HA Sustainable Infrastructure Capital Inc (HASI) 2017 Q3 法說會逐字稿

Good afternoon, and welcome to the Hannon Armstrong's conference call on its Q3 2017 financial results. Management will be utilizing a slide presentation for this call, which is available now for download on their 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. (Operator Instructions)

At this time, I would like to turn the conference call over to Amanda Cimaglia, Investor Relations Director for the company.

Thank you, Sophie. Good afternoon, everyone, and welcome. Earlier this afternoon, Hannon Armstrong distributed a press release detailing its third quarter 2017 results. A copy of which is available on our website. This conference call is being webcast live on the Investor Relations page of our website, where a replay will be available later today.

Before the call begins, I would like to remind you that some of the comments made in the course of this call are forward-looking statements and within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. The company claims the protections of the Safe Harbor for forward-looking statements contained in such sections. The forward-looking statements made in this call are subject to the risks and uncertainties described in the Risk Factor section of the company's Form 10-K and other filings with the SEC. Actual results may differ materially from those described during the call.

In addition, all forward-looking statements are made as of today and the company does not undertake any responsibility to update any forward-looking statements based on new circumstances or revised expectations. Please note that certain non-GAAP financial measures will be discussed on this conference call. A presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. A reconciliation of GAAP to non-GAAP financial measures is available on our posted earnings release and slide presentation.

Joining me on today's call are Jeffrey Eckel, the company's President and CEO; Brendan Herron, our CFO; and Justin Cressall, Our deputy CFO. With that, I'll turn the call over to Jeff, who will begin on Slide 3. Jeff?

Thanks, Amanda, and good afternoon. Thank you all for dialing in. Today we are announcing quarterly GAAP earnings of $7.9 million or $0.14 per share and core earnings of $16.4 million or $0.31 per share. Given rising interest rates and the flattening yield curve, we took to the decision to proactively fix out a significant amount of our interest rate risk during the quarter. We have committed the fix rate on approximately 94% of our debt, while extending maturities, increasing leverage to 2:1 to 1, strengthening the balance sheet and significantly increasing liquidity. While we believe this was a prudent decision to ensure a strong and stable base for growth in the future, the higher cost of fixed-rate debt lead us to project our annual core earnings per share will be at or a bit below the low point of our guidance range.

We're very proud of this quarter. We get all of the fixed-rate transactions done at the coupons we achieved which, a few facts here, almost $450 million of the debt has an average rate of approximately 3.86%, including nearly $300 million of debt at approximately 25 years. This was no small feat. We now sit with a solid investment-grade balance sheet, largely insulated from what many considered to be our largest risk: a rising rate environment. And we are now in a good position to preserve and grow the dividend. We've closed approximately $750 million of transactions year-to-date, and are well positioned to achieve our $1 billion annual investment target.

Turning to Slide 4. Our balance sheet portfolio is $2 billion after profitably exiting one of our non-investment grade transactions. The portfolio consist of over 170 separate investments with an average investment of $12 million and is diversified across markets, technologies, obligors and geographic regions. Forward-looking portfolio yields remained consistent over the last several quarters, with a blended yield of 6.2%.

It is timely to note the impact of the quarters extreme weather events on our portfolio. We have 3 solar projects affected by Hurricane Irma, all with insurance coverage to the extent of the damage. We mapped our residential solar portfolio to the Napa Valley fires and concluded the impact as de minimis. No wind assets in Texas were affected by Hurricane Harvey. Individually and corporately, we have supported several charitable activities to minimize the human impacts from these weather events. Overall, our portfolio remains comprised of high credit quality assets, with less than 1% or only $10 million not considered investment grade.

Turning to Slide 5. We continue to enjoy a deep diversified pipeline of more than $2.5 billion of investment opportunities. The government efficiency business continues relatively unchanged in cadence and volumes, while the commercial market shows increased activity. We found a recent JCI Energy Efficiency Indicator survey interesting in that, for the first time, non-economic factors like greenhouse gas reduction goals and improved energy security are the top 2 buying influences for commercial property managers. This augurs well for our commercial efficiency prospects.

According to the AWEA Q3 report, new builds for wind in Q2 and Q3 were lower compared to the prior 3 years, although conversations with CEOs of the largest wind sponsors suggest 2018 looks strong. We also still find an active market for recycling capital in operating wind projects to optimize our clients' capital stack.

