HA Sustainable Infrastructure Capital, Inc. (HASI) Q3 2015 Earnings Report, Transcript and Summary

Good afternoon and welcome to Hannon Armstrong's Conference Call on its Q3 2015 Financial Results. Management will be utilizing a slide presentation for this call which is now available for download on their Investor Relations page at investors.hannonarmstrong.com. [Operator Instructions] At this time, I would like to turn the conference call over to Amanda Cimaglia, Investor Relations Manager for the company.

Thank you, operator. Good afternoon, everyone. By now you should have received a copy of the earnings release for the company's 2015 third quarter results. On the call today, we have Jeffrey Eckel, our President and CEO; and Brendan Herron, our CFO. As a reminder, a replay of this call will be available later today on the Investor Relations page of our website. Before we begin, I would like to remind you that some of the comments made on today's call are forward-looking statements and within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities and Exchange Act of 1934 as amended. The company claims the protections of the Safe Harbor for forward-looking statements contained in such sections. The forward-looking statements made in this call are subject to the risks and uncertainties described in the risk factor section of the company's Form 10-K and other filings with the SEC. Actual results may differ materially from those described during the call. In addition, all forward-looking statements are made as of today, and the company does not undertake any responsibility to update any forward-looking statements based on new circumstances or revised expectations. With that, I'd like to turn the call over to Jeff, who will begin on Slide 3. Jeff?

Thanks, Amanda. Good afternoon. Today we are announcing core earnings of $8.5 million for the quarter or $0.26 per share, which when annualized is approximately 5.8% dividend yield. We closed over $140 million of transactions in Q2, which was on the low end but primarily due to a few key transactions slipping into early October. Still, year-to-date volume is up 18% over this time last year. We were pleased to complete our second sustainable yield bond with an A rating, a 19-year term and the first green bound to have a carbon count rating. Subsequent to the quarter and we completed a $100 million follow-on offering. Today we reaffirm our annual earnings growth guidance in the 14% to 16% range for 2015, taking into account the added share count in Q4 and reaffirm 14% to 16% for 2016 as well. Turning to Slide 4, we've consistently heard two questions from investors; what is our exposure to YieldCo's, and what is going on in our markets. Our exposure to assets owned by YieldCo's or apparent with the intent to drop into YieldCo is less than 15%. We have investments in and senior project level debt and land. Consistent with our underwriting criteria, all of our YieldCo exposure is based on project cash flows, not the credit support of the project owner. In addition to these exposures, we have approximately $160 million in cross-collateralized residential solar assets with Sun Power as the sponsor. As for the market question, we are experiencing welcome increases in pricing across asset classes driven in part by increasing credit spreads and equity yield requirements. For instance, the 10-year Triple B spread over treasuries is up almost 40 basis points over the last six months, and this is a positive trend for Hannon Armstrong. We continue to believe the diversification of our portfolio across sponsors, obligors, technology and projects is a real strength of our business model. Building on the theme of our well diversified portfolio please turn to Page 5 which explains why we invest where we do. We invest across a number of diverse asset classes in order to get the best risk-adjusted yields. In general, we sit senior to investors in the electric utility industry, senior to the equity sponsors of asset owners such as YieldCo's, and senior to the vendors of the distributed energy assets such as rooftop solar and efficiency. The efficiency market continues to be robust in all sectors including Federal, state and local, industrial, and in the commercial pace market. These are consistently the highest rated transactions in our portfolio, often with a government obligor. Distributed solar has many of the same financial characteristics as efficiency. As mentioned earlier, we've been able to provide SunPower with capital, a senior to their equity, and like efficiency, senior in the waterfall to the utility investors. On the utility scale solar side, we continue to invest in land under solar projects where on average 25X our investment it's on top of us but importantly below us in the waterfall with cash distribution. Finally, in the utility scale wind business we like to senior preferred return position in the tax equity tales but would certainly look at equity structures alongside the sponsor if the return is there to compensate for variation in wind resources and equivalent performance. In summary, our for asset classes; efficiency, distributed solar, utility scale solar, and utility scale wind, all relate to the cash flow the comes from the energy consumer. Some of which goes through the utility and gets paid to us, ahead of investors in the utility capital stock, and some that never even gets to the utility investors. And within those asset classes we are generally senior to another size of capital such as the sponsor equity. Moving the Slide 6, we note that our pipeline remains in excess of $2.5 billion for the next 12 months with an uptick in the efficiency pipeline, primarily driven by the Federal ESPC business and pace. I think this pipeline mix also significantly distinguishes our business from the YieldCo business. We believe the largest opportunity for Hannon is efficiency, and yet our business is inclusive of the significant growth opportunities in wind and solar. As we do each quarter, we calculate the metric tons of greenhouse gases reduced in every investment we make. This quarter our investments reduce approximately 90,000 metric tons of greenhouse gases annually, equivalent to a reduction of 44,000 tons of coal. We go one step further in our analysis by calculating the impact by asset class. For those who are interested in the path to carbon reduction, this quarter's results indicate that geography can trump technology in impact. Usually efficiency is the most impactful followed by wind, then solar. For the quarter however, most of our efficiency investments were in low carbon areas like California where the wind investment was in the coal heavy Midwest. Now I will turn it over to Brendan to detail our financial performance.

