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

Greetings. I'm Christopher Van Horn, an analyst at B. Riley FBR, covering the alternative energy sector. I'm pleased to welcome you to our call with Hannon Armstrong management. Before we get started, I need to tell you the following. In the normal course of its business, B. Riley FBR Capital Markets seeks to perform investment banking and other services for companies under coverage and to receive compensation in connection with such services. As such, investors should assume that B. Riley FBR intends to seek investment banking or other business relationships with any and all of the companies mentioned today. Hannon Armstrong currently is or within the past 12 months was a client of B. Riley FBR. The services provided were investment banking services. B. Riley FBR or any of its affiliates expects to receive or intend to seek compensation for investment banking services from Hannon Armstrong in the next 3 months. B. Riley FBR or any of its affiliates has received compensation for investment banking services from Hannon Armstrong in the past 12 months. B. Riley FBR or any of its affiliates has managed or co-managed a public offering of securities for Hannon Armstrong and has received compensation for investment banking services from Hannon Armstrong in the past 12 months. Today, we are pleased to have with us Hannon Armstrong's Chairman, President and CEO, Jeff Eckel; Jeff Lipson, Executive Vice President and CFO; and Chad Reed, Investor Relations and ESG. We appreciate our speakers spending time with us today. Their opinions are their own and do not necessarily reflect those of B. Riley FBR. We ask them to avoid any disclosure of confidential nonpublic information. With that, I'll hand the call over to Chad Reed.

Thank you, Chris. Good afternoon, everyone, and welcome. Before the call begins, I would like to remind you that some of the comments made in the course of this call are forward-looking statements and within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934 as amended. The company claims the protection of the safe harbor for forward-looking statements contained in such sections. The forward-looking statements made in this call 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 described during the call. In addition, all forward-looking statements are made as of today, and the company does not undertake any responsibility to update any forward-looking statements based on new circumstances or revised expectations. Please note that certain non-GAAP financial measures will be discussed on this conference call. A presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. A reconciliation of GAAP to non-GAAP financial measures is available on our Q4 and full year 2019 posted earnings release and slide presentation. Joining me on today's call are Jeff Eckel, the company's Chairman and CEO; and Jeff Lipson, our CFO. With that, I'd like to turn the call over to Jeff, who will start on Slide 3. Jeff?

Thank you, Chad, and good morning, everyone. I guess now good afternoon. These are indeed unprecedented times we are experiencing. I first want to update you on the actions that Hannon Armstrong is taking, and the impact on our business. Our first concern is the safety and health of our employees, their families and our community. As a result, we took early action on March 10 to close the office and move to a remote workforce and prevent further spread of the virus. We're pleased to report that as of today, all of our employees remain healthy, knock on wood. In addition, we've spent significant time and resources over the last several years to update our IT infrastructure, including the use of the cloud, to make us more secure and resilient. I'm glad to report that our IT infrastructure is working well and our team's productivity and cohesiveness remains strong. Second, in this time of market uncertainty, investors are rightfully concerned whether companies can meet expectations related to earnings and dividend guidance provided before the world changed just a short time ago. We are continuing to evaluate market conditions as we should and as they evolve, and expect to have more to say on this as we have historically done on our upcoming quarterly earnings call. Further, in times like these, liquidity and asset quality are top of mind. As long-term investors, we are cognizant of the potential for market disruptions, and over the last year, have increased our cash balances and short-term liquidity while reducing our leverage. Jeff Lipson will touch on this further in a minute. We've also focused on portfolio diversification, counterparty credit quality and maintaining multiple sources of capital, including through syndications with life insurance companies. We have used that tool to finance our business over the last 4 decades, particularly including during the 2008-2009 financial crisis. We believe we are in a strong financial shape for this disruption and will, of course, make our next dividend payment on April 10. Now I'll turn it over to Jeff L., who has very relevant experience navigating the prior financial crisis.

