HA Sustainable Infrastructure Capital Inc (HASI) 2015 Q2 法說會逐字稿

Greetings and welcome to the Hannon Armstrong second-quarter 2015 earnings call. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Katherine Dent. Thank you. Ms. Dent, you may begin.

Thank you, operator. Good afternoon, everyone. By now, you should have received a copy of the earnings release for the Company's 2015 second-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 protection 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.

Thank you, Kate and good afternoon, everyone. We are announcing core earnings of $8.1 million for the quarter, or $0.26 per share, which when annualized is approximately a 5.3% dividend yield. We closed over $350 million of transactions in Q2 and year-to-date volume is up 38% over this time last year. The strong quarter helped us maintain core earnings despite the 12% increase in weighted average shares outstanding from our capital raise in May. We reaffirm our annual earnings growth guidance in the 14% to 16% range for both 2015 and 2016.

Turning to slide 4, I'd like to highlight developments in the quarter. In the efficiency market, we are now executing on a pipeline of PACE transactions with a top 10 REIT. This is a market we have been developing for years and is now starting to bear fruit. We also have had recent successes in the industrial energy efficiency market, historically a difficult market for the industry and foresee a future flow of business. And finally, we've added a new platform -- several new platform ESPC clients in the federal, state and local markets, which should continue to drive our organic originations.

We completed the first follow-on wind transaction with J.P. Morgan and believe these seasoned operating wind projects will continue to bear fruit for us regardless of what happens with the PTC going forward. On the solar front, we continue to execute by growing our solar land portfolio, which now stands at over 14,000 acres and closing on a follow-on residential solar portfolio with SunPower.

It is important to note that we are seeing spreads widen in many asset classes, which is quite supportive of our growth and will help preserve margins in a rising rate environment. In short, we continue to execute on our business plan and remain confident that we are on a positive course.

Turning to slide 5, we show the three large markets we participate in, which looks a lot like the President's recently announced Clean Power Plan. As we have said many times, however, our business is built to finance the clean energy market independent of federal energy policy and so the President's Clean Power Plan is a nice to have wind at our back, but we are in no way dependent on its ultimate implementation.

The chart on the right shows where Hannon fits in in the industry. The follow-on wind transaction with JPMorgan demonstrates the point that we are complementing the industry's incumbents. Our flexibility in deal size and tenor is one of our competitive advantages in addition to a relatively low cost of capital compared to say BDCs and hedge funds.

We will attempt to demonstrate what we mean by clear-eyed view of the risk and returns beginning on slide 6. Please bear with me as I walk through these somewhat complicated but we hope illuminating slides addressing why we invest where we do. Let's start with a traditional utility model. We think it is important to note that the sources of all revenues for utilities, yieldcos and Hannon are they residential, commercial and industrial energy consumers. Traditionally, energy consumers only pay the utility for kilowatt hours consumed and utility in turn paid its operating costs like PPAs and then its debt, preferred equity and its regulated rate of return to the common equity investors.

Building on the previous slide, slide 7 shows two markets on the retail side of the utility meter. The upper right of the chart represents the efficiency market. Instead of a commercial or industrial customer paying 100% of energy costs to the utility, many customers are choosing to reduce the amount of kilowatt hours used and instead do an ESPC or PACE transaction. In effect, Hannon is monetizing this choice to convert KWh purchases from the utility to money-saving so-called megawatt purchases.

Our clients, such as Johnson Controls, are leading this market by engineering the solutions we finance. Perhaps the ESPC and PACE markets are one of the reasons utility kilowatt hour sales are not increasing despite GDP growth. Distributed solar on the left has many of the same financial characteristics as efficiency. By choosing to put solar on a rooftop, the consumer is choosing to send less money to the utility and more to a company like SunPower. We have been able to provide resi solar providers with capital that is senior to their equity in the deal and like efficiency, senior in the waterfall to the utility investors in the sense that this is money that never even gets to the utility.

Moving to utility scale solar and utility scale wind, which is seen on slide 8, the source of revenue to these projects are power purchase agreements with utilities. On the solar side to date, we have found the best value in the land leases, which are senior to both the senior debt and the sponsor equity, which might be from a yieldco. Finally, the utility scale wind business has two slices of investable capital for us -- the tax equity tails like our JPMorgan transactions and the sponsor equity. We like the senior preferred return position in the tax equity tails, but would certainly look at equity structures alongside of the sponsor if the return is there to compensate for variations in wind resources and equipment performance.

