HA Sustainable Infrastructure Capital Inc (HASI) 2015 Q3 法說會逐字稿

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.hannonartmstrong.com.

Today's call is being recorded and we have allocated one hour 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 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 on this call are subject to the risks and uncertainties described in the risk factors section in the Company's Form 10K 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 bond to have a carbon count rating. Subsequent to the quarter end, 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 yieldcos and what is going on in our markets? Our exposure to assets owned by yieldcos, or apparent with the intent to drop into a yieldco, is less than 15%. We have investments in 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 SunPower as the sponsor.

As for the market question, we are experiencing welcomed increases in pricing across asset classes, driven in part by increasing credit spreads and equity yield requirements. For instance, the 10 year BBB 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 yieldcos, 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 as 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, 25 times our investment [sits] on top of us, but importantly, below us in the waterfall of cash distributions.

Finally, in the utilities scale wind business, we like the senior preferred return position in the tax equity tails, but would certainly look at equity structures alongside the sponsor if the return is there to compensate for variation in wind resources and equipment performance.

In summary, our four assets 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 investors. And within those asset classes, we are generally senior to another slice of capital such as the sponsor equity.

Moving to 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 reduced 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 and then solar. For the quarter, however, most of our efficiency investments were in low-carbon areas like California, while 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 from 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 at 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 decline 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 of 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 have discussed, that originations in our business are lumpy and while we have a strong pipeline, any one quarter does not make a trend.

I'll comment on the equity raise. If you look at the timing of the last two raises, early in Q4 2014 and early in Q2 2015, you will note that the time of the last two raises proceeded larger quarters of origination, which is reflective of our desire to avoid excessive dilution. In deciding to do 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 record a core earnings interest based on our 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.

The 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 consists 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 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 and real estate. As we have discussed, new assets are originated at current rates which, in effect, is similar to a bond ladder.

On the debt side, we [earned] 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. 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 $1 million rated AVS transaction was another step in this process. The fixed-rate bonds have an A rating and mature 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, yieldcos, infrastructure funds and electric and gas utilities. And given our generally senior position in the capital stack, limited exposure to fossil fuel risk and assets that are diverse with low asset 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 we'll use that capital to execute on our investment proposition, delivering attractive dividend yield from long-term cash flows, increase that dividend from a large growing clean energy market, all while we're maintaining a diverse portfolio of high credit quality obligors.

Again, it's a pleasure and 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 will now open the call for a few questions.

(Operator Instructions).

Noah Kaye, Oppenheimer & Co.

Let me just start with a question about the federal and municipal ESPC business. You mentioned that that looks to be kind of a growing pipeline of opportunity. So, could you just give us a little more color, what are your programmatic partners saying as kind of the drivers behind the growth of that opportunity? And how do you think the cost of capital is going to impact the size?

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 in much higher interest rate environments.

We talked about the economic internal rates of returns of LEDs at like 50% and controls that say 30%. So, having started my career with a much higher interest rate environment than we have had in the last 10 years, it's always good to have assets that have high economic IRRs and we'll always be able to finance it, we believe.

There's a lot of drivers in the federal market and in the state and 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.

They're 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're, 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 10 REIT that we talked about last quarter and the industrial market is starting to work.

So, to summarize, the organizational and structural drivers, while at the same time, modestly increasing spreads in the environment you're looking at there.

So, moving to the wind and solar piece, just wanted to look at the wind tax equity opportunity. How are you thinking about that going forward? Perhaps looking at a 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 expect 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, [as] the PTC is about to expire and banks like JPMorgan need, for regulatory reasons, to exit. So, there's 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're very committed to letting that tax credit roll down and still having very viable businesses. They're squeezing the heck out of a lot of costs. So, we still hope there's a decent solar business in the 10% environment.

[Philip Shen, ROTH Capital Partners.]

This is actually Justin Clare on for Philip 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 a similar term and size?

So, the bonds, just to correct one thing, the bonds were $101 million. So, the presale was $125 million, but there were some assets that were pulled out of the presale to get to the $101 million. And we chose not to sell the B notes at this point in time, which would have given us another $18 million.

As far as future transactions, we continue to look at a variety of opportunities. As I 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 and 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 term.

So, we will do additional offerings. We're not prepared at this point to give exact guidance as to when.

That's helpful. Next question, can you share some color on what you're seeing in terms of back leverage opportunities? With SolarCity 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?

Well, I think we mentioned, you're really talking about solar, we mentioned this call $160 million with SunPower. And that's substantially all of our solar back leverage in resi. There are other transactions with wind and maybe commercial solar, but they're relatively minor.

As to where that goes, as we say, 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 we're not out trying to win the resi solar back leverage race.

Tyler Frank, Robert Baird.

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 to impact overall solar growth or demand as well as wind and then energy efficiency projects?

We certainly can't crystal ball out actual breaking points. And we're always impressed with the top tier clients that we work with, how they adjust their business and their cost structures to work in any economic environment.

We've always said that solar has the lowest economic IRRs, so you'd have to think it's the most impacted. But I wouldn't rule out the solar guys from having a continued great run, even at 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 all together, we'll have to use debt. But I think there's some good tradeoffs between debt and PTC equity. That's not the cheapest form of equity in the world.

So, that's a very vague 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.

And just looking at your transactions, it looks like it's up almost 20% year-over-year for the amount of transactions 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 for that year as well?

So, I think what we've given as targets is we've said we're going to do more than what we did last year. So, we're kind of vague on our guidance target on 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 when we typically update our guidance looking forward. So, we'll consider giving origination targets at that point in time.

I 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 us, continuing to be steady and choose the right projects.

(Operator Instructions).

Joel Houck, Wells Fargo.

Jeff, you mentioned BBB was up 40 BPs over treasuries. 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, 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.

I just don't see a difference between clean energy and say dirty energy assets, or any other assets, in this interest rate environment.

Okay, and I guess as a follow-on, 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, that we'll start to see yields, at least on the renewable energy side, start to creep higher into next year?

Yeah, 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.

I don't think there's any question that we certainly hope Janet Yellen does 25 basis points in December. We can get that off the CNN screen or the Bloomberg screen and then we expect interest rates to rise. If they do, we're going to be waiting in a really good spot.

And then last, I guess, maybe 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 trajectory could remain intact for 2016 at this point? It sounds like everything at the business is good, pipeline's good, yield spreads are rising. But I just wanted to kind of check in, make sure we're not missing anything.

Jeff did reaffirm earlier on that we're maintaining our guidance of 14% to 16% for the remainder of 2015 and for 2016. What I was referring to is we tend to give a more [wholesome] outlook at the first call of the year, after we're done business planning and things. So, we'll give a further update then. But we don't see anything will change our 2016 guidance at this point.

We have time for one more question.

[Michael Morosi, Avondale Partners.]

Matt White here for Michael Morosi. Thanks for taking our question. Two part question here, first part, 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 tradeoffs between debt and equity. Can you elaborate how that might open up opportunities for business (inaudible)?

Forgive a little bit of a story, but I was with Hannon in the 80s and we financed the SEG solar projects that are still operating out in the Mojave Desert. And in 1989, Congress failed to extend the 11% energy tax credit. And there was no more SEGs 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 they're 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 saved energy costs. It doesn't matter what anybody's view is on climate change. This stuff is just economic.

The second part of 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 with our 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 relatively 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 boom for us.

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

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.