HA Sustainable Infrastructure Capital, Inc. (HASI) Q1 2016 Earnings Report, Transcript and Summary

Good afternoon everyone. Welcome to Hannon Armstrong's Conference Call and its Q1 2016 Financial Results Conference. Management will be utilizing a slide presentation for this call which is available now for download on the Investor Relations page at investors.hannonarmstrong.com. Today's call is being recorded, and we have allocated 30 minutes for prepared remarks and Q&A. All participants will be in a listen-only mode. [Operator Instructions] At this time, I would like to turn the conference over to Ms. Amanda Cimaglia, Investor Relations Director for the Company. Please go ahead.

Thank you, operator. Good afternoon, everyone. By now you should have received a copy of the earnings release for the Company's 2016 first 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 Web site. 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 Factors 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're announcing core earnings for the quarter of $0.32 per share, a 19% increase from Q1 of last year. We financed 213 million in the quarter up from 104 million in the first quarter of last year. We increased our leverage now at 2.31 and at 66% fixed rate debt we continue to be within our 50% to 70% target range. Our $0.30 dividend produces a 6.1% annualized yield and is generated from a mix of clean energy assets principally efficiency, wind and solar. Finally, we reaffirm our 2016 guidance of a 14% to 19% increase in our annual core earnings per share as well as double-digit growth for 2017. Turning to Page 4, we have now been public for three years and have produced a total shareholder return of over 100% in that period. Performance that is supportive of our investment thesis, which is, we will earn better risk adjusted returns by investing on the right side of the climate change line and by making those investments in the senior or preferred equity position of the capital stack. Let me detail that thesis a bit more, by investing on the right side of the climate change line, we mean our investments would be in assets that are neutral to negative on incremental greenhouse gas emissions. We believe that in a world increasingly defined by carbon, we don’t sacrifice returns to have positive environmental impact, but rather we will do better than if we ignore carbon. As we’ve done for years, we analyze each investment for its greenhouse gas impact and in Q1 the aggregate investments reduced GHTs 176,000 metric tonnes equivalent to 86,000 metric tonnes of coal. Examples of Q1 investments that are senior or preferred include senior debt type structures in commercial and governmental efficiency, senior investment for wind and a land transaction for solar. As we have for decades, we continue to provide capital to the leading companies in our markets, capital that helps them grow there clean energy businesses. Moving to Slide 5, we provide a bit more detail on the growth prospects in our three key asset classes. The efficiency market continues to grow at a steady rate in the governmental market and a bit faster in the commercial market due to PACE, albeit from a much smaller base. Based on data from Navigant, we estimate the U.S. ESCO market will be approximately 22% larger in 2018 than 2015. In our last call I said the expansion of the ITC and PTC was an unexpected positive for the solar and wind businesses and we have seen estimates from both NREL and Greentech Media that show just how positive. Greentech Media estimates that by 2018, solar volumes will be approximately 50% greater reflecting the results of the ITC expansion and NREL has estimated that wind market size would double after taking into account PTC. Turning to Page 6, our pipeline is strong, remains at more than $2.5 billion for the next 12 month. Now that our renewable energy clients have unprecedented visibility on U.S. tax policy for the next 5 years, we’re seeing new ways to participate in the wind and solar markets, as these clients prepare more ambitious business plans. As these plans are implemented over the next several years, this should lead us to increase the volumes of wind and solar transactions in our pipeline, which would balance out our robust efficiency pipeline. Our pipeline derives growth in the balance sheet portfolio and also allows us to optimize the portfolio as markets change, the forward-looking yields on our portfolio have ticked up 6.3% from 6.2% and we continue to use our pipeline to help us build a portfolio with the best risk adjusted yields. You will note the difference in the size of efficiency transactions in our pipeline 65% versus the balance sheet 28%. This difference exists because we securitize a significant volume of the longer dated lower coupon transactions. This generates free income and reduces capital requirements, compared to putting everything on the balance sheet. In summary we had a strong quarter, our investment thesis is solid and our markets are growing. Now I’ll turn it over to Brendan to detail our financial performance.

