Hannon Armstrong Sustainable Infrastructure Capital Inc

NYSE:HASI

Earnings Call Transcript 2020-Q4

[Operator]

Good afternoon, and welcome to Hannon Armstrong's Conference Call on its fourth quarter and full year 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. [Operator Instructions].

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

[Chad Reed, VP, IR & ESG Strategy]

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

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

[Jeffrey Eckel, Chairman & CEO]

Thank you, Chad, and good afternoon, everyone. Today, we are reporting that 2020 distributable earnings, previously known as core earnings total $1.55 per share, an increase of 11% over 2019, and the 7% 3-year compound annual growth rate, exceeding the high end of our previous guidance.

We grew our portfolio 38% year-over-year to $2.9 billion. We closed $1.9 billion of transactions in 2020, a record, including almost $800 million in Q4. And finally, we're providing 3-year guidance of 7% to 10% compound annual growth in distributable earnings.

Let's turn to Page 4 and discuss guidance and dividend in more detail. Given the earnings trajectory of our existing portfolio and the strength of the pipeline, we are guiding, as I said, to a 7% to 10% growth in distributable earnings per share through 2023 relative to a 2020 baseline of $1.55 per share. If you look at the chart, this is equivalent to a 2023 midpoint of $1.98 per share. To be clear, there may be lumpiness in the yearly earnings, but we expect at the end of 2023 to be within our guidance range.

Given the expectation for accelerated earnings growth, we intend to grow the dividend at a rate of 3% to 5% annually from 2021 to '23. With distributable earnings growing faster than our dividend, we can continue to retain capital for accretive investments and remain attractive on a total return basis. So today we're also announcing a 3% increase in our dividend to $0.35 per share for the first quarter of 2021.

Now turning to Slide 5. We would like to address some of the key macro themes that are top of mind for our investors and analysts. First, evidence of a changing climate continues to mount. 2020 tied for the warmest year on record. In addition, there were 416 natural disasters across the globe last year, resulting in economic losses of approximately $250 billion. The deep freeze in Texas causing the massive power outages may be an example of climate change-induced extreme weather events. But regardless of the cause, we are concerned for the people affected and hope power is restored as soon as possible. We're also grateful for our partners operating our wind and solar assets in Texas for their commitment and competence in managing through this disaster.

Clean energy assets have generally performed well in 2020, and our portfolio has proven very resilient, despite the pandemic and recession. Our portfolio of long duration, noncyclical, climate-positive assets has performed as expected.

While it is too early to fully understand the net impacts of the Texas events on our portfolio, we are confident our diversity and preferred structures mitigate the impact of this week's events.

The climate solutions market continues to grow as does our pipeline. Our deep relationships with large clean energy and infrastructure clients, combined with our flexible permanent capital solutions, have led to a greater volume of investment opportunities at attractive risk-adjusted returns.

In addition, the demand for ESG equities is growing, driven by institutional investor mandates and the strong performance of proven ESG leaders. We continue to believe that ESG reporting is a material disclosure all companies should make. We also support the efforts for global standardized performance metrics to prevent green and social washing. As ESG investing matures, we believe that the competitive advantages of ESG leaders will become more apparent and that this will be reflected in their market performance.

Finally, for the first time in several years, federal policy is acting as a tailwind rather than a headwind for our industry and our business. As the competitiveness of renewables, energy efficiency and sustainable infrastructure improves, corporates and governments are setting evermore aggressive clean energy and net 0 targets.

In addition, from rejoining the Paris Agreement to the appointment of key personnel, the Biden Administration is taking aggressive action across the Executive branch to move policy in a climate-positive direction. We also believe there is momentum for a price on carbon by way of a carbon dividend plan we have long advocated for.

Turning to Slide 6, we provide an update on our 12-month pipeline, which we are reporting is greater than $3 billion, up from the prior quarter of $2.5 billion. It is notable that we increased the pipeline from last quarter even as we converted almost $800 million from that pipeline to closings in Q4.

We continue to help our clients grow by striving to make the financing transactions as aerodynamic as possible through programmatic relationships. We see strong growth in virtually every one of the approximately 10 end markets where we invest.

The bulk of our pipeline remains behind the meter and is weighted toward energy efficiency opportunities in the government and industrial sectors. We do expect President Biden to drive the federal ESPC program to return to the levels achieved during the Obama Administration.

In addition, the behind-the-meter solar pipeline remains strong, including residential, C&I and community solar projects, an increasing number of which include a storage component. The grid-connected portion is similarly well-balanced between onshore wind, grid-connected solar and solar land. Lastly, we continue to see interesting climate resilience opportunities as reflected in our sustainable infrastructure pipeline.

