAs that provide a total of

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434 MW of firm capacity, representing 24% of HECO’s total net generating and firm purchased capacity on Oahu as of December 31, 2009.

HELCO and MECO PPAs. As of December 31, 2009, HELCO has PPAs for 90 MW and MECO has PPAs for 16 MW (includes 4 MW of system protection) of firm capacity, which PPAs have been approved by the PUC.

HELCO has a 35-year PPA with Puna Geothermal Venture (PGV) for 30 MW of firm capacity from its geothermal steam facility, which will expire on December 31, 2027. Since April 2009, PGV’s output has been reduced due to problems with two of its production wells, but expects its output to be restored to 30 MW by June 2010.

In October 1997, HELCO entered into an agreement with Encogen, which has been succeeded by Hamakua Energy Partners, L. P. (HEP). The agreement requires HELCO to purchase up to 60 MW (net) of firm capacity for a period of 30 years, expiring on December 31, 2030. The dual-train combined-cycle DTCC facility, which primarily burns naphtha, consists of two oil-fired combustion turbines and a steam turbine that utilizes waste heat from the combustion turbines.

MECO has a PPA with Hawaiian Commercial & Sugar Company (HC&S) for 16 MW of firm capacity. The HC&S generating units primarily burn bagasse (sugar cane waste) along with secondary fuels of diesel oil or coal. The PPA runs through December 31, 2014, and from year to year thereafter, subject to termination on or after December 31, 2014 on not less than two years’ prior written notice by either party.

HELCO and MECO purchase energy on an as-available basis from a number of nonutility generators, including hydroelectric facilities, windfarms and photovoltaic systems. The PUC has allowed rate recovery for the firm capacity and purchased energy costs for HELCO’s and MECO’s approved firm capacity and as-available energy PPAs.

Fuel oil usage and supply.

The rate schedules of the Company’s electric utility subsidiaries include ECACs under which electric rates (and consequently the revenues of the electric utility subsidiaries generally) are adjusted for changes in the weighted-average price paid for fuel oil and certain components of purchased power, and the relative amounts of company-generated power and purchased power. See discussion of rates and issues relating to the ECAC below under “Rates,” and “Electric utility—Certain factors that may affect future results and financial condition—Regulation of electric utility rates” and “Electric utility–Material estimates and critical accounting policies–Revenues” in HEI’s MD&A.

HECO’s steam generating units burn LSFO. HECO’s combustion turbine peaking units burn diesel fuel (diesel) and B99 and B100 grade biodiesel (biodiesel) and diesel engine generating units burn diesel. HECO’s new CIP CT-1 is being prepared to burn biodiesel. A HECO steam unit is being prepared for a co-firing project to burn a mixture of LSFO and crude palm oil (CPO). MECO’s and HELCO’s steam generating units burn medium sulfur fuel oil (MSFO) and their combustion turbine and diesel engine generating units burn diesel and biodiesel.

In April 2004, HECO executed a 10-year extension of the existing contract, commencing January 1, 2005, for the purchase of LSFO with Tesoro Hawaii Corporation (Tesoro) with no material changes in the primary commercial arrangements including volumes and pricing formulas. In December 2004, HECO executed long-term contracts with Chevron Products Company (Chevron) for the continued use of certain Chevron fuel distribution facilities and for the operation and maintenance of certain HECO fuel distribution facilities. In March and April of 2004, HECO, HELCO and MECO executed 10-year extensions of existing contracts with Chevron and Tesoro, commencing January 1, 2005, for the purchase of diesel and MSFO, including the use of certain petroleum storage and distribution facilities, with no material changes in the primary commercial arrangements including volumes and pricing formulas.

On December 2, 2009, HECO and Chevron executed an amendment to their existing contract. The amendment modified the pricing formula, which could result in higher prices. The amended agreement terminates on April 30, 2013, subject to automatic annual extensions unless either party gives notice of termination, and has been approved by the PUC on an interim basis.

HECO and Tesoro are exploring whether there may be a mutually beneficial amendment to the terms of their LSFO contract.

The electric utilities pay market-related prices for fuel supplies purchased under the Chevron and Tesoro agreements.

In December 2009, HECO signed an operational volume contract with REG for a 2-year biodiesel supply for CIP CT-1, subject to PUC approval, which is pending. HECO will pay for biodiesel purchased under this agreement on the basis of market-related prices for animal fat and other process feedstock.

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In June 2009, HECO signed a one-time CPO supply contract with Sime Darby for use during the steam unit co-firing demonstration project. In June 2009, MECO signed a one-time supply contract with Sime Darby for the purchase of one million gallons of biodiesel for use during its biodiesel demonstration project. PUC applications for contract approval and cost recovery are awaiting PUC decisions and orders (D&Os).

The diesel supplies acquired by the Lanai Division of MECO are purchased under the provisions of a contract with a local petroleum wholesaler, Lanai Oil Co., Inc., which provides for automatic one-year term extensions unless terminated by either party with 180 days notice.

