Hannon Armstrong Sustainable Infrastructure Capital, Inc.
Q2 2013 Earnings Call Transcript

Published: 11 Aug 2013

[Operator:]

Good afternoon, and welcome to the Hannon Armstrong Sustainable Infrastructure Capital’s 2013 Second Quarter Earnings Conference Call. Management will be utilizing a slide presentation for this call, which is available now for download on Hannon Armstrong’s Investor Relations page at investors.hannonarmstrong.com. Today’s call is being recorded, and we have allocated 1 hour for prepared remarks and Q&A. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. At this time, I would like to turn the conference call over to Steve Chuslo, General Counsel at Hannon Armstrong.

[Steve Chuslo:]

Thank you, operator. Good afternoon, everyone. By now you should have received a copy of the earnings release for the company’s second quarter 2013 results. If you have not, a copy is available on our website at www.hannonarmstrong.com. Today’s speakers are Jeff Eckel, Chief Executive Officer and Brendan Herron, Chief Financial Officer. But before we begin, I would like to remind you that some of the comments made on today’s call are forward-looking statements and within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The company claims the protections of the Safe Harbor for forward-looking statements contained in such sections. The forward-looking statements made on this call are subject to the risks and uncertainties described in the Risk Factors section of the Company’s Form 10-Q 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. I would now like to turn the call over to Jeff Eckel, the Chief Executive Officer.

[Jeff Eckel:]

Thank you, Steve, and good afternoon everyone. I’d like to welcome you all to our Hannon Armstrong’s second quarter earnings call. I am joined as Steve said by our CFO, Brendan Herron. I will start off the call by providing some comments about our dividend, our execution this quarter, and of course, our business model. And then Brendan will discuss the Q2 results. Finally, I will walk through our plans for the rest of 2013 and we’ll wrap up by taking your questions. We are pleased to declare our first dividend of $0.06 per share for shareholders of record as of August 20. This equates to a 2.5% annualized yield based on our $12.50 IPO share price and is the first building block for our ramp target yield of more than 7% by Q4. The dividend is paid from core earnings of $0.07 per share, which was generated by our execution on $204 million of transaction closings. The closings were accompanied by an expansion of our pipeline to over $2 billion and supported by the closing of our $700 million warehouse credit facility. Hannon Armstrong has always been about execution and being a public company, it doesn’t change that. Let’s go a little deeper on some of the execution highlights. Of the $204 million of transactions, a $134 million were newly originated, which we believe demonstrates our strong origination capabilities. We went public with an initial portfolio of $110 million of transactions. We closed $701 million from that portfolio with remaining $40 million closing in the near-term. A $165 million of the transactions are held on the balance sheet with the remainder closed in our fee generating securitization vehicles such as the Hannie Mae. Overall, the portfolio is rated as solid investment grade. While the execution team was doing its job, our origination team was busy selling our new financing capabilities and expanded the 12-month pipeline by more than 33% to over $2 billion. Finally, leveraging our IPO proceeds is critical to the business model and we were pleased to have closed the $700 million warehouse facility and start to draw funds from it. Turning to page five, we believe that $204 million of closings and the 33% growth in the pipeline reflect positive trends in each of our markets. We closed transaction in each of our three target asset classes, energy efficiency, clean energy, and other infrastructure and expanded the pipeline in each as well. Some of the positive market trends we see include state and local governments seeing the value in the kind of public-private partnerships we can offer with our new financing capability. Our financings effectively increased the borrowing capacity of a better rated jurisdictions preserving their precious bonding capacity. U.S. federal government the world’s largest energy consumer is accelerating its decade-old efforts to reduce energy usage impart due to President Obama’s recently announced carbon initiative, but also for the need to reduce energy costs and increase energy security. Finally the clean energy market is expanding as expected due to renewable mandates and stable natural gas prices, both of which are driving the transition to a cleaner stock of power plants in this country and contributing high quality opportunities to our pipeline. These market trends flange up well with our proprietary origination platform which has produced financing transactions two of which we discussed on page six. The first example is a $25 million energy efficiency transaction with AAA rated school system we closed in May. It is engineered by our long time federal client Johnson Controls who is expanding its state and local offering based in part on our ability to fund transactions like this. By using capital from Hannon Armstrong, the school system will be able to invest in things more directly related to education rather than using their scarce capital for heating and cooling system upgrades. The second example involves Siemens integrating wind turbines that it manufactures into a $29 million project for the U.S. government, one of the largest wind projects on federal land. The ground breaking ceremony is next week in the Texas, Panhandle one of the best wind regimes in the country making this a particularly productive investment in terms of reducing CO2 emissions by offsetting utility coal generation. We are improving our new business model of combining a balance sheet with our legacy securitization and syndication capability as evidenced by the addition of two new Fortune 150 origination relationships due impart to our increased credibility as a public company. These relationships are the once that drive our sales as they have many people on the ground selling new transactions. We leveraged one of our syndication mandates in order to make an investment in the geothermal asset that we know well. And finally we are starting to refine our financial offerings by combining our balance sheet and securitization capabilities in a way that should significantly improve margins. In summary Hannon Armstrong is proving its business model and showing that our expanded financial capabilities from the IPO are directly leading to expanded originations and investments. All of our Q2 activities are occurring in an increasingly favorable interest rate environment for us. The steepening yield curve, an issue for many mortgage rates is actually helping Hannon Armstrong. On the left hand side of this page is the chart of the changes in the yield curve during the period we have been public. The 10-year treasury is up almost 90 basis points. On the right is the chart that shows the simple payback of the energy efficiency in clean energy projects we finance, with a range of simple paybacks from 5 to 10 years the implied internal rate of return in these assets basically their inherent economic value is – ranges between 10% and 20% IRRs. With a relevant treasury yield still on the single-low digits I think the 10-year closed at 260 yesterday for instance, treasuries could triple or go even higher and these projects still make economic sense. So, basically because of the inherit project returns of these infrastructure assets are multiples of our target yields arising longer term treasury does not negatively impact our originations. In fact, it may cause some projects to accelerate in order to lock in lower rates. Further, because we hold our assets to maturity, we do not mark to market our balance sheet and thus are not exposed to the book value declines seeing recently by the mortgage REITs. In fact, the steepening of the yield curve is improving our margins and we will continue to adjust pricing to reflect higher rates or managing the cost of borrowings through the hedging program we are implementing in Q3. Now, I will turn it over the Brendan to discuss the financials.