On Slide 7, we detail the $663 million preferred equity transaction we closed at the end of last year alongside Clearway Energy in a 2 gigawatt grid-connected portfolio of 7 onshore wind, solar and solar + storage projects. The portfolio enjoys highly contracted generation, predominantly investment-grade counter parties, a 14-year weighted average contract life and significant geographic diversity. The portfolio also represents our first grid-connected solar plus storage investment and provides the potential for continued programmatic deal flow with Clearway, a large ambitious partner focused on the U.S. market.

As of the end of last year, we had funded $200 million of this larger commitment, and we anticipate funding the balance as the remaining projects achieve commercial operation over the next few years. On Slide 8, we provide an overview of our $93 million preferred equity investment in a 78 megawatt behind-the-meter portfolio of more than 60 distributed solar + storage projects. Co-investors include Morgan Stanley as tax equity and ENGIE as sponsor equity. With a weighted average contract life of 24 years, the portfolio is with highly creditworthy consumer, C&I and rural electric co-op off-takers.

We also highlight the unique structure of this transaction, which combines tax equity financing and a forward flow of projects. With $37 million funded to date, we anticipate funding the balance of the commitment as projects reach completion milestones over the next year or so.

Turning to Slide 9. What these investments also highlight is our quarterly and annual headline close transaction number is perhaps not the most useful metric for evaluating our performance going forward. Historically, we've said that we expect to close at least $1 billion of transactions each year, and last year we announced $1.9 billion in closed transactions. However, as of December 31, nearly $600 million of that headline number will be funded in future periods under forward flow funding commitments. We would suggest that portfolio growth and NII growth will perhaps be more useful metrics for tracking our performance. We will still disclose closed transactions for the foreseeable future, but think these additional metrics may prove useful.

Now I'll turn it over to Jeff L., to discuss our portfolio performance and financial results.

[Jeffrey Lipson, CFO & COO]

Thanks, Jeff. Welcome, everyone, to the call. Turning to Slide 10, we detail our balance sheet portfolio at year-end 2020 and compare it to year-end 2019. First, the portfolio is significantly larger. It's grown by approximately 38%, from $2.1 billion to $2.9 billion over the last year as we've added approximately 50 incremental investments. We've achieved this growth while maintaining our portfolio yield of 7.6% and with no meaningful change in average investment size, which stands at $12 million.

Secondly, our portfolio diversity is stronger than ever. No asset class comprises more than 28% of the portfolio, and we've added a new asset class grid-connected solar. Finally, our portfolio is even longer-dated as we've extended our weighted average life to 17 years. We remain very pleased with the quality and diversity of our portfolio and believe this is a key driver of its consistently strong performance and resilience.

As we turn to Slide 11, our high-quality assets have continued to perform within our expectations throughout 2020. This performance is driven in part by the structural seniority of our investments and the credit quality of our obligors. This quarter we've added a table detailing the structural seniority and obligor credit attributes associated with each of our asset classes.

In nearly all of our investments, we are in a preferred senior or super senior position. And in addition, our obligors are typically investment-grade government or corporate entities or creditworthy consumers.

The structure of our investments, most notably our structural seniority, has a very meaningful impact in reducing our exposure to both operating and commodity price risk.

Moving to Slide 12. Let's begin with a quick explanation of the transition to distributable earnings, which is summarized in the bottom left. Prior to 2020, we utilized core earnings as our primary non-GAAP performance measure. In 2020, we implemented the current expected loss standard known as CECL, and we utilized core earnings pre-CECL as our primary non-GAAP earnings metric, which we had communicated would be a transitional metric. However, the SEC has recently clarified that REITs, subject to certain conditions, may use distributable earnings as their primary non-GAAP performance measure, which excludes most CECL provisions, and we have elected to use a distributable earnings as our primary non-GAAP measure. For simplicity, please think of distributable earnings as equivalent to the core earnings pre-CECL metric that we used in the first 3 quarters of 2020.

Fundamentally, we believe that distributable earnings, as we have defined it, remains the best indicator of our economic performance and is useful to both our investors and the leadership team in evaluating our performance and calibrating our dividend.

Summarizing our results. We recorded distributable earnings per share of $1.55 in 2020, an 11% increase compared to the $1.40 in 2019. Higher revenue from both gain on sale and our larger portfolio was only partially offset by higher interest expense.

I'll also note that distributable net investment income increased 7% year-over-year to $88 million in 2020. This increase was despite the fact we maintained an outsized low-yielding cash balance during much of the year.

In addition, we recorded significant gain on sale income in 2020, as our access to private institutional debt remains strong. Our cash collected on equity method investments was also robust in 2020 as we continued to receive both return of and return on capital from the portfolio.

