Q3 2022 Hannon Armstrong Sustainable Infrastructure Capital Inc Earnings Call
Combined with anticipated extension and step up in tax credits and election of certain solar projects from ITC to PTC.
While our clients are seeing these benefits in grid connected projects. It is happening faster than the behind the meter projects because they are quicker to build leader leading to faster utilization of these benefits.
<unk> and transport benefit from the clean fuel credits in the ITC respectively.
And speaking with our clients about their pipeline and the 2024 to 2006 period, we're hearing a significant increase in ambition and we still resulting volumes in both grid connected and behind the meter developments.
Terms from the clarity and certainty of the IRA provisions, including the ITC Adders we.
The transferability provision could be a significant opportunity for us along with Standalone storage.
24 to 26 looks to be a pivotal time when our clients scale of project development, which will then reflect volume growth in our pipeline to be clear our pipeline has a 12 month pipeline and does not reflect these increases.
By 2026, and beyond we expect significant new markets to develop in green hydrogen transmission and grid modernization.
<unk> the energy transition is starting to accelerate and yet it will take time for that acceleration to appear in our pipeline.
Now I'll turn it over to Jeff L to detail our financial results.
Thanks, Jeff on slide seven we detail our $3 9 billion dollar balance sheet portfolio as of the third quarter of 2022, which has grown 22% over the last year.
We added over 100, new events investments in the past year contributing to our recurring net investment income.
Portfolio now includes over 365 investments across eight asset classes.
The diversity of the business remains an ongoing positive attribute.
The projects underlying these investments represent over 12 gigawatts of clean energy to have improving economic value in times of higher commodity prices and provide cost effective critical energy to end users.
Therefore, these investments are non cyclical with 99% of investments currently performing within our financial expectations and we do not expect a recession to negatively impact the performance of these investments.
Further we detail our Q3 portfolio a reconciliation on the right side of the slide.
The portfolio balance was flat for the quarter as we funded $91 million of investments offset by collections and securitizations on existing assets.
Funding expectations of previously closed transactions is over $625 million expected to fund through 2023.
On slide eight we have summarized our third quarter results with a year over year comparison on the top left and year to date comparisons on the remainder of the slide.
We recorded distributable earnings per share of <unk> 49 in the third quarter, which is up 20% year over year.
We also had a strong quarter of distributable net investment income of approximately $43 million, which is up 36% year over year and recorded a gain on sale of $19 million.
In the upper right. We note year to date distributable EPS growth was 13% year over year, primarily due to higher revenue from a larger portfolio.
In addition, as shown on the lower right. We are on track for another strong year of gain on sale and fees was $64 million of this revenue source through three quarters.
This is a very similar number as last year, despite the higher rate environment, reflecting that our securitization profitability is unaffected by rates a topic I will discuss in more detail in a few minutes.
On the lower left distributable net investment income was approximately $134 million year to date.
Collecting year over year growth of 40% driven by a larger portfolio and continued strong margins.
In summary, despite higher rates and capital markets disruption, we were able to achieve our targeted level of profitability and are able to once again affirm our guidance.
The next two slides both address interest rate risk in our business a topic, which we are frequently asked about page.
Page nine addresses this risk related to our balance sheet and page 10 addresses our off balance sheet investments.
As the top left graph on page nine indicates we've maintained strong margins that are now entering a phase during which we expect our cost of debt to increase.
However, most of that increase will be offset with higher yields on new investments as Jeff described earlier.
It is also important to note that our current portfolio yield and cost of debt include a substantial amount of existing assets and liabilities. So neither figure will move up quickly as incremental investments and debt at higher rates will only initially comprise a modest percentage of the balance sheet.
The primary conclusion of this chart is that in this illustrative scenario, we believe higher yields and higher debt costs would result in margins large enough to support a run rate of approximately 10% to 12% Roe.
Consistent with our historic levels of profitability.
On the upper right of the slide we detail other factors, which we expect will allow us to maintain strong margins, including utilizing lower leverage and pivoting to bank and private debt, while public debt markets are volatile.
