HA Sustainable Infrastructure Capital Inc (HASI) 2018 Q1 法說會逐字稿

Good afternoon, and welcome to Hannon Armstrong's Conference Call on its Quarter 1 2018 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 over to Amanda Cimaglia, Investor Relations Director for the company. Please go ahead.

Thank you, Abby. Good afternoon, everyone, and welcome. Earlier this afternoon, Hannon Armstrong distributed a press release detailing its first quarter 2018 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 Exchange Act of 1934, as amended. The company claims the protections of the safe harbor for forward-looking statements contained in such sections. The forward-looking statements made in this call are subject to the risks and uncertainties described in the Risk Factors section of the company's Form 10-K and other filings with the SEC. Actual results may differ materially from those described during the call. In addition, all forward-looking statements are made as of today, and the company does not undertake any responsibility to update any forward-looking statements based on new circumstances or revised expectations.

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; and Brendan Herron, our CFO.

With that, I'll turn the call over to Jeff who will begin on Slide 3. Jeff?

Thanks, Amanda, and good afternoon, everyone. 2018 has started, as we suggested it might in our last call, with lumpy earnings. Today, we are announcing a GAAP loss of $0.03 per share for the quarter, primarily related to a noncash HLBV loss, which Brendan will discuss in a few minutes, and also announcing core earnings of $0.27 per share.

While total revenue grew 17% compared to this quarter last year, originations of $108 million in the quarter were lower than an average quarter. We do expect earnings to increase significantly over the next several quarters and forecast that our 2018 core earnings should grow at our guidance level of between 2% and 6%, with the midpoint being equal to $1.32 per share.

As discussed last quarter, we've taken 2 actions based on our view of the market. First, given strong institutional demand for certain of the assets we originate, it is more profitable to securitize those assets than hold them on the balance sheet. Thus, we expect to increase the level of securitization for gain-on-sale income. The timing of securitizations means that the quarters will be lumpier than in the past with some, like this one, lower than the $0.33 quarterly dividend and some higher than $0.33.

Second, we expect to maintain a fixed-rate level at the high end of our target range until the Fed slows or stops interest rate increases. We estimated last quarter that this additional fixed-rate debt could cost us up to $0.10 per share of annualized higher interest expense, and estimate it cost us approximately $0.02 this quarter. Still, we are pleased with our timing and believe it to be in the best interest of the business.

I think I overly complicated our guidance last quarter. Actually, I know I overly complicated our guidance last quarter. I want to reiterate and hopefully clarify our 2018-2020 guidance. We expect 2% to 6% growth in core earnings on an average annual basis. As I said earlier, we expect to be in that 2% to 6% growth range for 2018 as well so, again, $1.32 at the midpoint. We expect to pay dividends at that same $1.32 level in 2018. As we grow earnings in 2019 and 2020, we will consider growing the dividend, perhaps at a lower growth rate than the growth in core earnings.

Turning to Page 4. We want to make sure investors understand the gain on sale securitization portion of our business. This is our historical business, and we've been securitizing these types of assets annually since 2000, presently managing $2.8 billion of securitized assets. We believe that the flexibility to securitize is a valuable component of our business, especially in periods like now with a flat yield curve or when equity capital markets are not open. Our trust structures are in place, and no new investments are required to execute incremental securitizations. We have and continue to enjoy strong, diversified institutional investor base. For example, before our IPO, even during the financial crisis of '08 and '09 and now post IPO. While most securitizations require warehousing until they reach scale, we do not typically warehouse. We rather put them in the existing trust structures as they are originated.

Let me walk through an example. Assume a $10 million, 20-year term, energy-efficiency investment. We originate these assets at a 20 to 25 basis points spread above where an institutional investor might invest with us. With these assumptions, we can generate a 2% or $200,000 cash gain on sale. If we had put that same asset on the balance sheet using the same assumptions, we'd have earned $20,000 dollars in net interest margin. So in this example, securitization increases near-term earnings by 10x compared to putting it on the balance sheet.