Thanks, Jeff, and thanks, everyone, for joining, and I hope everyone is doing well. I echo Jeff's comments that the safety of our employees and our community has always been our first priority, and that we have quickly migrated to a remote infrastructure that is fully functional. Jeff Eckel mentioned my experience, but I would likewise add that Jeff has navigated several business cycles and is providing outstanding leadership in a challenging environment. Our entire executive team is fully engaged and operating at a high level to address this crisis. Let me now turn to Slide 4 and describe how Hannon is effectively positioned for these very challenging macroeconomic conditions. First, our portfolio of high-quality, long-dated, 15-year assets is well diversified across multiple climate-positive asset classes and is primarily noncyclical. Our assets are typically supported by contracted cash flows from high-quality counterparties, including governments and other investment-grade entities. We also maintained structural protections in our transactions that reduce our risk. Further, our assets typically save customers' money relative to their baseline utility costs. Turning to Slide 5. I'd like to touch on our residential solar portfolio, which is our primary exposure to consumer credit risk. The portfolio includes 145,000 consumer obligors across 22 states with an average FICO score of greater than 740. While the historic delinquency rate on this asset class has been less than 2% over the last decade, we would expect the current economic conditions to increase delinquencies in all consumer obligations. Our client sponsors are putting in place various temporary programs to assist customers through this difficult period. Our original underwriting of these transactions included reasonable assumptions regarding expected defaults based on the credit characteristics of the portfolio, and we advanced an amount consistent with this expectation. Our underwriting also included an assessment of the customer savings. Typically, the homeowner saves money with solar panels versus their alternate source of power. Therefore, this lease payment on the panels is a priority payment because failure to make the payment will ultimately result in the customer reverting back to a more expensive source of power. Our clients retain the customer relationship and are responsible for collections, including overseeing the escalation process regarding delinquent accounts. We continue to work closely with our clients and actively monitor the performance of the portfolio. Turning to Slide 6. We fund our long-dated, fixed-rate investments with term fixed-rate debt, utilizing a modest amount of leverage. Since our leverage was relatively low at 1.5x debt-to-equity entering the crisis, we do not expect to be subject to the significant deleveraging that will inevitably occur with certain other REITs and specialty finance companies. Next, we maintain adequate liquidity. We have access to 2 multibank, multi-asset credit facilities which together provide up to $450 million in capacity and which do not mature until 2023. In addition, with our recently announced Iowa transaction already funded, we have no term material funding need -- no near-term material funding needs. Our next material maturity of debt is not until September of 2022. We also retain access to diverse set of liquidity sources, including public equity via our at-the-market issuance platform or regular way offerings, unsecured debt, secured debt and private securitizations and syndications with insurance companies. For the first few decades of our existence, we funded ourselves exclusively through the private markets, and we believe that our strong multi-decade relationships with some of the largest life insurance companies will ensure we'll retain access to this funding source, even when access to public debt and equity markets is temporarily disrupted. With a portfolio of high-quality, long-dated assets and liabilities, ample liquidity, a conservative leverage position, access to diverse funding sources and industry-leading ESG practices, we remain focused on maintaining strong liquidity and capital positions as we face the anticipated market and macroeconomic headwinds. Now I'll turn the call back over to Jeff.