So we have recently been asked about the refinancing of our low coupon debt maturing in 2026.
Before addressing refinancing I will note that issuing low cost debt and substantial size in 2021, we will continue to be a catalyst of strong margins over the 2021% to 2026 period.
As it relates to refinancing this bond in 2026, there are several potential outcomes in several rate scenarios that may occur over the next four years.
However, even if we assume a high cost outcome of simply refinancing it with a similar bond offering at a rate 350 to 400 basis points higher than its current coupon. We believe the size and profitability of our business by 2026 will be such that it will not cause our profitability to fall below our targeted Roe range.
This is because by that time the portfolio is expected to be larger and at a higher investment yield.
This scenario also ignores the fact that our recent investment grade credit rating positions us more favorably for that cost optimization when public debt markets return to more normalized historic patterns.
The bottom portion of this slide reflects our luxury business model in a rising rate environment depicted as a percent of assets that reconciles back to our targeted ROE range of 10% to 12%.
As we have stated several times, we have managed this business and markets in which rates have been high low flat, Steve or inverted and have consistently maintained earnings growth.
This is a reflection of the flexible business model, we deploy using diversified sources of capital both on and off balance sheet.
Turning to slide 10, we've also received questions recently regarding our expected securitization activity now that rates have risen.
To be clear, our securitization activity and the corresponding games are not impacted by rates.
Fluctuations in our gains are the result of volume and mix non interest rates.
Our securitization transactions are fundamentally purchase and sale arrangements in which we typically buy receivables from clients only after we have an agreed upon sale price from our securitization partner.
We then closed the purchase and sale either simultaneously or typically within a short period utilizing a rate lock to minimize interest rate risk.
We do not use warehouse lines, nor do we typically hold these investments unhedged on our balance sheet exposing ourselves to changes in rates prior to the receivables being sold.
For example, in 2021 and 2022 year to date over two thirds of our securitization transactions have been simultaneous or hedged and the majority of the remainder had less than 30 days unhedged exposure.
It is also important to note that these transactions occur outside of the ABS market and are not impacted by the dynamics and volatility of the ABS capital markets.
These are bilateral arrangements with partners, primarily life insurance companies that have transacted with us over multiple decades, including under a variety of interest rate and macroeconomic conditions.
Therefore, this remains a flexible and resilient component of the business that is not subject to meaningful market risks.
In 2021, we recorded $80 million of gain on sale and fees, reflecting a 23% increase from 2020.
We are on track to duplicate that outstanding level of gains in fees in 2022, despite rates being much higher further evidenced these gains are not rate sensitive.
Turning to slide 11, we are pleased to highlight our successful recent debt transaction.
Subsequent to quarter end, we closed a $383 million three year term loan a arranged by JP Morgan and including six total banks.
Theres, a credit spread of $222 five basis points above term sofa, which can be reduced based on carbon count thresholds.
When combined with the $600 million bank revolver, we closed in the first quarter. We have successfully raised approximately $1 billion of bank debt in 2022.
The support from the banks underscores the strength of our business model and our long term predictable cash flows. These.
These bank facilities have allowed us to pre fund a meaningful portion of our expected 2023 investment fundings, while avoiding the currently volatile public debt markets.
Evidence of the resiliency of our business and our ability to weather market disruptions.
In the third quarter, we issued $49 million of equity at an average price of $36 85.
With all of these transactions our current liquidity has improved even further and is over $1 2 billion on a pro forma basis.
Our fixed rate debt percentage was 93% at quarter end and is expected to decrease modestly at year end due to the term loan a.
We also continued to manage our leverage in a consistent range and our debt to equity ratio was one seven times at year end.
Please note we have an updated cash sources and uses slide on page 15 in the appendix in the format that we began utilizing in the second quarter.
Reflecting the net cash collections remained well above the dividend and the $158 million of year to date excess cash collections can be utilized to fund new higher yielding investments further reducing our reliance on external funding.
In summary, it was another quarter of strong growth in earnings and net investment income the portfolio is performing as expected and our liquidity profile remains excellent.
