Q4 2022 Hannon Armstrong Sustainable Infrastructure Capital Inc Earnings Call

Greetings and welcome to the Hannon Armstrong fourth quarter, and full year earnings conference call and webcast.

At this time, all participants are in listen only mode.

Brief question and answer session will follow the formal presentation.

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This conference is being recorded.

It's now my pleasure to introduce your host they have got them senior director of Investor Relations and corporate finance.

Thank you operator, good afternoon, everyone and welcome earlier this afternoon Hannon Armstrong distributed a press release detailing our fourth quarter and full year 2022 results a copy of which is available on our website. This conference call is being webcast live on our Investor Relations page of our what that site, where a replay will be available later today.

Some of the comments made in this call are forward looking statements, which 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 stated today's discussions also include some non-GAAP financial measures a reconciliation of GAAP to non-GAAP 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 , Jeff Lipson, our CFO and C O O and Mark thing Burns Executive Vice President and co Chief investment Officer.

Before turning the call over to Jeff I'd like to announce that we are hosting an investor day on March 21st during which we will discuss the company in more detail and a lot of investors and analysts to meet more members of our leadership team more details on the event will be forthcoming.

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

Thank you, Dave and good afternoon, everyone I'm pleased to report the company continues to execute in 2022 with distributable earnings of $2 <unk> per share up 11% year over year, we reaffirm our guidance for annual growth in distributable EPS of 10% to 13% through 2024 and five to eight.

Percent annual growth in our dividend for the same period.

Board has declared a quarterly dividend of <unk> 39, and half cents per share an increase of five 3%.

Please note that growing earnings faster than the dividend is intentional in order to provide more retained capital for the growth of investments we are anticipating.

As signaled in prior calls we executed on strong volume in the fourth quarter with over $880 million in transactions, bringing total volume 2022 to $1 $8 billion.

The average yield for newly closed transactions on balance sheet with more than 8% last quarter. A notable increase in the yield on new investments compared to average portfolio yield of seven 5%.

These new transactions will fund over the course of 2023.

Finally, we announced our leadership transition, which will separate the role of chairman and CEO and Jeff Lipson will become president and CEO Mark first Jeff arrived four years ago was a former bank CEO and it's simply a remarkable job building out our corporate and asset finance capability as well as running operations for the last two.

Two years.

Gordon I have the highest conviction in his leadership of the company.

Mark Pangbourne will be promoted to CFO from his current role as co Chief investment Officer, Mark has been with the company since just after the IPO in 2013 and has been instrumental in building out the company's investment portfolio client base.

I congratulate Jeff and Mark on their promotions and I'm highly confident we have the right people to lead the company.

In the nearly 10 years since the IPO I'm pleased to report that we have outperformed the S&P 500 by almost one and a half times on annualized total shareholder return returning more than 18% per year.

We did this while investing on the right side of the climate change line setting the standard for measuring impact from climate solutions investing.

Most importantly, we've built deep and highly skilled team mission driven professional to continue to produce superior risk adjusted returns, while making a measurable impact on carbon emissions.

I'm excited to focus on my role as chairman and confident of Jeff Mark and the rest of the leadership team's ability to execute our growth that's overwhelmingly supportive public policy backdrop.

Let's talk about that policy backdrop on slide four.

The inflation reduction positively affect our business as evidenced by our clients increasing their pipeline due to the long term ITC PTC policy certainty and tax credits for renewable fuels.

Tax credits battery storage has made standalone projects conducive for investment and example policy accelerating new investable asset classes for us.

The transferability of tax credits will expand the tax capacity available for renewable projects as well as provide an opportunity for us to participate in those transactions.

And finally, an infrastructure bill and chipset provide constructive policy backdrop for new transmission and onshoring manufacturing.

My 40, plus year career I never imagined in this level.

Policy support for the energy transition. This is unmitigated is for housing.

That I will turn it over to Jeff Jeff L.

Thanks, Jeff.

Now that we have moved forward with our leadership transition I would like to take a moment and recognize the enormous achievements that have occurred under Jeff's tenure.

Jeff is overseeing the growth of this company from a small enterprise into a significant industry trailblazer and leader in climate solutions.