The solar markets continue to be awash in capital, with yields nearing surprising lows in the most competitive markets. While the solar pipeline fell from 8% to 6% quarter-over-quarter, we continue to increase the pipeline of other sustainable infrastructure. This is an example of our willingness and ability to pursue more attractive yielding assets and trim pipeline were yields are not as attractive.

We also are seeing larger opportunities than we have in the past, like our $200 million portfolio of utility privatization assets last quarter, in part because our potential bite size has increased as our portfolio has grown. These transactions are interesting and that they can change our trajectory to the positive much faster than smaller transactions. But of course, they increase lumpiness in any given quarter.

I'll now turn it over to Brendan to detail our financial performance.

Thanks, Jeff. Turning to Slide 6. For the quarter, we generated GAAP interest income, rental income and income from equity method investments, which we have labeled investment income, of $28.9 million. An increase from approximately $16.8 million last year as a result of approximately 45% growth in the portfolio from this time last year as well as increases in the equity method investments and allocations under GAAP.

We generated gain on sale and fee income, which we label other investment revenue, of approximately $4.4 million compared to $3.5 million in the prior year. Given the nature of the assets sold and general market conditions, we achieved higher margins in the quarter and year-to-date which drove the higher other investment revenue.

Interest expense grew to $17.6 million from $10.6 million in Q3 last year, primarily as a result of the approximate 45% increase in debt in 2017 used to fund our portfolio growth. Comp and general and administrative expenses increased by approximately $1.4 million for the quarter and approximately $2.8 million year-to-date, primarily due to the additional cost associated with the growth of the company. Full time headcount was 43 at the end of the quarter, as compared to 38 at the end of Q3 last year.

In total, we have $7.9 million or $0.14 per share of GAAP income compared to $3.3 million or $0.07 per share in Q3 last year. As a reminder, the GAAP earnings do not include the full effect of the cash we received from the renewable energy equity investments, especially where we have invested alongside the tax equity and received a limited allocation of profits and losses. Although a much larger allocation of cash.

In addition, the GAAP accounting method, HLBV, can be heavily influenced by the allocation of tax attributes like the investment tax credit or production tax credit. As we are not investing for these tax attributes, we will periodically, like in this quarter, end up with large profit allocations where other investors have received tax attributes. Year-to-date, we collected $66 million in cash from our equity method investments, as compared to GAAP income on these investments of approximately $19 million.

Since we have based our investments in the future cash flows discounted back to a present value, we believe the cash we received reflects both a return of capital and a return on our investment. Thus, we make a core adjustment of approximately $12 million to recognize the return on the investment which, year-to-date, when added to the $19 million GAAP income, gives a total core return of $31 million, unless the other $35 million represents a return of capital.

One comment on our debt, as Jeff mentioned, we made the strategic decision to increase our fixed-rate debt beyond our 60% to 85% range. With deals closed in Q3 and early Q4 as well as one additional Q4 transaction, we expect our fixed-rate debt to have more than doubled since the start of the year. Obviously, this comes at a cost. Using the Q3 ending average debt levels and rates, we estimate that the difference between the low end of our fixed-rate debt target of 60% and the 94% we now expect, could impact us by up to $0.10 per share on an annual basis.

I have often discussed the concept of fixing out vintages of assets. With these deals, we have largely fixed out the first 5 years of assets. We would expect that, over time, we will move back down into the target range. And while there is a short-term impact on earnings that Jeff discussed, we, and from various investor conversations over the years, understand that many of you believe that it is a small cost to reduce the risk of further increases in rates, as indicated by the fed. We expect, longer term, as base rates rise that our yields will rise, and the decision to fix out rates positions us well for future growth.

We are glad to have Justin Cressall, who joined us from Ares approximately 7 months ago, as our Deputy Chief Financial Officer, along with Chuck Melko, who joined us as our Chief Accounting Officer from PwC's National Office, around the same time. Both have bought great capabilities and experience they have and we expect will, in the future, help us to drive the business forward.

I will now turn it over to Justin who will provide an additional update from the execution of our financing strategy.

Thanks, Brendan. Turning to Slide 7. We wanted to highlight the progress we've made on our financing strategy this quarter. We closed or expect to close approximately $645 million of debt transactions involving our efficiency, wind and solar assets. And importantly, our first transaction with Hannon as a general corporate debt issuer.