And with that I'll turn the call back over to Jeff.
Great job Thanks, Jeff.
Turning to slide 12, an update on our ESG activity includes finalizing and improved carbon count methodology and kicking off our business partner ESG engagement program.
And we're very pleased to have Beth already sounded join our board and audit Committee Beth brings significant experience and a renewable fuel and transport sectors to our board.
We'll wrap up on slide 13.
Good businesses get tested in rough markets and we're pleased with how we performed this quarter and this year. We believe this is due to our resilient dual revenue business model of net investment income and securitization gains on sale.
Our pipeline is growing and yields are adjusting to the higher price of capital.
This pipeline growth is driven by partnering with the best clients in the best market climate solutions investing.
Despite higher interest rates, we're able to affirm our guidance for earnings and dividend growth through 2024.
That will conclude our remarks and open up the line for questions operator.
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We will take our first question from Noah Kaye with Oppenheimer. Please go ahead.
Thanks for taking the questions and appreciate some of these incremental.
First just to clarify on the securitization platform slide discussion. So there is a bilateral transaction you're buying and selling at pretty much the same time.
Higher rate environment, where the discount rate is higher is the assumption that the spread between X and Y should should.
Expand to kind of keep the NPV constant is that the right way to think about it is that what you're effectively seeing and getting acceptance for in the market.
So.
I mean, the base rates will go up on both sides the spread may or may not go up typically have seen over the years.
Two decades, we've been doing this that spreads are proportional to the base rates. So as base rates go up spreads go up but that's not that's more of an anecdote.
<unk>.
La physics.
But I do want to highlight that.
No nine when markets were.
Even more <unk> than they are now to say the least that was still open.
Life insurance companies still have.
The liabilities from their life insurance policies, and they still need to offset that with high quality and AIC one.
<unk> set our long dated and have a premium to the U S Treasury and that's what we've been able to supply or over the last two decades.
Very helpful. And then you mentioned in the prepared remarks, the potential value of the onetime transferability of the tax credits can you maybe expand on that a little bit how that might be useful to you how you might position yourself.
In terms of utilizing the transferability.
Yeah. Good question I mean, we're all waiting for.
Right to finalize regulations to see what it actually is but if it's what we think it could be.
It's just another way for us to solve our clients' problems by.
Using our broker dealer whatever two <unk>.
Arrange the tax equity as well.
We have lots of.
Corporate relationships with tax liability, so it's an opportunity, but again its a couple years out and a whole lot of details on the regulations before we'll really know what's there.
Okay, great, maybe if I could sneak one more in you highlighted some of the new sustainable infrastructure investments.
They do have a sort of shorter tenor versus.
The portfolio average and.
Maybe you could talk a little bit about.
The expected trends there.
With some of these newer asset classes I guess it makes sense to have relatively shorter tenors early on but.
Are some of these asset classes and your view maturing.
Where we get long term off takes and you can kind of pair up the tenor of your investment to match those long term ppas.
Let me answer the tenor question with the cash flow.
Cash flow is.
More front end loaded, which when I talk about tenant I'm talking about the weighted average life.
Which shortens the weighted average life, but these are these are not like.
36 months transactions. These are.
Approximately 10 years or even longer but with a front end loaded cash flow.
We certainly see ETB, yes, sorry go ahead.
Yes, yes.
The tenure is comparable to.
Some of your <unk>.
Longer dated investments, but the cash flows are more front weighted.
Correct Okay.
Okay.
Alright, I think Thats a helpful clarification. Thanks, so much.
If you find that your question has been answered you may remove yourself from the queue by pressing star one on your telephone keypad, we will take our next question from Chris <unk> with B Riley the floor is yours.
Hey, guys. Thanks for taking my question here.
Maybe just on the pipeline increase.
$2 $4 5 billion.
Any color on.
How are you.
<unk> the weighting of that timeline over the next 12 months.
It's been a challenge traditionally.
To predict on a quarter to quarter basis, but I'm curious just generally if youre seeing stuff.