Thanks, Jeff. Turning to the Q3 results. We generated $16.3 million of core investment revenue, approximately a 95% increase than the same quarter last year. The core investment income increase is due to an increase in the size of our portfolio to over $1.1 billion at the end of Q3 from approximately $600 million at the same time last year. The increase in core investment revenue was partially offset by higher interest expense as we increased our leverage to 2.0 to 1.0, from 1.4 to 1.0 in the same time last year. And we ended the quarter with 43% of our non-match funded debt at fixed rates. We also realized fee income of $2.5 million in the quarter, a climb from last year but consistent with the second quarter. Our core total revenue, net of investment interest expense was $12.1 million in Q3, an increase from $7.9 million in the same quarter last year. Other expenses core rose to approximately $3.6 million, and year-to-date we are tracking to our $3.3 million target per quarter for the year. We remain very efficient as total headcount is just over 30 people. Core earnings rose to $8.5 million compared to $5 million in the same quarter last year. Core EPS grew 18% over Q3 2014 to $0.26 per share in Q3 2015. On a forward looking basis, as a September 30, 2015, our average portfolio yield remains at approximately 6% with energy efficiency yielding approximately 4.5% and renewable energy yielding approximately 6.5%. These numbers are largely consistent with previous quarters and will vary slightly based upon the portfolio mix. The chart on the right makes the case. As we've discussed that originations in our business are lumpy and while we have a strong pipeline, any one quarter does not make a trend. A comment on the equity rates, if you look at the time in the last two raises early in Q4 '14 and early in Q2 '15, you will note that the time in the last two raises proceeded larger quarters of origination which is reflective of our desire to avoid excessive dilution. Inside into the October raise, we felt that a raise would help us to capitalize on the opportunities that we saw in front of us. A quick update on the wind equity investments. As we have discussed, the best way to think about how we account for wind equity in core is as an amortizing loan. Thus we recorded core earnings interest-based or an estimated yield. Year-to-date we have in core earnings $9.5 million of earnings from our wind equity investments. The projects are tracking to projections and this year we have collected approximately $21 million in cash from the investments. Difference between core and cash is effectively the change in principle and reduces the investment balance for future core yield calculations. Turning to Slide 8, one of the things that makes our business unique is our focus on a diversified portfolio of high credit quality assets. Our debt real estate portfolio continues to be 99% Investment grade quality at September 30. This consist of 39% of our assets from government obligors and 60% commercial transactions, with only 1% or $13 million not considered investment grade. Given the nature of the wind equity investments, we did not include the equity investments in the analysis. Our portfolio is widely diversified with over 100 projects, and an average outstanding balance of approximately $11 million dollars per project. Turning to Slide 9, we want to again focus on the potential impact of higher rates. Presently 65% of our assets are fixed rate debt with the remaining consisting of floating rate debt equity method investments in real estate. As we have discussed, new assets are originated at current rates which in effect is similar to a bond letter. On the debt side, we were at approximately 43% of our non-match funded debt at fixed rates and we are re-leveraging from our equity raise back to our 2.5 to 1.0 leverage target where we presently sit at 1.5 to 1.0 after giving effect to the equity raise. We have discussed that given the continued low short-term rates, we continue to focus on increasing our fixed rate debt to be 50% to 70% and the $100 million and $1 million rated ABS transaction was another step in this process. The fixed rate bonds have an A rating and maturing in 2034. We continue to look at additional debt transactions to move us towards our target. As of September 30, 2015 we estimate that a 25 basis point increase in LIBOR would increase quarterly interest expense by approximately $200,000 or less than $0.01 a share, certainly a manageable number. I will now turn it back to Jeff who will wrap up the presentation.

