HA Sustainable Infrastructure Capital Inc (HASI) 2014 Q1 法說會逐字稿

Good afternoon and welcome to Hannon Armstrong Sustainable Infrastructure Capital's 2014 first-quarter earnings conference call. Management will be utilizing a slide presentation for this call which is available now for download on Hannon Armstrong's Investor Relations page at Investors.HannonArmstrong.com.

Today's call is being recorded and we have allocated for prepared remarks and Q&A. All participants will be in a listen-only mode. (Operator Instructions).

At this time, I would like to now turn the conference call over to Steve Chuslo, General Counsel for Hannon Armstrong.

Thank you operator. Good afternoon everyone. By now, you should have received a copy of the earnings release for the Company's first-quarter 2014 results. If you have not, a copy is available on our website, www.HannonArmstrong.com.

Today's speakers are Jeffrey Eckel, Chief Executive Officer, and Brendan Herron, Chief Financial Officer.

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 27-A of the Securities Act of 1933 as amended, and Section 21-E 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 this 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. I would now like to turn the call over to Jeffrey Eckel, President and CEO.

Thanks, Steve, and good afternoon, everyone, and thank you for listening to HASI's Q1 earnings call.

Today, we are announcing core earnings of $3.3 million or $0.20 per share, in line with the $0.22 dividend we announced in March. This is down $0.02 from Q4, mostly related to increased interest expense that Brendan will speak to. But we are on track to grow core earnings by the previously indicated 13% to 15% by Q4 2014.

We continued our execution of our business plan as we have in prior quarters by closing on over $125 million of transactions, adding SunPower and Soltage as new clients to our existing client base, increasing our leverage from 1.2 to 1.5 to 1, and managing our 97% investment grade portfolio as well as our interest-rate exposure.

As most of you know, we went back to the equity markets in April, a year from our IPO date, and raised an additional $70 million of capital, which, when levered with our BAML credit facility, will provide us another five to eight months of capital to invest. As we were raising that equity and speaking with investors, one of the consistent questions that came up was the desire for more granularity around where we are investing and what those yields are in the various markets.

Page 4 is an effort to provide more information on the various investment opportunities we see today. On the left and representing lower historical yields and spreads are the federal, state, and local markets. This is a relatively high credit quality asset class and a reliable source of originations for HASI. In fact, the federal ESPC market received another boost from the Obama administration last Friday with a call for another $2 billion of federal ESPC transactions over the next three years. This builds on the prior 2011 presidential memo calling also for $2 billion of ESPC transactions, indicating continuity in the ESPC pipeline to at least 2017.

Spreads in the utility scale renewables markets are higher than in the governmental market. However, this market has seen fewer newbuild opportunities as renewable portfolio standards have reached targets. And as such, spreads have tightened to become of marginal interest. Instead we are more interested in the niche investment areas such as owning the land underneath utility scale, solar and wind power plants.

As we have discussed in prior quarters, the distributed energy asset class, particularly residential, commercial, and industrial solar, is the most active segment and producing the highest risk-adjusted spreads. This market plays to HASI's historic strength in aggregating smaller individual projects to create diversified portfolios of transactions. When taken together, we like HASI's ability and nimbleness to invest in a range of transactions, and to seek out the best risk-adjusted yields for our portfolio.

I've joked a few times that while we're seeing lots of solar opportunities now, I'm glad our name is not Solar Armstrong as we expect to see lots of attractive C-PACE, cogeneration and other transaction in the near future which can provide attractive returns as well as in the solar market.

Turning to page 5, we profile to Q1 investments that emphasize the growth in the distributed energy class. On the left is our $42 million transaction with SunPower comprised of over 4300 leases spread over 10 states. On the right is another quality solar project developer you may not have heard of, Soltage, for whom we've provided financing for a portfolio of seven projects serving commercial, industrial and municipal obligors in the Northeast. Together, these two transactions represent over 30 megawatts of solar in two diversified portfolios. We expect to see more of this business in future quarters and these clients significantly expand our origination platform.

Now, I will turn it over to Brendan to detail our financial performance and credit quality.

Thanks Jeff. We make our money by holding assets on our balance sheet or by securitizing originated projects with institutional investors in exchange for fee income. Given the change in the business model IPO to hold more assets and generate net investment revenue, we believe the appropriate comparison of our results is to the prior quarter, and thus we will discuss our results on a sequential quarter-to-quarter basis.

In Q1, our total revenue net of investment interest expense was $5.7 million, a decline from $6.2 million in Q4. Approximately $300,000 of this is the incremental interest expense relating to the first full quarter of our 2.79% fixed-rate debt as compared to the interest expense we would have incurred if we had continued to use our floating-rate BAML credit facility.

We also experienced higher interest expense due to increased leverage as we moved our leverage ratio to 1.5 to 1.