Yes slip into next year, given some of the incentives coming around and also the volatility we've had great. So.
So just kind of curious how your customers are thinking about timelines. When there is kind of interest rate uncertainty that might be kind of bumping up the returns you guys would be.
Looking to get on different projects.
Okay.
Well I think we've talked about grid connected solar being.
Dominant.
American Clean Power Association reported yesterday or today that.
The panel shortages still plagued the industry and that's true.
We think our pipeline factors in the delays with the best information.
Available to us and.
Unfortunately, Chris.
Our ability to predict that mix of our pipeline is pretty limited.
It's hard for us to detect a pattern of.
Which transactions will mature.
On any reliable timeline.
Again, Thats why we like to have a pipeline that is multiples of what we're trying to invest annually.
Okay got.
Got it.
Makes sense and just historically, if you go back and kind of see how you guys matched up.
The 12 month pipeline. Unlike a go forward basis, it's almost always above 50%.
If you go back to at least like 2019 or so.
Is that kind of a good.
We should be thinking about.
The success rate now that the pipeline has gotten a lot bigger or do you think it's just kind of larger.
Larger size, but maybe not.
At the same kind of success rate on a go forward basis do you have any sense there.
I think theres two answers to that question.
One is a larger pipeline allows us to be a bit more selective on.
Where we invest not every.
Client adjust to higher capital costs.
And precisely the same way and timing.
And there is no question. The market is is working through higher cost throughout all supply chains, including that for capital.
The flip side is.
We generally have programmatic clients, who we expect to get our fair share of the business.
50% is not a bad estimate we certainly are.
Are telling.
The market is growing.
We expect to grow but it.
It's.
It would be lovely to have it be the.
Stay at the 50% a lot of moving parts. However in this industry right now as you well know.
Okay.
And just last one you guys mentioned the transferability opportunities.
Potentially.
Helping you out specifically I was curious if that was just.
<unk>.
Overall market or something specifically that you think you'd be able to benefit with that.
First of all I think the.
The overall provision will be a healthy one for the industry. It shouldn't if structured correctly should introduce more competition and tax equity, which.
Everybody should rejoice yet.
Yes.
I think the transferability provision might be more useful to smaller.
Clients with smaller projects, who have typically had more challenging time getting.
The big tax equity suppliers to pay attention to them. So thats one of the.
The more obvious.
Opportunities.
Yeah.
But I don't know any of our clients choice at the prospect of negotiating.
On tax equity so to the extent you can.
Provide another solution, we will be glad to step in there and be competitive.
Makes sense.
Thanks, guys.
Thanks Kurt.
We'll take our next question from Ben <unk> with Baird. Please go ahead.
Hey, guys.
Good evening. Thank you.
So.
Just what the pipeline how should we think about the yield of the portfolio were expected I.
I think Jeff.
So it would be.
You kind of talked about this pipeline.
Or opportunities but.
Is there going to be.
Big change.
I have a follow up.
I mean, if it's a $4 billion pipeline and let's say, we had a $1 billion in a year.
At.
Higher rates, but not we're not.
Doubling our yield thats for sure.
And Jeff I'll talk about this this is kind of move.
Relatively slowly and proportionate to the investments as well as the change in liabilities.
It's not going to be.
Radical uptick in yields.
And it's just.
Yes, sorry, if I missed this path of $4 billion at seven four.
And the amount, we add each quarter and each year that will be.
As we.
<unk>.
Paired remarks that will be.
Slow moving uptick.
Expect anything big overnight.
And you highlighted the <unk>.
Z deal.
No those were booked in the quarter, but spoke to our $1 billion.
So the bulk of what you guys did.
So we expect a bigger chunk actually but let me let me let me correct that.
<unk> transaction was in Q4, we talked about it on this call because of the <unk> press release.
It came out.
Ago or so.
So it's not in the Q3 number.
So so so my question was.
We do a bigger.
Chuck your yields are.
We're still trying to.
Focus on quality mid teen.
Fuel cells.
Yes.