Thanks, Brendan. We'll close it out by turning to Slide 10. We've updated the yields as of Tuesday in a variety of asset classes, MLPs, YieldCo's, infrastructure funds, and electric and gas utilities. And given our generally senior position in the capital sack, limited exposure to fossil fuel risk and assets that are diverse with low acid concentration, we believe the Hannon dividend yield and growth guidance is, and remains attractive relative to other investment options. To close. we remain excited by the depth of opportunities in front of us. We will continue to be thoughtful about raising additional capital and will use that capital to execute on our investment proposition, deliver an attractive dividend yield from long-term cash flows, increase that dividend from a large growing clean energy market, all while maintaining a diverse portfolio of high credit quality obligors. Again, it's a pleasure and honor to work with my colleagues and co-investors at Hannon, and I thank them publicly for another outstanding quarter. We appreciate you listening to our update. And we'll now open the call for a few questions.

Thank you. [Operator Instructions] We'll take our first question from Noah Kaye with Oppenheimer & Co.

Yes, thank you. Let me just start with a question about the Federal and Municipal DSPC business. You mention that, that looks to be kind of a growing pipeline opportunity. So could you just give a little bit more color, what are your programmatic partners saying as kind of the drivers behind to close that opportunity? And how do you think the cost of capitals could impact the size? Thank you.

Let's take the cost of capital question first. We've talked in a number of prior quarters that our focus on efficiency is really in large part because of its resistance or its ability to be economic and much higher interest rate environment. We talk about the economic internal rate of returns of LEDs like 50%, and controls, let's say 30%. So having started my career with much higher interest rate environment than we have had in the last ten years, it's always good to have assets that have high economic ROIs and we'll always be able to finance it we believe. There is a lot of drivers in the Federal market and in the state local market. President Obama has been very impactful with his $2 billion executive orders for greening up the Federal Government. And the state and local market continues to produce transactions that are interesting, that are outside of the normal tax exempt financing market that dominates state and local, and we see a lot of the higher rated obligors wanting to do taxable deals when they are say under $10 million or under $20 million. So it's a niche market but one that's productive for us. We continue to see good growth in pace with our Top Ten REIT that we talked about last quarter, and the industrial market is starting to work.

Great. So to summarize the organizational and structural drivers, while at the same time modestly increasing spreads is the environment you're looking at there. So moving to the wind and solar piece, I just want to look at the wind tax equity opportunity. How are you thinking about that going forward, perhaps looking at step down in incentives, I suppose we could say the same for solar even though we know you don't participate in solar tax equity. How long do you think this will continue to be a growth opportunity for you? And what should we inspect in terms of investment in these equity opportunities?

I think your question is if PTC doesn't get extended what happens to our wind business, and the answer is, the transactions we're doing, say with JPMorgan are legacy transactions, these are ones that which the PTC is about to expire and banks like JPMorgan need for regulatory reasons to exit. So there is a fairly significant pipeline of those kinds of transactions regardless of what happens to incremental PTC. And on solar, I think we've been selective in that, we like the land business. As we've said before we're glad our name isn't Solar Armstrong because I think it will be challenging when the ITC steps down from 30% to 10%. But the vendors that we work with, they are very committed to letting that tax credit roll down and still having very viable businesses, they are squeezing the heck out of a lot of cost. So we still hope there is a decent solar business in the 10% environment.