To conclude, our dual revenue model continued to generate strong results in 2020, despite the pandemic and recession. As we turn to Slide 13, we reflect multiyear growth rates at or above 15% in managed assets and NII. We achieved this while continuing to generate a steady portfolio yield and a return on equity above 10%. our closed transactions have averaged $1.3 billion over the last 5 years, 30% above the previously disclosed target; although the chart on the bottom right is a good reminder that our volumes can be lumpy, which is one of the reasons why we think 3-year guidance is appropriate for our business.

Moving to Slide 14, we detail our balance sheet as of year-end 2020. In the fourth quarter, we funded $739 million of investments, resulting in a 30% increase in the portfolio as compared to 9/30. We anticipate these fundings will result in significant net investment income growth in 2021. Even after this elevated level of investment, we have nearly $300 million of cash on our balance sheet at year-end for scheduled fundings and further organic growth in the portfolio.

On Slide 15, we highlight our continued access to the capital markets. In 2020, we raised $1.2 billion in debt and equity, including $775 million in unsecured green bonds, $144 million in 0 coupon convertible green bonds and nearly $300 million in equity.

Following the filing of our year-end financials, we intend to refresh our at-the-market equity issuance registration up to $500 million. We are also excited to announce the closing just last week of a $50 million unsecured sustainability-linked revolving credit facility with JPMorgan. We anticipate expanding this facility in the future by adding additional relationship banks, which will further provide funding flexibility. So during a prolonged pandemic and recession, we actually enhanced our ability to flexibly access the capital markets and other sources of capital.

In addition, we continue to manage our leverage maturity profile and interest rate risk at prudent levels. In summary, we were pleased with our 2020 performance, including our earnings, funding platform and asset quality, and we remain poised to take advantage of favorable market conditions.

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

[Jeffrey Eckel, Chairman & CEO]

Thanks. Turning to Slide 17, we highlight our ESG initiatives. With regard to the E, in 2020, we achieved the highest carbon reduction in our history, almost 7x greater than 2019. This was driven in part by our elevated transaction volumes, but also by the higher efficiency with which we use capital to reduce carbon, reflected in a carbon count of 1.03 for the year.

With regard to the S in ESG, we're pleased to declare a social dividend of $1 million to capitalize our newly formed Hannon Armstrong Foundation. The foundation will provide a long-term strategic focus for our philanthropic efforts to find the intersection of climate change and social justice. I hope to provide more updates on this effort in future earnings calls.

Finally, with regard to governance, as our company grows, it's important to grow our Board of Directors in number, competencies and diversity. As you may have seen in yesterday's press release, I'm pleased to welcome 2 new board members; Clay Armbrister, President of Johnson C. Smith University; and Nancy Floyd, founder of one of the first clean energy venture capital platforms 30 years ago.

With our new board members and our previously announced leadership realignment, we are well positioned to best serve our clients, investors and employees to deliver on our climate-positive investing vision.

We'll conclude on Slide 17. I want to summarize why we believe we offer a compelling value proposition to investors. Our Programmatic Growth platform is backed by a robust pipeline of projects developed by the leading clean energy and infrastructure companies that drives our diversified and high-quality portfolio that's been tested in 2020, and performed quite well. With a durable capital structure backed by a prudent approach to leverage and array of funding sources and our transparent and quantitative carbon reporting provides confidence to ESG investors. And we have a proven track record as a public company for nearly 8 years, along with a stable and growing dividend.

For these reasons, we've significantly outperformed the S&P 500 ESG Index as well as REIT and YieldCo indices over the last 5 years.

To sum up, we're thrilled about the accomplishments in 2020 and the opportunities in front of us and confident in our ability to execute on them in the months and years ahead.

And I would like to close by thanking the staff of Hannon Armstrong for their outstanding efforts in 2020, truly a remarkable group.

Operator, please open the line for questions.

[Operator]

[Operator Instructions]. Our first question today comes from Mark Strouse with JPMorgan.

[Mark Strouse, JPMorgan Chase & Co.]

Jeff, I know you said that it's too early to kind of know the impact of what's happening in Texas. Two questions there. How do you go about kind of framing that potential risk, I guess? I mean, what is your exposure in your portfolio to Texas?

And then bigger picture, I think you're a good spokesperson for the industry. I mean, hearing a lot of different debate going on about who's to blame for what's happening, just curious for your high-level thoughts.

[Jeffrey Eckel, Chairman & CEO]

Thanks, Mark. As I said, it's too early to know the net impact. You've got some generators that are selling power at high rates and others that are not. I would say our clients, and this is a very real-time effort; we have daily calls with them. They are doing a phenomenal job getting the plants restarted in truly difficult conditions. We're very grateful to have them as partners.