The investment thesis that he developed was well ahead of its time, but has proven to be a superior and durable strategic focus.

Jeff has built a talented team which will carry on his legacy.

Personally I am honored to be selected as the next CEO and look forward to continuing to work closely with Jeff as executive Chairman.

I will note, we are not announcing a strategic change as part of the succession plans.

Our current strategy is working and we will continue to grow the business with a similar approach adapting the strategy as necessary.

Before discussing our results I'd like to recognize our incoming CFO Mark Penguin.

Mark has been an integral part of our investment team for many years and I look forward to continuing to work with him in his new role.

Mark will discuss our fourth quarter investment volume Mark Thank.

Thank you, Jeff and thank you Jeff It is a privilege to support you both and our growth to date and on the capitalization of the opportunity ahead.

I have spent the past nine years with the company building deep relationships with the best clients in the business I look forward to building similar relationships with our investors and analysts now on slide five we are pleased to report a great quarter with approximately $883 million of closed transactions across our markets a significant majority of these investor.

<unk> will remain on balance sheet with an average yield above 8% highlighting the upward trend in yields discussed on previous calls.

The diversity of clients and asset classes as a noteworthy feature of our business.

In the fourth quarter, we closed 18 transactions with multiple clients.

<unk> programmatic clients to with whom we've expanded existing relationships into new asset classes and one new clients.

These clients will continue to drive our business forward in the years to come.

I'd also like to highlight the carbon count on one of our transactions. We closed last quarter. There was an equity investment with a yes and a one three gigawatt portfolio of 18 projects across six states and.

And we calculate a carbon count of 1.1 significantly higher than the portfolio average reported carbon counterpoint for with the difference being driven by the specific location of the underlying assets.

As a reminder, carbon count is heavily influenced by the energy mix of the applicable grid. These assets are displacing a larger amount of carbon emissions per dollar invested.

I will conclude by restating that fourth quarter volume represents a strong diversity of clients markets and asset classes. They provide long term recurring or recurring income with an upward trend on yield.

And play a key role in the energy transition with that I will turn it back to Jeff though.

Thank you Mark.

Slide six displays our volume of $1 8 billion in 2022, consistent with recent history.

One of the key reasons that we have successfully grown our portfolio is that our strategy incorporates multiple asset classes.

If we were reliant on a single asset class, our gross would unlikely be as consistent.

2020, and grid connected wins was a primary driver of volume in 2021 grid connected solar in public sector transactions led the volume growth.

And in 2022 volume was spread evenly across grid connected solar <unk> solar and public sector.

And we also made strong progress in sustainable infrastructure.

This diversity as a result of a significant number of clients that we work closely with many of them involved in multiple asset classes as well as our ability to pivot towards opportunity opportunities quickly.

Our business is becoming even more diverse as recent transactions and renewable natural gas and transportation indicate.

Likewise, our 12 month pipeline of greater than four and a half billion is also well balanced as our behind the meter pipeline is benefiting from increasing utility rates are grid connected pipeline is primarily solar opportunities and our sustainable infrastructure pipeline is mostly clean fuels transportation and nature based solutions.

It's balanced profile allows investors to participate across the entire clean energy transition market.

Turning to slide seven we show our $4 $3 billion balance sheet portfolio as of year end 2022, which represents growth of 19% over the prior year.

The average yield of our investments was seven 5% up slightly from the third quarter.

The projects underlying these investments represent over 12 Gigawatts of clean energy. In addition to the non power related investments in the sustainable infrastructure market.

Our investments are non cyclical resilient across economic cycles and represent real assets with long term income generation.

On the right side of the page, we detail our portfolio reconciliation.

The portfolio increased nearly 10% for the quarter as we funded $458 million of investments.

Funding expectations of previously closed transactions is now over $750 million, including the recently announced Aes grid connected investment, which we expense, which we expect to fund in the first quarter.

Summarizing our 2022 results on slide eight.

We reported distributable EPS of $2.08 and 11% growth rate versus 'twenty, 'twenty, one and consistent with our guidance range the.

The growth is primarily driven by distributable net investment income, which grew by 34% to $180 million in 2022, reflecting a larger portfolio and strong margins.

We had another outstanding year securitizing assets, resulting in gain on sale and fees of 79 million in 2022 very consistent with 2021.