See the fuel oil commitments information set forth in the “Fuel contracts” section in Note 3 to HEI’s Consolidated Financial Statements.

The following table sets forth the average cost of fuel oil used by HECO, HELCO and MECO to generate electricity in the years 2009, 2008 and 2007:

The average per-unit cost of fuel oil consumed to generate electricity for HECO, HELCO and MECO reflects a different volume mix of fuel types and grades as follows:

The prices of LSFO, MSFO and diesel fell in the early months of 2009, continuing the trend from late summer 2008. Fuel prices bottomed in spring 2009, thereafter gradually but steadily rising into the fourth quarter of 2009, such that at the end of 2009, LSFO, MSFO and diesel prices were approximately 30%, 40% and 10%, respectively, above prices at the start of the year. During 2008, the prices of LSFO, MSFO and diesel rose with crude oil prices, peaked in the August-September period, and gradually fell to end the year below the January 2008 level.

In December 2000, HELCO and MECO executed contracts of private carriage with Hawaiian Interisland Towing, Inc. (HITI) for the employment of a double-hull tank barge for the shipment of MSFO and diesel supplies from their fuel suppliers’ facilities on Oahu to storage locations on the islands of Hawaii and Maui, respectively, commencing January 1, 2002. The contracts were extended for a second 5-year term commencing January 1, 2007 and contain options for two additional 5-year extensions. On August 14, 2007 the equity interest of Smith Maritime, Ltd., the parent company of HITI, was acquired by a subsidiary of K-Sea Transportation Partners L.P. (K-Sea), which provides refined petroleum products marine transportation, distribution and logistics services in the U.S. domestic marine transportation industry.

K-Sea never takes title to the fuel oil or diesel fuel, but does have custody and control while the fuel is in transit from Oahu. If there were an oil spill in transit, K-Sea is generally contractually obligated to indemnify HELCO and/or MECO for resulting clean-up costs, fines and damages. K-Sea has liability insurance coverage for oil spill related damage in excess of $1 billion. State law provides a cap of $700 million on liability for releases of heavy fuel oil transported interisland by tank barge. In the event of a release, HELCO and/or MECO may be responsible for any clean-up, damages, and/or fines that K-Sea or its insurance carrier does not cover.

The prices that HECO, HELCO and MECO pay for purchased energy from nonutility generators are generally linked to the price of oil. The AES Hawaii energy prices vary primarily with an inflation indicator. The energy prices for Kalaeloa, which purchases LSFO from Tesoro, vary primarily with world LSFO prices. The HPower, HC&S and PGV energy prices are based on the electric utilities’ respective PUC-filed short-run avoided energy cost rates (which vary with their respective composite fuel costs), subject to minimum floor rates specified in their approved PPAs. HEP energy prices vary primarily with HELCO’s diesel costs.

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The Company estimates that 74% of the net energy generated and purchased by HECO and its subsidiaries in 2010 will be generated from the burning of fossil fuel oil. HECO generally maintains an average system fuel inventory level equivalent to 35 days of forward consumption. HELCO and MECO generally maintain an average system fuel inventory level equivalent to approximately one month’s supply of both MSFO and diesel. The PPAs with AES Hawaii and HEP require that they maintain certain minimum fuel inventory levels.

Rates.

HECO, HELCO and MECO are subject to the regulatory jurisdiction of the PUC with respect to rates, issuance of securities, accounting and certain other matters. See “Regulation” below.

All rate schedules of HECO and its subsidiaries contain ECACs as described previously. Under current law and practices, specific and separate PUC approval is not required for each rate change pursuant to automatic rate adjustment clauses previously approved by the PUC. All other rate increases require the prior approval of the PUC after public and contested case hearings. PURPA requires the PUC to periodically review the ECACs of electric and gas utilities in the state, and such clauses, as well as the rates charged by the utilities generally, are subject to change. Further, Act 162 may impact the ECACs. See Act 162 discussion in “Energy cost adjustment clauses” under “Commitments and contingencies” in Note 3 to HEI’s Consolidated Financial Statements.

See “Electric utility–Most recent rate requests,” “Electric utility–Decoupling proceeding,” “Electric utility–Certain factors that may affect future results and financial condition–Regulation of electric utility rates” and “Electric utility–Material estimates and critical accounting policies–Revenues” in HEI’s MD&A and “Hawaii Clean Energy Initiative–Decoupling rates form sales,” “Interim increases,” “Energy cost adjustment clauses” and “Major projects–CIP CT-1 and transmission line” under “Commitments and contingencies” in Note 3 to HEI’s Consolidated Financial Statements. For a discussion of the PUC’s February 19, 2010 orders granting a second interim increase in HECO’s 2009 test year rate case and granting interim approval of HECO’s and the Consumer Advocate’s Joint Proposal on decoupling rates from sales, see “Generating reliability and reserve margin” above and “Regulation” below, respectively.

Public Utilities Commission and Division of Consumer Advocacy of the Department of Commerce and Consumer Affairs of the State of Hawaii.