As we stated in the past, we've been working with various rating agencies to rate each of our asset classes. And in August, we were pleased to receive our first investment-grade corporate rating by DBRS, which represents a culmination of our efforts on this front. Additionally, we issued a $150 million of investment-grade 5 year senior unsecured convertible notes with a 4.125% coupon and a 20% conversion premium.

We were happy with the execution on this transaction and viewed it as a good first step towards our goal of issuing straight, unsecured corporate debt. As a result of this and other transactions, our percentage of fixed-rate debt is expected to increase to over 90%.

Furthermore, as you heard from Jeff earlier, we successfully added a significant amount of long-dated debt to our balance sheet. This further extended our maturity profile. And notably, as the chart on the bottom of the page illustrates, we have no maturities before 2019. And those anticipated maturity amounts represent no more than 11% of our current debt outstanding in any given year. Importantly, we have further diversified and expanded our investor and lender base. Overall, we believe these actions position Hannon well for the future.

With that, I'll turn the call back to Jeff.

Thanks, Justin. We'll wrap this up on Page 8. We believe this quarter is another example of Hannon Armstrong continuing to execute, this time on both sides of the balance sheet. We produced an attractive yield that is now substantially protected from rising interest rates, generated by a high credit quality, diversified portfolio, financed with a stronger balance sheet and managed by a team aligned with you, the shareholders.

We will now open up the call for questions.

(Operator Instructions) And we'll take our first question from Philip Shen with Roth Capital Partners.

Two questions. Brendan, you mentioned that next year as you guys originate more transactions, the fixed ratio could come down. Would you -- and I think you mentioned it could come back down to the original target. Can you just talk about how that might work? And then in turn, with the higher fixed-rate of debt or fixed out interest rates on your debt, can you talk about being able to support your dividend of $0.33 and the potential impact to core earnings for next year as well?

Sure. So on the first part about how it will work. We, obviously, did a lot of fixed-rate debt this quarter given where the fed was and what they were saying about rising interest rates and a number of rate hikes coming. We wanted to protect ourselves against that. As we've talked about, our assets work very much like a bond ladder and it will originate new assets at new rates. And as rates -- so as rates rise, we'll then use debt on those rates. And some of that debt will be either in the form of our credit facility or other floating rate debt. So we would expect, over a period of time, that we'll adjust back down to the -- from the 94%, back down into kind of the target range. We thought this was the right strategic move at the time, given where the market was and where rates were. But we do believe, long term, that the 60% to 85% makes sense for us. I think Jeff mentioned that we think this helps position us to continue to grow the dividend. We're not giving specific dividend guidance at this point in time. We don't usually do that at this point in time. So we would do that later in the year. But we do think that this positions us well strategically. The pipeline, I think, remains strong and we look forward to continuing to grow the business and to grow our dividend.

Great. I think you also mentioned, Brendan, that you expect yields to rise. Can you give us some additional color as to -- perhaps by segment, or just some color on your end markets, and do you expect the yields to rise at a similar rate? Do you have that pricing power to be able to perhaps drive the yields a little bit faster -- or higher or faster relative to your cost of funding? Some perspective on that will be helpful.

Phil, this is Jeff. I'm not sure we have the power to drive yields higher. We're certainly -- we've been flat on the gross forward-looking portfolio yield for 3 or 4 quarters now. What we can do is continue to shift the portfolio and shift our focus to areas that are marginally more lucrative than, frankly, some of the over banked markets. I was so much struck at Solar Power International, and I know you were there as well, at the shockingly low yields people are willing to accept for equity investments in solar. That's probably not an area that we're going to be very active in at those levels. But there are other areas where we will, and have been, continually trying to grow the business.

Okay. Good. One more here. In terms of your corporate rating by DBRS, can you talk about when we might be able to expect your first corporate-grade debt issuance? Is it around the corner? Is it -- how are you thinking about what the timing or size or some of the details of that might be?

Philip, this is Justin. So the convertible bond was corporate rated. It was rated BBB (low) by DBRS. I can't give specifics on future debt offerings, but this is part of a longer-term process where we undertook the convert and have a view that we want to be an issuer in these sort of the unsecured market ideally at a rated level. So it's all part of a longer-term plan we have in place, but I can't give specific guidance as to when we might access the market in other forms.

