HA Sustainable Infrastructure Capital, Inc. (HASI) Earnings Call Transcript & Summary

Good day, and welcome to the investor call for Hannon Armstrong hosted by Roth Capital Partners. Today's conference is being recorded. Our host today is Philip Shen. Please go ahead, sir.

Thank you, Lauren. Hi, everyone, and thanks for joining us today for our investor call with Hannon Armstrong. My name is Philip Shen, and I am a Managing Director and Senior Research Analyst covering cleantech. I've been here just about a decade now. And I'm happy to have Jeff Eckel, Chairman and CEO; and Jeff Lipson, CFO; Chad Reed, the VP of IR, with us today. So in terms of today's call, I think I'd like to structure it as follows. Both Jeffs will give us a quick overview of their backgrounds with a focus on how their past experience helps us with how they're navigating through this challenging time, and how they're really well positioned for this situation. Afterwards, I'll do about 20 to 30 minutes of formal Q&A, and we'll hit on the following 4 topics: number one, we'll explore the quality of the cash flows for each asset class and the sustainability of their dividend; two, we'll explore how they're built to weather the storm and talk through liquidity; three, we'll talk about how important their gain on sale line item is for their dividend. We believe that 90% to 100% of their dividend can be supported by their assets on balance sheet, but just want to check that off and explore that line item; and then number four, we'll get through the outlook for originations and how that has been impacted by coronavirus. And then we'll turn it over to some Q&A with the investors on the call. So I may refer or we may refer to Hannon's March '20 deck. So that might be something that you may want to bring up, specifically check out slides 2 and 22. And if you prefer to e-mail me questions to ask, I can do that and my e-mail is [email protected]. I'd prefer the questions to come from institutional investors and clients and not reporters, for example. And let me read some disclosures, and then we'll get it going. There's a little bit of background noise. So if one of the speakers can go to mute, that would be great. Lauren, any idea on that noise? Hello, Lauren, please...

I'm not hearing any background noise at the time.

Okay. Okay. Great. Sorry for that -- sorry for that. So Roth makes some market and shares of Hannon Armstrong. And as such, we buy and sell from customers on a principal basis. So with that, thanks, again, to both Jeffs for being with us today. Jeff Eckel, can we just start with a quick 1 to 2 minutes on how your background prepares you with your 4 decades of experience to navigate the situation that we're in.

Thanks, Phil. I actually have a huge smile on my face because I haven't had to think about like Ivan Boesky and all the problems in the '80s in a long time and a lot of lessons over the years. One of the more painful ones was running a business sponsored by Bechtel outside of the U.S. in the '90s and largely in India, Indonesia and Brazil. And the Thai baht fell apart, and the Indonesian rupiah fell apart, and then the real fell apart and then that business fell apart. And then, of course, '99, 2000 with the dot-com bubble, and then I was back at Hannon then. And then, of course, '08 and '09, where we were a smaller firm but remained profitable through those really dark days in '08 and '09. Every Monday in our management team meeting, we talk about interest rates and markets, and we've been talking for quarters about what's going to pop this bubble because you know it's going to happen. And certainly, none of us predicted coronavirus would do it. But the overwhelming lesson from all of those experiences is we never have enough liquidity, and you should always focus on how your assets will perform when nobody has money. Used to finance floating power plants in the Caribbean. And the ability to get largely bankrupt utilities to continue to pay was a really good lesson in managing credit and one that we've applied to virtually all of our asset classes. So the first 2 lessons are liquidity and good structure and portfolio management. In this case and with the physical harm being done from the virus, the very first lesson that, fortunately, with a good focus on our employees is intuitive to us, make sure your employees are safe. We moved very quickly on March 10 to shut the office well in advance of anybody that I was aware. And we invested heavily in our IT infrastructure for continuity of the business. We're east of Washington, D.C. so there's always worry about a terrorist attack and have to -- since we're downwind, have to imagine that you're not in your office for an extended period of time. So our team is safe. Our infrastructure is working well. And I'm going to turn it over to Jeff Lipson to detail how his experience in some of these same crises has helped us work on our liquidity and portfolio management.