I think the third piece, and we've mentioned it in the script, is the preference features in our investments mitigate the impacts from the Texas events, just really not that meaningful. So we, being kind of conservative folks, we have a worst-case estimate that assumes everything goes bad and nothing goes well. And what we found is the impact is not material. And I think the best evidence of that is we are issuing 3-year guidance even in light of the ERCOT issues we've seen this week. It's just, to us, the strongest possible statement we can make that we feel very good about where we are even with the impacts of Texas.

On the ERCOT issues, I've always been perplexed by their desire to remain Island, having done Island Power Solutions in the '90s. It's a tough way to run a utility. I'm certainly hoping the American Clean Power Association will be getting the true story out there.

I think the other thing, Mark, that I would say is, I've never been a big fan of people saying 100% clean energy. I get the aspiration in that comment, but that's not how utility systems work. You need a mix of generation; and this, I think, just reinforces it.

So obviously there are going to be fingers pointing for a long time. This is a real disaster for a lot of people and it just should not happen. So with that, why don't I stop and see if I've answered your question.

[Mark Strouse, JPMorgan Chase & Co.]

Yes. Yes, that was very helpful. Just one more follow-up for Jeff L. The guidance obviously points to higher growth for earnings than it does for the dividend, so the payout ratio coming down. Just given your, I mean your proven ability to access capital markets, I mean, even during 2020, can you just kind of give a bit more color into the rationale for being a bit more conservative with the payout ratio?

[Jeffrey Lipson, CFO & COO]

Sure, Mark. So we've been previewing for some time that EPS will grow faster than DPS. And I think we've been saying that very consistently for at least a couple of years. This new guidance just reinforces that message in a more quantitative way, and we just think it's a more prudent way to run the business to retain more capital when we have such a good pipeline and expect to have a strong pipeline for a long time.

So you're right, we could just re-access that capital and recycle it and remain confident in our capital markets platform. But there's a balance there, and retaining some capital we do think makes sense. And we are putting forth an accelerated growth in DPS, just not quite as high as EPS.

[Operator]

Our next question comes from Philip Shen with ROTH Capital Partners.

[Philip Shen, ROTH Capital Partners]

I wanted to touch base with you guys on the outlook for originations. Jeff, I know you talked about having maybe a bit of a shift in focus to overall portfolio growth and NII. But that said, originations still, I think, are important. And was wondering if you could share what the implied originations might be embedded in the 3-year guidance. So if you're at this $1.9 billion a year, should we be thinking more along the lines of $1.5 billion? Or do you think 2021, for example, could be higher than the $1.9 billion?

[Jeffrey Eckel, Chairman & CEO]

Thanks, Phil. I think we're -- you said you still think originations are important; so do we. We've averaged $1.3 billion over 5 years. That's not a bad number. I think we've proven we can do $1.9 billion. We're certainly not -- we don't need to do that to hit our guidance numbers. So I mean, I think something on the order of $1 billion to $1.5 billion, that's in that range. And there's always this tension between can you originate more and take a lower return? And the answer is yes, you could. But ultimately, we're running the business for the long-term return on equity and stability of the business. So hopefully that answers your question, Phil.

[Philip Shen, ROTH Capital Partners]

It does, yes.

[Jeffrey Lipson, CFO & COO]

And Phil, if I could add to that answer a little bit. Just to reinforce our at least slight movement away from that number, keep in mind, as Jeff said in his comments or implied in this comments, there's a big difference between originating, let's say, $1.3 billion in a year and it all funds and originating $1.3 billion, which includes a future flow component and perhaps only half of it funds. And so that's why that number as a standalone number is not quite as meaningful as we think people have been using it, and that's the reason why we're deemphasizing it just a little bit.

[Jeffrey Eckel, Chairman & CEO]

And if you look at the $1.9 billion, but we still haven't funded $600 million, that's to $1.3 billion, which I think makes your point, Jeff.

[Philip Shen, ROTH Capital Partners]

Great. Yes, that's very helpful. Shifting over to gain on sale from a modeling standpoint. You guys have been pretty consistent in this kind of mid-teens-type level. Is this something we should be counting on going forward? I know there are lots of puts and takes in the market and it depends on a lot of factors. But in the near term, coming quarters, do you expect that to remain kind of in the mid-teens millions?

[Jeffrey Lipson, CFO & COO]

It's tough to say. That is the lumpiest part of the business, as you know. We start every quarter at zero, pretty much. And we have had some very successful quarters, including the fourth quarter and some a little bit less of gain on sales. So in total, I view the $66 million we did at 2020, as a bit of an outsized number. I don't think we want to promise that that's a number will be consistent as it relates to gain on sale going forward.