Okay, thank you very much. Congratulations on the quarter.

Thank you.

And next we'll hear from Philip Shen with ROTH Capital Partners.

Hey guys, this is actually Justin Clear [ph] on for Phil today. So in Q3 you successfully issued a $125 million in bonds locked in rates for a 19-year term. Given your expected transaction volumes, can you talk about when you might be able to bring another issuance to the market and can we expect similar term and size?

This is Brendan, the bonds, just to correct one thing, the bonds were $101 million. So the pre-sale was $125 million but there were some assets that were pulled out of the pre-sale to get to the $101 million. And we chose not to sell the BNO to this point in time which would have given us another $18 million. It's large - future transactions, we continue to look at a variety of opportunities as we've said in my remarks, we do want to get to the 50% to 70% and this is one of the ways that we think we get there. I don't think we're ready to give exact guidance as to when we would do those transactions. The 19-year term, the transaction that we did was largely the land assets, so if you think about land and the long-term leases on land, it makes a lot of sense to have a very long-term, especially given the credit quality there. So we took advantage of the high quality assets to take the 19-year term. We will probably blend in other terms at different points in times so that our debt is spread out and expires at different points in time, is one of the things we think about when we look at terms. So we will do additional offerings, we're not prepared at this point to give exact guidance as to when.

Okay, thank you, that's helpful. So next question, can you share some color on what you're seeing in terms of back leverage opportunities with Solar City pivoting to lower volumes, has that impacted your back leverage outlook? And can you quantify how much back leverage for resident/commercial is in your current portfolio?

I think we mentioned, and you're really talking about solar, we mentioned in this call $160 million with SunPower, and that's substantially all of our Solar back leverage. There are other transactions, with wind and maybe commercial solar but they're relatively minor. As to where that goes, and as we say, it's not our - solar isn't our biggest piece of business, when it's attractive and we can help a good company like SunPower, we're delighted to participate but it's not - we're not trying to win the solar back leverage race.

Okay, thanks guys.

And next we'll hear from Tyler Frank - Robert Baird.

Hi, guys, thanks for taking the questions. Just hoping if you can just discuss with widening spreads, looking out over the next few years, is there a point where - obviously, it's good for your business because you're able to capture a larger margin but is there a point where it affects each bucket such as once rates hit a certain level you expect it impact overall solar growth or demand, as well as wind and then energy efficiency projects?

We certainly can't crystal ball actual breaking points. It's - and we're always impressed with the top tier clients that we work with, how they adjust their business and their cost structure to work in any economic environment. We've always said that solar has the lowest economic ROR so you have to think it's the most impacted but I wouldn't rule out the solar guys from having a continued great run, even in a much higher interest rate environment. Wind really doesn't use an awful lot of debt, it uses tax equity and sponsor equity. If the PTC goes away altogether, we'll have to use debt. But I think there is some good trade-ups between debt and PTC equity, that's not the cheapest form of equity in the world. This is a very big answer to your question, we're focused on efficiency because of its resiliency to higher interest rates, and wind and solar, I think are going to make adjustments to do just fine.

Great. And then just look at your transactions, it looks like it's up almost 20% year-over-year for the amount of transitions you've done. Year-to-date is there a target that you guys have internally for what you want to - the amount of transactions you want to complete this year and how should we be thinking about that milestone as we go into the fourth quarter? And then looking forward to 2016, is there some sort of rough target we should be looking for that year as well?

So I think what we've given as targets is, we've said we were going to do more than what we did last year, so we're kind of vague on our guidance target on revenue, originations quite honestly. So we said we're going to do more than we did last year and we have not given guidance for next year yet, we plan on continuing to give additional guidance next quarter, that's the one we typically update our guidance looking forward. So we'll consider giving origination target to that point in time. We think our focus is always on choosing the right projects, so we don't view our business as a - we need a hockey stick of origination in order to be very successful, it's for a lot of process, continue to be steady and choose the right projects.