Thanks, Jeff. And you certainly are providing great leadership as well even though the voice -- I suspect everybody is having a bit of audio difficulty, but you're providing great, strong leadership. With regard to growth, we are, in fact, open for business and continuing to identify new investment opportunities and to close deals with our top-tier clients. An excellent example of these efforts is our preferred equity investment of $115 million in the Hawkeye Energy collaborative, a landmark public-private partnership, otherwise called P3. This is a joint venture between ENGIE, Meridiam and Hannon Armstrong, and the Hawkeye Energy collaborative was awarded $1 billion 50-year utility management concession contract in December of last year, and the investment reached financial closing on March 10. This collaborative will support the University of Iowa's energy, water and sustainability objectives for 2 campuses spanning 1,700 acres in Iowa City. Notably, the P3 will help the university meet a zero-carbon energy transition objectives, becoming coal-free in campus energy production on or before 2025. Innovative in both scope and ambition, the comprehensive concession agreement to address multiple utility systems serves as a campus utility system model that many of the thousands of U.S. colleges and universities may look to for improved system efficiency, cost and performance. The investment also affords Hannon Armstrong the following strategic benefits, including an attractive risk-adjusted return from contracted cash flows for over 50 years. Those cash flows are with a strong investment-grade counterparty and further expands our efforts into the sizable higher education P3 market. We, with this transaction, diversify and strengthen the credit quality of our balance sheet portfolio and, of course, while fully aligning with our climate-positive ESG objectives. Now I'd like to address another item, our recent stock price volatility. The health and financial impacts of the coronavirus outbreak are already rippling through the U.S. economy. And understandably, equity prices are down significantly across the board. However, we believe there are several reasons our share price is down further than might be expected since this crisis erupted in the U.S a few weeks ago. First, the traditional commercial REIT sector has been hit particularly hard with many names down more than 50% year-to-date due to valid concerns over the potential impact of COVID-19 to them from reduced employment, consumer spending and business profitability. Just as our share price benefited from our inclusion in various passive REIT indices over the last couple of years, our share price has suffered as funds have flowed out of these indices. As reported by Bloomberg News 2 weeks ago, there was a liquidation of a highly levered UBS trust that invested in a number of mortgage REITs, including our shares. As a result, even though we're a nontraditional REIT focused on climate-positive investments funded with term debt, our shares are facing the same sectoral sell-off as mortgage REITs that borrow short-term to fund short-duration assets. Second, there are understandable concerns over the growth prospects of residential solar installations, which will clearly experience disruption. Given our client relationships with multiple resi solar providers, some may perceive our growth prospects is more tied to those of our clients than is actually the case. It's important to note that our current portfolio is not impacted by new installations that customers typically save money, as Jeff pointed out, by making their lease payments. It's also important to note that our origination pipeline is more than $2.5 billion and well diversified across multiple spaces, including energy efficiency, distributed solar, utility-scale land, onshore wind, sustainable infrastructure and now with the Iowa investment, the P3 infrastructure space. As a result, our growth prospects are not dependent on any one of these sectors. Rather, we have the flexibility to shift our capital to the asset classes where it is needed most and where we can earn the most attractive risk-adjusted returns. To summarize, we do not believe these factors reflect the long-term fundamentals of our business. And in fact, several of our executives and directors, including both Jeff and myself, recently purchased additional shares just a couple of weeks ago. Let me conclude by saying that we continue to be focused on the large business opportunity in front of us, while at the same time, developing various contingency plans in place if conditions deteriorate. We believe our long-dated assets and staggered debt maturities provide a buffer in this difficult time. But fundamentally, it's great to have a large number of clients with outstanding corporate practices. They're all doing the right things for their employees and maintaining their ability to operate. We don't see any of these clients being reckless or pushing for deals that cannot or should not be implemented now. There are also very large companies planning for how to accelerate out of the curve and maybe even hit their numbers for the year. There is uncertainty, especially with regard to how long this lasts and the associated impact on the business, but there is optimism among our client base, not like the need for these projects they build, rather it's -- it's not like the need for the projects they build goes away, it's rather a question of timing. With that, we'll open the line for questions.

Okay. Great. Thank you very much, Jeff, Jeff and Chad. I'm going to facilitate the Q&A. I've received questions submitted to me, so I'll facilitate that. So first and foremost, thank you for all the color regarding the current situation and, obviously, it's very dynamic. But maybe could you elaborate a little bit on what -- it sounds like there are certain customers that are looking at maybe some timing headwinds. It sounds like other customers are proceeding as planned. How has this impacted -- how has the COVID-19 impacted your ability to complete the sales process or to continue origination, et cetera? And again, I'm sure a lot has changed in the past week and some might change next week, but to the best of your ability, could you describe the environment?

Well, I think the projects that are already in construction, we understand they are taking good precautions to create extra space, but projects in construction are happening. I think the projects that are going to get delayed are the ones that are just about ready to start, but you need a couple more meetings to finalize the details, execute the contract. I'm not sure anybody is particularly focused on those kinds of projects right now. There's time for that. Right now is the time to focus on safety, but the things that are in construction or installation are progressing.

Okay. Got it. And then just generally speaking, if we do -- this does kind of result in more of a 6 to 12 months' recession environment. I imagine the interest rates will stay low. How does interest rates kind of play into your business? And do -- how do low interest rates impact you going forward?

Jeff L.?

Sure. So we've been in a low interest rate environment for the past few years, and the company has done quite well. We're not overwhelmingly impacted by the absolute level of interest rates. We have fixed-rate assets funded by fixed-rate debt. The level of interest rates on incremental investments again is not a huge driver, it's more of the credit spreads. So to the extent -- in a recession, the credit spreads on our investments widen, but perhaps our cost of funds and the credit spread for folks lending money to us widens, then we would expect to remain equally as profitable at low rates as we were at high rates or really in any interest rate environment. So the business is not particularly impacted by the absolute level of rates.

Okay. Got it. And then I imagine there's a percent of the portfolio that despite the end user falling on tough times, there's still a secular theme. And I think you've kind of alluded to that in your prepared remarks around you're saving money with this -- the source of energy. Does that apply to most of your asset classes, certain asset classes? Any additional color there?