In summary, our four asset classes -- efficiency, distributed solar, utility scale solar and utility scale wind -- all relate to the cash flow that comes from the energy consumer, some of which goes through the utility and gets paid to us ahead of investors in the utility capital stack and some that never even gets to the utility or its investors. And within those asset classes, we are generally senior to another slice of capital such as the sponsor equity. We like that position.

Additionally, we benefit from a diverse portfolio of clients and projects that insulate us from the vagaries of any one client, project or asset class. We hope this chart gives investors a better understanding of the financial characteristics of our investments relative to the utility and yieldco capital stack.

All right, moving to slide 9, we note that our pipeline remains robust in excess of $2.5 billion for the next 12 months with a balanced mix between wind and solar to go with our efficiency business. Now that climate change and greenhouse gases are back in the national dialogue, we thought we would move sustainability data to the midsection of the presentation instead of leaving it in the back.

As we have since the IPO, we calculate the metric tons of greenhouse gases reduced in every investment we make. This quarter, our investments reduced approximately 140,000 metric tons of greenhouse gases annually equivalent to a reduction of 69,000 tons of coal. And under the premise that if carbon counts and capital is scarce, we go one step further in our analysis by calculating the reduction of greenhouse gases per $1000 of investment, which shows that efficiency investments were the most impactful per dollar invested followed by wind and then solar.

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

Thanks, Jeff. Turning to the Q2 results, we generated $14.5 million of core investment revenue, an over 100% increase from Q2 last year. The core investment income increase is due to an increase in the size of our portfolio to approximately $1.1 billion at the end of Q2 from just under $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 1.8 to 1 from 1.2 to 1 at the same time last year. And we ended the quarter with 32% of our non-match funded debt at fixed rates.

We also realized fee income of $2.4 million in the quarter, a decline from last year as we held more transactions on our balance sheet. Our core total revenue net of investment interest expense was $10.8 million in Q2, an increase from $7.6 million in the same quarter last year. Other expenses core were flat at approximately $2.8 million despite an 83% increase in the balance sheet. This is the power of our internally managed platform with no overhangs from IDRs. We remain very efficient as total headcount is approximately 30 people.

Core earnings grew to $8.1 million compared to $4.8 million in the same quarter last year. Core EPS grew 18% from Q2 2014 to $0.26 per share in Q2 2015. This reflects the impact of the dilution of the approximately $0.01 to $0.02 from the May equity raise that we discussed last call.

On a look-forward basis, as of June 30, 2015, our average portfolio yield is approximately 6% with energy efficiency yielding approximately 4.4% and renewable energy yielding approximately 6.6%. These numbers are largely consistent with previous quarters and will vary slightly based on portfolio mix.

The chart on the right makes the case as we have discussed that originations in our business are lumpy and while we have a strong pipeline, any one quarter does not make a trend. Despite the lumpiness in originations, you see the stableness of the earnings. In addition, you will note that the timing of the last two raises preceded large quarters of origination, which is reflective of our desire to avoid excessive dilution.

A quick update on our wind equity investments. Included in core earnings year-to-date is $6.4 million of earnings from our wind equity investments. The projects are tracking to our projections and this year, we have collected $14.6 million in cash from these investments.

Turning to slide 11, one of the things that makes our business unique is our focus on the diverse [five] portfolio of high credit quality assets. Our real estate and debt portfolio continues to be 99% investment-grade rated at June 30, 2015. This consists of 40% of our assets from government obligors and 59% in commercial transactions with only 1% or $13 million not considered investment-grade. Given the nature of the wind equity investments, we do not include them in the analysis. Our portfolio is widely diversified with over 95 projects and an average outstanding balance of approximately $11 million per project.

Turning to slide 12, we wanted to 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 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 remain at approximately 32% of our non-match funded debt at fixed rates and are releveraging from our equity raise back to our 2.5 to 1 leverage target and presently sit at 1.8 to 1. 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% fixed rate.

