Hannon Armstrong Sustainable Infrastructure Capital Inc

NYSE:HASI

Earnings Call Transcript 2020-Q3

[Operator]

Good afternoon and welcome to Hannon Armstrong's Conference Call on its Q3 2020 Financial Results. Leadership will be utilizing a slide presentation for this call which is available now for download on the company's 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. All participants will be in a listen-only mode. [Operator Instructions]

At this time, I would like to turn the conference over to Chad Reed, Vice President Investor Relations and ESG.

[Chad Reed, VP, IR and ESG]

Thank you, operator. Good afternoon everyone and welcome. Earlier this afternoon Hannon Armstrong distributed a press release detailing our third quarter 2020 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 protection 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 Jeff Eckel, the company's Chairman and CEO; and Jeff Lipson, our CFO.

With that I'd like to turn the call over to Jeff who will begin on Slide 3.

[Jeff Eckel, Chairman and CEO]

Thank you, Chad and good afternoon everyone.

Today we are announcing that we've grown core earnings year-to-date 18% to $1.19 per share with $0.36 core earnings for the quarter. Closed $716 million of transactions in Q3 this is inclusive of the previously announced $500 million investment with NG which puts us at a $1.1 billion investments year-to-date.

We've lowered our cost of corporate debt and extended its duration through our successful issuance of more than $0.5 billion of green bond, which Jeff will describe in more detail later. We recorded our highest quarterly avoided carbon emissions with an estimated 1.2 million metric tons representing a carbon count score of 1.67. Finally, we declared a dividend of $0.34 per share.

We're pleased to report these results and also note that since the global pandemic and resulting economic recession erupted in March. We've raised and committed to invest over $1 million in climate change solutions, while our portfolio continues to perform and generate historically strong earnings. Our teamwork has been excellent during this extraordinary period and we remain thankfully in good physical health.

Furthermore, we're counting on continuing our ESG leadership. We have been using carbon counts since 2013 in order to measure the efficiency with which our capital is reducing carbon. With our recent membership and the partnership for Carbon Accounting Financials or PCAF we have joined with over 70 financial institutions to help drive the development of a global transparent standard that will build on the carbon count concept. We've also continued to move forward on a number of social initiatives, which we'll discuss in the subsequent slide.

Before we move on, a few words about the election. The resiliency of the Hannon Armstrong business model to political changes has been proven over the last 40 years and particularly over the last four years. We expect our clients to continue to drive the low carbon energy future independent of what happens with federal climate policy.

As an example, the recent formation of the American Clean Power Association indicates the clean energy industry is showing strength and maturity to create a powerful and unified voice for the industry and advocacy efforts going forward a special recognition to our Susan Nickey for her leadership and helping form the ACPA.

To conclude given the likely congressional election results, it is clear the private clean energy sector, working with states will have to continue our leadership to decarbonize the U.S. power system.

Let's turn to Slide 4, we provide an update on our 12-month pipeline, which remains greater than $2.5 billion even as we converted the 500 million NG transaction from the pipeline to an investment. We continue to see strong growth in virtually every one of the approximately 10 end markets where we invest.

Behind the meter portion of our pipeline remains very strong and is weighted towards energy efficiency opportunities in the governmental and industrial sectors. In addition, residential C&I and community solar pipelines remain strong and increasingly include storage component. The grid connected portion is similarly well balanced between wind and solar including solar land.

Finally, we continue to source climate resilience opportunities as reflected in our sustainable infrastructure pipeline. On Slide 5, we detail our $2.2 billion balance sheet portfolio at the end of the third quarter. The expected portfolio yield of 7.7% is derived from more than 200 diverse investments with an average size of approximately $11 million and weighted average life of approximately 16 years.

And please note that as of 9/30 we've funded four of the 13 projects of the energy portfolio investment we announced in July and the balance will be added in the coming months. The behind the meter market represents nearly 60% of our portfolio and generates a forward-looking yield of 8.1%. The strong credit profile and extracted yield of these assets is driven by the fact that virtually all of these assets save money for the obligor.