Great. Thanks guys.

[Operator Instructions] Next we'll hear from Joel Houck with Wells Fargo.

Thanks, good evening guys. Jeff, you mentioned Triple B was up 40 bips over - I'm assuming that's generically across all fixed income classes. If that's the case can you put a little more granularity in what's going on in spreads with clean energy?

Sure. Well, I think investors like ourselves and others, generally mark these with some kind of a rating and I don't know that clean energy defies any interest rate scenario any better than any other asset class. So we - it's a really good proxy for our portfolio but as credit spreads rise across all asset classes, we're going to benefit from that as well. It's not - I just don't see a difference between clean energy and dirty energy assets or any other assets in this interest rate environment.

Okay. And I guess as a follow-on so - Hannon has always been focused on quality assets and spread widening is good for future yields and presumably returns, should we expect if spread widening continues it will start to see yields - at least on a renewable energy side, start to creep higher into next year?

Yes, I think they are. And I think you have the pullback of buyers of projects from the YieldCo issues. So I think the required rate of return for investors in the equity has gone up. I think that gives a little air cover for the senior slices of capital to go up as well. So I don't think there is any question that we certainly hope Janet Yellen does 25 basis points in December, we can get that off say the CNN screen, I mean the Bloomberg screen. And then we expect interest rates to rise, if they do we're going to be winning at a really good spot.

Okay. And last I guess, may be a question for Brendan, you guys have kind of historically done 12%, 15% core earnings growth in dividend, I think you just mentioned something about guidance next quarter. Is there any reason to believe that, that trajectory remain intact for 2016 at this point or anything at - I mean it sounds like everything, the business is good, pipeline is good, yield spreads are rising but I just wanted to kind of check-in and make sure we're not missing anything.

So Jeff did reaffirm earlier on that we're maintaining our guidance of 14% to 16% for remainder of 2015 and for 2016. What I was referring to is we tend to give a more fulsome outlook at the first call of the year, so after we're done business planning and things. So we'll give an further update. We don't think that would change our 2016 guidance at this point time.

All right, thank you very much guys.

Thanks, Joe.

We have time for one more question, we'll hear it from Michael Morosi with Avondale Partners.

Hey guys, Matt Wide [ph] for Michael Morosi, thanks for taking our question. Two part question here. First part is, historically can you just talk a little bit about how you've handled periods of policy change? And then the second part of my question is I know you mentioned the end of the PTC and spoke about the trade-offs between debt and equity. Can you elaborate how that might open up opportunities for business like HASI?

Forgive a little bit of a story Michael, but I was Hannon in 80's and we financed the Seg Solar projects that are still operating out of the Mojave Desert. And in 1989 Congress failed to extend the 11% energy tax credit and there was no more Seg's projects, there was no more me at Hannon Armstrong because of that. So I learned that it's really good to focus on cash flow which is why we focus on efficiency so much. We'll take advantage of Federal subsidies when the are there. We certainly look at the clean power plan, and something coming out of Paris as being a terrific tailwind for us. If all of that gets turned upside down and the policy goes against us, so much of what we do is just simply economic based on - saves energy costs, doesn't matter what anybody's view is on climate change, this stuff is just economic. There was a second part to your question - the mix of debt and equity, impossible for us to really say other than I would make the comment that we don't participate in the tax equity market where they are tax bill. Tax equity introduces a significant complicating factor into the structure of these deals. And frankly without tax equity, the deals would be much more conventionally structured, I think we would be able to perhaps have a larger slice of the capital stock rather than the rope, probably small slice we can take without a tax equity appetite. So, assuming the sponsors get their costs down to be competitive and get projects done, we think it's actually an environment with less tax policy, incentives would be a boon for us.

Fantastic, thank you very much.

Thank you.

That concludes our Q&A session for today. I'll turn the conference back to Jeff Eckel for any additional or closing remarks.

No, thanks for the good questions. We look forward to speaking with you again soon. Have a good evening.

Ladies and gentlemen, that does conclude our conference for today. We thank you for your participation.