Hannon Armstrong Sustainable Infrastructure Capital's (HASI) CEO Jeff Eckel on Q2 2014 Results - Earnings Call Transcript

Aug.11.14 | About: Hannon Armstrong (HASI)

Hannon Armstrong Sustainable Infrastructure Capital (NYSE:HASI)

Q2 2014 Earnings Conference Call

August 11, 2014 5:00 PM ET

Executives

Jeffrey W. Eckel – Chairman, President and Chief Executive Officer

Analysts

Charles Nevin – Wells Fargo Securities

Aditya Satghare – FBR Capital Markets & Co.

Unidentified Company Representative

[Call Starts Abruptly] 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 Jeffery Eckel, President and CEO of Hannon Armstrong, who will begin on Slide 3. Jeff?

Jeffrey W. Eckel

Thanks, [Catherine] (ph) and good afternoon everyone. Thank you for listening to our Q2 earnings call. Today, we are announcing core earnings of $4.7 million, or $0.22 per share in line with a $0.22 dividend we announced in June. We are pleased to achieve the $0.22 earnings level despite the share account increasing 33% from the April follow-on offering. We remain on track to grow core earnings by the previously indicated 13% to 15% by Q4 2014.

Execution highlights from the quarter include aforementioned $70 million follow-on offering in April. we put those proceeds to work by closing over $200 million of transactions, including a portfolio of land for solar projects and land leases for wind projects, we’ll speak more about, supplemented our equity capital with the $200 million increase in our credit facility, which allows us to continue to increase leverage to our target levels. Finally, our fixed rate borrowings stay the same in dollar terms decreased in percentage terms to 37%, due to increased borrowings under our floating-rate credit facility.

Turning to page 4, we provide more detail on the mix of close transactions, the yields of our on-balance sheet portfolio and our pipeline mix. Starting with the chart on the top left, since the IPO, we’ve closed almost $1 billion of transactions, $960 million to be exact, a considerable achievement by the Hannon Armstrong team, the majority 52% for energy efficiency transactions, which are generally with federal state and local governments and other institutions.

These are more likely to be the longest tenure, highest credit quality and lowest yielding transactions we do, and that’s our good candidates for fee generating securitizations in ABS transactions. 44% of the transactions were clean energy such as solar and wind. As we have noted, we increasingly find these clean energy transactions to be distributed energy assets, close to the customer meter relatively higher yielding and having shorter tenures than the energy efficiency transactions.

Moving to the chart on the top right, you will note that our on-balance sheet portfolio is more heavily weighted to clean energy assets, 58%m, or $343 million. these assets average a 6% yield. a smaller portion of our portfolio 29% are energy efficiency assets, which yield approximately 5%.

Lending the portfolio together, we have an average yield of approximately 5.8%, based on our portfolio at June 30, which is above our target gross asset yield at the IPO of 5.5%. As we’ve discussed in prior call, the landscape for our financings has involved rather rapidly since the IPO, from a heavy reliance on grid-connected renewables to more distributed energy assets, such as the residential solar portfolios we have completed with SunPower.

While the location side of individual projects varies greatly from grid-connected solar projects to residential portfolios. the financial structures and risks did not really vary that much and that these residential portfolios are highly structured, cross-collateralized pools, back by sponsor credit support in equity.

We think Hannon Armstrong’s nimbleness in adjusting to changing market conditions and our ability to capitalize on opportunity – opportunities is a real strength of this company. Our pipeline charted at the bottom of page 4 has grown by over $0.5 billion since the IPO, even as we were closing the nearly $1 billion of volume from that pipeline. This speaks to our ability to originate good, risk adjusted, yielding transaction at scale, even in a dynamic market.

To reiterate prior discussions, we originate transactions from the top tier participants in clean energy and the energy efficiency sectors, using programatic agreements that reduce transaction costs and accelerate closing timelines. I’ve mentioned SunPower is one of our key clean energy origination sources. we would also like to again highlight the six industrial ESCOs we work with, Honeywell, Ingersoll-Rand through its trained business unit, JCI, Siemens, Schneider and UTC. These are great companies with aggressive growth plans in energy efficiency and increasingly in distributed clean energy assets.

We also originate from utility-owned energy service companies, Exelon for example has several we worked with, as well as independent ESCOs like Lockheed Martin and Leidos. We really like the diversified nature of this great group of industry leaders as the source of originations and we think that everybody is valuable as the so-called yield curve dropdowns.