Thanks Jeff. Turning to Q1, for the quarter we generated $12.2 million of core earnings or $0.32 a share, as compared to $7.4 million last year or $0.27 a share, a 19% increase on a per share basis. This is largely the result of a greater than 50% increase in the size of our portfolio, which now stands at approximately $1.4 billion. Investment interest expense rose to $11 million from $6 million last year, as a result of the almost $400 million of fixed rate debt we added in the last fourth months of 2015. This debt allowed us to stay at the high-end of our 50% to 70% fixed rate debt target, with our fixed rate debt at 66% at the end of the quarter. Our other investment revenue was approximately $6 million in the quarter, as compared to $3 million last year, due to an increase in securitization activity. Our core total revenue net of investment interest expense was approximately $16 million in Q1, an increase from $11 million in the same quarter last year. Our other expenses core rose to approximately $4 million, comparable to last quarter and $3 million this time last year. We expect core expenses to be slightly above $16 million for 2016, we remain very efficient as total headcount was 34 people. The chart at the bottom makes the case, as we’ve discussed that originations in our business are lumpy and while we had a strong pipeline any one quarter does not make a trend. A quick update on the wind equity investments, as we’ve discussed the best way to think about how we account for the wind equity in core earnings is its amortizing loan. Thus we record in core earnings interest based on our estimated yield. The projects are tracking to our projections. Year-to-date we’ve recognized in core revenue of $7 million from our wind equity investments. This represents approximately 42% of the cash we received in the quarter from the wind projects. As I mentioned in core earnings and cash is effectively the change in principle and reduces the investment balance for our future core yield calculations. Turning to Slide 8, our focus on high credit quality assets is reflected in our portfolio that consists of 41% of our assets from government obligors and 57% commercial transactions with only 2% of our assets or $17 million not considered investment grade. Given the nature of the wind equity investments, we do not include the equity investments in the analysis. Our portfolio is widely diversified with over 110 projects and an average outstanding balance of approximately $12 million per project. We successfully collected the principle balance in a small gain roughly equivalent to our May call when the wind project that we have reported on over the last year a non-investment grade project. In our non-investment grade transactions currently reflect the diversified portfolio performing distributed solar projects with a private developer. Our exposure to projects other than the residential solar portfolio that involves yieldcos is approximately 8% and we do not expect any negative impact from the SunEdison bankruptcy. Turning to Slide 9, we want to focus on the balance sheet. Presently 61% of our assets are fixed rate debt with the remaining consisting of floating-rate debt, equity method investments and real estate. As we have discussed, new assets are originated at current rates, which is in effect similar to a bond ladder. On the debt side we were at approximately 66% of debt if it is fixed rates, and our leverage is 2.3 to 1 against our 2.5 to 1 leverage target, up from 2.1 to 1 last quarter. We have discussed that given continued low short-term rates, we continue to focus on increasing our fix rate debt to be 50% to 70% fixed rates, and we raised approximately $400 million of fixed rate debt in the last part of last year. As of March 31, 2016 we estimated a 25 basis point increase in LIBOR, would increase quarterly interest expense by about $200,000 or less than $0.01 a share certainly a manageable number. One other point that this quarter highlights is the robust nature of our business model. We saw an increased amount of volatility at the end of the year into the first in the financial markets. As we have discussed the long-term contractual nature and preferred position of our portfolio limits our exposure on the investment return side. And we were able to execute on both the securitization and the leverage side. The ability to securitize transactions reduces our reliance in the equity markets in times of volatility. As you may have noticed, we moved the way from the April equity rate that we had completed each of the last three years. We remain focused on increasing our leverage but continuing monitor our pipeline and the capital markets. And an attempt to raise equity when it best maximizes long-term shareholder value. As we have discussed, we will be putting in place an ATM. We expect this to be done in the next week or so. We plan to use this as a valley filler to help us increase leverage as the larger equity raises result in a lower leverage until we can reinvest and delever. We believe that this will -- the ATM will benefit shareholders and do not expect it to be a primary source of equity. I’ll now turn it back to Jeff, who will wrap up the presentation.

Thanks, Brendan. Turning to Slide 10, to close we continue to executive on our business plan and continue to produce for our shareholders. Our long-term cash flow from the senior slice of capital provides a stable dividend, delivering an attractive and growing dividend yield. Our portfolio is continuing to diversify with respect to the number of transactions, customer segments and technologies, and we pride ourselves on good governance and alignment of the managers of the business with the owners of the business you, the shareholders. Again, it is an honor to work with my colleagues at Hannon Armstrong, and I thank them publicly for another outstanding quarter as we continue to invest in the future of energy. We appreciate you listening to our update. And we will now open the call up for a few questions.