Our $300,000 increase in other investment income more than offset slightly lower investment revenue, resulting -- lower investment revenue which resulted from timing differences in redeploying approximately $50 million of repayments and asset sales that we received at the end of the year and the beginning of Q1.

We target our other investment revenue to largely offset our other expenses, which it did for the quarter. For the four quarters since our IPO, our other investment revenue was $10 million as opposed to core other expenses of $9.6 million, and thus we exceeded our target. Core earnings fell to $3.3 million or $0.20 per share compared to $3.6 million last quarter or $0.22 per share as a result of the incremental interest expense associated with our fixed rate debt of $300,000, or $0.02 a share.

It is important to note that we ended Q1 with 46% of our debt fixed. Our plan is to continue to accumulate assets in the credit facility and use asset-backed securitizations like the one we did in December to lock in fixed rates on a portion of our portfolio. While this will likely have a short-term negative impact on earnings like it did this quarter, we believe it is prudent to maintain a blend of fixed and floating-rate debt. And I will talk more of our capital structure in a couple of slides.

Two other notes on the financials. If you look at the detailed income statement, you will notice we had a slight shift between securitization gains and fee income as two transactions were accounted for as fee income this quarter instead of securitization gains. While we had a decline in SG&A for the quarter, for 2014, we expect SG&A expenses to run between 10% and 15% higher than 2013.

Turning to the next slide, one of the things that makes our business unique is our focus on a diversified portfolio of high credit quality assets with 97% investment-grade ratings at March 31, 2014 as opposed to 96% at December 31. This includes 62% of our assets from government obligors. Of the remaining 38% commercial transactions, only 3% of our assets or $16 million were not considered investment-grade, with the largest of these assets being a $15 million senior debt investment in operating a wind project owned by NRG.

Turning to the next slide, we have had a number of questions about how we think about our capitalization structure. As I discussed before, we intend to use our credit facility to aggregate transactions. Once we have accumulated transactions of a similar nature, we intend to complete additional ABS transactions similar to our $100 million HASI SYB in December, where we received a six-year term at a 2.79 fixed-rate with an approximately 10 to 1 leverage. We believe the use of this type of transaction allows us to lock in longer-term fixed-rate debt in a more efficient manner than hedges, especially when we are able to achieve rated debt.

Given continued short-term rates, we are looking to balance the impact on short-term earnings with the risk mitigation associated with locking in longer-term rates. It's hard to give an exact target due to the relative size of the ABS transactions as compared to overall debt, but we will continue to execute on fixed-rate transactions over the next 12 months so that, over a period of time, this will allow us to maintain or increase our current levels of fixed debt. It is likely we will use a ladder approach to this debt and have multiple maturities.

We also continue to focus on increasing our leverage up to the target of 2 to 1 from the present 1.5 to 1 at the end of the quarter. As Jeff mentioned, we did complete our first follow-on offering almost a year after our IPO and near the midpoint of our 9 to 14 month range guidance. We believe the current investment pace to this $70 million in net proceeds represents five to eight months of equity depending on the leverage.

We anticipate that the use of ABS transactions will provide us with the opportunity to increase our leverage, especially as we take away interest rate risk and the size of our portfolio grows. However, at the present time, the 2 to 1 remains our internal target.

Now that we have ramped up our dividend, we would expect dividends to grow periodically on a step basis based on earnings-per-share growth. Our target for EPS growth remains 13% to 15% Q4 2013 to Q4 2014. We are not providing individual quarter targets as the timing of transactions will impact individual quarters as seen in this quarter.

Turning to Slide 9, our current yield and our growth highlights why we believe we offer a unique value to various yield oriented investors, including those interested in yieldcos, specialty finance or sustainability. Yieldcos have been getting a lot of attention in the last several months, and will likely continue to receive attention with several large IPOs planned. We believe we offer a compelling value to investors who would be interested in yieldcos in that we provide approximately an 85% higher dividend yield and sit senior in the capital stack for some of the projects owned or intended to be owned by the yieldcos.

For example, our lowest rated project is senior debt on a project that has been identified as a drop-down candidate for NRG yield. While one of the attractions in the yieldco is the fully contracted nature of the projects, the same fully contracted nature limits upside normally associated with equity ownership. Thus, we believe earning a higher return on senior assets is an attractive opportunity for yieldco investors.

For specialty finance investors, we offer an investment-grade portfolio with low economic correlation and fully contracted revenues with an average life of nine to ten years. More importantly, we are in a different market from most of these companies and not exposed to the same market pressures seen in commercial real estate or BDCs.

For socially responsible investors, we offer a low carbon alternative with projects that positively impact the environment, help reduce greenhouse gas emissions, and maximize both economic and environmental returns. To all investors, we offer an origination platform with access to unique, high quality assets in a growing market and an attractive risk-adjusted yield. Investors get all of this in an internally managed, tax efficient platform that is well-positioned for future growth.