And the consumers and organizations are increasingly focused on the sustainability and the reliability and resiliency of power where they live and work. 40% of our portfolio and generating a forward-looking yield of 7.1% the grid connected market continues to be driven primarily by wind and solar.

We expect next quarter to add a new category called utility scale solar projects, once we start to fund some of those projects from the NG portfolio. We remain very pleased with the technological and geographic diversity of our portfolio and believe this is a key driver of our consistently strong portfolio performance.

Now I will turn it over to Jeff Lipson to detail our financial performance.

[Jeff Lipson, CFO]

Thanks, Jeff and good afternoon.

Summarizing our results on Slide 6, we recorded core earnings per share prior to NEC supervisions of $0.36 in the second quarter - compared to third quarter compared to $0.38 in the third quarter last year. Higher revenue from both the portfolio and gain on sale was partially offset by higher interest expense resulting from the recent green bond issuances.

Noted for the quarter in accordance with CECL, we increased our allowance on receivables by $2 million, primarily as a result of additional loan commitments made during the period, which resulted in core earnings per share of $0.33. On a year-to-date basis, core earnings prior to CECL provision is up 18% versus last year to $1.19, as we remain on pace to exceed the midpoint of our three-year guidance.

I'll also note that year-to-date core net investment income increased 16% year-over-year to $67 million. This increase was despite the fact we maintained an outsized low yielding cash balance during the second and third quarters. In addition, we recorded another quarter of solid gain on sale income as our access to private capital remains strong. Including over $18 million in the third quarter, our year-to-date gain on sale income is over $47 million.

With significant year-to-date growth in both NII and gain on sale, our dual revenue model continues to generate strong results despite the ongoing recession. As we turn to Slide 7, we highlight the discontinued growth we've seen in core NII has been driven in large part to the growth in our portfolio and our ability to maintain an attractive portfolio yield of 7.7%, despite a low yield environment.

In addition, we continue to prudently manage our leverage. Turning to Slide 8, we display the dynamics that capital markets continue to favor clean energy and ESG companies including Hannon Armstrong. For us, this is translated into a higher share price of our equity and tighter spreads on our debt. As of the end of the third quarter, we've nearly doubled the S&P 500 in total shareholder return over the last five years.

In addition, our corporate debt is trading below 4% about half the level of the S&P U.S. High-Yield Energy Index. With this attractive capital markets backdrop, we highlight our very successful recent debt issuances on Slide 9. In August, we issued $375 million of 10-year unsecured corporate green bonds at a 3.75% coupon and $144 million of three-year convertible green bonds at a zero percent coupon.

Both will fund anticipated identified investment opportunities. Our research indicates that we are one of the few dividend paying companies ever to issue zero-coupon convertible bonds. As part of the issuance process our BB+ credit rating was reaffirmed by both S&P and Fitch. The 10-year issuance further extends and ladders our corporate debt maturities. We continue to have no material recourse debt maturities until September 2022, when our first series of convertible bonds mature.

Given these may be settled in shares, this maturity does not necessarily reflect a cash need. Year-to-date, we've raised $1.1 billion across capital markets, which further demonstrates that all of our funding sources remain open and accessible to us, even during a prolonged pandemic and recession. And finally, we have limited interest rate risk, as the vast majority of our assets and liabilities are fixed rate.

On Slide 10, we provide an update on our balance sheet, which expanded to $3.3 billion in the third quarter as we continue to maintain a more liquid profile in this period with over $880 million of cash. We expect to convert a significant portion of this cash into earning investments over the next few quarters, including funding the majority of the remainder of the NG portfolio by the end of this year.

Our portfolio expanded 8% to $2.2 billion this quarter as we funded assets originated in both this and previous quarters. Finally as we continue to reduce our cost of capital, we utilize a small portion of our cash to voluntarily prepay high rate debt. As we turn to Slide 11, our portfolio of high quality assets have continued to perform within our expectations, despite the ongoing recession.

This performance is driven in part by the credit quality of our counterparties and the structure of our investments. All of our government and the vast majority of our commercial obligors enjoy investment grade ratings. In addition, the obligors of our residential solar assets include over 158,000 high credit quality consumers located across 22 states.