Thank you. [Operator Instruction] We have first from Philip Shen with ROTH Capital Partners.

So you mentioned that there were greater securitizations in Q1 due to the market conditions, and historically you talk about having 300 million or so of as you efficiency in securitizations in a given year is -- could we expect a higher level in 2016, given the current market conditions? And if so, how much more could we see?

This is Jeff, Phil I mean it's certainly possible, where you are getting the 300 million is when we talk about doing $1 billion of transactions a year, putting 700 million on the balance sheet and 300 million in securitizations. That’s just a basic model for the business it could be higher, it could be lower and again wherever the best return for us is.

Okay, that’s fair. Moving on to the wind business, it appears the wind asset line kind of fell by 15 million kind of to 304 million. Can you talk about what happened there and just give us a general update on what you are seeing in wind if you see something big perhaps next quarter or two? Thanks.

Sore, so that’s I think primarily the cash we get back, we get as I said about $16 million, we have about $16 million of distribution this quarter.

Okay great, thanks. And in term of the wind market outlook clearly the pipeline and opportunity set has increased, when you think about in Greenfield versus recycling a cap of opportunities, do you expect -- what is the mix now, it seems like it is -- or of a recycling opportunity but do you expect to see more Greenfield opportunities with the PTC extension looking forward?

Absolutely the, as I think I have said a number of times I have never imagined the renewable energy business looking as bright as it does right now, so I think our clients finally have the ability to do a proper business plan with five or seven or eight years of planning horizon which is how these capital intensive businesses should be run, so we expect lots of new build, lots of new solar, lots of new wind and of course mid low energy efficiency will continue to chug them off.

We will move next to Carter Driscoll with FBR.

More specifically about solar and it's been a lot of this illuminations about maybe some projects being pushed out I know you are very positive on ITC in longer term probably has less of an effect on you, but are you seeing anyone extending projects beyond what was the initial push in 2016-2017 there seems to be a lot of consternation industry wide versus 2017, so just be interested to get your particular tick?

If you look at our pipeline I think 8% of our 25 billion pipeline is solar so, that implies a relatively small exposure to solar and we expect it to grow not shrink. But frankly Carter I wouldn’t -- I don’t think we would have that visibility on the marginal project getting shoved from '16 to '17. I think we are certainly seeing a robust pipeline that marginal project is not going to rise to the surface of where we are affected by it?

I think one thing also to think about it is that, these are large infrastructure projects so the turning to wind and responding to regulatory policy doesn’t happen overnight, so just the fact that the regulatory policy change in December it takes a while to go from that change to a project actually being in a position where it has been financed worth of tail end of that so it takes a while for us to kind of see the impact of those changes.

And then maybe just as a follow-up, it looked like there may have been sort of movement in the Northeast in terms of supporting offshore wind projects and do you care to comment on there it seems to be a certainly more than geographically certainly and particularly in the United States and do you care to add as to whether that could be on the horizon longer term?

I'd say that offshore wind will always be on the horizon but yes we will see when those projects happen.

We will move next to Robert W. Baird’s Tyler Frank.

Can you discuss sort of how large do you think the ATM might be and what we should except throughout this year in terms of potential equity raises?

Sure so I think the ATM is going to be somewhere in the $60 million to $80 million range we are still deciding exactly where it's going to be in that range. The equity raises -- I mean back to the rough model Jeff was talking about before, if we do $1 billion in transactions and put 300 in securitizations, that gives you 700 million if you do 2.5 of leverage on that 5 remaining 700 that’s 500 of debt and 200 of equity. We had some equity starting the year we are getting some cash flow back so you would look at equity raise as being somewhat below the $200 million range in total. So we continue to focus on try to how we get the – you set the 2.5 to 1 leverage target so we continue to focus on, what tools can we put in place to get us up towards that leverage target and we have put a lot of fixed rate debt in the last year with good advance rate so we are continuing the work up to that target. And we will continue to monitor as I said we will continue to monitor both the capital markets and the cash flow needs and based on that decide them and if and when we raise equity.

And then your comments about the ITC extension and how you expect that to drive additional projects both wind with PTC and then solar with the ITC what are the puts and takes around rising interest rates at least from your angle, do you think that rising interest rates would more than offset the increase in projects or do you feel like the regulatory environment is favorable up until a certain level of interest rates?