I will now turn it back to Jeff, who will wrap up the presentation.

Thanks, Brendan, and once again, thank you to the HASI team for another terrific effort this quarter. Our priorities for 2014 include capitalizing on the high growth distributed energy asset market, expanding our HASI SYB ABS program with rated debt, driving EPS growth in the 13% to 15% range, which when combined with our dividend should provide investors with a 20% total return, and finally, targeting $1 billion of assets by year-end on the balance sheet.

We appreciate you listening to our Q1 update and we'll now open the call up for a few questions.

(Operator Instructions). Ben Kallo, Robert W. Baird.

Hey gentlemen. Thanks for taking my question. As far as the $125 million transaction goes for Q1, looking back over your past quarters, it seems kind of on the lower end. Is there anything to read through on that?

No. Good question. We always said transactions will flip and the one thing we worried about was any one quarter counting on anyone deal. We did have a few transactions flip from Q1 to Q2, but in fact if you look at it on an annualized basis, that it was a short quarter in the first quarter, we are at about 99.5% of our annualized rate for originations on an $800 million target. So we feel like we are completely on target. And going forward, the market just looks really rich for us.

Great. And then as far as pipeline, you guys mentioned the $2 billion, in excess of $2 billion. Can you guys give any granularity on that, on where you are seeing the opportunities, and how we should think about that going forward?

We tried to make these slides a little more interesting and change them up a b it, but generally the energy efficiency and the clean energy split is pretty consistent between this quarter and prior quarters. As we said, we are definitely seeing a shift towards distributed energy assets, distributed generation in the clean energy category. And I think the SunPower and Soltage transactions just speak to that. Those wouldn't have been on our lead list a year ago, and they certainly are a growing area for us to focus on.

Great, thank you. And then my last one, the $2 billion of federal energy efficiency projects is self-explanatory. But also at the same time, the President called for the IRS and the Treasury to clarify laws around solar and real property. How does that impact you guys? What's your view and your take on that? And I'll hop back in queue.

Sure. (technical difficulty) studying the proposed rules, what they generally do is confirm our view of the rules. These are not changes to the rules; they are meant to be clarifications. And we don't see a significant change to our business.

The one thing that might actually happen is that REITs that actually owned buildings may be able to call some solar assets a good REIT asset. Beyond that, it's not clear what else is actually being proposed.

Brendan, would you add anything to that?

No, I think that's a good summary. It's mostly saying it a different way, it's kind of the cumulative case law and revenue rulings and things that we've had over the years. They did specifically address solar focused on some place where an owner owned -- put solar panels on his roof.

Got it. Thank you.

(Operator Instructions). Ken Bruce, Bank of America.

Thanks. Good evening gentlemen. Just a clarifying point on one of the last questions there. So, the move towards distributed energy, is that going away from the other sustainable, or is that the way to think about it just in the context of how you laid out the general composition of the balance sheet and the origination mix going forward?

Thanks Ken. The other sustainable has always been a bit of a catchall category for us until we see a real trend in one of those asset classes, like fiber or water. They're more occasional transactions. I think -- and we continue to see those transactions.

I really think the proportions between clean energy and energy efficiency, and then by definition other sustainable, are staying pretty much in the same ratios, just trending towards more distributed rather than utility scale.

Okay. And the opportunity as it is evolving in the distributed energy you obviously seem very excited about. It seems a little abrupt just in terms of how quick this market has shifted. Can you maybe give us a little understanding as to what was happening on the utility scale side that's made it less attractive to you, and why the pursuit of distributed at this point?

I think we've been talking about this for at least the last three quarters, so it's not a surprising shift for us. Really, I think it starts with new builds are down in the large-scale wind the business and large-scale solar business in part because the expiry of the PTC for wind, but also the renewable portfolio standards, particularly in California, have been pretty well satisfied by the existing set of projects. So, there isn't the regulatory drive for additional projects at the same level there were in the past. That will change as RPS has increased. New projects will turn around, but in let's say 2014, we are seeing a pronounced shift toward distributed away from utility.

And the distributed in part is due to the increasing competitiveness of especially solar, and the continued upward trend, expected upward trend, in retail rates. And so solar and the distributed assets compete against retail price of electricity. And although the cost of generation has come down with lower natural gas, retail rates have stayed flat or increased due to other investments the utilities have to make in improving the reliability of the grid and those types of things.

Okay, thank you. And then, in terms of residential, that particular asset class obviously gets a lot of press for a lot of different reasons. And I guess I'm trying to understand what the nature of the credit is and how it's different than what you may have been used to looking at in other types of investments, in addition to that what you've needed to do to develop the infrastructure to do that business in a large scale if you intend to do so.