Thanks, Jeff. And folks, I'm sure, can look up what the relevant experience to the current crisis that I had or at least the most relevant experience was at CapitalSource, which was a $15 billion to $20 billion that was 100% wholesale...

Jeff, I'm having a hard time hearing you. Jeff, are you here?

Can you hear me better now? Yes.

Yes.

Can you hear me? Okay. I was saying the most relevant portion of my experience to the current situation is as the treasurer of CapitalSource, a large commercial finance company that was 100% wholesale funded. And that crisis hit us very, very hard. And some differences this time around, there are some similarity [indiscernible] about particularly related to liquidity and asset quality at Hannon Armstrong are directly out of the playbook we used at CapitalSource. And I think CapitalSource came out of the '08, '09 financial crisis much, much better than similarly situated finance companies. So I think that's a good one. And we'll continue to use it to the extent it's relevant.

Okay. Great. So everybody turn to Slide 6, if you have the deck from March. In terms of your balance sheet, you guys have $2-plus billion of assets on balance sheet, average life is 14 years of your investments. And I think you fixed out 98% of your debt. So I think the focus that we have is on the quality of the cash flows by asset class. And on Slide 6, I think we'll just go rank order from the size of that pie slice down. So we'll start with resi solar, because I think that might be the biggest mix there at 30% of your overall asset base. And wanted to talk through what you expect in terms of defaults if any, how reliable do you think that cash flow outlook is and how reliable do you expect that return to be for those investments?

I'd like to just give an overarching view on this pie chart, and then let Jeff will go through it in more detail. But similar to my lessons in Latin America, you have to be able to get your collateral or shut off the savings. Or if they can't -- if failure to pay you causes them to pay more to somebody else, you're in an enviable credit position. And if you look through each of these pie slices, we have some element of structure where it's cheaper to pay us than not pay us. And we'll also obviously talk about credit quality, but that's been fundamental in our underwriting of trying to be more senior rather than junior and having some structure in these cash flows. So with that, Jeff, do you want to take resi solar?

Sure thing. So resi solar, just the level set, is our mezzanine, primarily our mezzanine investments in financing solar leases between homeowners and the providers, and it's 145,000 homeowners. That collateralized our total pool there across 22 states, and the average FICO of that group is above 740. So these are high credit quality homeowners. And as Jeff said, this is a payment that actually ultimately saves them money because the solar energy is cheaper than the alternative source of power to the home, and that savings is part of our underwriting to begin with. We look at that metric very closely. We also, as in most investments of this type, haircut our investments to begin with, so we don't advance clearly against every dollar of every lease that's haircut to assume some level of defaults in our initial investment in the way that we size it.

Great. And if there is some impairment, is -- how do you expect those situations to resolve? Do you have any recourse? And do you expect to need to use any of that recourse?

Well, recourse to SunPower or Vivint or solar who would be there -- or Sunrun. Is that what you're talking about?

Yes. So I guess, they would be the primary players to -- if the customer is not paying. I mean, the reality is you guys have mezz debts, right? So you're higher in the stack than the equity by those players. But if you end up -- if they end up not paying, how does it -- like would you reach out to maybe Vivint and then they would in turn reach out to the customer? Or just walk us through that process if somebody ends up not paying.

So the provider, let's just say, SunPower, for example, maintains the customer relationship. So it's not -- in Europe, the way you phrased the question, it wouldn't be us reaching out to SunPower. SunPower retains that relationship all along and retains the responsibility that collect. And if a customer is delinquent, there's a whole series of collection processes that they would normally go through, and it would ultimately result if there's no collection over a long enough period of time to the panels being shut off.

Okay. And is there a situation where the homeowner doesn't pay anybody? I mean the utilities -- I mean do your clients or partners have the ability to shut off the power. And if that's the case, do they just go back to the utilities and then in turn, either they pay a higher power price or the utilities can ultimately shut off the power as well? So just curious on that topic as well.

Well, they would [indiscernible tax.

Yes. Go ahead.