But I think you should expect some lumpiness. I think you should expect it to continue to be material though, as there are several asset classes that we do remain active in and have a bullish outlook for that lend themselves well to securitization. And likewise, our securitization partners continue to express strong demand for that type of investment. So it'll continue to be material, but lumpy.

[Philip Shen, ROTH Capital Partners]

Okay. One last one, if I may. On Slide 11, you guys have a really nice depiction of how well-performing your asset base has been through this challenging past year. And then your commentary, Jeff, on the challenges in Texas still kind of, in spite of that, you're issuing robust 3-year guidance. And so with that, that's yet another shock to arguably your portfolio and it sounds like you'll likely perform well.

So as I think through your credit situation and the potential for an investment-grade rating, can you talk us through what the potential of that might be for this year? I know the rating agencies, they can't signal exactly. But just from your perspective, if you could update us on the potential that would be fantastic.

[Jeffrey Lipson, CFO & COO]

It's difficult to handicap, Phil. I wouldn't characterize it in terms of likely or unlikely or reasonably likely. I would only say that it's a conversation we'll have in detail this year. And I think performing well in a recession will certainly work in our favor. The business is also achieving more scale, which is something the agencies look to. We've achieved more unsecured credit, particularly with this new JPMorgan facility, which, again, is a positive attribute for the rating agencies. So I think we have a good case, but I would hesitate to handicap it in terms of likelihood.

[Operator]

And our next question will come from Noah Kaye with Oppenheimer.

[Noah Kaye, Oppenheimer]

For the first time in a while, the 12-month pipeline has increased to $3 billion. So just a question. Does that include or is that inflated by, versus a traditional $2.5 billion number you've given in the past has been inflated by the announced investments that have yet to be funded? Would you call that out as unusually inflating this year's pipeline? Or do you feel like this is structurally what we could anticipate in the future, a larger pipeline?

[Jeffrey Eckel, Chairman & CEO]

First of all, we went from more than $2.5 billion to more than $3 billion, and that more than $3 billion subtracts the approximately $800 million that we closed on in Q4. So we will never double count, if that's an aspect of your question. No, we think, as we said on the, I think, the third slide, climate solutions investing is growing, and our pipeline is growing. So this is just a fundamental good news that there's more business out there.

[Noah Kaye, Oppenheimer]

Your pipeline is just structurally expanded because of the investment opportunities in climate?

[Jeffrey Eckel, Chairman & CEO]

Yes.

[Noah Kaye, Oppenheimer]

Yes. Great. I think the yield curve finally steepening, good time to have 99% fixed-rate debt going into that. I think certainly has been impacting equities today. But can you remind investors of how a steepening yield curve could impact your business in terms of spreads, deal flow? How do you think you're positioned now for potential interest rate increases relative to, say, where you were in the past?

[Jeffrey Lipson, CFO & COO]

So I think the duration of our liabilities, we've extended, particularly with the most recent 10-year deal. I think there was a time you'd look at this business, and you would say the duration of the liabilities was a bit shorter than the duration of the assets. So the steepening yield curve would help. By same token, we'd have some risk in doing that. I think we've taken out some of that risk, but that's also, in some ways, reduced the benefit of a steepening yield curve. So I don't think it'll have a big benefit for the business. I think it's more a second-tier impact that a steepening yield curve is usually indicative of a strong economy, it's usually indicative of some movement in credit spreads. And I think ultimately it's the credit spread differential between our investments and our debt that drives profitability, not the yield curve itself.

[Noah Kaye, Oppenheimer]

Yes. Makes sense. I want to come at the impacts of Texas in a little bit of a different way. In the past, whether it's been Superstorm Sandy or the PG&E wildfires, some of the arc of investments in the power industry has been tending to bend towards increased resiliency, localization, distributed energy, energy plus renewables on site plus storage.

Obviously too early to tell. But do you see potential for this week's events to spur on those types of funding opportunities and that kind of pipeline? Because certainly, I think resiliency, increased resiliency on the grid is paramount given what we're seeing this week.

[Jeffrey Eckel, Chairman & CEO]

No, I don't see how it couldn't. Particularly as the U.S. continues to electrify, we need a much more reliable grid and we need more distributed, decentralized energy resources. That's a trend that's been going on for a long time. Our pipeline is dominated by behind-the-meter solutions, in part because it is a different quality of power service. And this is just a hideous event in Texas, should not be happening. But yes, it'd be hard for me to see why it wouldn't expand the shift to distributed energy resources.

[Operator]

Our next question comes from Greg Lewis with BTIG.