Turning to page 5, we gained profile of two Q2 investments in an attempt to increase investor understanding of our investments, and the growth potential in the various markets in which we transact. On the left is the picture of the four Fort Carson Army Installation, where we financed lighting upgrades and water conservation measures for JCI.

Fort Carson is one of the two army facilities targeted to achieve net zero energy, water and waste and will take many transactions like this one to achieve that. And in fact, this is our third investment at Fort Carson. On the right is the transaction utilizing our new structure, commercial property assessed clean energy or C-PACE, which is allowing us to generate incremental volume in a market, in this case, commercial office buildings, we have not previously been able to finance.

C-PACE is the structure that allows us to attach our repayment rights to taxing jurisdictions property tax bill, effectively making a senior to the senior mortgage that might be on the property. We think the potential for this structure is quite significant, especially since commercial buildings account from approximately 18% of all energy used in the U.S.

Turning to page 6, we summarize another new origination source for Hannon Armstrong, generated by our acquisition of a portfolio of land and their solar projects, and land leases for wind projects. We did a $170 million transaction. We improved our portfolio, yield and our credit quality and added good REIT assets to the balance sheet.

Some more to the C-PACE transaction, I just described our investment in the underlying land to solar and wind projects is senior to the senior debt in these projects, basically our return is considered a must pay operating expense that comes out of approximately the first 5% of revenues received. The project owners Southern Company NRG yield First Solar, NextEra to name a few have to pay Hannon Armstrong before they pay the project lenders or pay dividends to themselves. In addition to the acquired portfolio, we have to write a first refusal to do additional transactions with the management that built the acquired portfolio; you should expect to see more of these transactions in the future.

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

J. Brendan Herron

Thanks Jeff. As a way of background, we make our money by holding assets on our balance sheet or by securitizing or selling originated projects to institutional investors and exchange our other investment income. Given the change in the business model at the IPO to hold more assets and generate net investment revenue, we believe the appropriate comparison of our results is to the prior quarter and thus our results on a sequential quarter-to-quarter basis.

Turning to the Q2 results, we generated $6.8 million of investment revenue in Q2 an increase of approximately $900,000 from Q1, in large part due to the portfolio acquisition Jeff mentioned. Like many transactions we closed, this was closed in last 35 days of the quarter, so the full quarterly impact will be realized next quarter.

The increase in investment revenue was offset by slightly higher interest expense as we increased our credit facility borrowings by $49 million in Q2 and thus our net investment revenue grew by $700,000 in the quarter. We ended the quarter with 1.2 to 1 leverage and 37% fixed rate debt.

We also realized $4.5 million or an increase of $1.2 million of other investment revenue in the quarter as a result of us capitalizing on declining interest rates to make some portfolio adjustments. Our total revenue net of investment interest expense was $7.6 million in Q2 an increase from $5.7 million in Q1.

Other expense core rose by $600,000 to $2.9 million as a result of higher non-management compensation expenses and higher professional fees. We anticipate that other expenses remain just below $3 million per quarter for the remaining of the year. We also incurred $1.1 million of portfolio acquisition related cost that we have expensed for GAAP purposes, would have added back for core.

As we've discussed, we target our other investment revenue to largely offset our SG&A expenses which had more than did this quarter. For the five quarters since our IPO, our other investment revenue was $14.5 million as appose to core other experiences of $12.5 million. While we have exceeded this target to-date, we believe this target remains a good benchmark of future other investment revenues. Our core earnings rose to $4.7 million of $0.22 per share compared to $3.3 million last quarter or $0.20 per share. We were able to grow EPS even with the dilution of the April equity rates.

Two other notes with regard to our portfolio on balance sheet investments. First with the land portfolio acquisitions, you will see a new line on our income statement for rental income and two new lines on our balance sheet for real estate and real estate intangibles. we record the income received in the land that we acquired in the land transaction as well as any land we purchase in the future in rental income.

On the balance sheet we recorded the land value and real estate, under GAAP you attribute a value of the in-place leases to the real estate intangibles, which is amortized over the life of the lease as a reduction to rental income. We've reversed this non-cash amortization for core earning purposes.

They acquired wind leases our counter for as financing receivables and appear in the investment income from financing receivable line on the income statement and the financing receivable line on the balance sheet.