Well, the -- I mean, let's be clear. We're -- this is an asset class that has not been tested. It is very difficult for utility to turn off power. But there's a very good reason we're focused on the high-FICO score obligors in this portfolio. These are the people who will generally be able to pay. If they're late, there are definitely consumer protection laws that give them some cure periods, but then ultimately, the ability to take the savings from them is there with our client. Maybe another question that should be asked is what happens if our client and servicer goes away. In that case, we've already structured in backup servicing invoicing collection kind of operations, the existing entities that are out there providing backup servicer. So that's something in the underwriting that we look at upfront.

Great. Okay. And I'm guessing this time, utilities probably cannot shut off power during this crisis anyway. So good.

I hope they don't. yes.

Yes, great. Let's shift gears to the next slice in the pie as it relates to solar land, and what kind of credit risk do you guys see there at all? The way I think about it is you guys are even ahead of the most senior debt because you're in operating expense before the interest payments. But can you highlight -- this is 22% of your portfolio and resi solar is 30%, how do you think of the quality or the cash flow characteristic of that 22% slice?

So again, there, just to level set, we're the landlord. And we've leased it back to a project, which is selling solar power under a long-term power purchase agreement to a utility. And as you said, we're an operating expense, so our cash flow comes ahead of any debt or equity on the project. So we're paid within the first 10% of cash flows coming back to the project. So it's a very, very safe investment even in a recession.

Okay. As it relates to onshore wind, that 17% of your balance sheet. What are -- maybe characterize what the mix of onshore wind might be? Is it all, for example, investments that are preferred equity, that are seasoned, meaning 10-plus years or older? Or are you actually doing any -- or did you recently do any greenfield investments? And then talk about the risks and -- to that cash flow stream.

Jeff, why don't I take this one. I think you hit on -- we have seasoned assets where we're alongside the tax equity, which is senior. We have some preferred equity investments, and then there is some greenfield, not very much. And I think the risk in these projects are quite low. Power markets are working. The grid, thank goodness, is functioning. And those wind projects are going to find a market. The single biggest challenge in all of these projects is natural gas price below $2, but that's not related to your recession question. And checking with -- we do have 1 project in construction and checking with a number of clients, construction crews are working particularly on the utility-scale solar and wind projects. They're able to social distance and get their work done. Now that said, it's probably going to be marginally more expensive for everybody to do anything it needs. But from a risk standpoint, we don't see cessation of construction as being a material risk in any business in construction now.

Okay. In terms of the public sector, that's 15% in the slice -- or the 15% slice of the pie, that's a mix of federal, state and municipal exposure. Can you give us a rough mix of how much municipal exposure you might have, for example, in that 15% and talk through the cash flow risk for each of those sub slice -- or subsegments?

Why don't I take this one, Jeff. It's -- given our legacy, it's going to be more federal than municipal. And all of these transactions generally are paid from savings, and the savings are still being generated. So the credits are good. The structure is great and the value to the obligor is tangible.

Okay. And then shifting to the last slice in the pie, which is C&I at 7%. If commercial buildings are empty and utility bills are reduced meaningfully, how does that affect this slice of the pie?

Jeff, do you want to do that one?

Sure. So here, we have quite a bit of investment-grade companies who are the off-takers, and retaining power to their facilities remains a priority, even though clearly, even investment-grade companies may struggle over the next few months. But we do think maintaining power and making this payment to keep their building operational as it relates to power is going to be a priority. And many of these companies have self-imposed renewable mandates, which are important to them, and they've made large public statements accordingly. So again, even though some of these companies may struggle, we feel this is a priority payment that they'll continue to make.

Okay. So let's shift over to the next topic. How are you guys built to weather this storm? Clearly, from an asset quality standpoint, you're there. In your backgrounds, you guys talked about learning the lessons of the importance of liquidity. And then Jeff Eckel, you talked about the portfolio construction importance. So let's talk about liquidity for a bit, if you can. I think in Q4, at year-end last year, you had $6 million of cash. So can you talk through what -- where your liquidity is now to be able to cover overhead while originations come to a halt? I know you guys recently announced this University of Iowa project, which sounds meaningful and large. So you were able to raise some money to fund that. And then you guys had an ATM, $250 million ATM as of end of February. So just to the degree that you can, talk through your liquidity situation.

Sure. And -- got it.