This week, we announced another step in this process with the kickoff of an approximately $125 million rated asset-backed securitization transaction. The fixed rate bonds have been preliminarily rated with an A-rating and a 25-year maturity and we would expect subject to market conditions to complete this transaction over the quarter.

Assuming we close this transaction, we would have been at approximately 50% fixed rate debt. Even without this or other future fixed-rate transactions, we estimate that a 25 basis point increase in LIBOR would increase quarterly interest expense by about $300,000 or less than $0.01 a share, certainly a manageable number. With that, I'll turn it back to Jeff who will wrap up the presentation.

Thanks, Brendan. Turning to slide 13, the chart on the left shows yields as of Tuesday in a variety of asset classes. Given our generally senior position in the capital stack, minimal exposure to fossil fuel price risk and assets that are diverse with low asset concentration, we continue to believe that Hannon dividend yield and growth guidance is attractive relative to other investment options.

To close, we are excited by the depth of opportunities in front of us. We will continue to be thoughtful about raising capital and we will use that capital to execute on our investment proposition, deliver an attractive dividend yield from long-term contracted cash flows and grow that dividend from a large, growing, clean energy market all with a diverse portfolio of high credit quality obligors.

Once again, it is an 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 will now open the call for a few questions.

Thank you. (Operator Instructions). Paul Strigler, Esplanade.

So now that the yieldco space realizes that the cost of equity is actually higher than the cost of debt, are you seeing any new opportunities in that space to help these guys hit their very aggressive growth targets that they intended to finance largely with equity, but now that the cost of that has skyrocketed in the past few weeks, is this an opportunity for Hannon here?

We've always said that our growth potential was inclusive of the yieldco growth potential in that they've always needed leverage to, we think, make their numbers work. And so to the extent they value our capital more than they might have in the past, I think the answer is yes. But early days to see how these changes in the market will go, but, yes, it's certainly supportive of our business.

Great. Thanks, guys.

Philip Shen, ROTH Capital Partners.

So in your release, you highlighted growth in residential solar. Can you give us a little bit more color on the structure of those transactions and how you see resi playing out for you going forward?

Well, we've said the SunPower transaction is quite similar to the prior two transactions we've announced and I think consistent with our origination strategy of doing programmatic agreements with some of the best players in the business. These are transactions that have three elements of capital in them. They have tax equity, they have sponsor equity and then we fit in the middle with capital that's in back of the tax equity, but in front of SunPower's equity.

Great. And as a follow-up to Paul's question there, given the tumult in the yieldco and solar stocks in recent weeks, and given your experience, how do you expect this to play out over the next six months?

Obviously, we can only talk about how it affects our market. I've joked in the past that I'm glad our name isn't Solar Armstrong and we have a nice, more than 50% of our pipeline is efficiency. So if the entire yieldco opportunity went away, we still have a nice business. But it doesn't go away, it's -- I think those are sound businesses with nice cash flowing projects, with good well-rated obligors and we think we will be able to put some capital to work with those projects.

Great. Thanks, Jeff. I'll jump back into queue.

Tyler Frank, Robert Baird.

Could you comment a little bit more on the spreads that you see rising in the different asset classes and maybe provide a little bit more color on how rapidly you've been seeing them rise and do you expect these spreads to continue to increase if the US were to start raising interest rates?

Most of the rise we are seeing in spreads is on the long end. We don't really do much on the short end except borrow a little bit. So I think you do see institutional investors demanding more and getting it. Obviously, supply and demand in each of our submarkets is different and that affects the pricing power that we or any investor has. I guess we would say we feel like we found a bottom and in certain markets, it's starting to go up and we think that's appropriate.

And I think I'd add to that, Tyler, that we, like many financial institutions, expect -- it's hard to add a big spread on a small base rate. So as base rates rise, you typically would see spreads rise also. So I think there's a combination there and spreads are probably rising in part because people are expecting the base rates to go up.

Got it. And then with the strong transactions during the quarter, were there one or two large transactions that underscored that, or can you provide a little bit more color on how that breaks down?

No, it was a pretty diversified group of transactions and across all categories, so I think all the markets were working well for us in the quarter.

Great. Thanks, guys.

Michael Morosi, Avondale Partners.