These fees are primarily driven by asset mix and unaffected by interest rate changes or the ABS market.

We expect our gain on sale and fees to remain roughly in the same range for 2023 and over time to represent a lower percentage of revenue as we continue to grow our net investment income.

I will note our GAAP EPS was <unk> 47 for 2022, a lower result in 2021.

This was substantially driven by mark to market losses on power price swaps at the project level.

Energy prices rose the project's value was increased which does not show up in the GAAP numbers, but the swaps incurred losses, which does result in noncash unrealized losses.

As we remind investors consistently this project level HBV accounting is not a good indicator of our period economics, which is better represented by our non-GAAP measures.

Slide nine summarizes the long term consistent success of the business utilizing a variety of metrics.

Our distributable EPS has experienced consistent growth. Despite all the challenges of the last few years, including the pandemic supply chain and interest rates, achieving an 11% compound average growth rate for the five years ending 2022.

Likewise, our distributable NII has experienced an average growth rate of 28% over the last five years as we've continued to build the balance sheet with accretive investments.

Our managed assets and portfolio as well as our investment margins have also experienced healthy growth over the last five years.

The multi year demonstrated success of our business as represented on this slide represents a strong foundation on which to build.

Which brings us to slide 10, reflecting that we continue to affirm our 10% to 13% EPS guidance, despite the macroeconomic challenges and market volatility.

We expect to achieve our 2024 EPS guidance growing approximately ratably over the next two years.

Turning to slide 11, we discuss our funding platform.

Our liquidity as of year end 2022 stands at over $870 million, even after making all of the aforementioned accretive investments in the fourth quarter.

In the upper right. We know we have been successful raising capital from diverse sources over the last two years.

In 2022, we raised approximately $1 5 billion from our term loan a our unsecured revolver commercial paper convertible debt and equity, whereas in 2020, one we focus more permanently on unsecured bonds.

In 2023, we expect to continue to raise capital to support our growth utilizing diverse funding sources, including securitization incremental secured convertible unsecured debt and revolver utilization.

Plus equity issuance to maintain our leverage.

We have no material refinancing risk until 2026, and our leverage and fixed rate debt percentage remained consistent with historical ranges.

I would also note we included our cash flow reconciliation in the appendix consistent with the disclosure we began providing in the second quarter.

In conclusion, our track record of earnings growth has been outstanding and we are well positioned for further growth.

Our diverse funding platform continues to provide ongoing sources of capital and liquidity.

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

Thanks, Jeff and congratulations a company is in great hands under your leadership.

Turning to slide 12, we note a number of ESG accomplishments as well as our periodic carbon and water count disclosures.

Last quarter in collaboration with other leading corporate with Cofounded. The emissions first partnership to improved corporate and Investor emissions accounting are moving beyond megawatt hour matching and focusing more on quantified emissions impact we declared a social dividend to the Hana has the foundation to support climate Justice initiatives.

And some of those projects in 2022 include.

Energy efficiency projects, we're non-profit nonprofits.

Billions hubs for disadvantaged communities scholarships and fellowships for climate focused young professionals.

Finally, we have enhanced our governance protocol with the announced executive succession that would separate the roles of chairman and CEO .

We will conclude on slide 13.

The business outlook is the brightest it has ever been in the company's history, the energy transition to a lower carbon world is accelerating with supportive public policy in the IRA the bipartisan infrastructure Bill on the chips Act.

Because of this our clients aspirations are expanding.

We believe our long participation this industry positions us well for continued programmatic investment with our top tier client base we.

We have a proven strategy executed by our mission driven team announced leadership succession sets up the company to prosper in its next chapter.

I'll close by thanking our clients who are doing the hard work engineering. This energy transition our investors and analysts who have appreciated the opportunity for this business My fellow directors, who have gotta make through this succession process and finally, the hassey team, which continues to inspire me and for whom I'm working with them day to day.

It's been an honor.

With that I'll ask the operator to open the line for questions operator.

Thank you.

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Thank you and our first question is from the line of Noah Kaye with Oppenheimer. Please proceed with your questions.

Thanks, very much for taking the questions and I guess why we'd be the first on the analysts me to congratulate you all for the leadership transitions and wishing you all the best of success.