Why don't you -- let me just bridge between the pie chart to liquidity and then it's all yours. When you asked the question of how are we built, every -- virtually every one of our assets, if somebody is not paying us today because they have a liquidity problem, it's not like that payment is gone. There is a cushion on the back-end and in virtually all of these deals where it -- we should get caught up and maybe with late interest. So we believe we will ultimately get paid. That's exactly -- that question of how long does it ultimately take is precisely the question on liquidity that Jeff will address now.

Sure. And Phil mentioned the $6 million of cash -- unrestricted cash that's on the 10-K sounds like a very small number. But of course, we had very significant availability in our credit facilities as detailed in our 10-K as well. So we did fund just a couple of weeks ago $115 million related to the University of Iowa deal. That's a fully funded transaction upfront. And even following that transaction, we have adequate liquidity. When we closed the first quarter, we'll be able to put more specific numbers on that. But for now I think suffice it to say, we have adequate liquidity. And as Jeff said, more is always better, both coming into and during a crisis. We have several avenues of liquidity including our multibank, multi-asset credit facilities that have an aggregate committed amount of $450 million as well as our at-the-market equity, which we filed just after the 10-K at $250 million. Of course, we can't talk specifically as to whether we've used that or not, but it is a potential source of liquidity. And we've managed liquidity very conservatively and continue to have that as our primary focus.

Great. And staying with that theme of how you're built to weather the storm. I know the -- you have an avenue of securitizations that you guys have leveraged over the years with private -- well, the private securitizations with insurance companies. Can you talk through how you expect to use that potentially through this time, if at all? And then just bigger picture, how else do you think you guys are built to weather the storm in a differentiated way?

Maybe I can start with a little historical perspective here. So again, Hannon Armstrong is in its 40th year, and we've been accessing insurance company capital virtually that entire time. We've only had access to public debt markets for the last 9 months. Virtually, all of our leverage has come from particularly life insurance companies, also main life insurance companies. They were a terrific source of capital for us during the great recession. We have maintained those relationships, and we have maintained our securitization vehicles with them. Now we're moving into our second decade -- no, we're ending our second decade with the original securitization vehicle we've created. So those relationships are long and deep. And when assets come up, we -- for -- that are accretive, we believe there is a well-proven path to monetize those transactions for our benefit. All right, Jeff.

No. Well said, I don't have anything to add to that. That's exactly right. Just to crystallize it more, the insurance company component of our funding has been around since the founding. The equity component was added in 2013, and the unsecured debt component was added in 2019. And the latter 2 are a little bit of a potential pause right now given where markets are, so we're going back to the insurance company bid, which remains active. Sorry if that's a little bit of repeat to what Jeff said.

It's fine. That's great. Historically, I've always thought about the insurance companies as buying the investments in the energy efficiency end market. But clearly -- so here's the question. Have they been able to diversify what they buy from you beyond energy efficiency? And can you give us some color as to what that might be as we look at your pie of resi solar, solar land and onshore wind?

Sure. And I think the word buy, you might substitute also the word finance there. And if you go to -- I don't have my 10-K, unfortunately, right in front of me, but I think it's footnote 8 or whatever the footnote is that has our nonrecourse financings in it. You'll see, for instance, several land transactions in there that have secured financing associated with it, and those are certainly insurance companies on the other side of the table providing those funds. And you'll see some other asset classes in that footnote as well. And I think it's fair to assume those are primarily insurance company-funded transactions even though they're on balance sheet.

Just one perspective over time, Phil, the global search for yield that every fixed income investors are engaged in continues with these low-base rates. Insurance companies and pension funds have had to, over the last decade, expand the risk tolerance in order to get meaningful yield to satisfy their liabilities. So where they were 20 years ago, maybe federal energy efficiency was about all they would look at. Now they're much more active in virtually all of our asset classes. But I also have biography of Marcus Goldman, Founder of Goldman Sachs, and one phrase that I tell everybody in our company, good times and bad, a deal well sold is a deal well bought. To the extent there's no-bid in the market for financing an asset, we're not going to own the asset.