[Gregory Lewis, BTIG]

I guess I just want to follow up on Noah's question. Clearly, the pipeline is expanding. In looking at the behind the meter, as a percentage basis it went down a little bit, but on an absolute basis it went up. Is there kind of any way to understand, and knowing that you mentioned California earlier from last year, this event, is there a growing pipeline of battery storage behind the meter that is just kind of quietly accelerating? Is that kind of what's helping grow out the pipeline?

[Jeffrey Eckel, Chairman & CEO]

I wouldn't say necessarily storage. But if you listen to Sunrun or SunPower or Nova or anybody in the C&I markets, storage is increasingly part of the solution. I think we'd be hard-pressed to say that's why our pipeline is up. But it just makes solar that much more valuable.

[Gregory Lewis, BTIG]

Okay. Great. And then just thinking about the opportunity set; clearly, it's growing. Grid-connected, which is, as we think about, is attractive yields, a little bit lower than behind the meter. Like as we think about putting the portfolio with an eye on maximizing yield, is some of the grid-connected just not going to be as attractive as we need it to be to sort of throw it into -- invest in it in the portfolio?

[Jeffrey Eckel, Chairman & CEO]

No, that's quite possible. And we've always said, when there are very large common equity positions that are highly competitive with global institutional investors, that's probably not a great opportunity for us, and somebody else should win that business. We certainly like a little bit more structure and more of a partnership feel than an auction.

So I certainly see grid-connected as needing a lot of capital. There's a lot of capital chasing those investments, and that's a good thing for our clients. Whether they have the best risk-adjusted return for us, we take case by case.

[Operator]

Our next question comes from Chris Souther with B. Riley.

[Christopher Souther, B. Riley Securities]

Maybe you could just touch on -- to piggyback on the question around gain on sale. How should we think about the impacts, not necessarily in the shorter term where it's tougher to predict, but in the 3-year targets that you're giving out, how much should we think about that being baked in as part of the growth there?

[Jeffrey Lipson, CFO & COO]

Well, I think we're clearly, given the fundings we did in the fourth quarter, going to grow NII next year; I think that's fairly obvious. In terms of the gain on sale, we're not going to disclose specific growth targets. But what I said earlier in terms of you should expect it to continue to be a material contributor to our earnings and our earnings are going to be growing 7% to 10%, you should logically conclude that that's going to remain a very active part of the business.

[Jeffrey Eckel, Chairman & CEO]

I would add though, that we've always wanted to drive to higher NII relative to gain on sale just because gain on sale can be more episodic. It's just a more reliable business. We seem to be well positioned from 2020 to do that. And I've always said I want a gain on sale to be earnings noise to the upside. And I think we're in a marginally better position for that to be true, incrementally better position for that to be true.

[Christopher Souther, B. Riley Securities]

No, that's great to hear. That makes a lot of sense. So looking at the other side, do you think you'd be able to talk about the balance sheet growth that we should be thinking about to get to the low or high end of the targets that you've given today, on kind of broad strokes maybe? Or is that not something you'd want to provide at this point?

[Jeffrey Lipson, CFO & COO]

We're not going to disclose growth targets specifically on the portfolio. But I think, again, you can probably triangulate that a bit when you think about that we are guiding towards a relatively flat yield. You can see where we're guiding to on earnings. Jeff mentioned roughly $1 billion to $1.5 billion of new investments per year. I think there's an ability with the numbers we've put out for you to triangulate what portfolio growth will look like, without us disclosing that specifically.

[Christopher Souther, B. Riley Securities]

Okay. Got it. That's helpful. And maybe just the last one on the operating expenses. Just how should we think about the trend there throughout this year and then going forward would be helpful?

[Jeffrey Lipson, CFO & COO]

I think on a percentage increase basis, you should think about fairly significant increases in operating expenses because we are increasing our staffing materially to keep up with this growth. But as a percent of revenue, I think you should envision that coming down, which is actually the more important metric. I think we will be growing revenues faster than we're growing expenses, despite expenses growing on a percentage basis at a somewhat significant clip.

[Operator]

Our next question comes from Ben Kallo with Baird.

[Benjamin Kallo, Robert W. Baird & Co.]

Hey, Jeff and Jeff. I'm going to ask 3 questions. The first is a business fundamental. The second is about technology. Third's bigger picture. So business fundamentals, financials. The ROE, so we got asset yield steady, your capital costs are going down. You got leverage in your model. So where should the ROE go forward? How should we think about that going forward? That's my first question.

[Jeffrey Lipson, CFO & COO]

You should think about a steady to upward trajectory in ROE. I think, again, you laid out most of the variables that impact ROE; some of them are steady, some are improving. So I don't expect it's suddenly to be a 15% ROE business, but I think we'll see some steady increases in ROE.