Thanks, so much.

I guess, you know not to take any.

Our attention away from analyst day, because I'm sure you'll spend some time talking about this there, but it's just at a high level can you talk about why now was the right time for the leadership transition.

I'd love to hear each of your perspective.

Oh, Great question now what we've been doing this as a public company for 10 years.

I'll be 65 in April and there seems to be some symmetry around that but really the growth and the opportunity is such that there's a real role for me as chairman I'm working on strategy, some client issues public policy and thinking more about carbon but this is going to be a much.

Much bigger business and Jeff and Mark are the right to people too.

Ill take this on.

When I left Hannon Armstrong in 89, Mike Cannon sent me a note, saying I should have created more space for you to stay with us.

And I feel that's a true now there's so much opportunity that it's good for this organization to to evolve and grow and this is I think are the best way to do that.

And I would just add Noah.

Thinking on Investor day, one of our themes will be how deep the team we have.

And you'll get an opportunity to meet more members of the team. In addition to Mark and myself and so I think we're particularly able now to make this transition effectively.

Given all the talent, we hired and this was.

Entirely Jeff's unilateral decision of when he decided it was the right time for him. So I think it's really worked out well for everyone.

Okay appreciate that and looking forward to it and now to switch over to a very in the weeds question just around the equity method income it looks like on a non-GAAP basis, you know equity method income actually increased sequentially. It was it grew sequentially was pretty consistent with last quarter.

Can you just give us a little bit more color on you know how the market mark to market price swaps.

Impacted the GAAP losses, and just remind us what you know the underlying economics represented by the non-GAAP actually reflect.

Sure so to reiterate the non-GAAP accounting for equity method investments.

Fundamentally the IRR that we expect to achieve and earn over the life of the investments taken on a ratable basis and we do.

Adjust that.

Accruing IRR level for changes in the projects as we did in the first quarter of 2022, but other than for Incrementals.

Mental.

Changes in the projects at accruing rate tends to stay in place for a very long time, and we do believe reflects fundamentally the economics of our investment which is why the non-GAAP measure is very helpful for investors and analysts.

At the GAAP level, we're required to use HBV as you know.

And one of the items that occurs there. So we have these power price swaps down at the project levels and as I mentioned in the prepared remarks as power prices increase the project level. The project itself becomes more valuable, but theres no actual immediate accounting associated with that.

But the swaps themselves become less valuable and are more out of the money theyre doing the exact.

Hedged that they're designed to do but they on a mark to market basis are not worth less that does have immediate accounting. So you have losses at the project level that then become part of the <unk> calculation and part of the cap.

The earnings on those projects Likewise, if there were a second item to mention is.

Utility scale solar projects are put in service there tends to be an immediate one time increase through the ITC that also flows through our HBV financials and there were a lot more of those in 2021 2022 which also affects the GAAP income.

So hopefully that's Uh huh.

Helpful way to understand the difference between GAAP and non-GAAP for the equity method investments, yeah, and so just to reflect back a fundamentally these projects are more valuable now they have higher revenue associated with them because energy prices are higher and you haven't changed your IRR assumptions regardless.

That's the first that's a good thing alright.

Alright, thanks, very much I'll turn it over.

Thanks, Don.

The next question is from the line of Christopher <unk> with B Riley. Please proceed with your question.

Hey, guys. Thanks for taking my questions here and congrats on the on the new roles all around here.

Hey, Scott, maybe just yeah, maybe on the the gain on sale.

Historically that was pretty lumpy recently it it hasnt been a it's been like really steady.

And until this quarter's down I assume that's just a function of lower public sector volumes in the quarter not any change in spreads for that business and in fact, it looks like Theres a high receivables held for sale at quarter end. So I'm just kind of curious if you could talk about.

But the gain on sale.

The public sector market activity looks.

In the near near term, obviously, it's a portion of the behind the meter stuff, but I wanted to get a sense of how that particular segment.

Just looking these days.

Sure. There's there is no real trend to report there Chris I think as you know it can get lumpy by quarter and I think you've picked up on there are some things that we didn't.

You get a chance to securitize in the fourth quarter that will spill into next year. So I wouldn't read anything into that other than then from one quarter to the next.

