Q2 2023 Hannon Armstrong Sustainable Infrastructure Capital Inc Earnings Call

Greetings and welcome to <unk> second quarter earnings Conference call and webcast. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone.

Pat as a reminder, this conference is being recorded its now my pleasure to introduce your host Nighthawk at them Senior director of Investor Relations and corporate finance.

Thank you operator, good afternoon, everyone and welcome earlier. This afternoon chassis distributed a press release detailing our second quarter of 2020 to be resolved a copy of which is available on our website. This conference call is being webcast live on Investor Relations Web page, where a replay will be available later today.

One of the comments made on this call are forward looking statements, which are subject to risks and uncertainties described in 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 discussion also includes some non-GAAP financial measures.

So the Asian of GAAP to non-GAAP financial measures is available in our earnings release and slide presentation.

Joining me on today's call are Jeff Lipson.

The company's president and CEO , Mark <unk>, CFO , and Susan Nicky, our Chief Fine Officer.

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

Uh Huh and good afternoon, everyone.

Why 2023 is likely to be recognized the hottest month of history to date.

In 2023 is trending to be the hottest year on record.

Fortunately climate risks continue to escalate these.

These trends also highlight the enormous amount of projects and capital that would be required to mitigate these risks.

In this context as he continues to actively engage with our clients providing capital industry expertise and advocacy to address these growing challenges.

Our business remains uniquely positioned to invest in the increasing number of projects being developed with a climate positive.

As evidence of these trends and a growing opportunity set.

Please to announce that our investment volume for the first half of the year.

Highest ever at $815 million, including 426 billion for the second quarter.

This is paired with our highest investment Neil Chapman over the same period with a weighted average yield of eight 5% for balance sheet investments.

This combination of larger volumes and higher yield provides significant momentum for the business for future earnings growth.

In addition, our portfolio yield has increased seven 5% to seven 7%.

We also closed on a successful capital raise any long term equity growth capital that provides the foundation for another $1 billion of accretive balance sheet investing roughly.

Our roughly $2 billion of total investments.

So it includes securitized investments.

And we Upsized, our bank revolver provided providing enhanced financial flexibility.

The second quarter, we announced the shred it all EPS of <unk> 53.

And GAAP EPS of 14.

We have declared a quarterly dividend of $39.05 per share and are affirming our earnings and dividend guidance.

In our Investor day in March we disclose we were performing a thorough analysis of our tax and corporate structure.

As a result of that as a result of this process, we have determined that the growth opportunity in renewable fuels another non reclassifying investments.

Best be obtained outside of a REIT structure.

Therefore, we have preliminarily concluded our optimal structure going forward.

Discontinue electing REIT status beginning in 2024.

This change in tax election will not impact our dividend policy, nor our strategy.

Now I'll make a few additional comments on this matter towards the end of our prepared remarks.

Moving to slide four we are very excited about our investment pipeline is greater than $5 billion.

The pipeline has grown recently due to both growth in our business development efforts and our investment team as well as increased project volumes from our clients.

Notably the yield on the pipeline transactions targeted for the balance sheet.

Consistent with the higher yields on newly closed transactions in the first half that I discussed earlier.

The pipeline.

Pipeline also remains extremely diverse with no asset class comprising an outsized portion of the chart.

Our STM business has grown from 12% of the pipeline in Q1 to 15% in Q2, as we continue to see strong opportunities in schools and transport.

Yeah.

Our behind the meter business has a large pipeline of attractive opportunities.

Community solar energy efficiency, and BSI solar all remain active asset classes.

And our grid connected business is experiencing robust growth.

I R. A is triggered in an increasing volume of development.

And recently, we have also added several standalone storage transactions through our pipe.

Yeah.

In summary, this diverse pipeline provide substantial optimism regarding our ability to continue to grow our business and continued confidence in our business model.

Turning to page five we provide additional detail on a record $815 million of close transactions year to date.

That's always diversity remains a strength of the business.

Displayed on the left the transactions are all three of our target markets with six different asset classes represented.

On the right. We note five transactions that had been previously disclose that as a reminder of the types of projects and clients that comprise our portfolio.

Highlighting one transaction our credit facility with great point.