Hey, guys. Matt Wyatt here filling in for Michael. Just a quick question on efficiency yields. Last quarter, you had mentioned a potential bottom in those. With the slight decline this quarter, do you think this is kind of maybe the bottom?

We give the rates every quarter going forward. It's very difficult to look at the mix of any one quarter if it moves 10 basis points or something on the chart. A lot of it is mix, a lot of it's rounding. So it's not -- I think any one quarter doesn't make the trend. I think, as Jeff said, we expect that looking forward we will see some things rising. So it's hard to characterize on any one thing because there's a lot of things -- the duration of the assets, so on and so forth can all affect the mix that we post for any one quarter. But I think our view is that, as Jeff indicated, that there's the potential now for a further spread increase in a lot of the things we're looking at.

Fantastic. Thank you.

Charles Nabhan, Wells Fargo.

I was hoping you could comment more broadly on the C-PACE opportunity. Specifically I know that some states are ahead of others in the regulatory process, but are you starting to see more progress on that front? And if you could give us some specifics around some of your more recent investments as far as where you are seeing the most activity geographically.

Well, I think the usual answer to these questions is California in that they are the leader in most of these things. But PACE is in something like 70% of the US jurisdiction and that doesn't mean all the PACE legislation is functional or something we invest in, but generally it's there.

For us, the bigger question, Charles, was how do we -- what's our go-to market strategy for PACE. It's probably not a traditional ESCO-type market in the commercial office building sector. And that's what's really taken us some time and I would think with this top 10 REIT, we've figured out one model that we would really like to continue to invest in and expand it just as we did with ESPCs 15 years ago when we had one or two clients and now we have more than 15. We think that same potential is there in PACE.

That said, in terms of the legislation, Connecticut's got a nice program; Ohio's got a nice program. I think Texas is working on a good program and it almost takes the property owners like the top 10 REIT to go to the local jurisdiction and say this is really what we want. That's a far more effective way for us to see changes in the market than us going in and asking somebody to pass a law.

Okay, great.

I think the thing to add there is we did close transactions in multiple states this quarter. So I think that does show the continued growth.

Okay. And as a follow-up, I was hoping you could comment on yields across your portfolio. I know you gave the average size, about $11 million and the average yields about 6.6% and 4.4%, but if we were to look across the portfolio, how much deviation do you see away from those averages? Or is it typical -- do you see a lot or is it typically bunched up around those averages?

I think it depends -- you have to weigh in there then the duration of the individual asset and how we rate the asset because -- let me maybe step back and talk about how we price to start. So when we price, we look at how long of an asset and that helps us determine the base rate. We use treasuries or swap rates as a base rate and then we put a spread on top of it and the spread is really a credit analysis spread and a market condition spread.

So within a portfolio, you'll see some assets that are higher priced and some assets that are lower priced and I'll pick on energy efficiency for example. The federal government assets are going to tend to be on the lower end of the 4.4% because of the credit of the federal government and the long-term nature of that structure and things. Other transactions that are either in industrial or state and local or PACE or something else may be on the higher end of that. So it really depends on the mix of who we're originating transactions with, so there is some variability in that based on that.

Great. Appreciate the color, guys. Thank you.

Ken Bruce, Bank of America Merrill Lynch.

My first question relates to some of the discussion that you were having around wider spreads. I guess the specific question I have is how does the spread action color your decision to either put assets on the balance sheet or to prefer securitization if in fact those are in any way related or if they are mutually exclusive just in terms of what is coming through the pipeline?

Sure, and I think as we've talked about in the past, the poster child for securitization is a really long-dated federal ESPC. The insurance companies like the paper. They have a lower cost of funds, so that's attractive to them. It's attractive to us because we can get the fee and we can manage the duration of our portfolio. So that's kind of the poster child for what gets held or sold.

We use securitization as part of our portfolio management tools. So we are trying to keep the average duration somewhere around 10 to 13 years, which is where we've kind of been running. And so we use the securitization and when we see long-dated fixed-rate assets that make sense to securitize, we will securitize rather than put them on the balance sheet. It's all part of our interest management strategy.

Okay. And just in the context of wider spreads today, I imagine that that would increase your appetite for paper on the balance sheet?