Our business model has been to target $1 billion of originations annually, to put 70% on the balance sheet and to securitize 30%. In 2018, we are planning to increase the level of securitizations and decrease the amount added to the balance sheets. In markets like this one, with strong originations and strong institutional bids for some of these assets, it makes economic sense to do relatively more securitizations. To be clear, we still intend to grow the balance sheet portfolio in 2018, just perhaps a bit slower than in past years.

One of the reasons we gave 3-year guidance is that when we return to a more normal interest rate environment and hopefully yields and spreads have widened, it is likely we will choose to reduce the proportion of assets we securitize and thus increase additions to the balance sheet. This could cause earnings to fall in that transition period, thus reversing the example I just gave. We would recognize net interest margin that is 10% of the potential gain on sale. However, over the 3-year period, we expect to have grown core earnings by the 2% to 6% compounded annual rate.

Turning to Slide 5. We'd like to highlight that the pipeline remains strong, and our portfolio yields remain stable. As we discussed last quarter, we believe it is becoming increasingly important to focus on whether an asset, like utility-scale wind or solar, is grid-connected and competes against low wholesale power prices or is located at the customer premises and thus on the retail side, which we refer to as Behind The Meter or, occasionally, BTM.

While our efficiency projects historically have been a blend of lighting, heating and cooling assets, we're increasingly seeing solar and even storage integrated with efficiency and thus the technology itself seems less important to the economics of a transaction than its proximity to the customer.

Starting this quarter, we presented our pipeline and portfolio in this manner. For those of you still wanting to translate technology mix to grid-connected or BTM, there is a slide in the appendix of our posted presentation. That's the last page.

Our 12-month pipeline is well above $2.5 billion and is more than 75% comprised of assets behind the meter. This growth has come in part from new origination niches and behind-the-meter assets as well as the sustainable infrastructure category. A few examples of these new niche markets include efficiency initiatives like smart cities are driving new opportunities in street lighting upgrades, such as the one we did a few quarters ago with the division of EDF. We'll be seeing more of these. Commercial pace, or C-PACE, is accelerating nationally, and we recently announced an expansion of our relationship with CounterPointe, under the name Hannon Armstrong Sustainable Real Estate, or HASRE. We expect to be sharing some positive developments in that market fairly soon. We've been speaking about stormwater remediation for the last year and expect to be converting on those opportunities in the next several quarters along with expanding that pipeline. With attractive risk-adjusted returns, C-PACE and stormwater assets are examples of assets we intend to keep on the balance sheet.

Shifting from the left side of the page to the right, you will note that behind-the-meter assets represent 77% of the pipeline but only 50% of the portfolio. As discussed, we have 2 choices on how we finance some BTM assets: put them in the portfolio on balance sheet or securitize an off balance sheet trust. This optionality accounts for the variation in percentages between pipeline and portfolio. The forward-looking unlevered yield of the portfolio remains at 6.1%, with BTM assets yielding 5.1% and grid-connected assets yielding 7.3%. In making investment decisions, however, we evaluate based on the levered ROE of the assets and not the forward-looking yield. Once leverage is applied, the delta in the yields largely disappears in the ROE.

Now Brendan will discuss our financials. Brendan?

Thanks, Jeff. Turning to Slide 6. For the quarter, total revenue grew 17% to $27.9 million from $23.8 million in the same quarter last year as a result of portfolio growth and higher revenue due to increased levels of securitizations. As Jeff discussed, given the interest rate environment and the current appetite of institutional investors for the types of transactions we're originating, we expect to increase other investment revenue in 2018 as gain-on-sale securitization should be more attractive than adding to the balance sheet.

Interest expense grew to $18.7 million from $13.8 million in this quarter last year primarily because of the increase in fixed-rate debt in 2017 used to fund portfolio growth. Based on our current mix of fixed-rate debt and using our ending average debt cost at the end of Q1 compared to the average cost in Q1 last year, we estimate these decisions to reduce our risk cost approximately $0.02 in the quarter. We have chosen to be more cautious in this interest rate environment with higher fixed-rate debt and liquidity, and we believe those were the correct decisions and well timed. For example, our ending debt cost rose by 2 basis points compared to Q4, while market interest rates over the same period rose by approximately 32 basis points or a difference of 30 basis points. Thus, we have begun to see the benefit of our decision to fix rates and expect further benefits if the Fed follows their plan and raises rates another 150 to 175 basis points over the next 2 years. If and when interest rates rise and the yield curve steepens, we expect to see both base rates and spreads rise, which will be a positive for the business.