Secondly, we classified our investments the structure is bonds or securities instead of as a loan or financing receivables at debt securities. In the quarter we sold debt security that was held per maturity due to attractive pricing on the long dated asset. The impact of this was that we now carrier debt securities approximately $68 million of our portfolio as held for sales in mark these securities that fair value through our other comprehensive income which is reflected on the balance sheet net of any estimated tax liability. We do not recognize unrealized gains through core earnings.

Turning to Page 8, one of the things to makes our business unique is our focus on diversified portfolio high credit quality assets. Our portfolio continues to be 97% investment credit rated at June 30, 2014. This consists of 46% of our assets from government obligors and 54% commercial transactions with only 3% of our assets or $17.4 million not consider investment grade. With the largest of these assets being a $16.6 million senior debt investment on an operating wind project owned by NRG.

On Page 9, we had a number of questions about how we think about our capitalization structure. It is important to note that we ended Q2 with 37% of our debt fixed. Our plan to continue to accumulate assets in the credit facility and use the asset-backed securitizations, like the one we did in December to lock in fixed rates on a portion of our portfolio.

Once we have accumulate transactions for the similar nature intend to complete additional ABS transactions much like the happy save in December or received six year term and 2.79% fixed rate within approximate 10 to 1 leverage. We believe the use of this type of transaction allows us to lock in longer-term fixed rate debt in more efficient manner than edges especially as we are able to achieve rated debt.

While this will likely have a negative short-term impact on earnings like I did last quarter we believe it is prudent to maintain a blend of fixed in floating rate debt. Giving continued low short-term rates we are looking to balance the impact and short-term earnings with the risk mitigation – its hard to give an exact fixed to floating rate targets due to relatively large size of the ABS transactions as compared to our overall debt but we will continue to execute on fixed rate debt transactions over the next 12-months. So over the period of time this will allow us to maintain our increase our current level to fixed debt.

We were able to put $70 million April equity raised of work and increased are use of the credit facilities by $49 million. We continue to focus on increasing our leverage up to the 2 to 1 for in the present 1.2 to 1 at the end of the quarter. We will be filing to two S3 self registration in near feature. One is required registration statement under registration rights agreement with our former owners. This will cover approximately 3.2 million shares or less than 15% of our fully diluted shares. The other is $500 million compare shelf. Shelf which is estimated last about three years will provide flexibility in new capital raises.

As we said last quarter we believe in our planned investment pace that the $70 million raised in April represents approximately 5 months to 8 months of equity depending on leverage and that’s we all evaluate feature equity raises in Q4 2014 or Q1 in next year. We also anticipate that the use of ABS transactions will provide us with the opportunity to increase our leverage especially as we takeaway interest rate risk and the size of the portfolio growth. However, at the present time the two to one remains our internal target.

Now that we have ramped our dividend, we are presently yielding approximately 6.6% and would expect dividends to grow periodically on a step basis based on earnings per share growth. Our target for EPS growth remains 13% to 15%, Q4 2013 to Q4 2014. We are not providing individual quarter targets as the timing of transactions will impact individual quarters.

Turning to Slide 9, our current yields on our growth highlights why we believe we operate unique value to various yield oriented investors including those interested in yield cos specialty finance or sustainability. Yield co continues to get a lot of attention with the recent large IPOs. We believe we offer a compelling value to investors who will be interested in yield cos in that we provide nearly twice the dividend yield and sit senior in the capital stack for some of the projects owned or intended to be owned by the yield cos.

For large portion of our wind and solar assets are held in our taxable re-subsidiary, which functions as its own yield cos, with taxable income offset by depreciation and other tax reductions. Well one of attractions in the yield cos is the fully contracted nature of the projects, the same fully contracted nature limits upside normally associated with equity ownership.

Thus we believe earning a higher return on senior assets is more attractive opportunity for yield cos investors. For specialty finance investors we offer an investment grade portfolio, low economic correlation, fully contracted revenues with an average life of approximately 12-years. More importantly we’re in a different market than most of these companies and not exposed to the same market pressures that’s seen in commercial real-estate or Business Development Corporation.

For socially responsible investor, we offer a low carbon alternative that positively impacts the environment, reduces greenhouse gas emissions and maximize both economic and environmental returns. To all investors we offer the origination platform Jeff discussed with access to unique high quality assets in a rapidly growing market and attractive risk adjusted yield. Investors get all this in an internally managed tax efficient platform well positioned for future growth.

I will now turn it back to Jeff, who will wrap up the presentation.

