HA Sustainable Infrastructure Capital Inc (HASI) 2018 Q2 法說會逐字稿

Good afternoon, and welcome to Hannon Armstrong's conference call on its Q2 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 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'd like to turn the conference over to Amanda Cimaglia, Investor Relations Director for the company. Please go ahead.

Thank you. Good afternoon, everyone, and welcome. This afternoon, Hannon Armstrong distributed a press release detailing its second 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 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 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'd like to turn the call over to Jeff, who will begin on Slide 3. Jeff?

Thank you, Amanda, and good afternoon to all. Today, we are announcing GAAP earnings of $0.32 per share and core earnings of $0.39 per share. Originations for the quarter were approximately $200 million. We are a bit lighter than we expected to be for the first half of the year in originations, but we've had several significant transactions slip from Q2 into early Q3, and those transactions are now closing. We are still on track to reach our $1 billion annual origination target for 2018. So it would be reasonable to expect second half originations to be at a higher level than the first half.

We further reiterate 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 are driving to higher levels of securitizations for gain on sale income in 2018, a large contributor to our core earnings results this quarter. We expect that variability in earnings, determined by the level of assets held on balance sheet versus those securitized, could continue through this flat yield curve period. I will speak more on the benefits of our flexible business model in a few minutes.

We're pleased to announce the closing of our first stormwater remediation investment this quarter, a market we've been cultivating and discussing for quite some time. Located right here in Chesapeake Bay region, this transaction will help to reduce nitrogen and phosphorous runoff into the Chesapeake Bay. This investment meets our sustainability screen of having a positive environmental impact with a neutral impact on carbon. This is a new market that will take time to scale, but we look forward to additional programmatic transactions in this market in the upcoming quarters.

Continuing our persistent focus on tracking carbon, this quarter in aggregate, we will offset over 62,000 tonnes of carbon, a 0.31 CarbonCount.

We are also pleased to announce our recent commitment to the UN Global Compact, the world's largest voluntary corporate sustainability initiative in support of the broader United Nations Sustainable Development Goals. Going forward, on an annual basis, we will report our progress on the practical actions and measurable outcomes that support these goals, another sign of our commitment to ESG initiatives. This is, of course, in addition to becoming the first U.S. public company to commit to implementing the recommendations of the Task Force on Climate-related Financial Disclosures, or TCFD.

Turning to Page 4. Our pipeline remains quite robust, in excess of $2.5 billion and widely diversified across the niche markets in which we participate. We are seeing new transaction activity in each of the 3 categories of pipeline.

Let me provide a little color. For behind-the-meter assets, the federal sector is strong. Commercial PACE is continuing to develop well with transactions getting larger and more frequent, and residential and commercial solar continues to be a very solid market.

Grid-connected assets like wind preferred equity and utility scale solar land are showing renewed strength after digesting the reality of tax law change.

Sustainable infrastructure, including utility privatization and stormwater investments, provide excellent diversity for our pipeline.

The forward-looking unlevered yield of the portfolio remains at 6.1%, with behind-the-meter assets yielding 5.1% and grid-connected assets yielding 7.2%. In making investment decisions, however, we evaluate based on the levered return on equity, or ROE, of the assets and not the forward-looking yield. Once leverage is applied to the assets, the delta in the yields largely disappears in ROE, a concept I will detail as we move on to the next page, Page 5.

As a refresher on our business model, we seek to achieve a return on equity at or above 10% by originating programmatic transactions from the best energy service companies, manufacturers, project developers, utilities and owner-operators in the business. Our origination strategy is to use these historic and new client relationships to generate recurring, programmatic investment and fee-generating opportunities.

With a target of $1 billion of originations annually, our illustrative business model is to put 70% on the balance sheet, generating interest income, and to securitize 30%, generating gain on sale income.

Examples of projects we would likely hold on the balance sheet would be commercial PACE, solar land, wind equity and sustainable infrastructure assets. The prime candidate for a gain on sale securitization is likely to be a federal energy efficiency project, one that is high credit quality, long dated and lower yield. It makes more sense to securitize those assets rather than hold them on our balance sheet.