Almost every one of our asset classes, fundamentally, is cheaper than the alternative. The ones that I think well -- no, I was going to say stormwater remediation might not have the savings, but it's cheaper to do the stormwater projects and make the payments and suffer the penalties if you don't do it. So you never want to say always and everything, but directionally, that's true. And I think the reason we've highlighted resi solar is, it's obviously the one credit that's going to be most affected by people losing their jobs. Most of the other assets we invest in, really it's a pretty minor impact.

Okay. Got it. And then I think you mentioned you have -- I think it's in the pie chart, the percent of government work. Could you maybe describe that customer's -- their attitude given the recent times? And then is there a component of those -- of that government work that's military-related? And I imagine that's pretty sticky and not seeing a lot of volatility, but please correct me if I'm wrong.

No. And I think the best measure was how did that business perform in '08 and '09. We had a big book -- portfolio already that we were managing and payments -- there were occasional payment delays, somebody couldn't get into work or something like that. But generally, U.S. government was fine and operating. We checked in, and people are still making payments. I'm sure there will be more delays this time. In terms of new projects, they will continue. They certainly performed very well in '08 and '09. So anybody who says there's no impact is not paying attention, but it just doesn't seem to be anything like the hotel business or the cruise line business or any of those that require human beings that show up as your customers.

Okay. Makes sense. I want to take a couple of minutes, if you don't mind, on the university opportunity. Remind us, is this P3 a new asset class for you? Do you have other universities that you're doing transactions with? And then I think you mentioned that this was helping the University of Iowa meet its zero-carbon objective. Have there been any other major universities that you can see that have kind of put a target out there of being zero carbon by any time frame?

That's a good question on zero carbon. Certainly, every university has some level of a sustainability commitment, and that's driven by their faculty and students who say we don't want the on-site coal plant anymore from the '20s and then much larger aspirations. What ENGIE did with this project and what they're doing in Ohio State is really quite comprehensive. If you think of University of Iowa has got an on-site generation system, they've got a wastewater treatment system, a portable water system, stormwater system, these are all complicated systems, notwithstanding that they're relatively small. It's really hard for any university engineering group to do a great job with these because they're generally not funded very well and sort of an afterthought, people only think about the utilities when they're broken. With ENGIE coming in and bringing in the sustainability goal, you've got a world-class utility operator and expertise that it would be very difficult for any of the thousands of utility operators in the university sector to replicate. So we're thrilled with ENGIE's ambition and the scope of this transaction and pleased to be part of it.

Okay. Got it. And then how did this -- maybe how did this opportunity come about? Was it a competitive bid process? Was it a solution that you guys kind of came up with and went to the university with? How did it kind of originate?

No, there's quite -- of course, it's public sector, so there was a competitive bid, a tender process. And there are other companies that offer this service. ENGIE, having won Ohio State, is in a very good position to have a customer to give them a good reference on. So we were fortunate to be able to team with ENGIE, but to be clear, ENGIE did the heavy lifting and the hard work of proposing the solution and doing all that. We're glad to support them. They're a world-class operator and glad to be on the team.

Got it. And then just to make sure, just for my own edification, your investment was around $115 million, correct?

Yes.

Okay. Got it. Okay. So moving on, I've -- when I'm talking about your stock and kind of your strategy, often what comes up is the impact of oil price and how that may affect your business. So could you let us know if at all how oil price affects what you do?

That's interesting. I dropped the comment on oil price because I thought maybe people really don't care about that. There is 0 and -- again, I shouldn't say 0, but -- and very hard to measure correlation between how our assets perform in new originations with the price of oil. In the U.S. electric sector, I think Hawaii and there's one oil burner in Connecticut, it is a rounding error in terms of the U.S. electric power sector, what's generated in oil. Most of the assets we invest in relate to the U.S. electric power sector. So it's been baffling to me why the solar stocks sell off with the price of oil. They simply don't compete. The only asset that would compete with oil directly are electric vehicles. And our big fans of the EV business, we've not announced any transactions there. So I'm baffled by it. We simply don't see it. And it hasn't been that way since, oh my goodness, the Arab oil embargoes, when Long Island Lighting, and I'm updating myself, took out their coal burners and converted their plants to oil. That was in the '70s. And what you actually see now is when oil prices are low, there's less drilling. If there's less drilling, there's less associated gas. If there's less gas, that increases the price of natural gas on the margin, which would be actually beneficial to any renewable selling into the wholesale market.