I think that is a lot of calculations to do, I think the way we have always looked at it is efficiency is the most insulated from interest rate increases because the internal rates of return are higher next is wind and after that is solar. So there is just, you have got some pluses you have got some minuses if interest rates are risen and I am not sure we were smart enough to know what happens to the overall market.

We will hear now from Jeff Osborne from Cowen & Company.

I just want to talk about the core earnings expectations for the second quarter, was there any one time items in the first quarter, I’m still working my way through the numbers here but I always thought just kind of by principal your EPS would be below the dividend per share in the first half of the year and then exceeding that in the second half so I just want to make sure that we don’t straight line the estimates, based on the reported results here?

I mean, I think what we have tried to do is and Jeff reconfirmed the guidance for the year so things like securitizations add a little lumpiness at times to revenue, so, and I don’t that you can straight line a quarter you can look at the -- what we are giving in guidance in total, we don’t give quarter-to-quarter guidance impart because things are a little bit lumpy, quarter-to-quarter and what we have always said on the dividend is that we forward look the dividend for the year so, dividends is $1.20, we would expect to earn that within the framework and that’s within the framework of our guidance, so I don’t know that you can extrapolate any one quarter and I think with the combination of the portfolio build and then what we do in securitizations and if you look back over the history that has moved around a little bit quarter-to-quarter.

Got it, okay that is helpful, can you just, I may have missed this but in last call you mentioned a couple of deals that you renegotiated to more favorable terms, were all of those able to be re-negotiated and flow through inside this quarter or any of them other [Multiple Speakers] terms?

No they were all closed in Q4 2015 and I think we weren’t as clear on that as we could have been, the difference was did they close in October or December, that’s what cost us the net interest margin in Q4 but they were all closed.

And then just assuming that the capital markets, may be challenging here for the next couple of months into the election and what not, is there any discussion, either within the management ranks or potentially at the Board level to increase the debt to equity ratio, because that’s certainly wouldn’t change the equity needs?

Yes so I think we, as we’ve talked that 2.5 to 1 is an internal target we have the capability to go above that, right now we may be yet to achieve the 2.5 to 1 so I think the first target would be for us be able to achieve and then sustain that achievement before we talk about increasing it. And we do think about the fact that we have taken a large amount of the interest rate risk off the table, so with the higher rates mainly in it you could go to higher levels but, I think we -- that’s just something we will evaluate along with a number of other factors at the time, so right now our target remains the 2.5 to 1 and our goal is to work towards that target.

Perfect. And one last quick one, Brendan, I may have missed this as well but the 16 million that you talked about you received from the high loans to Mesa, NRG project, was there any P&L impact or was that all just a cash payment, any taxes on that or?

So I talked about this, we got the $13 million project that we have been carrying as non-investment grade, and the, so I said there is a small gain on that which would be roughly equivalent to what you would have gotten out in a May call on the project.

[Operator Instructions] We’ll hear now from Michael Morosi with Avondale Partners.

Hi guys Matt Wyatt for Michal today, congratulations on the quarter. Just, a question about renewable yields in the portfolio when you look at those overtime, it has kind of ticked up from the 6.6% last year, kind of at mid-year to 7.7% this year. And I know this can vary quarter-to-quarter but that's a pretty meaningful increase overtime. Can you kind of talk about what's driving that and how you expect that to develop?

We’re trying to get this if the -- there is two kinds of investments, we’ve talked about the land leasing business on any solar projects and the wind equity business, that are generally above the average renewable energy yields, other yield obviously are below average, like on senior debt. So there is a little bit of business mix in there, but also we have said that with the yieldcos, somewhat coming back to earth that it’s been a more rational market in which to price transactions, so some of it is, it is a better time to do business than it had been. As to where it goes, honestly we don’t know and we will let you know as soon as we know.

I understand and then just kind of touching on the securitizations, this quarter, I know you talked about kind of may be potential opportunities going forward as efficiency is a larger portion of that pipeline, but in terms of cleaning up what’s remaining on the balance sheet, are you happy with where that stands, and do you see any more opportunities there?

No I think the balance sheet is where we want it to be in terms of fixed rate, it’s incremental transactions, if equity markets are closed and we will bias towards more securitization than putting things on the balance sheet but generally we like our portfolio right now.

And just to clarify we do two kinds of securitizations, one is the ones where we take it off balance sheet and do a trust and get a gain on sale and that is what we did more of this quarter. We have also done securitizations with one balance sheet transactions where we continue to hold the assets on the balance sheet and that effect really is a form of debt and we did for example a land transaction at the end of Q3 in that area. We continue to see opportunities in both areas we continue to see a lot of demand for the paper from lifecos and other institutional investors, both of whom are in infrastructure and the only balance sheet structure. So we think there is a robust financing market for our business.