And in our equity method investments, we are typically preferred in the investment structure, which reduces our exposure to any periodic underperformance. Finally as our portfolio has grown and we have not witnessed an increase in credit losses. Our cumulative credit losses have dropped to just 20 basis points. In summary, even as the current recession has persisted, our earnings, liquidity and asset quality have remained resilient.

And with that I will turn the call back over to Jeff.

[Jeff Eckel, Chairman and CEO]

Thanks.

Let's now turn to Slide 12 where I will highlight notable recent developments on the ESG front. In addition to our recent PCAF membership in green bond issuances, our renewed commitment to racial justice, diversity and inclusion continues. We made meaningful contributions in the third quarter to the NAACP Legal Defense & Education Fund, Campaign Zero and the Baltimore Action Legal Team.

Our diversity equity and inclusion consultant continues to help us develop a multi-year plan for impact on these persistent challenges. In addition, we're pleased to report that our ESG score was recently upgraded by MSCI by two notches to A. We'll conclude on Slide 13. The ongoing pandemic and recession has tested the business models of companies across the spectrum and the resilience of our business model has once again proven strong.

We remain poised for growth, with a robust pipeline from leading energy and infrastructure clients and recent strategic investments in people and systems to support our increasing scale. Finally, our ESG leadership is being increasingly recognized by others and we expect that to continue as we ramp up our social initiatives while also leading the industry to report on the carbon intensity and investments. Our investment thesis, earning better risk adjusted returns investing on the right side of the climate change line continues to be proved out.

Thank you for joining us today. Stay well and operator, I think we'll take some questions.

[Operator]

[Operator Instructions] The first question comes from Noah Kaye from Oppenheimer & Company. Please go ahead.

[Noah Kaye, Oppenheimer & Company]

Just start with, if I am correct I think this might have been a record quarter for originations, so feel free to correct me. But just wanted to understand Jeff, I think you mentioned that a large portion of the NG investments are going to hit the balance sheet with you - in for 4Q. I'm assuming they are included in the originations you reported for this quarter?

If not, please correct me again, but essentially, you reported there's large number of investments, but a lot of them have to hit the balance sheet here in 4Q and then possibly a little bit into 1Q. And that's going to absorb the majority of the cash balance is that correct?

[Jeff Lipson, CFO]

That is a very good assessment. I did not research if it were a record quarter, but clearly, it's one of the largest quarters we've had.

[Jeff Eckel, Chairman and CEO]

It is.

[Jeff Lipson, CFO]

And then, yes, the way we announced transactions in that 716 number those are transactions closed. But not necessarily funded and you accurately described that we expect much of it to fund in the fourth quarter and that will be a large utilization of the existing cash. We did add recently, I think it was last quarter on what's Page 10 of the earnings presentation a balance sheet reconciliation as to what funds in the quarter. So that's the best way to track what has been funding.

[Noah Kaye, Oppenheimer & Company]

That's great. I think if you back out NG from the transactions, it looks like you still got a healthy volume it would be in sort of the 200 to 300 range of originations.

[Jeff Eckel, Chairman and CEO]

That's right Noah. As I said the - and this is the other Jeff you have so many Jeffs to choose from on this call, but as I said, virtually every one of our 10 origination markets is performing quite well so strong quarter even without the NG investment.

[Noah Kaye, Oppenheimer & Company]

Okay. And that leads me to the final question here which is, it looks like the percentage of your portfolio that's been performing to metrics at least based on the framework shift reported, that actually improved by a point. But just, do you see any potential trouble spots in the portfolio as we get later in the year here either on the consumer or the commercial side? What if anything has you worried, do you need further stimulus that you feel comfortable with these performance metrics continuing to hold up?

[Jeff Eckel, Chairman and CEO]

Go ahead, Jeff you have a very good answer on this that I appreciate.

[Jeff Lipson, CFO]

We don't - clearly to the first part of the question, if we saw something that we were specifically aware of, we would have to account for it now. So I think the clear answer to your first part of the question is no, we're not seeing anything. To the second part of the question are we worried? Of course we're always worried, but the portfolio has held up well, and again as we always talk about the portfolio is constructed in a way, whereby the counterparty typically is incented to continue making payments.