In 2018, as expected, we've driven to an increased level of securitizations with a lesser amount added to the balance sheet. In markets like this one, with strong originations and strong institutional investor bids for some of these assets, it makes economic sense to do relatively more securitizations. As such, raising equity capital is less of a need for us in this market environment. We very much like the flexibility in our business model to be able to shift between relatively more or less balance sheet investments to take advantage of changes in the interest rate environment, origination and institutional investor appetite.

The table on the right side of the page illustrates the basic economics of our business model. And these are returns as a percent of assets. This is the same illustrative model that we used at the IPO, and while various components move around based on market conditions, it still is a useful way to think of the business on a long-term basis. The model begins with the unlevered asset yield of 6%. This equates to the 6.1% forward-looking yield on our portfolio I just discussed on the prior page.

After deducting interest expense, we target a net interest margin, or NIM, of approximately 3%. Fees generated from gain on sale securitizations are approximately 1% and typically offset SG&A. Assuming 2.5 to 1 leverage along with the equity, you multiply the 3% NIM by 3.5, resulting in our return on equity target of approximately in the 10% range. This quarter, the higher gain on sale fees offset both the SG&A expenses and the higher interest expense, which gives us a higher ROE for the quarter. Though variability in asset yields exist in each of our niche markets, the ROE continues to be attractive.

I will now turn it over to Brendan to discuss financials.

Thanks, Jeff. Turning to Slide 6. For the quarter, total GAAP revenue grew to $35.8 million, a 27% increase from the same quarter last year. This was the result of growth in the average portfolio and increased level of securitizations with securitization volume up almost 50% year-to-date compared to last year.

Interest expense grew to $19 million from $15 million in this quarter last year, primarily because of the increase in fixed rate debt in 2017 used to fund our portfolio growth. Comp and general and administrative expenses increased by approximately $1.1 million. And after adjusting for stock-based comp, core comp and G&A rose by approximately $700,000 over the same quarter last year. The increase is a result of our continued investment for growth of the business.

Income from equity investments increased by approximately $2 million, due in large part to a onetime HLBV impact of the lower tax rates. On a year-to-date basis, income from equity investments decreased by approximately $4 million. The decline is primarily the result of the noncash HLBV loss recognized on the one equity investment we discussed last quarter. That project is performing in line with our revised expectations.

For the 3 months ended June 30, 2018, we recognized a GAAP profit of $17 million for the quarter, an increase of $5 million from the same quarter last year.

As a reminder, the GAAP earnings do not include the full effect of the cash we receive from our equity

investments. In the first half of 2018, we collected $70 million in cash from these investments, up from $39 million last year. Since we've based our investment on 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 $12.2 million to recognize the return on our investment, which year-to-date, when added to GAAP earnings of $8.3 million, gives a total core return of $20.5 million. The difference between this core return and the cash collected of $70 million represents the 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.

This quarter, due to the high HLBV income, the core adjustment to get to the return on capital was actually a slight reduction of $700,000 as the HLBV income was higher than we would have recognized under core. After this adjustment and adjusting for stock-based comp, in total, core earnings were $20.8 million for the quarter or $0.39 per share.

As a reminder, we have talked about some variability in earnings this year, which we expect to continue given the current market environment. Thus, we remain focused on our earnings guidance for the full year as the appropriate target.

Turning to Slide 7. We wanted to highlight our diversified sources of capital. As Jeff mentioned, higher levels of securitizations allow us to be capital light in the present market. To date, we have successfully focused on issuing debt on an asset class by asset class basis.

As part of our evolution of our financing strategy last year, we received our first corporate investment-grade debt rating from DBRS, which we used to issue our first corporate-level debt, the convertible. We continue to explore achieving a convertible debt rating from the big 3 rating agencies to expand our capability to issue and to lower the cost of corporate debt. This process can be lengthy, especially given the nature of our assets. We also believe that we have access to the equity markets through regular way offerings for attractive transactions or the ATM, which we use as a valley filler.

We are presently above the high end of our fixed rate debt target. We would expect that number to decline somewhat over the next couple of quarters as we continue to focus on being more efficient with our debt transactions but to remain near the higher end of our fixed-rate debt range of 60% to 85% given the Federal Reserve's continued indications of interest rate increases.

Turning to Slide 8. 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 is 32% and our commercial portfolio, including our real estate portfolio, is 45%, all of which are considered investment grade, with only 2 projects representing less than 1% of our assets or $8 million not considered investment grade. The remainder of our transactions are equity investments. The average life of our portfolio is approximately 12 years.