It really depends on the mix and that's one of the things we look at and obviously, if you can hold paper that earns more, you'll hold more of it. But if market pricing is such that we can make and attract (inaudible) and it makes sense to do that given where it sits into the duration and other alternatives we have to put on the balance sheet, then we will take advantage of it.

But I would add that, as the balance sheet builds, the need to do fee-generating securitizations falls. It may still be the right choice, but at least now we have a choice to do it where early on when we were ramping, the fees were pretty important. If you look at the percentage of our fees as part of our total income, it's falling and it should.

Yes. Well, having followed the Company for a while, it has -- the complexion of the P&L has changed a lot and I believe taken out a lot of the volatility. Obviously there's a few other things that have introduced some new volatility, but that relationship seems to have improved.

The next question relates to just the investment-grade investments that you are making. There was a pretty big pickup in the commercial investment-grade and you added a new disclosure, or at least in the press release, relating to what is rated investment-grade externally versus internally. And maybe you can just help me understand if in fact there's any change in terms of the appetite for what's going on the balance sheet in this area and maybe walk us through the disclosure, please?

Sure. So we've actually disclosed in past quarters what was rated internally versus what was rated externally, so I think that's consistent. We did add a disclosure about how much residential solar we had that was subordinated to the tax equity and we just wanted to call that out so people were aware that we had that. And in that case, we're relying on the publicly traded solar -- residential solar provider to honor certain tax equity indemnities that they've made because we are a subordinate to the tax equity. So there's a little bit more analysis there, so we just wanted people to be aware of how much exposure we had of the portfolio, which is roughly 10% that we had to the residential solar area.

Okay, great. And lastly, I guess, as we think about the buildout of the skill set for Hannon Armstrong, do you believe that you've got, as you're entertaining more commercial credit risk, what the -- do you feel like you've got the right human capital on the team to manage that? Maybe just update us on the buildout of the infrastructure from that standpoint, please?

That's a good question. We definitely have added people. We've added a credit manager from a commercial bank. We've really increased our legal team, in-house legal team, as well as asset management people with more operating credit and compliance experience. So it's never perfect, but we feel like we've really added some skills that we do need and they're really helping us make better decisions.

Great. Well, thank you for your comments.

(Operator Instructions). Paul Strigler, Esplanade.

Just a quick follow-up. So you mentioned that spreads from the baseline are increasing, which is great, but when do you think we can expect to see the results of the carnage in the yieldco space flow through to asset pricing? So I think one of your competitors, I think NRG Yield, mentioned that wind pricing had gotten crazy, like uneconomic for those guys, but that I think we all know who the person driving those prices up was. Now that that particular buyer is pretty compromised right now, how soon until we see sort of flowthrough and asset owners and their expectations for debt and equity pricing flow through?

Paul, that's a terrific question. I don't have an answer, but it's a terrific question. I'm not dodging it; it's just we're all kind of watching this stuff real-time. And I guess we stay pretty focused on execution and our clients and it'll be obvious to us probably -- maybe after it's obvious to you -- when those changes will hit. But our clients are generally -- they go through ups and downs and have been doing that for a very long time and they still have to sell and they still need to embed our financing in their sales offers. So we don't worry about the disruption in one sector's equity market that much, frankly.

Is it at least fair to say that you could have a double-pronged tailwind and that you have base rates going up, but spreads increasing modestly combined with just demands from equity and debtholders or customers coming down?

I think we play in growth markets and so there's lots of opportunities and I think the one thing we've tried to stay very disciplined on is finding the best risk-adjusted returns. And so today, that's been in land and senior debt and other places that puts us ahead of the equity. If equity pricing would change in a dramatic way that it made sense for us to look at the equity, then we would look at it. But, to date, we have the flexibility to go wherever and today, we've tried to be very displayed about being in the right -- in what we thought were the right risk-adjusted returns, and I think we'll continue to focus on that.

Thanks so much, guys.

I have one correction to the comments I made earlier, just want to bring up. On the future ABS transaction, approximately $110 million of the $125 million is A-rated. The rest is a BBB-rated slice.

Thank you. There are no further questions at this time. I would like to turn the floor over to the management for closing comments.

Thanks. You asked great questions once again and we look forward to speaking with you again soon. Have a good night.

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