[Brendan Herron:]

Thanks Jeff. For those of you who are not as familiar with us as background we provide capital mostly debt to sustainable infrastructure projects including energy efficiency, clean energy such as wind and solar and water and communications projects that we call as sustainable infrastructure. We focus on projects that have high credit quality obligors and have been at this a very long time with an experienced management team. We have structures and internally managed REIT. We make our money three ways. Historically, we have securitized and syndicated transactions with institutional investors in exchange for a fee or gain on sale income. With the IPO and the new credit facility, we will hold a significant portion of the transactions on our balance sheet and generate net investment income. Today, we report on the first quarter results filing the IPO on April 23, which reflect 69 days of operations under our new business model. For this quarter and for the rest of this year and next year, we will be reporting results that include periods prior to April 23 that relate to the operations of our predecessor, and do not reflect our enhanced business model or our earnings potential post-IPO. Turning now to the Q2 results, total revenue net of investment interest expense increased by 86% to $2.8 million, as discussed above, this is the result of the change business model, where we are holding assets on our balance sheet using equity this quarter and in future quarters a blend of equity and debt. On a weighted average dollar basis, the average deal was completed in the second half of May. And thus the earnings potential of these deals has not yet been fully realized in the results. Going forward, you will see net investment revenue growing from the deals Jeff described and other deals that we put on the balance sheet. Total expenses were 8.6%. This includes $6.2 million non-cash stock-based compensation charge which reflects the one-time previously discussed $5.8 million charge related to the reallocation of equity of our predecessor prior to the IPO, and a $400,000 charge for stock-based expense for the quarter. After adjusting to these non-cash charges, total expenses were $2.4 million. The GAAP loss was $5.8 million compared to $2.2 million in 2012. Under GAAP, the pre-IPO period and the approximate 3% share of our limited partners in the post-IPO losses are allocated to non-controlling interest in the amount of $800,000. So, loss attributable to common stockholders is $5 million. Moving to slide 10, we compute core earnings for our common shareholders starting with a $5 million loss and adding back 97% in the stock-based compensation and a small percent of the intangible amortization to get to core earnings of $1.1 million, or $0.07 per share. A couple of points from the balance sheet. Investments rose by $143 million for the quarter and we paid off our old credit facility. The one transaction that has deferred funding and thus we have established a $28 million deferred funding obligation, which in this case we have funded with restricted cash. We operate as a REIT and use our TRS to hold non-requalifying investments, including wind and solar assets, in effect, a shelf-sheltering internal yield curve. On the new credit facility, we have a total capacity of $700 million that reached the maximum borrowings outstanding at any point in time of $350 million. The final size was based on our analysis of the use of this facility as a warehouse and other alternative financing methods available to us. Turning to the yield on slide 11, Hannon Armstrong offers a unique value to yield-oriented investors. When you compare our expected 7% yield to the other yield alternatives, you see we stack up well. We believe the closest comps that the companies invest in similar assets like Brookfield, Macquarie Infrastructure, and a new public entity, NRG Yield. The group of whom we have listed as infrastructure on the chart and who on average yield about 5%. Other similar yield investments that we compare favorably against include MLPs, triple net leases, and specialty REITs. While many of these businesses have some of the characteristics of Hannon Armstrong, it is difficult to find any other company, the blends in investment grade portfolio, long-term contractually committed revenues, and the investment protection of being senior in the capital stack with a significant equity cushion. While the commercial mortgage REITs are comparable in yield, Hannon Armstrong offers to high credit quality, non-economically correlated alternative. And as Jeff described, our originations not as exposed to interest rate changes, investors get all of this in an internally managed tax efficient platform that is well-positioned for future growth. With that, I’ll turn it back to Jeff who will wrap up the presentation.