Yes. Okay. So it sounds like you don't want to say 0, but very, very, very small, if any, impact.

Yes. Exactly. I'm sitting here smiling thinking Chad's probably pounding his forehead that I went off on a tangent on Long Island Lighting Company, a company he's never heard of.

Hey, we all need history, nothing wrong with that. Okay. Great. And then resi solar is certainly a part of your asset class mix, and it's been growing impressively. I think people want to correlate tough consumer times with resi solar facing challenges, and there's been some public resi solar servicers talking about maybe a 20% decline or something of that nature due to this virus. But I'm wondering if -- you said you have a high FICO score there. What if the servicer runs into problems? And how does that maybe affect your portfolio?

I'll start and then Jeff can finish. We start out -- when we underwrite these transactions, we underwrite to the asset. We don't assume that SunPower, Vivint or Sunrun stay in business, and we're not investing in those companies or investing in those assets. We think those are 3 client companies, but we underwrite to the asset. And with that, I'll let Jeff polish the answer off.

I think that's right. And I'd expand on that to say a couple of things. First of all, the exposure we have tends to be a mezzanine exposure and the senior debt is in securitized format. And as with many securitizations, there's a deemed backup servicer or transition servicer right from day 1. And that's typically some large reputable institution like a Wells Fargo that's required as part of the securitization to step in and continue to make collections and disburse payments. And then the other way we look at it is we have relationships with many of the resi solar folks, and one could certainly step in and act as a servicer if another one was unable to. And having those multiple relationships we think really helps.

Okay. Got it. And then kind of -- as you've highlighted on your portfolio overview slide, the average investment and your duration, in my view, has kind of increased over the past few years. Are you just -- is that part of the macro environment ex -- obviously, excluding where we are in the next weeks to months? But generally speaking, there's a move to more of the projects and the alternative energy that you're funding. Are the project sizes getting larger? And are the duration times getting longer? How do we think about that?

I think it's very hard to generalize. I think things are probably up a little bit because of Iowa. I think the -- if I were to generalize, I would say the trend is away from grid-connected projects affected by natural gas prices through more behind-the-meter as we talked about, a more decentralized model. What you do see in the decentralized model, and we've talked about Ameresco's $80 million project at Paris Island in prior calls is much like ENGIE at Iowa. The offering is much more sophisticated, looking much more like utility rate base type structures even though they're behind-the-meter. And I think that's a very good development. But the ambition of the -- and the capability of the companies like ENGIE and Ameresco to engineer far more ambitious solutions is growing, and that means there's larger project sizes.

Okay. Got it. And then just to follow up on your comment around the ETF and the ETNs, have you seen that unwinding kind of flatten out? Do you think there's others out there that have a lot of REIT exposure that might see a similar thing happen? Or do you think that's mostly behind us to your assessment?

Jeff, do you want to take that?

Sure. It's hard to know for sure. I mean, certainly, when this ETN was liquidated, we tried to gather intelligence as to were there any others that looked like this given the dramatic impact on our stock price on a particular 2- or 3-hour period. And we're not aware of any others, but we can't definitively confirm that there are none others out there. The percent of our shares that are in REIT index funds is generally pretty low. But we can't 100% confirm that there are no other highly leveraged ETNs out there.

Okay. Got it. And then I guess final for me. If we do -- trying to be on the optimistic side of the curve here, if we do see this, the COVID start to mitigate and start to flatten out in the summer, I imagine your kind of long-term strategy around what's going on in the alternative energy space, the need for a lot of the projects and the cost savings that come with it really isn't going anywhere once we get through this, and your pipeline still looks strong from a financial services perspective. You can do a lot of this work from home in the intermediate term or from remotely. And I just want to verify that you still feel good longer term about what the strategy is and how you guys are managing your business prior to this happening.

Well, since I did my first solar project in '87, I'm pretty convinced this is a good business. Now we're going to keep going. This is a shift out to the right. It happens. We sincerely hope we get this virus under control and a vaccination out there and life can get back to some measure of normalcy. But our markets are intact, our client base is intact, our team is intact, and the business is poised to continue to grow.

Great. Well, let me thank you once again for taking the time, and hope everyone out there stays safe. Thank you very much.

Thank you.

Thanks, Chris.

Thanks, Chris.