I think, to answer to those questions, we continue to look at transactions that where we have -- that are either well structured or we have the ability to structure. We look at them at a portfolio basis with very good coverage ratios and those types of things.

If you do look at a portfolio of residential projects, you're going to look at the credit scores throughout the portfolio but you're also looking at the cash flows and how you can structure that so that you are not exposed to individual homeowner credits. And I think that's one of our focuses is that we look at this as, when we are doing residential, we're looking at it as a portfolio basis.

If you think about compared to what we're doing in residential compared to for example a solar city, they are getting credit for their equity value in those transactions. We are sitting senior and, again, continuing to be senior debt. So to the extent there was any issue in the portfolio or in the nature of those transactions, obviously the equity is going to take the first hit. So, we think these transactions, at least the ones we've entered into, have been well structured and we continue to focus on that and pay particular attention to the credit attributes of the portfolio. But we are not -- to be clear, we are not aggregating individual transactions ourselves. We are going to manufacturers, are working with manufacturers and others who are aggregating the transactions and coming to us with a portfolio.

Great. Thank you very much, gentlemen.

Charles Nabhan, Wells Fargo.

Hi guys. Thank you for taking my question. You've indicated in the past that the 2 to 1 leverage target isn't necessary an absolute cap. Could you give us a sense of how high maybe above that target that you would be willing to go, given that the leverage on the fixed rate bond is 10 to 1?

I think it's something we continue to talk about and look internally. The 2 to 1 is what has been approved by the board, and what we think is reasonable right now given the size of the portfolio and the percentage of fixed versus floating interest rate.

As we've always said, on individual transactions, especially where we can take interest rate off the table like the bond, will go to a higher leverage target. So I think you'll see individual transactions take advantage of higher leverage. And whether that leads us to eventually being in a position where we feel comfortable changing from our 2 to 1 target, I think we continue to look at that and think about that. But at this point in time, on the overall portfolio, I don't think we are prepared to give you a particular number, and I think we're sticking to our 2 to 1 target.

Okay, great. And also, it would seem there is a diverse set of opportunity, and a huge pipeline of opportunity out there. Looking at the Company from an infrastructure standpoint, do you feel that the current employee base is sufficient to capitalize on that set of opportunity, or do you see potential growth in the Company's infrastructure maybe over the next year or two?

I think we will be adding one or two people. Brendan referred to some increase in SG&A, but any rate of increase will be substantially less than the rate of growth in the assets and the interest earnings. And that's the scalable nature of the platform. But yes, we have a plan to add a few people, but it's de minimis relative to the current staff.

The other thing to think about there, Charles, is when we are going after these new markets, we're going after it the way we historically have gone after it. So, SunPower, you can think about SunPower in solar as being no different than JCI or Honeywell in energy efficiency. They are the manufacturer, the likely participant in the projects, and we are just helping them sell their panels.

And they are in all the markets. There in the utility market, commercial, industrial, and residential, similar to JCI and Honeywell.

So, we are continue to approach the markets the same way using kind of the leverage of the manufacturers and other key participants in the market.

Okay. If I could sneak one more in, in your past slides, you've outlined a federal government goal of 30% reduction in energy consumption by 2015. Now, is the $2 billion in projects through 2016, is that incremental to that consumption goal, or how does that correlate?

It is incremental. It builds on top of the prior $2 billion. As to what that does to the 30% number, I'm not sure that anybody at the White House has done that math or we haven't seen it.

Okay, great. I appreciate the color guys. Thank you.

(Operator Instructions). Paul Strigler, Esplanade.

Hey guys. Can you just -- I'm looking through the presentation. Can you just tie in for me the sort of $0.25 to $0.26 core EPS in Q4 2014 with that 6.6% sort of target yield based on the current stock price? It seems like, at least by my math, the yield would be well over 7%.

The 6.6% is the current yield, so $0.22 times 4 divided by where we were trading yesterday.

Right, okay, so that 6% -- 6.6% dividend yield is simply the current yield? There's not a change in your target yield?

Correct. That was -- it may have been not labeled clearly, but our intention was just to say where we were today.

Good. And on the SG&A, will there be -- will you be able to cover the 10% to 15% increase with fees and gains on securitization, or should we expect sort of that relationship to change a little bit?

We've always talked in generality that we expect it to largely offset it, so we'll continue to work towards that target. We are a little ahead of the target this year, but we will continue to work towards a target that makes sense.

As we've always talked, we look at the opportunity to hold or sell transactions on an individual transaction basis and what it does on the portfolio. So, depending on what we see in transactions and how they impact the portfolio, will drive the exact math of how that will work.

Great. Thanks a lot guys.

Thank you. Ladies and gentlemen, that's all the time we have for questions today. I'd like to turn the floor back over to management for closing comments.

Thank you very much. We have our annual meeting on May 20. Hopefully, some of you can come. We look forward to it. I think that's it. Thank you very much.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.