Particularly, I think part of your question was alluding to resi solar, where the counterparty is incented to make payments, it is a less costly form of energy for the home and we're not seeing anything concerning yet and obviously the recession has been ongoing and high levels of unemployment, have an ongoing since March. So with each passing month and quarterly reporting that we get, we continue to see a strong performance in the portfolio and don't have any specific reason to be concerned at this point.

[Noah Kaye, Oppenheimer & Company]

Okay, well thank you very much, I'll leave the election questions to make my fellow analysts. Thank you.

[Jeff Eckel, Chairman and CEO]

Thanks, Noah.

[Operator]

The next question comes from Julien Dumoulin-Smith from Bank of America. Please go ahead.

[Anya Shelekhin, Bank of America]

This is Anya stepping in for Julien. Yes first off, I just wanted to ask, when do you expect to roll forward the EPS CAGR and what are the updates that come on that call in terms of a clear growth expectations?

[Jeff Lipson, CFO]

Well Anya, as we've said we're reaching the end of our three year guidance period, we’ll discuss additional guidance with the Board and any extension of guidance will come out of those discussions. You should expect if there is any, it would be in Q4 and that is also in the Q4 call, and that is also when we have as a, matter of practice reconsider the dividend level as well. So that's the quarter to look at, without committing to any actual action.

[Anya Shelekhin, Bank of America]

And a follow-up, what kind of growth, could you expect over the next few years, potentially coming from energy efficiency installations for government facilities?

[Jeff Eckel, Chairman and CEO]

Good question and presuming a Biden Presidency and a Republican Senate, we don't expect any sweeping federal energy legislation. But that during the Obama-Biden years, the federal efficiency market really boom to record level, some of which we're still seeing through the Trump administration, due to executive orders. The executive order process is very meaningful to the energy management groups and they take them seriously.

The lack of leadership on the White House on this issues if it were to persist would limit that market, but assuming Biden does win the presidency. You can expect he would be a strong supporter of expanding the ESPC, [UASC] and other federal market. So we're promise, it looks promising, and I'll just reinforce that these programs have been enjoying since they were first put in place during the Reagan administration, bipartisan support.

Nobody doesn't like saving the government money creating jobs in all 50 states and improving conditions for the war-fighter. So, we generally get support on both sides of the aisle - if it was needed, but with the executive orders you really don't need it.

[Operator]

The next question comes from Chris Souther from B. Riley. Please go ahead.

[Christopher Souther]

Thanks so much for taking my question here and congrats in the quarter. On the guidance - implies just $0.24 for the fourth quarter to hit the midpoint that you've talked about exceeding there. Obviously a lot of cash is still to deploy at the end of the quarter there and there have been interest on the debt?

But just curious given there was high, gain on sale this past quarter, are you seeing similar market conditions where we could expect that to be elevated. Just realize we're a month in so maybe it might be coming later in the quarter, but I was curious how you feel about the gain on sale for this coming quarter here?

[Jeff Eckel, Chairman and CEO]

You know maybe I have been watching so much politics on TV, I will take page from a politician and say, it's still early to say but we're feeling pretty good about things. Yes I - we have reaffirmed it will be at the high end of our guidance, so feeling pretty good about things.

[Christopher Souther]

I mean I have been looking at kind of the pipeline mix, it looks like grid connected with back up compared to the last quarter. And obviously you had taken the energy portion out in the second quarter when you gave those metrics, but I believe it might have been in there in the first quarter?

So we're seeing kind of similar percentage of the pipeline in that grid connected as we saw before the NG deal was announced. Do you see the potential for similar large types of deals like that in the grid connected space over the next couple of months quarters here. I am just wanted to see if there is anything we should be pushing out there?

[Jeff Eckel, Chairman and CEO]

Yes, no I think you've made a correct observation, it is up somewhat, I think anybody in this and the developer side of the business is rushing to get projects developed, should tax credits start to expire, so to me, it's not surprising that that pipeline remains strong.

[Operator]

There are no more questions in the queue, this concludes our question-and-answer session, and the conference has now concluded. Thank you for attending today's presentation, you may now disconnect.