Serving as Chairman of the PUC is Carlito P. Caliboso (whose term expires in June 2010), an attorney previously in private practice. Also serving as commissioners are: (1) John E. Cole (whose term expires in June 2012), who previously served as the Executive Director of the Division of Consumer Advocacy and, prior to holding that position, served as a member of the Governor of the State of Hawaii’s Policy Team, and (2) Leslie Kondo (whose term expires in June 2014), an attorney previously in private practice and who previously served as the Director of the State of Hawaii Office of Information Practices.

Effective December 7, 2009, serving as Executive Director of the Division of Consumer Advocacy is Dean Nishina, a certified public accountant who previously served as the Utilities/Transportation Administrator and Chief Auditor for the Division of Consumer Advocacy.

Competition.

See “Electric utility–Certain factors that may affect future results and financial condition–Competition” in HEI’s MD&A.

Electric and magnetic fields.

The generation, transmission and use of electricity produces low-frequency (50Hz-60Hz) electrical and magnetic fields (EMF). While EMF has been classified as a possible human carcinogen by more than one public health organization and remains the subject of ongoing studies and evaluations, no definite causal relationship between EMF and health risks has been clearly demonstrated to date and there are no federal standards in the U.S. limiting occupational or residential exposure to 50Hz-60Hz EMF. HECO and its subsidiaries are continuing to monitor the ongoing research and continue to participate in utility industry funded studies on EMF and, where technically feasible and economically reasonable, continue to pursue a policy of prudent avoidance in the design and installation of new transmission and distribution facilities. Management cannot predict the impact, if any, the EMF issue may have on HECO, HELCO and MECO in the future.

Global climate change and greenhouse gas (GHG) emissions reduction.

The Company shares the concerns of many regarding the potential effects of global warming and the human contributions to this phenomenon, including burning of fossil fuels for electricity production, transportation, manufacturing and agricultural activities, as well as deforestation. Recognizing that effectively addressing global warming requires commitment by the private sector, all levels of government, and the public, the Company is committed to taking direct action to mitigate greenhouse gas

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emissions from its operations. See “Environmental regulation—Global climate change and greenhouse gas (GHG) emissions reduction” under “Commitments and contingencies” in Note 3 to HEI’s Consolidated Financial Statements.

Legislation.

See “Electric utility–Legislation and regulation” in HEI’s MD&A.

Commitments and contingencies.

See “HEI Consolidated–Selected contractual obligations and commitments” in HECO’s MD&A and “Electric utility–Certain factors that may affect future results and financial condition–Other regulatory and permitting contingencies” in HEI’s MD&A, Item 1A. Risk Factors, and Note 3 to HEI’s Consolidated Financial Statements for a discussion of important commitments and contingencies, including (but not limited to) fuel contracts, PPAs, interim increases, HCEI, ECACs, major projects, the Honolulu Harbor environmental investigation and response, compliance with environmental regulations, disputes with third parties and collective bargaining agreements.

Regulation.

The PUC regulates the rates, issuance of securities, accounting and certain other aspects of the operations of HECO and its electric utility subsidiaries. See the previous discussion under “Rates” and the discussions under “Electric utility–Results of operations–Most recent rate requests” and “Electric utility–Certain factors that may affect future results and financial condition–Regulation of electric utility rates” in HEI’s MD&A.

Any adverse decision or policy made or adopted by the PUC, or any prolonged delay in rendering a decision, could have a material adverse effect on consolidated HECO’s and the Company’s financial condition, results of operations or liquidity.

On October 20, 2008, HECO signed an Energy Agreement (see “Significant customers” above and Note 3 to HEI’s Consolidated Financial Statements) setting forth goals, objectives and actions with the purpose of decreasing Hawaii’s dependence on imported fossil fuels through substantial increases in the use of renewable energy and implementation of new programs intended to secure greater energy efficiency and conservation. As a result of the Energy Agreement, in May 2009, the PUC opened an investigative proceeding to examine a proposed Clean Energy Scenario Planning (CESP) framework which is intended to be used to determine future investments in transmission, distribution and generation that will be necessary to facilitate high levels of renewable energy production, and to replace the existing integrated resource planning process. The PUC is also reviewing a number of HECO applications to implement Energy Agreement commitments, including feed-in tariffs. On February 19, 2010, the PUC issued a D&O approving the joint final statement of position on decoupling submitted by the utilities and the Consumer Advocate in May 2009, as amended by subsequent filings and modified by proposals in HECO’s motion for interim approval, subject to the PUC’s final D&O in the proceeding. Generally, the effect of such filings and proposals would be to: decouple revenues from usage and allow a periodic true-up of sales revenues through a revenue balancing account; provide an annual adjustment to electric revenues to account for indexed changes in expenses through a revenue adjustment mechanism; and, provide an annual revenue adjustment mechanism to account for capital additions during the year. HECO and the Consumer Advocate are required to jointly prepare and file a proposed final D&O to define implementation details of the February 19, 2010 D&O within 30 days for the PUC’s review and approval. The other parties in the docket will have an opportunity to comment on the proposed final D&O within five days of such filing. Management cannot predict the timing or the ultimate outcome of the final D&O in this proceeding.