Our shareholder base remains widely diversified with approximately 25% that are sustainability focused, adding in an ESG lens through which they evaluate us.

With that, I will turn the call back to Jeff.

Thanks, Brendan.

Turning to Slide 9 to finish up. 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 climate mitigation and adaptation. While the investable market is quite large, in any one period, the value in some of the markets ebbs and flows. 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, although we've only been public 5 years, we also have a great deal of experience over political and economic cycles, including several of the big downturns in the clean energy industry as well as in the broader markets. Still, we have continued to prosper, and we 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 our strong ESG commitment.

As a top shareholder in the company, I'm pleased with the continued execution of our team in continually evolving our origination platform, seeking returns across varied asset classes, the flexibility of the business model to adapt to various market conditions and finally, the great opportunity to invest in assets reducing the impact of climate change.

Thank you to the Hannon Armstrong team for your hard work and your continued commitment. Thank you to our investors and interested investors for joining us today.

I'll now open up the call for a few questions.

(Operator Instructions) And our first question will come from Noah Kaye with Oppenheimer & Co.

Let me start with a question on commercial PACE.

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quarters we've seen some early examples of securitization

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financing, getting AA and even AAA rated. Just wondering, what's your ability at this point to securitize those C-PACE assets? How over-collateralized do you think they need to be? And what kind of appetite do you see in the market?

Yes. No. I have to admit you broke up, but I think your basic question is how financeable are the commercial PACE transactions. We certainly think they are financeable. That's why we're investing in them. Our ability to lever them, we think, is still to be tested. We're early days. We haven't built up enough of a portfolio to really test that. But some of the early signs are investors will appreciate the collateral and the legal structure. And we think we can get paid for our ability to aggregate these relatively small assets into a larger pool. We're very optimistic about C-PACE. And forgive me if I missed your question. As I said, you're breaking up a bit.

Yes, it seems it was a bit patchy in our end as well. So hopefully, it's not something other folks are hearing. But I think you answered the question well. Just -- it looks like the equity method investments, that stepped down on the balance sheet. But you mentioned kind of the assets

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that you had to make an adjustment for last quarter are performing in line. So just how do we bridge from last quarter to this quarter the value of the equity method investment on the balance sheet?

I'm sorry, no, again, I lost half of your question. I think you asked about the balance coming down. As we talked about, we got $70 million of cash in this quarter. So when you get cash in, that reduces the balance, and that's up substantially from the cash we got in this time last year. The project that we did have the adjustment for last quarter is performing in line with revised expectations.

Our next question will come from Chris Souther from Cowen.

I think there might be kind of an issue because I'm getting the same kind of hiccups here. So excuse me if it does kind of break. It looks like the Grid Connected was up when looking at the 12-month backlog after you guys have seemed to kind of shift from some of those markets in recent quarters. You mentioned a few areas where you're seeing opportunities now. Can you just talk a bit about what some of the factors are that are making those markets more attractive now?

I think, Chris, the -- as I said, I think the wind and the solar industry collectively had to digest tax reform. All of the tax equity investors had to adjust their pricing. I think that delayed a lot of stuff. I think we have continued to think the wind industry, [REIT large], and the solar industry on the utility side are strong. It's just that has not been the largest area of focus for us. It's more Behind the Meter. That said, as those 2 technologies start to get back on their feet from a development standpoint, we're going to see opportunities, which is, I think, what you saw on the pipeline.

Got it. And then just looking at the HLBV, it was higher than the kind of core earnings adjustments for this quarter. Is that reflecting like a tax

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Or can you remind us how that works and what you might be expecting for the rest of the year there?

Yes. So that was -- the GAAP number was high because of some adjustments coming through in HLBV from the tax rate change where we get a benefit because of the lower tax rate coming through in HLBV. So that's why GAAP this time was higher. It was a onetime adjustment this quarter to the high side. So it was actually higher than what we would have recognized under core, which is why we had the negative core adjustment.

Our next question will come from Philip Shen with Roth Partners.

This is Justin Clare on for Phil today. So first, in Q2, it looks like many of the escrows reported pretty strong sales growth. And I was just wondering if you could talk about the demand that you're seeing with your escrow partners and how that might contribute to potentially an increase in originations in your Q4.