[Jeffrey Eckel, Chairman & CEO]

And the thing that really drives changes in ROE is -- well, I was going to say, Ben, the thing that really changes ROE in any one period is the amount of gain on sale. And the NII is going to produce a steadier ROE and the noise is going to be around gain on sale.

[Benjamin Kallo, Robert W. Baird & Co.]

Okay. On the technology part, fuel cells, Jeff, Jeff and Jeff, what do you guys, what are your views on that? then my third one is a bigger picture question.

[Jeffrey Eckel, Chairman & CEO]

Well, I wished I'd bought Plug Power when I had a chance. I got to say that. I kind of missed that one by a mile. Then we always look at things from a carbon lens first. I think the amount of progress in the hydrogen fuel cells is outstanding. We would fundamentally figure out what the carbon count on it is. I think they're proving to be, after almost 30 years of trying, this technology seems quite viable now. So I congratulate those companies. They've been at this a long time and have really built something that can work. To us, it should be part of microgrids and distributed generation future. And again, so long as it's got a acceptable carbon story for us.

[Benjamin Kallo, Robert W. Baird & Co.]

The bigger picture, I guess, was -- and I think I've asked this before. But if I go to Slide 16, I was asked, last night I was doing something and a young person coming into the field asked about when do investors start valuing ESG and metrics like that. And you guys have always put out your carbon avoidance and you've been a leader on that front.

And just from your perspective, when do people or how do we start valuing that? Or do people do that? Or is that already being valued? And I know that's my job. But from your perspective, what's the tipping point there?

[Jeffrey Eckel, Chairman & CEO]

Well, I would argue that we may have reached it. It's fundamental to our strategy, Ben, that having a verifiable and transparent carbon story would some day reduce our cost of capital as investors increasingly recognize the risk to investing when they disregard carbon. I don't think they are disregarding carbon or climate change anymore, and I think we've seen it on the equity side and the fixed income side.

What I don't think is happening is a real refined analysis of the carbon impact of companies. If you're green, you're really green. And I think over time, a metric like carbon count can be useful.

I think on governance, to me, it's more binary. You either have good governance or you've got lousy governance. And it's harder to say, but I think a lot of companies run away from poorly governed businesses. The S is clearly harder. We are all learning how to value it. We have implicitly valued the social aspects as it relates to our employees because for the same reasons climate change matters to them and why they want to work here, the social aspect of the business matters as well. And I think every company has work to do; and we are, I think, well advanced and starting on that work.

[Benjamin Kallo, Robert W. Baird & Co.]

Maybe just jumping in there. Where is the SEC? And do you think they're going and reporting this and these different metrics? I hear different things out there. So what do you think's going to happen?

[Jeffrey Eckel, Chairman & CEO]

We do have a new disclosure on our 10-K that will be filed at some point in the future soon on human capital disclosures. That's a new SEC requirement. I think we are going beyond what the SEC required and adding a few more dimensions to the human capital question that I think is just absolutely great that the SEC is doing it. Could they do more? Sure. Under their new leadership, I suspect they will.

[Operator]

Our next question comes from Julien Dumoulin-Smith with Bank of America.

[Julien Dumoulin-Smith, Bank of America Merrill Lynch]

Congrats on this guidance. Let me try to leave it a little open-ended, but I'd be curious how you would describe things. So this 3-year view, when we get there, what does that mix look like with regards to your portfolio? And what kind of yield do you think you have? But more importantly, what does that mix look like, right, when you think about where this, whether it's $1 billion or $1.5 billion per year, what's the net size of that portfolio that you're aspiring to? Maybe asked a little bit differently from Philip. And then separately, what's the composition here, really, critically?

[Jeffrey Eckel, Chairman & CEO]

We certainly don't have any goal for any specific portfolio mix, other than we don't want to be over-concentrated in any one asset class. And a few years ago everyone was worried that we were going to have only residential solar. Well, we don't have only residential solar. And perhaps now people will worry we'll have too much onshore wind. We're not going to tilt or unbalance the portfolio here in those ways.

I think one of the great advantages of our business model, Julien, is the ability to look at all sorts of asset classes, whether in the power sector or not, both for getting incremental returns but also diversity. I think we love having more than 230 total investments in our pipeline. And I've been saying this for a long time, there's no one asset or asset class that's going to bring us down.

So don't have any prescription as to what it's going to look like. If I had to venture a guess, I would say probably not going to look a whole lot different than it does now.