<unk> has fundamentally changed in the way we are investing.
We'll have some larger investments.
I think there are three.
Assets in the <unk> portfolio. So we would consider those three separate projects.
But no nothing has changed that says we're going to be writing.
Single project checks and the.
Multi hundred dollar range.
Last question.
Debt financing.
Get credit for.
A reduction you talked about maybe.
There was other.
How is that process.
Yes.
Okay.
Okay.
Yes.
A reduction.
Sure.
Sure.
Okay.
Well this is a category to answer the second part of the question.
Sustainably sustainability linked.
So a lot of the banks now.
In order to provide incentive to address climate change will lower the rate based on thresholds that they established for that particular client in our case, we already have metric carbon count. So if we maintain carbon count.
A certain level, we do get a reduction in the interest rate on the loan.
So the first part of the question. It comes out of just ongoing dialogue, we have with our bank partners.
Great relationship with a number of banks as evidenced by our revolver in this transaction.
And talking about various funding alternatives.
We mutually arrives at the notion.
Syndicated term loan a in this particular.
Capital markets environment being an optimal solution for US right now so it was it was a joint dialogue it wasn't necessarily one party coming to the other.
Thank you.
As a reminder, next I would like to ask a question you May press star one to join the queue. If you find that your question has been asked you May press star one to remove yourself from the queue. We will take our next question from Julien Dumoulin Smith with Bank of America. Please go ahead.
Your line is now open.
Julian you might check your mute button working real hard time hearing you.
Now we'll move on to our next question from Jeff Osborne with Cowen <unk> Company. Please go ahead.
Yes, good evening guys. A couple questions on my end I was curious with the changes that the IRA and given how typically in particular in grid scale.
<unk> come in late to the equation are you seeing any projects being delayed as people await guidance from treasury or possibly moving from ITC to PTC.
Okay.
First as Jeff first hi.
I would say every one of our.
Lead list.
The projects on our lead list gets delayed it.
Some point in its lifecycle so.
The honest answer is yes, everything gets delayed I wouldnt say that theres anything.
Any pattern in the delays right now that would be related to.
The IRA I think there was a lot of.
Consternation over whether there would be an IRR and a lot of.
Analysts had to do infinite runs on ITC versus PTC, the clarity that the IRA provides us I think.
<unk>.
Break that logjam. So now we're seeing some projects go forward with the clarity of tax policy.
I think the.
Any delays are going to be.
Transferability and things like that.
There is no treasury regulations to implement.
Got it that's helpful and then I want to make sure I understand what's going on here right you mentioned $620 million of previously closed.
<unk> is sort of locked and loaded in the pipeline and that's one of the rationales for the funding.
And as all of that in calendar 'twenty three so if we were to assume year to do roughly one and a quarter to $1 5 billion or you're about halfway through maybe at the low end of that range. If youre in that typical funded volume commitment range I'm, just trying to think about visibility into 'twenty three at this point.
So as a reminder.
The closed transactions.
And the unfunded amounts related to them from a reporting perspective, when we say transactions closed like this quarter, we said $2 73.
That doesn't mean, that's what's funded and this is what's remaining to be funded from transactions, we've already announced.
Not all of it will be in 'twenty, three probably some of it.
We will be in 'twenty, two but as Jeff said that's always.
Okay.
Subject to change anyway, it's very hard to necessarily identify when things are going to close but some of it maybe in 'twenty two.
But I wouldn't make that incrementally.
Related to the amount of the pipeline that we expect to close in earlier questions that we'd answered. This is completely separate from that these transactions have already closed.
Got it and then if I could sneak one more in on the newer areas great to see the Boston the R&D market something we've been looking for for a while from you folks.
The cash flow dynamics.
I wanted to understand.
Two things one is what the yield of those types of efforts are.
And then B would be is there any type of.
Accelerated risk or elevated risk.
Relative to typical PPA structures for example in the bus space.
There are several companies out there that essentially are arbitraging energy.
Marvy degree vehicle to grid.