Well, I think there is a very strong correlation. We continue to follow the best companies in the industry. Many of their logos appear on our pipeline page, our business model page. And what's good for them is good for us. I would say a couple of trends. We're seeing more comprehensive retrofits of properties that makes for a larger escrow job and that makes for a larger financing for us. These still are real big investments. But as the scope of work gets more complex, adding storage, adding cogeneration, adding EV charging and things like that, these become more interesting kind of mini-grids for the owners of the properties. And generally, that's good for us.

Okay. Great. And then turning to the yield curve, so the curve has continued to flatten since last quarter. I was wondering if you could just give us a sense for the mix of the assets that you are securitizing versus holding on the balance sheet. And then if the curve continues to flatten in Q3, Q4, would you anticipate a increasing mix of securitization?

Very much depends on the mix of originations. [Not every] asset we originated is a good candidate for securitization. Hopefully, it's an attractive asset to add to the balance sheet, and we will continue to add assets to the balance sheet. Just on the margin, with a flat yield curve and a strong institutional bid for some of these assets that we can aggregate, I think it makes great sense for the shareholders to securitize. So I'm not giving you precise percentages because frankly, we don't know. And that -- and more importantly, we don't have to know. We have that flexibility in the model to shift real time based on market conditions.

Okay. I appreciate the color. Maybe just one last one for me here on C-PACE. So you mentioned that transactions are becoming larger and more frequent. Can you give us a sense for how much C-PACE lending you did in Q2 and how large those transactions might be getting at this point?

Yes. We haven't broken out individual markets or the size of individual markets. But it's probably

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This quarter, we talked about C-PACE. We talked about CounterPointe shifting to

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from sustainable real estate. We're clearly focused on developing this market. And I think the way that one sees in sustainability and virtually every aspect of business is going to affect the real property business. And we think that is nothing but a positive for our transactions, which -- a C-PACE transaction is generally accretive to an owner as it substitutes in part for higher-cost mezzanine capital. And so the economics are in the favor of us expanding as well as the general market trends towards sustainability.

(Operator Instructions) And our next question will come from Carson Sippel from B. Riley FBR.

This is Carson on for Carter. I just had a quick one. Some of the tariffs

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seen, how does that affect you in the near term and then maybe more in the long term like the 12- to 24-month range?

You mean the solar tariffs?

That's right, the solar tariffs.

Yes, I don't think there's much of an impact. I mean, solar is not a big piece in our pipeline. But the solar panel tariff is only a portion -- affects only a portion of the project cost. It's much more of an issue for the manufacturer of a panel that's subject to tariffs than one who's not. But from our standpoint, that impact is relatively muted because it's, I think, less than 50% of the total cost to install and it's even less than that for Behind the Meter solar. So it's a struggle if you're a manufacturer, for sure. We honestly don't sense any impact on our business.

And we do have a follow-up from Chris Souther from Cowen.

Just on the stormwater remediation, I just want to get an idea of what the size of that kind of transaction was and how performing that transaction you're going to see in the market kind of open up.

Well, the backdrop for this is EPA mandate to the states around Chesapeake Bay to reduce phosphorus and nitrogen runoff, which happens when you increase pavement. It's pretty -- gravity does a good job of getting the pavement cleaned up and phosphorus and nitrogen running into streams. So these are relatively low technology, civil engineering projects that slow down the pace of water, increase the amount of filtration that's done by soil so that the nitrogen and phosphorus can be captured in the soil rather than dumped into the bay and create algae blooms. Because pavement is relatively localized, the projects are relatively localized. They're generally going to be smaller, which kind of fits our appetite of $1 million to $10 million to $20 million kinds of investments. They are private partnerships. And you're doing transactions with a number of parties who may be relatively new to P3-type structures. Patience is rewarded in this market. You have to help people understand the economics of using taxable capital versus tax-exempt capital. And I think the more precedents that are out there, the more governmental entities that transact in these, the more confidence other governmental entities will have that this is a good, sound way to accelerate the required investments.

And that does conclude our Q&A session for today. And at this time, I'll turn the conference back over to Jeff Eckel for any closing remarks.

Well, thank you. Good questions. We'll be in, I guess, New York and Boston next week talking to a number of investors. So thank you for your time this evening, and have a good evening. Goodnight.

That does conclude our conference for today. Thank you for your participation.