[Jeff Eckel:]

Thanks, Brendan. First, I’d like to thank the Hannon Armstrong team for outstanding first quarter as public company. It’s quite an honor to get to work with this group. We knew going public was the right decision of our firm and we believe we are starting to prove it to you our investors. Turning to our priorities for the rest of 2013, we will continue to execute and close transactions very simply that’s what we do. These closings will drive the dividend ramping toward a target yield of 7% by Q4. We will maintain and expand our high-quality pipeline to ensure the best possible mix of business. And finally, with our execution pieces in place, we will expand the platform to grow the business, and ultimately the dividend in order to capitalize on the large and growing market for sustainable infrastructure. We will have more to say on the last point in upcoming quarters but for now focus on executing our business plan. We appreciate you taking the time to hear our story. We’ll now open the call up for a few questions. Thank you.

[Operator:]

Thank you. (Operator Instructions) Our first question comes from Joel Houck from Wells Fargo.

[Joel Houck:]

Good afternoon and thanks for the slide show, it’s very helpful. I guess the first question is on the energy efficiency, I guess roughly $100 million in volume this quarter. Can you provide a breakdown between what was the U.S. government versus non-US government?

[Jeff Eckel:]

Joel, this is Jeff. The – substantially all of the transactions are in the federal government. I would say it’s probably 75-25 if we did the math. What we’re seeing is our legacy federal business continues to produce transactions. Post-IPO we are starting to see a significant flow of business in the state and local side, so we expect to see more of that relative to the federal in future quarters.

[Joel Houck:]

Okay. So, the example on page six, the $25 million that was the non-government – that was AAA rated right?

[Jeff Eckel:]

Right, so that’s the state and local transaction.

[Joel Houck:]

Yeah. Okay, good. And can you talk a little bit about the spreads on the various productions in the quarter. We had obviously modeled certain spread assumptions on the IPO and I am just going to make sure that we are tracking similar or if there have been any changes in the various three buckets?

[Brendan Herron:]

Joel, this is Brendan. No, I think we are still tracking to the target model as far as yields and target yields we’re looking at in spreads.

[Joel Houck:]

Okay and then the non-energy efficiency, can you make some comments around the credit quality in terms of what you originated in the quarter. I know you mentioned investment grade but…?

[Brendan Herron:]

Yeah. I mean overall, the balance sheet breaks out to investment grade and the transactions were all around that target.

[Joel Houck:]

Okay, alright. Thank you very much.

[Operator:]

Thank you. Our next question comes from Ben Kallo from Robert W. Baird.

[Ben Kallo:]

Hi, thanks guys. Congrats on the progress so far. I was wondering you talked about existing the year at the 7% yield, but you got a couple of things that you are back of this strong at size as you guys have been conservative from this (indiscernible)?

[Brendan Herron:]

I think when you look back over the quarter and kind of the blend, the target yields are kind of where we expected them to be. And so I guess if you are referring to the fact that the yield curves moved up a little bit on the long side.

[Ben Kallo:]

Right.