In 2009, the State Legislature amended Hawaii’s RPS law to require electric utilities to meet an RPS of 10%, 15%, 25% and 40% by December 31, 2010, 2015, 2020 and 2030, respectively. The amended RPS law is consistent with the commitment in the Energy Agreement.

Certain transactions between HEI’s electric public utility subsidiaries (HECO, HELCO and MECO) and HEI and affiliated interests are subject to regulation by the PUC. An “affiliated interest” is defined by statute and includes officers and directors of a public utility, every person owning or holding, directly or indirectly, 10% or more of the voting securities of a public utility, and corporations which have in common with a public utility more than one-third of the directors of that public utility. All contracts (including summaries of unwritten agreements) made on or after July 1, 1988 of $300,000 or more in a calendar year for management, supervisory, construction, engineering, accounting, legal, financial and similar services and for the sale, lease or transfer of property between a public utility and affiliated interests must be filed with the PUC to be effective, and the PUC may issue cease and desist orders if such contracts are not filed. All such “affiliated contracts” for capital expenditures (except for real property) must be accompanied by comparative price quotations from two nonaffiliates, unless the quotations cannot be obtained without substantial

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expense. Moreover, all transfers of $300,000 or more of real property between a public utility and affiliated interests require the prior approval of the PUC and proof that the transfer is in the best interest of the public utility and its customers. If the PUC, in its discretion, determines that an affiliated contract is unreasonable or otherwise contrary to the public interest, the utility must either revise the contract or risk disallowance of the payments for ratemaking purposes. In ratemaking proceedings, a utility must also prove the reasonableness of payments made to affiliated interests under any affiliated contract of $300,000 or more by clear and convincing evidence.

In December 1996, the PUC issued an order in a docket that had been opened to review the relationship between HEI and HECO and the effects of that relationship on the operations of HECO. The order adopted the report of the consultant the PUC had retained and ordered HECO to continue to provide the PUC with periodic status reports on its compliance with the PUC Agreement (pursuant to which HEI became the holding company of HECO). HECO files such status reports annually. In the order, the PUC also required HECO, HELCO and MECO to present a comprehensive analysis of the impact that the holding company structure and investments in nonutility subsidiaries have on a case-by-case basis on the cost of capital to each utility in future rate cases and remove any such effects from the cost of capital. The PUC has not disputed, in subsequent rate cases, the presentations made by HECO, HELCO and MECO that there was no evidence that would modify the PUC’s finding that HECO’s access to capital did not suffer as a result of HEI’s involvement in nonutility activities and that HEI’s diversification did not permanently raise or lower the cost of capital incorporated into the rates paid by HECO’s utility customers.

HECO and its electric utility subsidiaries are not subject to regulation by the Federal Energy Regulatory Commission under the Federal Power Act, except under Sections 210 through 212 (added by Title II of PURPA and amended by the Energy Policy Act of 1992), which permit the Federal Energy Regulatory Commission to order electric utilities to interconnect with qualifying cogenerators and small power producers, and to wheel power to other electric utilities. Title I of PURPA, which relates to retail regulatory policies for electric utilities, and Title VII of the Energy Policy Act of 1992, which addresses transmission access, also apply to HECO and its electric utility subsidiaries. HECO and its electric utility subsidiaries are also required to file various operational reports with the Federal Energy Regulatory Commission. The Company cannot predict the extent to which cogeneration or transmission access will reduce its electrical loads, reduce its current and future generating and transmission capability requirements or affect its financial condition, results of operations or liquidity.

Because they are located in the State of Hawaii, HECO and its subsidiaries are exempt by statute from limitations set forth in the Powerplant and Industrial Fuel Use Act of 1978 on the use of petroleum as a primary energy source.

See also “HEI—Regulation” above.

Environmental regulation. HECO, HELCO and MECO, like other utilities, are subject to periodic inspections by federal, state, and in some cases, local environmental regulatory agencies, including, but not limited to, agencies responsible for regulation of water quality, air quality, hazardous and other waste, and hazardous materials. These inspections may result in the identification of items needing corrective or other action. When the corrective or other necessary action is taken, no further regulatory action is expected. Except as otherwise disclosed in this report (see “Certain factors that may affect future results and financial condition—Environmental matters” for HEI Consolidated, the Electric utility and the Bank sections in HEI’s MD&A and Note 3 to HEI’s Consolidated Financial Statements, which are incorporated herein by reference), the Company believes that each subsidiary has appropriately responded to environmental conditions requiring action and that, as a result of such actions, such environmental conditions will not have a material adverse effect on the Company or HECO.

Water quality controls. The generating stations, substations and other utility subsidiaries facilities operate under federal and state water quality regulations and permits, including but not limited to the Clean Water Act National Pollution Discharge Elimination System (governing point source discharges, including wastewater and storm water discharges), Underground Injection Control (regulating disposal of wastewater into the subsurface), the Spill Prevention, Control and Countermeasure (SPCC) program, the Oil Pollution Act of 1990 (OPA), and other regulations associated with discharges of oil and other substances to surface water.