In particular over the summer months as well as during the day when school buses aren't moving and so are you a bit more exposed to say merchant.
<unk> prices are someone's software platform exercising those efforts I'm not that familiar with zoom have you made the investment with so if you could just.
Highlight what potential risks are with some of these newer areas would be helpful.
Sure Mike a couple of points.
As you know we haven't been the first movers and RMG or.
Fleet.
Modernization and Thats intentional we'd like to.
Like to go slow and then when we do get and we'd like to be senior.
While we learn how the assets perform.
The.
And we are so.
I think it's fair to say we're not.
It's still not the sportiest.
The kind of capital around and.
Intentionally trying to not.
Take on risks, we probably don't understand in terms of pricing, we would rather not talk about individual transaction pricing, but the MRO scope.
Press release does include pricing.
And we like.
Zoom, we have not not disclosed.
Got it that's helpful. Appreciate it Jeff.
Alright.
We will take our next question from Julien Dumoulin Smith with Bank of America. Your line is now open.
Brown to always works. Thanks, guys I appreciate it listen I wanted to just ask a first off going back a little bit to what we've talked about before I wanted to hear you a little bit on the timing right. I mean, we talk about the spread at time.
Obviously, you guys hit that squarely in the remarks can you talk about sort of how you think about the sort of the step up in rates and how that filters into your financing costs relative to how that sort of transposed itself in asset returns sort of in an incremental way not across the portfolio can you talk to that a little bit on.
<unk> and across the next couple of quarters and what we should be seeing is one going to outpace the other just given the large gyrations.
Across both.
So julien characterize them, both as moving slowly as we move through the next few quarters again underlying our portfolio yield and underlying our cost of funds.
Is a large portfolio in quite a bit of that so as we incrementally close transactions and issue new debt, it's not going to have an overly dramatic impacts on either of those numbers. This will take time and so as we move through the next few quarters I would expect very slow upward movements in both of those figures.
Yes.
Maybe just to clarify a little bit like how much of an uptick are you seeing in sort of the incremental assets coming in here. Obviously the cost of debt is a little bit more transparent, but how quickly is the market responded on asset returns. It sounds like it's been pretty dramatic in terms of asset returns as well.
Implying that right.
Again, obviously incremental on both sides.
I wanted to say dramatically.
Julien I wouldn't say dramatic we might want it to be dramatic but it.
Sometimes the pro forma is are baked.
And you push where you can and get some some more pricing.
I think the more constructive set of conversations we're having are on the projects that have not been fully priced and baked and thats, where we are having.
Not everybody gets the memo at the same day on on what happened in the market and.
These aren't the easiest easiest of discussions.
But we are definitely.
Expressing the need.
And I think our clients are hearing the need.
For increased pricing.
It won't be.
As Jeff said, something thats going to tick up the yields by 100 basis points.
On the overall portfolio and a few quarters. So it's just mathematically not not in the cards.
Yes, no clearly across the portfolio that will take some time excellent.
And then can you talk a little bit about what the IRA afford in terms of new asset classes, and then I'm just curious as the dust settles here you guys have clearly been looking at a lot.
Wide array you guys are clearly looking past tense a wider array of and many other diversified renewable companies out there what are you seeing to get into today, right as being attractive or sort of niche and.
<unk> opportunity.
Coming out of this right given the array outside of just traditional wind and solar.
Our IRI.
So <unk>.
LNG is a good example of a market that's been around Nextera had a great announcement, a number of other great companies.
Or in this.
Dl CFS.
Credits, while not a part of the <unk> project necessarily because they were.
Almost completely landfill gas.
Okay.
Does.
Afford us an opportunity to go deeper into the RMG market.
The ITC on.
Storage is one more.
Interested in.
And that it makes standalone storage projects.
More viable I don't think we are on the cusp of closing any standalone storage projects, yet, but those would be the two areas that I would highlight.
Yeah.
Excellent. Thank you guys for the time.
Thank you Sam.
Thanks Julie.
There are no further questions at this time ladies.
Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may now disconnect your lines and have a wonderful day.