Which has been established to finance a portfolio of commercial energy efficiency retrofits and has a carbon count of five point too.

Representing a very significant emissions.

A reminder, that energy efficiency is often the most impactful in an economic way to address carbon emissions.

A good example of a profitable investment significant impact as we continue to execute effectively converting our pipeline into closed transactions.

Now I'd like to turn it over to Mark Pangbourne to detail our financial results.

Thank you, Jeff I'll begin by summarizing our financial performance on slide six in the second quarter, we recorded distributable earnings per share of 53.

GAAP earnings per share of <unk> 14.

Over the last year, we grew our portfolio by 26% to $4 9 billion in managed assets, 15% to $10 7 billion.

Our portfolio is driving a 12% increase in distributable net investment income compared to the same period last year.

We also recorded $39 billion of gain on sale.

And securitization income for the first half of this year and anticipate full year to be in line with prior year.

Our execution has remained consistent and any number.

Current macroeconomic environments provide some context for this consistent execution.

Queen.

2019 in 2020, one we approximately doubles our gain on sale have maintained these levels.

Well, you've also more than doubled our portfolios in 2019 and continue to see a shift where a larger portion of our earnings are anticipated to be derived from NII.

This shift is particularly important as we see a higher level of visibility into profitable growth.

Turning to slide seven.

Our portfolio yield increased from seven five to seven seven in the second quarter, we funded $290 million of investments during the quarter and recent closings at higher yields are beginning to show their impact.

As we continue to convert our pipeline and fund newer transaction at higher yields we expect portfolio yield to continue its upward trend.

On slide eight I'm pleased to update that our disciplined focus on margins is working.

While our investment yields are increasing our cost of debt has remained constant.

Year to date, we've managed our debt cost primarily through our hedging program and more efficiently managing our revolver and cash position.

During the second half of 'twenty, three we anticipate our focus to be on further debt ratings.

Although we expect some increase in the cost of debt over time due to the higher interest rate environment. We.

We see this is being offset by increasing investment yields should provide some context behind this comment.

We received investor questions on our 25 and 26 bond refinancings.

We've entered into hedges relating to the refinancing to lock in base rates around 3%.

Using our current trading levels for credit spread and the hedged base rates, we estimate that a refinancing would increase the total cost of debt from four 8% to approximately five 6%.

We have more than two years before a refinancing as required however, even a five 6% our margins on the existing portfolio are attractive and drive continued long term profitability.

To reiterate my lead in unprofitable growth, we are seeing a high level higher level visibility into continued strong margins with both investment yields increasing and that market's recovery.

Before I move on to discuss liquidity and capital I'd like to address two industry trends not on the slides, which have recently come into focus.

The first relates to future volumes in the residential solar market.

We remain highly active with our residential solar clients on new investment opportunities and continue to be bullish on the long term industry fundamentals.

Driven by the continued diversification of our business residential solar represents less than 10% of our pipe.

The second trend relates to multiple grid connected clients reporting low quarterly wind performance.

We are seeing similar data in our wind investments.

However, the impact on our business muted as we generally underwrite to a lower lifetime production forecasts and our preferred equity investment structures to mitigate downside risk.

Our current period cash collections are lower however, with our preferred equity structures. The cash we do not collect this purion will accrue at our preferred rate and be collected in the future.

Getting back to the slide on slide nine I'll cover liquidity and capital.

Starting on the top left our liquidity remains strong with a total of over $790 billion of cash and Undrawn revolver capacity. We're pleased to highlight the successful upsized, our unsecured revolver by $240 million to a total of $840 million.

An increase of our bank group to 15 banks I cannot emphasize more what a sign of support and confidence. This shows from our banking relationships, especially in the backdrop of a tight lending environment and the aftermath of STB.

The fact that our credit spread remains below two is evidence of the high quality assets we originate.

Confidence that our lenders have in this company.

Additionally, Fitch has recently placed are double b plus rating on our positive outlook, which is an encouraging development as we continue to target a second investment grade rating.

I'll take a moment to speak about the recent 345 million follow on equity offering in near term capital plan.

The proceeds from the raise are foundational for the next $2 billion of accretive investments such as Jeff identified earlier.