[Brendan Herron:]

I think that will depend on where we haven’t necessarily modeled that in. So, it depends on where our yields, we are not predicting interest rates, we are looking in our targets – kind of target spreads and we will wait and see where interest rates go.

[Ben Kallo:]

I might have missed this, but as far as the expansion in the pipeline goes, what do you see as the major drivers, public entity, non-funding or something else?

[Jeff Eckel:]

I think there is two things. On the state and local side clearly the IPO has enabled us to do business that we were here to for really unable to transact and in the structure we created that’s all some funding capacity issues for high credit quality jurisdictions. So, that’s one where we simply, we could have added deal store old deal list, but we never would have been able transact on them, they’ve been there now we are able to transact on them. So, we consider them part of our pipeline. On the federal side there is no question that President Obama’s willingness to talk about climate change and encourage the federal government to lead by example is very much putting a positive pressure on the business in the federal market.

[Ben Kallo:]

Great, thanks.

[Operator:]

Thank you. Our next question comes from Ken Bruce from Bank of America Merrill Lynch.

[Ken Bruce:]

Thank you. Good evening. Let me first congratulate you for very fine start as a public company. My first question and I have a number of them. My first question in terms of the increase in the pipeline is can you help or remind me as to how much you would expect of that pipeline to be coming on balance sheet versus securitized what the timing or how we should think about, what the duration of that pipeline – not duration, but the extent of getting that pipeline to closing, I know you’ve mentioned in the past couple of years, so I just want to make sure I understand kind of how that pipeline is forming and how that should impact your balance sheet and securitization activity going forward?

[Jeff Eckel:]

Sure. Basically, I think right way to think of it is two-thirds, maybe a little bit more than two-thirds goes on to balance sheet, and the balance is syndicated or securitized. In terms of the conversion rate, we have many multiples, I guess, 3X of what we are looking for the close in any one year in the pipeline. So, we probably aren’t as focused on the probability of any one deal closing. We are really focused on managing to having multiple projects that can close and the good problem I have if too many of them close at once, but we like to have A projects, B projects and C projects for each of the quarters, and I think I would probably haven’t spent a lot of time tracking the likelihood of any given deal closing, because what’s more relevant is not if it closes generally when will it close. That’s the harder thing to predict. Most infrastructure assets that need doesn’t go away, we may lose a deal, but the deals are still out there and they close eventually, but they often get delay. Thus you want to have a lot of fishing lines in a water.

[Ken Bruce:]

Okay, I think I understand that. I guess what I was probably what I’m trying to understand is if there is a – if this just naturally that deals are either falling out of the pipeline or said essentially may be you lose a transaction or if it’s affectively just the stock of potential financing is having and flowing for various reasons and as you are able to essentially execute against anyone particular deal, but those ultimately are close funded in kind of move through the pipeline because I’m just trying to better understand that. And I don’t know if there is a way to characterize it in terms of the average time that anyone transaction may or may be in the pipeline before you actually see it close.

[Brendan Herron:]

Ken, this is Brendan. Couple of things, first of all, you have to remember lot of these projects, are fairly complex. They have in many cases permitting requirements and other things, and we are kind on the tail end of the process, the projects been engineered, has been permitted, we may have been tracking the project, but it’s not until they are all ready to start construction, they are really going to drawdown financing. So, because of that, there are inherent delays in that process is that we’re all aware. So, I think that’s one thing as far as individual kind of categories certain projects we know about earlier so, some of the clean energy projects you may know in track earlier then some of the federal government energy efficiency project where our customers are very used to coming to us and when they are very closed to the being ready to start the project and that will execute on financing. So, some of those federal government projects may move through the pipeline very quickly. Some of the other projects may take longer and we have to watch them incubate through. So, it’s a little hard to make any one generalization about any particular type of project, because it really depends on what the project is and what the nature of the requirements are to get it to construction and that’s really where we start to come into play either construction or if it’s a post-construction that take out when the people – when the customer decide they want to do the take out.

[Ken Bruce:]

Okay. And do this syndication mandates are they included in that pipeline or is that separate in the pre-IPO discussions, there were affectively two different tracks, and I just want to make sure I understand where the syndication mandates stand, and if there are any near-term opportunities on that side of the business that we should be making sure we are accounting for (indiscernible)?

[Jeff Eckel:]

Good question. The – over $2 billion does not include the syndication mandates, they are growing. Those are the lumpier as we have talked about and we are a little bit less focused on the syndication mandates and the timing is because they are more complicated projects the timing is far less in our control than it is even in the federal or state and local or smaller project market.