Jeffrey W. Eckel

Thanks, Brendan and once again thank you to the Hannon Armstrong team for executing on our plan. Our priorities for 2014 include capitalizing on the high growth distributed energy asset market and further optimizing our pipeline, continue to increase leverage and fixed out interest rate using our sustainable yield bond, ABS program, which will help drive EPS growth in the 13% to 15% range and that growth when combined with our dividend should provide our investors with a 20% total return, and finally our plan is to grow assets to $1 billion of assets by year-end, which we think will give us the scale to attract even more investors.

We appreciate you’re listening to our Q2 update and we’ll now open the call up for few questions.

Question-and-Answer Session

(Operator Instructions) Our first question is from Ben Kallo of Robert W. Baird. Please go ahead.

Unidentified Analyst

Hi, guys, this is [Howard Frnak] (ph) with Baird on for Ben. I was wondering if you could just walk me through the – I know you said the commercial rate internally projects stepped up considerably quarter-over-quarter on a percentage basis. How should we think about these projects, is this more of the distributor generation solar projects and SunPower, can you provide a little bit more detail on where these projects are?

Jeffrey W. Eckel

Sure, so I think the book there is a 107 of it is the transactions we just acquired in the land portfolios. And a lot of those projects are – we typically qualify the debt on this projects we’re particularly investing grade and we are senior to the debt, so that’s why we reconsider them investment grade, we think they are very high credit quality.

Unidentified Analyst

Okay, great and how should we think about the gain on securitization is going forward? Is this quarter more of a unique quarter in that or should we expect to see further transactions focus the model in the coming course as well?

Jeffrey W. Eckel

(Indiscernible) I think is that investors don’t always appreciate that we are able to monetize transaction that offset SG&A I don’t think there is a lot of company is that allow their investors that I have to pay for SGA through that. But I think as we sit all along our target is to target to equal SG&A. So right now we are running a little bit ahead of target. But I think the best way to think about it is which continue to offset SG&A.

Unidentified Analyst

Okay, great thanks guys.

Jeffrey W. Eckel

Thanks (indiscernible)

Operator

The next question is from Charles Nevin of Wells Fargo. Please go ahead.

Charles Nevin – Wells Fargo Securities

Hi, thank you for taking my question. On a high level in the past you guided to roughly $200 million in quarterly originations and $100 million in retain on balance sheet originations. Going forward is the pipeline gets more diversified, how should we think about the retention of across those buckets.

I am assuming it will average roughly 50% going forward. But could you give a sense for how it will vary from project type to project type?

Jeffrey W. Eckel

Yes, so a lot depends on what we originate in the quarter, Charles. I think as Jeff alluded to in the conversation, if we have a quarter with lots of federal government energy efficiency that is very long dated and lower yields will probably sell more that in the quarter or securitize more of that in the quarter. We have a quarter that has more clean energy type transactions in the quarter will probably hold more so. It’s going to vary quarter to quarter. Our rough working model is that 200 a quarter 50% hold and 50% securitized.

Charles Nevin – Wells Fargo Securities

Okay, great thank you very much guys.

Operator

The next question is from Aditya Satghare of FBR Capital Markets. Please go ahead.

Aditya Satghare – FBR Capital Markets & Co.

Thank you, good evening all. And appreciate some of your increased exposure here. So two questions, one is on sort of sources of growth in the market. As we think about all the equity refinancing taking place in the market today that will (indiscernible) do you see the potential to add that introduce products given sort of the – given that the long-term cost of that is still pretty attractive. And then how can we potentially think about kind of (indiscernible) from participation.

Jeffrey W. Eckel

Hi Aditya yes we definitely think our senior debt is very attractive to the yield curve as they try to sustain their growth and the valuation they are going to need leverage. So we certainly think we will be in some of those deals. But in addition, we are not just in that market as we’ve hopefully made clear we think the things like C-pace opens up an entire market that we just had never participated until that transaction we have been working in that area for five years but the pipeline is only now maturing to executable deals. So the answer is yes, we’ll participate with the yield co’s and thankfully there are lot of other markets that we’re participating and that we see is quite attractive on the yield basis.

Aditya Satghare – FBR Capital Markets & Co.

Got it that’s helpful and then the second question is on the American Wind Capital so how should we think about the pipeline activity with American Wind Capital and then if we think about like what’s the best when you think about some of the volumes which could potentially pull back of Hannon Armstrong.