Notably this positions us well to meet our 2020 for guidance. It also reduces our leverage enabling us to shift focus to that capital.

We will utilize our diversified funding platform for additional issuances of convertible bonds secured debt and corporate unsecured bonds. We have been active in all three markets. We are tracking performance and again with the equity raise behind us we're moving on to debt.

We're also continuing to execute on our securitization activities and pursuits indications both of which are capital light.

To conclude we are executing on our key 2023 focus profitable growth.

We will continue to engage with our investor community to articulate the value of the business and opportunity. We are excited to capture with our unique platform.

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

Thanks Mark.

Turning to slide 10, I'll give you an update on our environmental social and governance efforts, which are embedded into our differentiated business model.

We made good progress in quantifying our scope III category 15 portfolio emissions for 2022, which certain investors have asked about with the goal of setting a scope III science based target later this year.

I'm also pleased to report that the hefty Foundation continues to make an impact at the intersection of climate change and social Justice.

And related to governance, a majority of our independent directors are women or from underrepresented communities.

Turning to page 11, a few more thoughts on our corporate structure transition.

Reiterating that as a C corp, we will be better positioned to capitalize on new opportunities, particularly in our F. T N business segment.

And that will again clarify that our change in corporate structure will have no impact on our investment strategy or dividend policy.

Quite simply the company will continue to operate in an identical fashion in virtually all aspects of our business.

We also expect the shareholder rotation will be minimal as our shares are held by very few REIT funds.

As it relates to tax efficiency.

We utilized existing Nols as well as newly generated Nols depreciation and tax credits all from our traditional equity investments in order to minimize our tax obligations going forward.

We expect to pay de Minimis cash taxes for at least the next five years.

And expect to deploy an effective tax planning strategy subsequent meters to maintain efficiency.

In summary, the business will have a higher growth trajectory unchanged dividend profile and continued tax efficiency.

Please note we have included in F. Q regarding the tax election on page 14 in the appendix.

Let's wrap up on slide 12.

Over the last several months, we've been responsive to investor and analyst advice to simplify our story.

On Investor Day in March we clarified we have a simple business model focused on climate clients and assets.

Today, we are further simplifying by communicating a simpler corporate structure in 2024.

We pared the simplified model with demonstrated success as we continue to execute quarter after quarter, achieving our profitability goals and establishing a path for continued success, despite higher interest rates and other real or perceived headwinds.

Our unique business offers investors access to the energy transition with both growth and income.

We are very proud of our success in the first half of 'twenty 23, and have positioned the business for additional prosperity.

These achievements are the results of a dedicated and talented team unhappy.

I had the privilege of working with every day.

I. Thank all of my teammates as well as our shareholders for their support of our business.

That concludes our prepared remarks, operator, please open the line for questions.

Thank you we will now be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is another question queue. You May press Star two if you would like to remove your question from the queue.

For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.

Your first question comes from Noah Kaye with Oppenheimer. Please go ahead.

Good afternoon, thanks for taking the questions.

Let's start with the REIT announcement.

Clearly you put a lot of effort and thought into this and.

Announcing tests today, but you know just indicating this is preliminary or I guess subject to board approval, maybe just walk us through expected process and timing.

For making this form all getting it formally approved by the board.

Thanks, Don and I appreciate you calling in.

There are few compliance and governance governance items involved and when companies are de reading, it's best to seek board approval and the Finalization in the fourth quarter for those governance and compliance reasons and so that will be our plan we will.

Targeting a fourth quarter board approval and so for now we're calling this a preliminary decision, but I think investors should.

It should certainly expect us to start to move in this direction for 2024.

Okay. That's a formal approval you you one would presume you.

Consulted already with the board on this.

Yes, we have informed the board we just haven't asked for their approval that is correct.

Okay. The second part of this have you had any discussions.

With the agencies that provide classification systems are about me.

Moving out of the REIT category or do you plan to I guess, what industry peer group.

Would you ultimately expect to be placed and if youre not classified as a REIT.

So we have looked at that issue I believe the way to think about it is C. S. I C code you select when you file your financial statements and the GIC code is primarily determined by MSCI and S&P.

And so you.

You don't have control over your GIC code those organizations generally selected for you.

But we are.

To advocate for a.