From Oppenheimer we will move to Noah Kaye.

Maybe I'd like to pick up on the comment about the momentum on C-PACE, maybe you could put that in just a bit of context for us, you provided the share of the 12 month pipeline that's from efficiency about 65%. It is a kind of possible to benchmark kind of where C-PACE might stand within that. And then I think that the related question would be, presumably there would be a higher weighted yield on the efficiency from the C-PACE type customers than from a governmental customer. So maybe sort of how we should think about that trend?

I think there is data out there that says that the commercial PACE market not residential but commercial is on the order of a couple $100 million for everybody. So presumably we haven’t done all of it and I ensure we haven't kind of -- it's going to be small. That said it's got a very large addressable market in 20% of the greenhouse gases come from the commercial office building sector. So it's an area we continue to invest in and as for the yield yes, compared to the yields on U.S. government efficiency transactions, C-PACE generally is going to be a nicer yield.

Sure, sure. And in terms of kind of the flow and the origin of deal opportunities on the C-PACE, would you say it's coming more from some of the, I guess sort of institutional partners that you have been able to work with like the Green bank or is it more of a mix and probably coming from some of this traditional building efficiency players that are looking at these opportunities and looking to you for financing and then being able to leverage the C-PACE structure may I wish to sort of understand how that work?

It's very much and I think I said in prior calls that the real challenge for the industry is to figure out how to originate at scale from the service provider to us the finance provider. So Connecticut Green Bank it is certainly a good origination source for us, we have also talked about transactions with a top 10 REIT that is another way for us to originate transactions. I think the whole industry is sorting out, who can make money in the value chain and how and we are trying a lot of different things and we will see which ones really get traction.

And then maybe it's just another a bit from the prepared remarks that we did pick-up on. Just talking about how -- with the policy certainty you were seeing kind of it sounds like a greater variety of opportunities ways to play within the financing ecosystem of how these wind and solar deals get done, maybe potentially different areas at the capital stack -- I would love to try and get a little bit more elaboration on that obviously without tipping your strategy to try to understand how you are thinking about the opportunity?

[Multiple Speakers] We were purposely vague on it, it is competitive market. And the simple thing our clients now have a much better chance to be thoughtful about raising capital and optimizing it and instead of rushing to the next cliff from ITC or PTC. So I think everybody gets a chance to do the business the way it should be done.

We will hear now from Zach Liggett with FIM Group.

Most of my have been answered. I was just curious sort of on the competitive environment, you had mentioned the eventually yieldcos but beyond the yieldcos, are there any new other broad categories of new players in your space that are impacting pricing or any other changes?

Well, I think I wouldn’t say they are new, I think you have got insurance companies and pension funds who are natural owners of long dated high credit quality transactions they have also been in the market, they grumbled a lot about the yields compression with the yieldcos. We don’t typically find ourselves competing with those entities they generally like larger transactions and Hancock just did a 200 plus million dollar deal in SolarCity, congrats to both of them and that is probably not that we would have wanted to compete on. So it's pretty much the same players; maybe a few less players than there were in 2015, but it's anybody is looking for capital it's going to find lots of good resources of capital.

And I think the key is that where we try to plan the capital stack so, we focused on small projects than the insurance companies like that will go longer than the bank so, and we will do a variety of structures so land or preferred equity so it creates opportunities for people to tell the capital stack as Jeff talked about a few minutes ago. And we are very good at helping people do that so I think that’s the area of opportunity that we see in the big insurance companies big infrastructure funds, they don’t want to do a transaction less than a couple of hundred million dollars we are perfectly happy with an average deal size of $12 million to $15 million to do smaller transactions that fill the hole in the capital stack.

That’s great and then the headcount to achieve that you need to increase staff if you are going to continue to do the smaller deals or you are pretty stable on that front?

We have been doing smaller deals for our -- for a very long time a couple of decades so.

We have increased the headcount to almost 50% since the IPO so we are at 34 from 22 in three years, it will give you an idea of kind of what we think there Zach.

And this time I'll turn the conference back to you all for closing remarks.

Thanks, you asked great questions once again. We look forward to speaking with you again soon.

That will conclude today's call. Thank you all for joining us.