OPA governs actual or threatened oil releases and establishes strict and joint and several liability for responsible parties for (1) oil removal costs incurred by the federal government or the state, and (2) damages to natural resources and real or personal property. Responsible parties include vessel owners and operators of on-shore facilities. OPA imposes fines and jail terms ranging in severity depending on how the release was caused.

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During 2009 and up through February 25, 2010, HECO, HELCO and MECO did not experience any significant petroleum releases. See the discussion concerning the ongoing Honolulu Harbor investigation under “Environmental regulation” in Note 3 to HEI’s Consolidated Financial Statements. Except as otherwise disclosed, the Company believes that each subsidiary’s costs of responding to petroleum releases to date will not have a material adverse effect on the respective subsidiary or the Company.

EPA regulations under OPA also require certain facilities that store petroleum to prepare and implement SPCC Plans in order to prevent releases of petroleum to navigable waters of the U.S. HECO, HELCO and MECO facilities subject to the SPCC program are in compliance with these requirements. In July 2002, the EPA amended the SPCC regulations to include facilities, such as substations, that use (as opposed to store) petroleum products. HECO, HELCO and MECO have determined that the amended SPCC program applies to a number of their substations. Since 2002, the EPA issued several extensions of the compliance dates for the amended regulations. The final compliance date is now November 10, 2010. HECO, HELCO and MECO have been developing and implementing SPCC plans for all facilities that are subject to the amended SPCC requirements and will be in full compliance by the final compliance date.

For a discussion of section 316(b) of the federal Clean Water Act, related U.S. Environmental Protection Agency (EPA) rules and their possible application to the electric utilities, see “Environmental regulation” in Note 3 to HEI’s Consolidated Financial Statements.

Air quality controls. The generating stations of the utility subsidiaries operate under air pollution control permits issued by the Department of Health of the State of Hawaii (DOH) and, in a limited number of cases, by the EPA. The entire electric utility industry has been affected by the 1990 amendments to the Clean Air Act (CAA), changes to the National Ambient Air Quality Standard (NAAQS) for ozone, and adoption of a NAAQS for fine particulate matter. See “Electric utility—Legislation and regulation—Air quality regulation” in HEI’s MD&A for recent EPA actions to NAAQS.

For discussions of the July 1999 Regional Haze Rule amendments, EPA Hazardous Air Pollutant control regulation, and the global climate change and greenhouse gas emissions reduction and their possible applicability to the electric utility, see “Environmental regulation” in Note 3 to HEI’s Consolidated Financial Statements.

CAA operating permits (Title V permits) have been issued for all affected generating units.

Hazardous waste and toxic substances controls. The operations of the electric utility and former freight transportation subsidiaries of HEI are subject to EPA regulations that implement provisions of the Resource Conservation and Recovery Act (RCRA), the Superfund Amendments and Reauthorization Act (SARA) and the Toxic Substances Control Act. In 2001, the DOH obtained primacy to operate state-authorized RCRA (hazardous waste) programs.

Both federal and state RCRA provisions identify certain wastes as hazardous and set forth measures that must be taken in the handling, storage, treatment, disposal and transportation of these wastes. Some wastes generated at steam electric generating stations possess characteristics that subject them to RCRA regulations. Since October 1986, all HECO generating stations have operated RCRA-exempt wastewater treatment units to treat potentially regulated wastes from occasional boiler waterside and fireside cleaning operations. Steam generating stations at MECO and HELCO also operate similar RCRA-exempt wastewater management systems.

The EPA issued a final regulatory determination on May 22, 2000, concluding that fossil fuel combustion wastes do not warrant regulation as hazardous under RCRA. This determination allows for more flexibility in waste management strategies. The electric utilities’ waste characterization programs continue to demonstrate the adequacy of the existing treatment systems. Waste recharacterization studies indicate that treatment facility waste streams are nonhazardous.

RCRA underground storage tank (UST) regulations require all facilities with USTs used for storing petroleum products to comply with leak detection, spill prevention and new tank standard retrofit requirements. All HECO, HELCO and MECO USTs currently meet these standards and continue in operation.

The Emergency Planning and Community Right-to-Know Act under SARA Title III requires HECO, HELCO and MECO to report potentially hazardous chemicals present in their facilities in order to provide the public with information so that emergency procedures can be established to protect the public in the event of hazardous chemical releases. All HECO, HELCO and MECO facilities are in compliance with applicable annual reporting requirements to the State Emergency Planning Commission, the Local Emergency Planning Committee and local fire

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departments. Since January 1, 1998, the steam electric industry category has been subject to Toxics Release Inventory (TRI) reporting requirements. All HECO, HELCO and MECO facilities are in compliance with TRI reporting requirements.