Certain code to the extent you can do so.

Okay, and the C code that you would elect would be.

That's to be determined.

We'll find out okay, [laughter] alright understood.

Okay.

I had to ask I guess, just the last question for me you know E D.

Appreciate it mark the the comments around.

Timing of cash collections on on those wind investments and it.

It seems like in general you know credit loss provisions tend to continue.

Continue to be de Minimis, but.

You know the the the overarching question. We have is in your cash sources and uses you know you've shown healthy coverage of the dividend a fiscal 'twenty two and then trailing 12 months.

Any concern that you.

As we move throughout the year, we may be getting tighter on that do.

Do you expect to have continued healthy coverage in terms of cash collections.

Thanks Noah.

Yes, there's no concern we have obviously identified.

Our quarter dynamic that I think everyone has seen show up.

Throughout the industry, but at this time I would not point to any long term trends.

Okay I'll turn it over.

Thank you.

Next question, Chris <unk> with B Riley Securities. Please go ahead.

Hey, Thanks for taking my questions guys, maybe just to follow up on the.

The wins in.

<unk>.

You kind of break that out versus kind of the general lumpiness.

All of the cash collection.

And kind of cash flows from operation I, just wanted to get a sense what the magnitude there specifically on the wind side.

And then if you had any sense of the timing of that.

Hi, Jack.

It would be helpful.

Yes.

The best place to look, which I'll point, you to I think will show up actually in.

Q, which will detail the key.

Cash collected from our <unk> investments.

As I think you know.

Our primarily the grid connected and grid connected wind investments so.

So that I think can help help start.

To quantify it for you.

In terms of the catch up.

I think that that will largely depend on what next quarters performances, but pursue assuming that.

When it bounces back and starts to perform her expectations. We would not anticipate that this is a long wait period for us.

Okay.

Asking you to predict the wind.

So maybe just on the pipeline mix dynamics.

Uptick in behind the meter I'm curious if that reflects additional partners customers.

Specific subsectors, there getting more exciting you could call out that would be great.

There are some new clients in there Chris.

You know the behind the meter side is mostly community solar energy efficiency and rescue solar.

And there's a lot in the pipeline from longstanding clients in those asset classes, but there are several transactions.

Also from some new clients as well as we expand or extend our business.

Okay. That's helpful I'll hop in the queue. Thanks Scott.

Next question Taylor with Baird. Please go ahead.

Hi.

Good evening and thanks for taking.

Quick question.

This is the REIT structure does it change anything.

Yep.

Do you think about.

Either the distribution rate for your dividend or the capital structure I know you guys walked out with a good a good two portfolio leverage ratio.

Yeah.

No Ben it really doesn't I think the leverage profile of less than two and a half it will be unchanged as a result of the tax election.

And I think the trajectory of dividends will be unchanged as well on Investor day, Mark for instance alluded to by 2030, the payout ratio being in that 50% to 60% range I think that's a reasonable way to think about the business with for our retained capital over time that the dividend will continue to grow but will grow at a <unk>.

Lower base than earnings and so the roughly 70%.

Payout ratio, we had this year, but well gratulate decline accordingly, so I think that's the way to think about the business.

Thank you as we see your your portfolio yield pick up.

You'll often we think that you might be taking on more risks could you just talk to that a little bit.

What if anything has changed I know you gave the examples there, but maybe just how you guys see to look at deferred but that's the truth.

Thank you.

Yeah. Good question, Ben and the answer is no we're not taking on a different risk profile in order to obtain the higher yield the higher yield is a function of higher base rates. So in many of the investments we've made for many years.

At the same risk profile, we're now achieving a higher yield naturally with the base rates higher and with more revenue in the projects.

Because of some of the dynamics there and then in some of the new asset classes, particularly in F. T N.

We're also achieving a higher yield because they're a bit less mature than some of our traditional asset classes.

From a risk profile perspective, they are really very very similar on Investor day, we talked about the six attributes that virtually all of our investments have and as we have expanded into F. T M.

We've maintained those six attributes as our risk profile.

<unk> and the way, we think about the business. So we have not taken on more risk in order to achieve this higher yield.

Thank you.

Uh huh.

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

Uh-huh.

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Okay.

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