Great. Okay. Let's shift here to the next topic in terms of gain on sale. I know you guys have gone through this balance sheet rotation over the past few quarters. I think you were just about kind of taking -- selling the lower-yielding assets and focusing on higher-yielding assets. As you -- as we look at the gain on sale line, it's actually been a pretty large number there. In Q4, I think it was $7-plus million, I think, when you take a look at the model, $7.7 million, almost $8 million in Q3. So as you look to that line item, especially for Q2 and Q3 of this year, how should we think about that line item trending, especially with originations, and we'll talk about that in a second, likely, coming to a very low halt or being very low?

You want to start, Jeff? Interest -- trend is an interesting choice of words because I'm not sure, in this early stage, any trends are visible. To the extent there are assets on balance sheets that don't necessarily need new contracts to get written, new construction to be done. We think those are conducive to doing gain on sale, whether in our balance sheet or somebody else's. And there will be some of those. To the extent new assets can be originated that are securitizable, that's helpful. For me, it would not be surprising to see the entire business in all of our asset classes shift out a quarter, 3 months of not a heck of a lot of activity. That would not be a shock. That's why I can't struggle with the trend.

Right. And I guess, the trend, I guess, is a trend of weakness clearly in originations. But in terms of -- do you need the gain on sale line item to be that $7-ish million in order to support the dividend? Or can you basically support the dividend with the assets on the balance sheet as you have them now?

Jeff, you want to take that?

Well, I think we are not specifically answering that question. I think we want to anchor folks in the core net investment income number in Q4, it was about $24 million. We do think that's a number that even if we don't do any originations for a time or a very limited number of them is likely to remain stable because we have slow runoff in the portfolio, and you generally use term debt. And likewise, you can -- because we publicly disclose it, you can certainly add Iowa to that number as well. As it relates to the gain on sale, there is a gain on sale that's historically been at origination for most of Hannon's life cycle, but now we also occasionally do securitization of assets that have been on the balance sheet. For a time, we did that in the fourth quarter, we disclosed with our commercial pace portfolio. And so that -- if we go through a period, as Jeff mentioned, of limited or no originations, so maybe an opportunity for some gain on sale related to existing assets. So keep that in mind as well.

Okay. That's great. In terms of originations, I think you guys may have already touched on this, where you think things could really growing slower for the next 3 months. What do you -- I wonder if you can elaborate that -- on that some more? Specifically, should we think of originations in Q2 as effectively 0? And how should we think about originations in Q3?

I think it's too early to give any kind of an informed view. What is -- in talking to our clients comforting, these are large companies that are doing the right thing for their employees and their capacity to execute. Nobody is taking undue risk to pump up sales, which is exactly appropriate but nor are the fundamental needs going away. These things really are going to shift to the right in time, and they will still get done, whether that's 1 month, 3 months, 6 months, it's -- we're all learning here real time. But the opportunities are not going away. And in fact, we think there'll be larger coming out of this. And these large companies are planning to accelerate business. It's early in the year. It's still only March. And assuming this thing can get passed in a reasonable amount of time, there's still enough time in the year to make for a good year for everybody. That's a general sentiment of the market.

Great. Good. Let's open the call up for questions from the audience. Lauren, can you give the instructions, please?

[Operator Instructions]

And in the meantime, if you want to e-mail me the question, and I can ask it, my e-mail is [email protected], R-O-T-H.com. So while we're queuing up for questions, do we have one here? Hold on. Let's -- Hey, Adam, e-mail me your question. So okay, in the meantime, let me ask another one. In terms of originations again, are you seeing -- how do you expect the origination pattern to be for resi solar? What were your resi solar partners telling you right now?

Well, I mean, you actually put out a pretty compelling note, and there was another S&P article about it. I mean I think it's a challenging time to do door-to-door sales, to say the least. We know some power at least is well geared for online applications and permitting to the extent -- I have to think that, that's harder business to do in March and April of this year.

Yes. Yes. And we're seeing certain states ban door-to-door sales as well. So we're going to shift a lot -- we're going to see a big shift to online activity and the close rates, I'm guessing, will be lower. Let's take our first question from Chris. Lauren?

We'll take our first question from [ Chris Arndt, ] private investor.