Comp and general administrative expenses increased by approximately $1.2 million and, after adjusting for stock-based comp, core comp and G&A rose by approximately $2 million or the equivalent of $0.04 per share over the same quarter last year. This increase is the result of our continued investment for the growth of the business.

We experienced a GAAP loss of $1.2 million due to a noncash hypothetical liquidation of book value, or HLBV loss on our equity-method investments of $2.3 million. As disclosed last quarter, we had one project where we were expecting a material HLBV loss for this quarter. This project, acquired as part of a portfolio of projects, represents approximately 1% of our overall assets. We made the initial investment at a discount to book value because of its exposure to natural gas prices. While we have some [flip] protection on this project, equipment failures and continued low natural gas prices have caused the sponsor to adjust the book value below our level [up to] the discounted purchase, which resulted in a noncash HLBV loss to us of approximately $8 million. We continue to work with the sponsor to maximize the value of the project and expect improvements in operational issues. The remainder of the equity portfolio in total had HLBV gains of approximately $6 million. As a reminder, the GAAP earnings do not include the full effect of the cash we receive from these renewable energy projects.

In Q1 2018, we collected $30.2 million in cash from our equity-method investments, up from $16.9 million last year, despite our GAAP loss in these investments of approximately $2 million. Since we have based our investment on future cash flows discounted back to a present value, we believe the cash we receive reflects both the return of capital and the return on our investments. Thus, we make a core adjustment of $12.9 million to recognize the return on our investment which, year-to-date, when added to the GAAP loss of $2.3 million, gives a total core return of $10.6 million; and thus, the other $19.6 million of cash collected represents a return of capital. It is important to note that the interest expense associated with the leverage on these investments is shown in the interest expense line above, as required under GAAP. In total, core earnings were $14 million for the quarter or $0.27 a share.

Turning to Slide 7. Our balance sheet portfolio approximates $2 billion, consisting of over 175 separate investments, with an average investment size of $11 million. The portfolio is diversified across markets, technologies, obligors and geographic regions with a strong credit quality profile. Our government portfolio at 32% and our commercial portfolio, including our real estate portfolio, at 44%, are all considered investment grade, with only 2 projects representing less than 1% of our assets or $8 million not considered investment-grade. The remainder of the transactions are our equity-method investments, which we do not rate. The average life of our portfolio is approximately 12 years. We have discussed the debt earlier but expect to remain near the present levels of fixed-rate debt given the Fed's continued indication of interest-rate increases.

Our shareholder base remains widely diversified, and given our 2018 plan to increase securitizations, we expect to have less need to raise capital. We will of course raise equity as needed for the right transactions.

With that, I will turn it back to Jeff.

Thanks, Brendan. Turning to Slide 8. We remain very optimistic about our business. The market opportunity is enormous, with estimates of up to $100 trillion to be spent over the next 35 years in energy efficiency and renewable energy. While the investable market is quite large, in any one period, the relative value in some of the markets will ebb and flow. Our flexible business model allows us to pursue the best risk-adjusted returns among a broad and uncorrelated set of investment opportunities. As a 37-year-old company, we also have a great deal of experience over many political and economic cycles, including several of the big downturns in the industry as well as in the broader markets. We have continued to prosper through these and are well positioned to grow earnings over time. Finally, we believe we are doing something important, addressing climate change while earning superior risk-adjusted returns consistent with our investment thesis, and we're doing this in a company that is a leader in ESG criteria.

As a top 5 shareholder in the company, I'm pleased with the continued execution of our team, continually evolving our origination platform, such as the expansion of Hannon Armstrong Sustainable Real Estate, the flexibility of the business model to adapt to various market conditions and the great opportunity to invest in assets, reducing the impact of climate change. We celebrated our 5-year IPO anniversary in April -- I think 2 weeks ago, with a total return 35% higher than the S&P 500. Yet, we know this is a marathon, not a sprint, and we're just getting started as a public company.