[Ken Bruce:]

Okay, thank you. And couple of your comments you mentioned the ability to transact on deals now that you are a public company with a bigger – with more financing potential, can you maybe give us an example or just describe kind of the nature of what these different transactions are that you can do now that you may have had to pass on before?

[Jeff Eckel:]

Well, I think the best example is the AAA-rated school district. This is a structure that we have really been looking at for a long time, but I haven’t been able to execute on. It solves a local governments have credit limitations and they want things that are off credit. I don’t care about off half balance sheet so much, but they want something that’s off credit, that doesn’t count against their borrowing authority. So, basically what we have done is taken the federal model for these energy efficiency contracts and apply that to the state and local market, and it’s relatively small change in the risk profile and certainly risk profile we are completely accustomed to. Yes, I just simply hadn’t been applied in the state and local market, and now we are able to transact on it without waiting for other institutional investors to catch up to us.

[Ken Bruce:]

I see. And would that be specifically incubated on the balance sheet for some period of time and you look for some other financing alternative if in fact the one comes about in terms of securitization, so, wouldn’t be putting the Hannie Mae deals today, but would be incubated on the balance sheet and then either stay there or possibly be securitized later?

[Jeff Eckel:]

Correct. So, it goes on our balance sheet. It fits into our credit facility and then we can decide if and when we pull it out as part of any kind of asset-backed securitization or other longer term financing.

[Ken Bruce:]

Okay. And is that part of what you are referencing in terms of some of the financial efficiencies that you could apply down the road?

[Jeff Eckel:]

Correct.

[Ken Bruce:]

Okay. And then in terms of Johnson Controls and Siemens are fairly well recognized names in partners of years are as you are moving to the market you are deepening into the market allowing you to increase your number of sponsors or partners however you want to characterize them, that in fact will grow your lending potential the distributed model that you have?

[Jeff Eckel:]

Absolutely. And we mentioned two of them that we knew platform or clients that we are glad to have in the fault just in this quarter. There are a number of other companies that we are working with now to really same vendor model, but different markets they all have dozens to 100s of people outselling projects. They have equipment and services they want to sell and then need of that capital into those service offerings. And frankly being public gives us credibility of that we just didn’t have before they don’t have to wonder where the money is that can see exactly where the money and so, from an origination standpoint, we are pretty fired up about the opportunities right now.

[Ken Bruce:]

Great, well. That’s very encouraging to hear. One last question if I may, in terms of the way to interrupt the $0.06 dividend I know we had some discussion just in terms of the way to think about where the dividend would be tracking is that more reflection of just what’s your core earnings were in the second quarter or is it any indication kind of how you are thinking about it in terms of the future earnings.

[Brendan Herron:]

So, this is Brendan, Ken. So, obviously as a rate, we’re going to payout 90% to 100%, the stated target is closer to 100%, we don’t have depreciation and capital requirements for most of our projects. So, we can payout closer to 100%. I think this quarter works out to be about 93%. So, we are within that range of the target. This is where the Board was comfortable. As a first dividend, obviously, we’ll continue to look at that and work within those targets.

[Ken Bruce:]

Right. I guess, I have said this to you, before I’m kind of more of the school of thought you want to get too far ahead of yourself on the dividend. So, I just want to make sure, I’m kind of interrupting which the timing as to how you are thinking about dividends and so if I understood what you said it was more a reflection of the quarter’s earnings and not a reflection of your expectations for future quarters?

[Jeff Eckel:]

Correct, yeah, that’s right. We evaluated based on this quarter’s earnings much to your point that we don’t want to get ahead of ourselves.

[Ken Bruce:]

Okay.

[Jeff Eckel:]

We expect as we’ve indicated that the dividend will grow and we’ll keep within the payout range that we just discussed.

[Ken Bruce:]

Okay, thank you for your comments and again congratulations on a first quarter of public company operations.

[Jeff Eckel:]

Thanks, Ken.

[Brendan Herron:]

Thanks, Ken.

[Operator:]

Thank you. (Operator Instructions) We appeared to have no further questions. I’d like to turn the call back to management for closing comments.

[Jeff Eckel:]

Thank you very much. Have a good evening.

[Operator:]

Thank you. This does conclude today’s conference. You may disconnect your lines at this time. Thank you for your participation.