[Julien Dumoulin-Smith, Bank of America Merrill Lynch]

Got it. Excellent. And then I'm thinking a little bit more broadly here. As you think about this trajectory right now and perhaps into the future and otherwise, how do you think about the REIT status, right? And does that matter or not over time relative to the portfolio as you see it evolve, specifically in direct renewable investments that may not qualify. I'm just curious how sustainable the trajectory is if you don't invest renewables and how you think about that balance of do we bother with the REIT status relative to the opportunity set in renewables directly versus maybe some of the more historical investments you guys have made?

[Jeffrey Eckel, Chairman & CEO]

Good question. Jeff L.?

[Jeffrey Lipson, CFO & COO]

So I would, Julien, say, reiterate, to some extent, in answering that, what Jeff just said, which is, to use some slightly different words, we have multiple paths to achieving this guidance. We have many, many different paths which will take us to $2 or more per share in 2023 in terms of the portfolio, in terms of the yield, in terms of the amount of gain on sale, and then also to your question, in terms of corporate status. So there's not one path to getting there, there's multiple.

It is highly likely as it relates to REIT status, that'll be a path that allows us to continue to be a REIT. But I also think there are scenarios where we're not a REIT. What we really don't want to do is miss out on some really good investment opportunities that we perhaps couldn't do if [indiscernible] too much of.

So I think it's likely we'll be a REIT over this 3 years, but it's not 100%, and that's one of those several elements of there are multiple paths to achieving this guidance.

[Julien Dumoulin-Smith, Bank of America Merrill Lynch]

Okay. All right. Fair enough. But let me maybe ask it this way. Obviously, you have over $4 billion of securitization assets on the balance sheet. How much latitude do you even have left over the next 3 years? It sounds like there's probably still some amount, again, obviously, depending on the path you choose. But there is latitude today. And more importantly, I think, as you say, there's probably a good amount of latitude still left then, depending on the securitization asset portfolio relative to the rest of the balance sheet?

[Jeffrey Lipson, CFO & COO]

Yes. And just to correct one thing. I think you said securitization assets on the balance sheet. I think you meant to say off the balance sheet.

[Julien Dumoulin-Smith, Bank of America Merrill Lynch]

Yes.

[Jeffrey Lipson, CFO & COO]

But yes, there is there still remains material flexibility as it relates to the REIT test at this point. So I think without getting into too many specifics, I think that's the best way to characterize it.

[Jeffrey Eckel, Chairman & CEO]

And remember, Julien, the off balance sheet assets are valued for repurposes at gross. And the bad REIT assets are valued at the net equity level. So that's always been a, I think, a misunderstood aspect and the power of having the efficiency assets as part of the business.

[Julien Dumoulin-Smith, Bank of America Merrill Lynch]

Yes, I hear you. Jeff, one last question for you, if you don't mind. Super quick. Did I miss you on quantifying that Mesquite impact in Texas? Or did you not do it? I just want to make sure I heard you right there.

[Jeffrey Eckel, Chairman & CEO]

You heard it exactly the way we intended it to be told. We issued guidance with -- it's just flat too early to say any specifics, Julien. But we have given guidance with full knowledge of the impact of the Texas issues.

[Operator]

Our next question comes from Stephen Byrd with Morgan Stanley.

[Stephen Byrd, Morgan Stanley]

Most of my questions have been addressed. Maybe just one on potential further democratic legislation. We've been seeing various drafts and have some sense for the different elements that might be in another round of legislation, and we're fairly bullish about the prospects for more support at the federal level. I guess when you look at the landscape of different areas of potential additional federal support, is there anything that stands out to you as especially beneficial or sort of noteworthy as you think about your business in the context of the democratic support for clean energy?

[Jeffrey Eckel, Chairman & CEO]

Steve, I was going to say, I would wait to get a note from you that describes this in far more detail than I would ever be able to understand it. I congratulated you on your recent note and look forward to them all the time. The last four years from a federal energy policy standpoint were a bit of a dark period, and, yet, the business was good. I don't know what federal government will do and what is possible with a split on Senate. But it's going to be a heck of a lot better than the last four years. We certainly see the federal energy efficiency and resiliency mandates as being completely in our wheelhouse. If President Biden can do what he and President Obama did, that is just a wonderful thing. That's a program that we still do business there, but it's atrophied without any Executive branch leadership. And that's executive order-type stuff.

I continue to believe that a price on carbon and a dividend is the way to unlock markets to really attack carbon, not just in the electric sector, but in ag and industry and transport. We hear things that that's not the craziest notion. I don't know what your mood ring says on that, but ours is turning a little more, what'd we say? Blue or green? Not black or yellow. And Stephen, I actually do have a mood ring that I put on whenever we have debates, but anyway . . .

[Operator]

This will conclude our question-and-answer session as well as today's conference call. Thank you for attending today's presentation. You may now disconnect.