I just want to make sure I understand when you talk about liquidity, what you mean in the context of this business. Because it seems like it's different in the context of other finance businesses, which is to say -- I mean, liquidity for you all right now, if I'm not mistaken, it really pertains to if you have the ability or wherewithal to add new assets to your balance sheet. It's not -- I mean, are there other -- aside from that, are there any other liquidity needs? I just want to make sure that's clear, like there's no one -- it's not like a bank where people are pulling deposits out of it and you need to meet that. There's nothing coming out or -- can you just elaborate that a little bit more?

Sure. So yes, our liquidity is there to service our existing debt, pay our expenses and fund new assets are the primary uses of liquidity. So more or less, I think, confirming what you just said. That's -- those are the major uses.

Got it. And those -- can I just follow-up, those are largely fixed. So are any of those sources of liquidity that you need to have the business stable, not to grow it, but just to have it stable or service be good. Are any of those -- they're not -- they're all intact, right? Has any of them dried up?

No, not per se. I mean the only source of liquidity that we had started to -- we've mentioned this earlier in the call that we had started to use, that at least for the moment is unavailable, is unsecured term debt. For noninvestment-grade companies that, at least for the moment, is a closed source. But we have many, many others, as we've talked about.

[Operator Instructions]

Great. And I have a question from an investor here, Jeff and Jeff. The question is around the CEF REIT liquidation? Are we past that? Can you provide some perspective on that?

Somebody is typing the voice. Yes.

Can somebody go to mute, who is typing? Jeff, did you guys get the question from me?

I think the question is, is there further liquidation of like ETFs and ATMs like we saw last week? Is that the question?

I think so, yes. But specifically, the investor was asking about CEF, the CEF REITs. I'm not familiar with that REIT, but is that one that has been going through liquidation?

I'm certainly not familiar with it either. I'm not familiar with it. I don't think that's the name of the UBS fund that's already liquidated. And I'm not separately familiar with the one you mentioned.

Okay. Here's another question from an investor. He says that it might be a bit provocative, so sorry. And I haven't read it yet, so I'm reading it live with you now. But why should investors buy HASI or Hannon Armstrong versus a diversified set of developers? What is the advantage of gaining exposure via an investment company versus direct? Where do you add value from an investor perspective? I have my answer, but you guys clearly can address that. So I'll kick it over to you.

Yes. I would say there's lots of great places and lots of good companies to invest in. We have a particular value proposition that is very focused on diversity, granular investments that are -- no one investment, no one investment class is going to take us down. We have a preference for being senior in the capital stock rather than junior. So if you like more risk and there are other places to put your money, we also believe the dividend is a very nice quarterly complement to our investors. So there -- if you wanted to buy a developer of a wind or solar project, they're out there, they're great companies, it's a different set of risk and return profiles.

Great. Another question here is, do you see opportunities for refinancing existing assets in the portfolio, given where -- how rates have moved lower?

I would say not -- and I assume the question really means refinancing debt, not refinancing assets, but not currently. We've done mostly, again, privately placed secured debt that runs the duration of the assets. And then we've done some of this public style, 144A term debt. And the ones we've done there are not called -- we're not in our call period anyway yet. And even if they were, we're obviously not in a great market for that kind of debt. So no, right now, at this very moment, not a lot of opportunity to refinance debt, and we were more focused on stockpiling liquidity as discussed.

As we come out of this, I guess, it will depend on where rates go, but that could ostensibly be an opportunity to refinance that debt depending on call periods and so forth.

Yes. It's possible, sure.

Okay. Great. Well, I think that might be it, guys. Thank you both. Thank you, Chad, as well, for putting this call together with us. And I'd like to say one more thing for investors, and that is -- oh, so this investor who is asking about the CEF REIT, it's actually for closed-end funds. So I don't know if that helps clarify anything or not. Okay. Anyway, let's just close up. So just for the investor base, I really like Hannon Armstrong, where it is now in terms of the stock. Effectively, my tagline that I'm using with everyone is, you get paid 7% to wait for the stock to double in the next 12 months. So look forward to -- if you have any follow-up questions, please feel free to reach out to me and/or the management team. And thanks very much for everyone in participating.

Everybody stay healthy. Thanks very much.

Thanks, Phil.

Thank you, Jeff, and thank you, Jeff L. Bye guys.

And that does conclude today's conference. We thank you for your participation. You may now disconnect.