And just to add to that, we viewed it as first step. The process we had gone through, I think we've talked about this in past calls, is we first worked on getting most of our individual asset classes rated investment grade. And then based on that, we were able to move to the corporate rating. And we had a lot of questions about why a convert -- we thought that convert was the first -- good first step in introducing ourselves to the public debt markets. The people in the public equity markets have gotten to know us, but the debt market is a whole different market and you have to kind reeducate and reintroduce yourself to those debt investors. So the convert was a good first step in that process for us and we do think that corporate debt becomes an important part of our finance plan going forward.

(Operator Instructions) And we'll take our next question from Noah Kaye with Oppenheimer Funds.

I hate to ask a speculative one, but it's a current topic. With tax reform ongoing some commentary that the investment tax credits for solar and the PTC for wind could be at stake here. Obviously, that would not be great for the industry. But would be interested to hear your thoughts on how it might affect, basically, what you're doing here? Typically, you've stayed away from debt finance for utility scale solar. But with tax equity potentially not being or being less a part of the capital stack, is there an upside to yields for Hannon potentially? Or how should we think about?

Noah, so I guess the first thing is we've always tried to inoculate ourselves from federal tax policy. And solar, being the most dependent on it, in our opinion, and it's 6% of our pipeline, it's relatively small. Wind, we have really 2 sets of opportunities. The legacy projects that no longer need PTCs, that's where we can recycle capital, really very limited impact on our business prospects. The new builds, I think, would be affected. I think that, in general, the wind business feels like, with the 5-year ramp down of PTCs, that they can get to an economic place in 5 years. If that ramp down gets truncated because of tax policy, I think, that is a negative for wind except that most of the wind developers have a tremendous amount of turbine supply already grandfathered for today's PTC. So I think it's -- we don't have a good enough forecasting tool to say whether that's 2 years or 3 years of capacity. But I think the delta between no PTCs and what they've got grandfathered is a relatively minor number. That said, if tax credits all went away and these projects still penciled out, then that's actually an economic opportunity for Hannon. Cash on cash investors become more of a desired source of capital than tax-oriented investors. So -- and I don't mean to say we're probably (inaudible) that we don't care, we worked as hard as any company I know of to inoculate ourselves from those things that we can't control.

Yes. Yes. Appreciate it. I think a couple of quarters ago -- and by the way, I'm picking up on your -- you have mentioned that kind of the federal businesses pretty much unchanged in terms of activity. I think that there have been some commentaries that some of the agencies might even be interested in some of the -- some other agencies within DOD, for example, in looking at applying the ESPC program to, say, transportation. Just curious to know whether you're seeing any traction on and the potential initiatives like that to expand the scope of the program?

Well, there has been some progress on the very -- the one thing that has frustrated the expansion of the ESPC and basically CBO, was given a direction by the chairs of the senate and House Budget Committees to look at these savings as well as the cost in an ESPC and all things. That does seem to open up the potential for going to more mobile assets. That said, any transportation system at DOD is a very complex procurement cycle and I think the prospects of having meaningful volumes would be best thought of in years away, not in 1 or 2 years. It takes a long time to upgrade technology at scale for particularly DOD. But if they can do it, long term, it's a great positive step for the treasury. We'll save the treasury money. We'll, certainly, create jobs and improve conditions for the war fighter which, hopefully, everybody can get beyond.

Our next question comes from Chris Souther with Cowen.

Just on the first subject within the sustainable infrastructure. I was curious if you're seeing any potential opportunities within smart city financing in addition to the resiliency water in the infrastructure you highlighted. Just wanted to get an idea of how you view that market opportunity.

I'm not particularly familiar with the smart city program that you mentioned, in part, because I think there are so many of those initiatives, which is a very positive thing for the industry. It's very much a local business. I know the city of Annapolis has a program and there are just a lot of activity worrying about resiliency. The flip side of that is there are so many programs that's really hard to get to a scale. The one technology that we see being implemented, and it's not necessarily for resiliency, but LED street lighting upgrades, is a good thing that's happening in a lot of varied jurisdictions.

That's helpful. And then just on the transaction amount for the quarter, the volume. Can you guys talk a little bit about -- I know there were some delays that you mentioned on kind of solar, could you just kind of maybe quantify that or give kind of a little bit of commentary on what was going on there?