Thank you to the Hannon Armstrong team for your 5 years of hard work and your continued commitment, and thank you all for joining us today. We'll open up the call for a few questions.

(Operator Instructions) And we will take our first question from Noah Kaye with Oppenheimer.

So talking about the flattened yield curves impact, you, clearly, with your 3-year target, have a view on how that will play out over the next, it seems, period of time. I think this is a continuation of some of the questions that you maybe got on last earnings call. But I wonder, is there an easy way for us and investors to think about what the upside could be to core EPS growth if long-term rates rise, if the curve normalizes? What's the simplest way to think about the upside?

Sadly, I'm not sure it is simple with respect to timing or how to make the calculation which, again, is one of the reasons we like being -- having the option to be flexible on whether we're adding to the balance sheet or securitizing. But typically, we have seen in rising and interest-rate environments, where spreads generally are a proportion of the base rate, that bodes well for us. So we would -- we love the fact that the 10-year hit 3. We, frankly, would be glad if it hit 4. Our spreads on top of that would grow proportionally. So you have to take some view of what the future interest rate environment looks like. We don't have a particular view. We're not interest rate forecasters. We just try to prosper in any of the environments that come up. I know that's not exactly the answer you're looking for, but I think it's -- Brendan, would you add anything to that?

Yes. I think, you could just look to a little of history on kind of the -- where the yield curve's been, and it's probably flattened over 100 basis points over the last year, give or take. And then, spreads -- so if you go back to a more normalized yield curve, you pick up 100 basis points on new deals plus some spread widening. So I think that would give you, as Jeff said, proportionate kind of spread widening. So that would give you an idea. And you probably could look at where BBBs have been historically and versus -- and where they've been in the last couple of years as an idea of that, if you were modeling.

Right. That's actually very helpful directionally. And I think a related question, and this may be, again, an iteration of a familiar question, but I just want to ask it simply. The 12-month pipeline has been in excess of $2.5 billion for as long as we've been following you guys, which is many years. You're still expecting to do $1 billion-or-so of originations. Just remind us, why would it be inadvisable to make up on higher origination volumes? Any kind of headwind from where curves are implying for the spreads? Why can't you do more volumes to grow EPS faster? What is the gating factor?

I think -- certainly, there's no constraint on the business for us to do more business. I look at this as -- with nearly 4 decades of watching pipelines of these kinds of assets, we are chronically and consistently overoptimistic on when transactions will close and so are our clients. They're all -- transactions move out to the right. We very rarely see them hurry up and close faster than we expected. So what we've constructed is something that's a pretty simple model of having 2.5x the $1 billion of originations. In this quarter, at a $100-plus million, not good. That means we have to do $900 million over the next 3 quarters, which is not a problem. We wish to average $250 million every quarter, and it was a nice, predictable stream. It's just not -- we don't drive the closing date on these. It's large sovereigns, it's large corporates. They close when they close. Our job is to have enough [N] in the pipeline to make sure that over accumulative 4 quarters, the business is solid.

Yes. I think the other thing I'd add to that is that we're probably late -- people talk about us being late-cycle. And so we constantly look to balance off growing originations about -- against what's the right risk-adjusted returns. So I think that also acts as a governor sometimes.

Yes, that makes sense. And then, one more for me and I'll get back in queue. Jeff, in your prepared remarks, you mentioned potentially growing the dividend at a lower rate than core earnings. I could contemplate several reasons why that might be your view. But let me ask you, what are some of the reasons why that might make sense to you?

Well, we've historically paid out 100% of core earnings. I think a more conservative approach is to continue to build some cushion into that. We think the dividend yield is very attractive. So we don't feel the need to throw extra dividend at investors. But also we can reinvest that capital, that delta between what we earn and what we pay out, we think, accretively and to the benefit of shareholders. So we think dividend growth is important. We think earnings growth is important, and they don't need to be the exact same number.