The Toxic Substances Control Act (TSCA) regulations specify procedures for the handling and disposal of polychlorinated biphenyls (PCB), a compound found in some transformer and capacitor dielectric fluids. The TSCA regulations also apply to responses to releases of PCB to the environment. HECO, HELCO and MECO have instituted procedures to monitor compliance with these regulations. In addition, HECO and its subsidiaries have implemented a program to identify and replace PCB transformers and capacitors in their systems. Management believes that all HECO, HELCO and MECO facilities are currently in compliance with PCB regulations.

Hawaii’s Environmental Response Law, as amended (ERL), governs releases of hazardous substances, including oil, to the environment in areas within the state’s jurisdiction. Responsible parties under the ERL are jointly, severally and strictly liable for a release of a hazardous substance. Responsible parties include owners or operators of a facility where a hazardous substance comes to be located and any person who at the time of disposal of the hazardous substance owned or operated any facility at which such hazardous substance was disposed. The DOH issued final rules (the State Contingency Plan) implementing the ERL in August 1995.

HECO, HELCO and MECO, like other utilities, periodically identify leaking petroleum-containing equipment such as USTs, piping and transformers. In a few instances, small amounts of PCBs have been identified in the leaking equipment. Each subsidiary reports releases from such equipment when and as required by applicable law and addresses impacts due to the releases in compliance with applicable regulatory requirements.

Research and development.

HECO and its subsidiaries expensed approximately $4.4 million, $4.0 million and $4.0 million in 2009, 2008 and 2007, respectively, for research and development (R&D). In 2009, 2008 and 2007, the electric utilities’ contributions to the Electric Power Research Institute (EPRI) accounted for approximately half of the R&D expenses. There were also utility expenditures in 2009, 2008 and 2007 related to new technologies, customer use and pricing (e.g., peak pricing and tiered rates base on usage), biofuels and other renewables (e.g., wind power integration).

Properties.

The utilities own transmission lines, distribution lines, underground cables, poles (some jointly) and towers. Electric lines are located over or under public and nonpublic properties. Lines are added when needed to serve increased loads and/or for reliability reasons. In some design districts on Oahu, lines must be placed underground. Under Hawaii law, the PUC generally must determine whether new 46 kilovolt (kV), 69 kV or 138 kV lines can be constructed overhead or must be placed underground.

See “HECO and subsidiaries and service areas” above for a discussion of the nonexclusive franchises of HECO and subsidiaries. Most of the leases, easements and licenses for HECO’s, HELCO’s and MECO’s lines have been recorded.

See “Generation statistics” above and “Limited insurance” in HEI’s MD&A for a further discussion of some of the electric utility properties.

HECO owns and operates four generating plants on the island of Oahu at Honolulu, Waiau, Kahe and Campbell Industrial Park. These plants, along with distributed generators (at three substation sites, at HECO’s Kalaeloa pole yard and at HECO’s Iwilei tank farm), have an aggregate net generating capability of 1,351.1 MW as of December 31, 2009. The four plants are situated on HECO-owned land having a combined area of 555 acres and one 3-acre parcel of land under a lease expiring December 31, 2018. In addition, HECO owns a total of 139 acres of land on which substations, transformer vaults, distribution baseyards and the Kalaeloa cogeneration facility are located.

HECO owns overhead transmission lines, overhead distribution lines, underground cables, poles (fully owned or jointly owned) and steel or aluminum high voltage transmission towers. The transmission system operates at 46 kV and 138 kV. The total capacity of HECO’s transmission and distribution substations was 7,035,000 kilovoltamperes as of December 31, 2009.

HECO owns buildings and approximately 11.6 acres of land located in Honolulu which houses its operating, engineering and information services departments and a warehousing center. It also leases an office building and certain office spaces in Honolulu. The lease for the office building expires in November 2021, with an option to extend through November 2024. The leases for certain office spaces expire on various dates from November 30, 2010 through November 30, 2017 with options to extend to various dates through January 31, 2020.

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HECO owns land at Campbell Industrial Park used to situate fuel storage facilities with a combined usable capacity of 844,847 barrels of fuel, which land is included in the power plant acreage above. HECO also has fuel storage facilities at each of its plant sites with a combined usable capacity of 874,269 barrels, as well as underground fuel pipelines that transport fuel from HECO’s tank farm at Campbell Industrial Park to HECO’s power plants at Waiau and Kahe. HECO also owns a fuel storage facility at its Iwilei site with a combined usable capacity of 76,739 barrels, and an underground pipeline that transports fuel from that site to its Honolulu power plant.