Well, actually, I don't know that there are specifically any mention of a delay in the solar transaction. I mean, our business model, and we talked about last quarter and really for last couple of years, has been to do $1 billion of transactions for the year. We're 3 quarters away through the year. We've done 3 quarters of that amount, and we're on track to do the $1 billion. And we've always said the biggest risk after interest rate risk which, hopefully, we've taken off the table to our business, is our inability to predict when a transaction will land and whether it lands September 30 or October 1, as a close deal. It doesn't matter to the enterprise value of Hannon Armstrong, it matters a lot on how you report a quarter. So we had a really good Q2. We're looking for a good Q4, that means Q3 is going to be where it was.

And then for the equity method adjustments, it looks like you've kind of broken that out between reverse GAAP income and the kind of core equity method investments or net -- earnings net out. Is that kind of netting out between those 2?

We were just trying to make it -- we've been -- we've worked very hard to try and make that a clearer adjustment that everyone understood. And we've had some suggestions, and maybe we'll be clearer if we show the reversal or GAAP and then showed how much we were adding back in the core, which is why we broke out those 2 lines. Definitely, there's no change really in how we're calculating either. It was just an attempt to make it more -- have a better way for people to be able to see exactly what we're doing.

Our next question comes from Carter Driscoll with B. Riley FBR.

So when you talk about the average transaction size you meant -- just a couple of quarter ago, it was closer to 10. Now you're up closer to 12. Maybe a characterization on mix and where it could potentially head, say, end of next year. Are we thinking maybe 13 or 15? And does that, at all, if you get in these larger deal sizes, put in a different -- or bump up against some of the larger players that wouldn't traditionally go down to some of the sizes of transactions you typically do? I guess, I'm just trying to get a better sense of where you might bump into some greater competitors as you move up size?

Good question. I think when we talk about the larger transactions, they are really portfolios or relatively small projects. We still don't see ourselves doing a single transaction that dominates the balance sheet that would completely tilt our portfolio to the point and our credit profile to something that we really have to talk about it every time. So I think you're still going to see a lot of diversity in the portfolio. That said, when we can acquire a portfolio like we did with wind land leases and some of the wind tax equity, those can be relatively large transactions. They were all in the 100-plus million range. Now maybe we'd be seeing portfolios in the 200 million-or-more plus range.

Okay. That's helpful. Maybe an update on your activities in commercial pace. I know it's pretty small, but one of the things you talked about kind of point was trying to get to more of a programmatic structure or what you guys have done so well in energy efficiency and obviously, now more in wind and solar, maybe an update there? And then the next one, I have a follow-up.

Not a whole lot to update you on that's new. It's definitely building on a platform to transact smaller transactions that take some time. That said, we are doing it and putting the building blocks in place. The reason I wanted to talk about the Johnson Controls Energy Efficiency survey is, they've been doing this for 11 years, and economics has always been the number one criteria. And for the very first year, economics still count and PACE is going to be economic. But the problem with the efficiency is the transactions are generally not a priority for commercial building owners if it's just economics. But now there are 2 other reasons to do it and its economic, sustainability and energy security, then that seems quite promising for this -- the commercial office building sector that we're pursuing with PACE.

And then just maybe the last one. Obviously, we had a number of natural disasters which you -- it addressed your current portfolio. Does this potentially offered up any new conversations on the infrastructure side?

Well, I think when we talk about resiliency, we've mentioned storm water in events of Hurricane Harvey, and we still think that is a critical issue in a number of places. And sadly for the people of Houston, it's still a critical issue. They're still suffering from the aftermath of that. So I'd be surprised if it's not a growing theme in infrastructure investing.

And this is not necessarily a play on transmission though where distribution or last mile in terms of resiliency or grid hardening?

I think that's what we see particularly at DOD and when we talk about commercial office building that worried about energy security. Having a more efficient building envelope and having some on-site generation, some measure of microgrid and storage, it may not be 30 days of energy security but sometimes 30 minutes can be very, very important to a business. So yes, I think that's definitely one of the big drivers. It's very hard for the central station utility model to provide a super secure solution behind the meter. It's just physically impossible.

And it appears there are no further phone questions at this moment. Mr. Eckel, I'd like to turn the conference back over to you for any additional or closing remarks.

No. Thank you very much, and thanks for good questions.

This concludes today's call. Thank you for your participation. You may now disconnect.