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

Let me talk about C-PACE, maybe the -- some of the changes, been very excited about it, but it seems like there's been movement obviously at the new partnership, and maybe type of form it might take on, more aggressive funding, different projects, maybe just talk about the scope. And I have a follow-up.

Well, it's a good question. We are excited for Hannon Armstrong Sustainable Real Estate. We've been working with CounterPointe for almost 2 years now, developing the partnerships, the relationships necessary to get to the commercial office building and commercial real estate market at scale and economically. And that's -- putting those 2 things together isn't as easy. But the HASRE folks are doing the kinds of things necessary to add staff around the country that can originate these transactions locally. We have our funding mechanisms in place. And I think one of the more interesting aspects is we're starting to see the owners of those properties get it. They're getting the value in a PACE loan compared to other sources of financing, and they're getting why making these kinds of investments makes great sense for the owners of the property. So we've always said it's -- PACE is an enormous market, still taking baby steps, and maybe we're crawling on our knees now, but it's definitely progress, and we're excited for the things that we think we'll be able to talk about it in the next couple of quarters.

I'm assuming some of that involves more solar-plus-storage being attached and just kind of getting over the learning curve for the opportunities that can present -- that can represent?

You'll know what the ECMs are when we do, or the energy conservation measures. I'm not sure solar and storage is the first thing people think about. There is a fair amount of solar in the storage -- in the PACE market. But again, it's, I think, it's led by LEDs and controls and some of the simpler measures to reduce energy consumption.

Okay. Maybe just one more quick one from me. So you talked about -- when you termed out last year, about a 10% headwind -- a $0.10 headwind to EPS. Is that -- has that potentially ticked up a little bit and you think you can overcome just on -- based on your forecast with securitizations? Or this $0.10 number is still a headwind you think to overcome on an annualized basis?

Yes, on an annualized basis, we think -- we said last quarter we thought it was $0.10. I think, our models kind of show that as being in the right relative range. As I said, $0.02 this quarter, we had a couple cents last week. So I think you -- over the course of a year, we'll kind of get rid of that as a comp item. But for the -- we really didn't fix until the second half of last year. So this quarter and next quarter is where you'll see the -- it come through more. After that, we'll start to get to better comps.

Our next question comes from Chris Souther with Cowen and Company.

On the equity loss, could you just provide a little bit more color on kind of where that project just took place, like what kind of technology and any other assumptions we can kind of think about going forward? Obviously, there's a piece that's tied to the natural gas pricing you mentioned, but I just wanted to go through what the other factors might be and whether there are any other projets that might have similar kind of issues.

Sure. So it's a Texas project. So it's -- ERCOT has a lot of natural gas obviously, so that affects it there. It's a wind project. It had some operational issues that the sponsor's been working through with the equipment manufacturers. So we think there's some potential good resolutions there. We continually -- we evaluate our portfolio on a quarterly basis. We're not aware of any other issues at this point in time. But we know it's -- we did try to highlight this last quarter as something was coming, so hopefully that wasn't a surprise.

Perfect. And then, as far as -- you discussed some of the leading indicators as far as project yields rebounding. At what levels -- what kind of yield levels do wind and solar need to get to for you guys to kind of be competitive at your current cost of capital?

It depends where we invest. And we have 2 niches on the utility scale, wind and solar. The wind niche is partnering with tax equity providers for the cash deals. I think we remain a desirable partner with competitive cost of capital for that market. But again, it's niche-y. We don't see transactions every quarter. Where we work in solar for utility scale is owning the land. Again, a niche-y business, but we're -- continue to do transactions generally every quarter, but they're relatively small. It's a small piece of the capital stack. So it's not so much that our cost of capital isn't competitive, it's -- we don't see the returns really commensurate with the risk for some of the other slices of the capital stack, say, the common equity.

And we'll take our next question from Philip Shen with Roth Capital Partners.

This is Justin Clare on for Phil today. So first off, so in Q1, it looks like you may have securitized the majority of the transactions that you completed in the quarter, just looking at the balance sheet. So just wondering if you could just share what was the actual mix of securitized transactions in Q1 and then, how do you see this mix trending in Q2.