HELCO owns and operates five generating plants on the island of Hawaii, two at Hilo and one at each of Waimea, Keahole and Puna, along with distributed generators at substation sites. These plants have an aggregate net generating capability of 195.5 MW as of December 31, 2009 (excluding several small run-of-river hydro units and a small windfarm). The plants are situated on HELCO-owned land having a combined area of approximately 44 acres. The distributed generators are located within HELCO-owned substation sites having a combined area of approximately 4 acres. HELCO also owns fuel storage facilities at these sites with a total maximum usable capacity of 66,387 barrels of bunker oil, and 83,819 barrels of diesel. There are an additional 30,341 barrels of diesel and 22,770 barrels of bunker oil storage capacity for HELCO-owned fuel off-site at Chevron-owned terminalling facilities. HELCO pays a storage fee to Chevron and has no other interest in the property, tanks or other infrastructure situated on Chevron’s property. HELCO also owns 6 acres of land in Kona, which is used for a baseyard, and one acre of land in Hilo, which houses its accounting, customer services and administrative offices. HELCO also leases 3.7 acres of land for its baseyard in Hilo under a lease expiring in 2030. In addition, HELCO owns a total of approximately 100 acres of land, and leases a total of approximately 8.5 acres of land, on which hydro facilities, substations and switching stations, microwave facilities, and transmission lines are located. The deeds to the sites located in Hilo contain certain restrictions, but the restrictions do not materially interfere with the use of the sites for public utility purposes. HELCO occupies 78 acres of land (located in Kamuela on the island of Hawaii) for the Lalamilo windfarm (with an aggregate net capability of 0.3 MW as of December 31, 2009), pursuant to a long-term agreement with the Water Commission of the County of Hawaii expiring in 2010. HELCO is making preparations to dismantle the site and return it to the Water Commission of the County of Hawaii by the end of the current lease term.

MECO owns and operates two generating plants on the island of Maui, at Kahului and Maalaea, with an aggregate net generating capability of 246.3 MW as of December 31, 2009. The plants are situated on MECO-owned land having a combined area of 28.6 acres. MECO also owns fuel oil storage facilities at these sites with a total maximum usable capacity of 176,355 barrels of fuel. MECO owns two 1 MW stand-by diesel generators and a 6,000 gallon fuel storage tank located in Hana. MECO owns 65.7 acres of undeveloped land at Waena. Prior to September 12, 2007, the Waena land was used for agricultural purposes by the former landowner under a license agreement dated November 19, 1996. On September 12, 2007, the parties executed an amendment, which terminated the license with respect to a portion of the property measuring approximately 15 acres, which has been identified as the site for a proposed biofuel plant. The September 12, 2007 amendment extended the term of the license for the remainder of the parcel on a month-to-month basis, terminable by either party upon thirty days written notice until the area is required for development by MECO for utility purposes, or until July 31, 2009, whichever occurs first. MECO is presently negotiating another amendment to the license which would allow the former land owner to continue to use the remainder of the parcel for agricultural purposes.

MECO’s administrative offices and engineering and distribution departments are located on 9.1 acres of MECO-owned land in Kahului.

MECO also owns and operates smaller distribution systems, generation systems (with an aggregate net capability of 21.9 MW as of December 31, 2009) and fuel storage facilities on the islands of Lanai and Molokai, primarily on land owned by MECO.

Bank

General.

ASB was granted a federal savings bank charter in January 1987. Prior to that time, ASB had operated since 1925 as the Hawaii division of American Savings & Loan Association of Salt Lake City, Utah. As of December 31, 2009, ASB was one of the largest financial institutions in the State of Hawaii based on total assets of $4.9 billion and deposits of $4.1 billion. In 2009, ASB’s revenues and net income amounted to approximately 12% and 26% of HEI’s consolidated revenues and net income, respectively, compared to approximately 11% and 20% in 2008 and approximately 17% and 63% in 2007, respectively.

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At the time of HEI’s acquisition of ASB in 1988, HEI agreed with the OTS’ 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 insure 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, 2009, as a result of certain HEI contributions of capital to ASB, HEI’s maximum obligation to contribute additional capital has been reduced to approximately $28.3 million. ASB is subject to OTS regulations on dividends and other distributions applicable to financial institutions and ASB must receive a letter of non-objection from the OTS before it can declare and pay a dividend to HEI.

ASB’s earnings depend primarily on its net interest income—the difference between the interest income earned on earning assets (loans receivable and investment and mortgage-related securities) and the interest expense incurred on costing liabilities (deposit liabilities and other borrowings, including advances from the Federal Home Loan Bank (FHLB) of Seattle and securities sold under agreements to repurchase). Other factors affecting ASB’s operating results include its provision for loan losses, fee income, other noninterest income (including gains and losses on sales of securities and notes and other-than-temporary impairments of securities) and noninterest expenses (including the loss on the early extinguishment of debt due to the balance sheet restructuring in June 2008).

For additional information about ASB, see the sections under “Bank” in HEI’s MD&A, HEI’s “Quantitative and Qualitative Disclosures about Market Risk” and Note 4 to HEI’s Consolidated Financial Statements.

The following table sets forth selected data for ASB for the years indicated (average balances calculated using the average daily balances):

All of the foregoing ratios and returns for 2009 were adversely affected by ASB’s sale of its private-issue mortgage-related securities portfolio. All of the foregoing ratios and returns for 2008 were adversely affected by ASB’s restructuring of its balance sheet in June 2008.