Jeffrey W. Eckel

Well, I think we’ll always we’ve reaffirmed $200 million a quarter and I think the best way to think about volumes from anyone sources when we change that number but we certainly see the management team at American Wind Capital Corp. pursuing lots more transactions they’re basically the leader and their portfolio was a $107 million there is very few of these transactions have been done relative to the potential market and they’re going to gratifying new build transactions as well as old transactions because the structure make so much sense to the equity owner to do a land lease for sale at the land if it is seller that the economics are good so I think what we prefer to do is rise our $200 million number at some point and but at this point where we’re staying with that target.

Aditya Satghare – FBR Capital Markets & Co.

All right thank you. Thanks for the update.

Unidentified Company Representative

Let me just amplify what we’ve always said with our pipeline is we’re kind of continue to optimize it for risk adjusted yield basically we’ve really like these assets and the risk adjusted yield there is some other stuff that maybe not doesn’t fair as well the drops off in terms of our pipeline.

Aditya Satghare – FBR Capital Markets & Co.

All right thank you.

Operator

(Operator Instructions) The next question from (indiscernible). Please go ahead.

Unidentified Analyst

Joint Secretary, John (indiscernible) here. Two questions if I can. First of all can you maybe give us a sense of what the investment revenue or the incremental revenue from the American Wind acquisition will be next quarter just look engaged and spending you don’t have front versus actually what’s the comment and maybe think about it that way.

J. Brendan Herron

I think I don’t know there is some disclosure and then 8-K talks about historical numbers I don’t think we intended to disclose a portion of our anyone particular portion of our portfolio I think that Jeff gave an indication where the clean energy portfolio is and in total and we think that this transaction contributed to the clean energy portfolio the increase you saw on this quarter really is only 35 days. So you can think about a calculation on that the what are you looking on annualized basis and also get a sense of it from that perspective.

Unidentified Analyst

What’s the total increase quarter-on-quarter than from the transaction.

J. Brendan Herron

No we had other transactions but it was the largest component of the additional balance sheet transaction.

Unidentified Analyst

Okay and then just secondly, you made a comments and talked a little bit about yield cos during your presentation I think you said that you’re attractive because you offered twice the yield of what some of the yield cos are offering, slightly different perspective on that it is the market valuing the yield cos twice as much as they are valuing their dividend stream. And actually if you look at the correlation across all the yield assets, you get a very high correlation between growth of dividend and the valuation of the yield that they trend on. So, one can argue that the market is not really willing to give any credence to the growth rate that you guys are talking about with the dividend.

So, could you maybe talk about what you think you could do to fix that, like would you move to a quarterly policy I think Chris you mentioned you would evaluate it, but why would you not do that to kind of help people understand, kind of what the dividend growth is or if not once should we expect the dividend increase and then would it be kind of out of 15% rate on an annual basis or just how do we think about it. Because the market is clearly not giving you the value, they are giving everyone else.

Jeffrey W. Eckel

We understand. So, I think we’ve tried to be transparent in the last year we probably going to ramp to the $0.22, which we accomplished. This year we said we were going to get to 13% to 15% increase. So that would take us from the $0.22 to approximately $0.25 Q4 earnings per share number. And that we – we’ve always said that we would ramp dividends in conjunction with growth. I can’t give you an exact data as when we raise this. If and when we raise the dividend, but our goal is to raise in conjunction with earnings per share growth and our goal – our stated goal is to drive that 13% to 15% earnings per share growth and continue that in the future.

So, we appreciate that we may not be getting full credit for that and we think that we just continue to focus on execution that we will get the credit for that. And so we’ve tried very hard to do what we said what we are going to do and hopefully eventually the market will appreciate that.

Unidentified Analyst

So, we should think about them $0.22 of dividend for a full quarter period. And then you would see a raised measure with that 13% to 15% is that the way you guys are thinking about growing the dividend or maybe in the next few quarters, you might move to more of a quarterly way?

Jeffrey W. Eckel

I think what we’ve said is that, when – what we did this year as we stepped up to the $0.22 and wanted to maintain yet again – one of the other things we wouldn’t want to do is obviously have our dividend fluctuating downward. So, as we get more visibility into earnings per share growth is, we will have discussions with the Board about the dividend out, but I can’t give you exact timing.

Unidentified Analyst

Okay. Thanks.

Operator

(Operator Instructions) Mr. Eckel, there are no further questions if you have any closing remarks?

Jeffrey W. Eckel

All right. Thank you for the questions. We remain really excited about the opportunity front of us. And I look forward speaking to investors, analysts and any of you in our travels. Thanks so much.

Operator

Ladies and gentlemen this concludes today’s conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.

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