So you're correct, the majority of the transactions, if not all, were securitized, which is, in part, how we got to $0.27 on 100 million of volume. And they are the kinds of transactions we will securitize. But there was -- the wind and solar transactions, utility scale transactions, were really delayed in Q1. And I think you've seen this from other calls we've monitored this week. Tax law change really caused tax-oriented projects to take a pause in Q1. Those are not the kind of transactions we would typically securitize. Those are transactions we typically put on the balance sheet. And depending on how PACE develops and how stormwater remediation develops, again as I mentioned, those are more balance sheet transactions, that will affect the level of securitizations. We put that graphic in there of a slide that can move back and forth with respect to securitizations. First, it's on balance sheet, and it will be sliding each quarter depending on the kinds of assets we're originating and their relative returns. So again, I can't give you a fixed percent, but it's a good thing we're -- we can be flexible when this market is rewarding that kind of flexibility.

Great. Okay, that's helpful. So then, moving to the next question here I have. For 2016 and 2017, you were able to achieve a core return on equity that was above 10%. So with the shift to greater securitizations and the higher fixed-rate debt, can you share how you see your ROE evolving and what your expectations might be for 2018?

Yes. I think, it's somewhat logical that if we are securitizing for a gain on sale, we're dropping earnings into the income statement, that is not requiring any equity or any capital. So you would tend to think our return on equity is going to go up in a higher securitization model. Some of that would be muted by higher fixed rate debt. But we're going to make money and hit the 2% to 6% range. But if we're using less capital to hit that range, ROE goes up. That make sense?

Okay, great. Yes, that make sense. One more for me. So I was looking into the deck. It looks like you get a 2% gain on sale when you securitize assets. With the changes in the yield curve, is -- do you expect any change in the fee that you will get or the profitability of the securitization business? Or is that very stable?

Well, first of all, the 2% is just an illustrative round number to ground everybody in just the basics of how a securitization transaction works. There's no -- it's not like we're guaranteed a 2% fee. It can be lower or it can be higher. And it -- I don't know that there's any real discernible pattern with respect to relative interest rates other than the higher rates are, the more scarce capital obviously is, we should be able to earn slightly better margins. We've used the example of 2007 before the financial crisis when spreads were probably at historic lows, at least in my career. And those gain-on-sale fee percentages were lower. But 2008, 2009, they had widened. And it ebbs and flows. So 2% is not a bad number to think of for those.

Our next question comes from Tyler Frank with Baird.

I guess, can you provide a little bit of color based on what you see today on how we should think about securities -- or securitizations in Q2 versus the second half and how back-half-weighted the year may or may not be? And then, it sounds like you're getting more cash flow from your equity method investments. How should we be thinking about a potential raise -- equity raise this year given the focus on securitizations?

So we'll extend out the theme of lumpiness in quarters based on timing of securitizations to Q2, Q3 and Q4. We have some views and some hopes and some aspirations for those pattern -- for that pattern of securitizations. Clearly, we'd love to do more in Q2 and be above the $0.33 and have everybody feeling comfortable that we are -- with $0.27 and north of $0.33, we're at the dividend. And that can happen. But it could also be the other way, where they all fall Q3 or Q4. We've given guidance for the year, and we're doing that because we know the pipeline is there. The transactions are there. Just darned if we know when they will actually close.

And then, on the equity raise, I think, Tyler, I think, at this point in time, we're thinking any significant equity raise as being totally opportunistic based on something that comes up in the pipeline that make sense for us to go raise equity. Otherwise, given the securitizations that we're expecting, we wouldn't expect to raise a lot of equity in big, lumpy offerings.

And we have no additional phone questions at this time, so I would like to turn our call back to Jeff Eckel for any additional or closing remarks.

Well, thanks, everybody, for listening, and we look forward to more detailed questions and meeting and talking with investors over the next few days. To the extent that you want to talk to us, we're always interested in talking with you. Thanks again.

Ladies and gentlemen, this concludes today's call, and we thank you for your participation. You may now disconnect.