In terms of the public sector pipeline it remains very consistent.

There are several transactions in the pipeline on the public sector side and there are several transactions not in the public sector that include investments that will also securitize. So that's where I was comfortable saying in my prepared remarks, we expect our gain on sale to be very similar again in 2023.

Okay got it it makes it makes sense and then.

I was curious you know obviously you guys have had you know significant liquidity.

<unk>.

<unk> been highlighting for several quarters.

But looking at kind of the current liquidity and taken the Aes deal closing in the first quarter that probably cuts it in half or so do you guys have like a target around liquidity that you'd have at it.

Any given point going forward just kind.

Kind of curious you know it seemed to kind of hover around where it is now are kind of trending up so I'm curious if there is.

You know if you guys are looking at that as like a metric we should continue to watch.

We do have a couple of liquidity targets internally that we've.

Agreed upon with our board, we have not disclosed them formally but they are a function of items that you might expect including availability on our revolver and near term closings that we expect in our pipeline.

And I would say, it's a very conservative measure and we tend to maintain quite a bit of liquidity.

Even going back all the way to 2020, when the pandemic hit we started to hold more liquidity.

Much more than we had previously in 2019 in previous years, and we've maintained that trends even as obviously markets have settled in a post pandemic way.

And we you know I suppose given your question, we may consider disclosing a liquidity metric, but I will confirm we do have very specific minimum liquidity targets here internally.

Okay that makes sense and maybe just my last one you called out they had a new quiet I'm curious what sector.

[noise] excuse me that was in the grid connected space.

Okay great.

That's all I had thanks, guys I'll hop in the queue.

Okay.

Our next question is from the line of Mark Strouse with Jpmorgan. Please proceed with your questions.

And thank you.

Yeah.

Relations to to all of you well deserved so.

Good to see.

Can I start with just the the comments going back to the the salt the policy support Jeff Eckel.

Okay.

Can you talk about what you're seeing in the market as far as the transaction volume that you have is in my opinion are pretty impressive.

To the extent that you are able to tell I mean, how much of that can you directly tie back to the I R array or some of these other bills that have been passed.

And maybe more specific to the I R array.

Kind of your expectations for timing, what you're hearing from some of your counterparts as far as.

Getting some some guidelines for them from treasury whatever it might be if we can see a more material uplift as we progress throughout the year.

Thanks Mark.

I think we can attribute zero in 2022 to.

The I R. A M S.

Since it only passed in 2022 and it hasn't really had an impact on our client development pipeline.

I think our.

Optimism about that impact it does come from our clients when they say, we've got a gigawatt and development and now they are saying well now it's two gigawatts now weak we see projects penciling that weren't penciling before.

And we query our clients' periodically and get updates on their view and they're just really quite.

Optimistic is it 2023 or 'twenty, 'twenty four or 2025.

We don't know I'm not sure our clients actually now.

You asked about the Treasury guidelines, some are coming out, but that's still a gating item before you can actually implement the law you have to have the the guidance and that's.

Not done yet.

But I think it's important to take a big step back and say.

With tax credit certainty for 10 years that this industry has never had.

Our clients are able to plan for with much much larger businesses.

Businesses in the U S.

And it's a as I said, an unmitigated positive for the business.

But always timing is different.

Yeah got it okay. Thank you just one quick follow up.

Just fully appreciating you know like you said how diversified your end markets are.

I'm just curious for your take on the state of the U S residential solar market. This year, just theres been some some mixed commentary.

You know from from some of the industry participants so far I'm, just curious kind of how you're thinking about that as your your outlook for this year.

I'm going to have Mark Pangbourne answer that thanks Jess.

Along the lines of just taking a step back we believe the long term fundamentals of the U S residential solar market remained very strong.

Driven both by the IRA and increasing utility rates.

Obviously, there are some short term headwinds, which have all been identified but as it relates to our business, we're seeing the increasing cost of capital.

Much smaller impact on leases and Ppas, which have been a majority of our focus to date. So.

We expect the industry will work through these.

And that our business will continue to benefit from from this focus on leases yes.

Personal loans versus long.

Makes sense okay. Thank you.

Thanks, Mark Thanks, Greg.

Thank you.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.

Okay.