ASB’s tangible efficiency ratio – the cost of earning $1 of revenue – increased from 66% in 2007 to 72% in 2009, primarily due to losses related to the sale of the private-issue mortgage-related securities portfolio and other-than-temporary impairment (OTTI) charges on ASB’s securities portfolio in 2009. The increase in tangible efficiency ratio for 2008 was due to charges to noninterest income and noninterest expenses as a result of the restructuring of its balance sheet.

Consolidated average balance sheet.

See “Average balance sheet and net interest margin” in HEI’s MD&A.

In 2009, average investment and mortgage-related securities decreased by $796.7 million due to the restructuring of the balance sheet in 2008, portfolio repayments and the sale of the private-issue mortgage-related securities portfolio in the fourth quarter of 2009. Average loans receivable decreased by $235.2 million, while average other investments increased by $114.0 million. ASB’s decision to sell substantially all of the fixed-rate mortgages it originated throughout 2009, weak loan demand and challenges in finding investments with adequate risk-adjusted returns resulted in declining loan balances and an increase in the bank’s liquidity position. The average residential mortgage portfolio decreased by $314.9 million, or 11.1% lower than 2008. The average home equity line of credit loan portfolio grew by $65.6 million, or 27.3% over 2008. The average commercial markets loan portfolio grew by $38.8 million, or 7.3% over 2008. Average deposit balances decreased in 2009 by $140.0 million, as ASB experienced a $337.4 million outflow of term certificates, partially offset by an increase of $197.4 million of core deposits. Average other borrowings for 2009 decreased by $754.9 million compared to 2008 due to the early

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extinguishment of other borrowings in the balance sheet restructuring in 2008 and the paydown of maturing other borrowings in 2009 with excess liquidity.

In 2008, average investment and mortgage-related securities decreased by $927 million primarily due to the restructuring of ASB’s balance sheet which included the sale of mortgage-related securities and agency notes.

In 2008, average loans receivable increased by $248.6 million, or 6.3%, over 2007 average loans receivable. The growth in the loan portfolio was due to growth in home equity lines of credit, continued growth in commercial market loans and residential loans purchased. The average residential mortgage portfolio balance grew by $158.4 million, or 5.5%, over 2007. The average commercial loan portfolio balance increased by $66.6 million, or 14.3%, due to higher originations. The average home equity line of credit loan portfolio balance grew by $42.0 million, or 21.9%, due to higher originations. The average commercial real estate loan portfolio balance was $13.4 million, or 4.2%, lower than 2007 primarily due to repayments of construction loans. Average consumer loan balances in 2008 also decreased by $2.6 million, or 3.3%, over 2007. Average deposit balances decreased in 2008 by $183.5 million, as the downward trend in interest rates made it difficult to retain interest-bearing deposits. Average other borrowings decreased in 2008 by $531.8 million compared to 2007 due to the early extinguishment of other borrowings in the balance sheet restructuring.

Asset/liability management.

See HEI’s “Quantitative and Qualitative Disclosures about Market Risk” in HEI’s Annual Report.

Interest income and interest expense.

See “Results of operations—Bank” in HEI’s MD&A for a table of average balances, interest and dividend income, interest expense and weighted-average yields earned and rates paid for certain categories of earning assets and costing liabilities for the years ended December 31, 2009, 2008 and 2007.

The following table shows for the periods indicated the effect on net interest income of (1) changes in interest rates (change in weighted-average interest rate multiplied by prior year average balance) and (2) changes in volume (change in average balance multiplied by prior period weighted-average interest rate). Any remaining change is allocated to the above two categories on a prorata basis.

Noninterest income.

In addition to net interest income, ASB has various sources of noninterest income, including fee income from credit and debit cards and fee income from deposit liabilities and other financial products and services. Noninterest income totaled approximately $29.9 million in 2009, $46.1 million in 2008 and $68.4 million in 2007. In 2009, the decrease in noninterest income was due to losses related to the sale of the private-issue mortgage-related securities ($32.1 million) and OTTI charges on eleven mortgage-related securities ($15.4 million). The decrease in noninterest income in 2008 compared to 2007 was primarily due to the loss on sale of securities from the balance sheet restructuring ($19.3 million) and OTTI charges on two mortgage-related securities ($7.8 million).

Lending activities.

General. Loans of $3.7 billion represented 74.3% of total assets as of December 31, 2009, compared to $4.2 billion, or 77.4%, and $4.1 billion, or 59.8%, as of December 31, 2008 and 2007, respectively. The decrease in the loans receivable balance in 2009 was primarily due to the bank’s decision to sell substantially all of its 2009 residential loan production. The increase in loans receivable in 2008 was primarily due to growth in home equity lines of credit and commercial markets loans. ASB’s loan portfolio consists primarily of residential 1-4 family mortgage loans.

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The following table sets forth the composition of ASB’s loan portfolio as of the dates indicated:

The following table summarizes ASB’s loan portfolio as of December 31, 2009 and 2008, excluding loans held for sale and undisbursed commercial real estate construction and development loan funds, based upon contractually scheduled principal payments and expected prepayments allocated to the indicated maturity categories: