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Edited Transcript of HASI earnings conference call or presentation 21-Feb-19 10:00pm GMT

Q4 2018 Hannon Armstrong Sustainable Infrastructure Capital Inc Earnings Call

Annapolis Mar 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Hannon Armstrong Sustainable Infrastructure Capital Inc earnings conference call or presentation Thursday, February 21, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Amanda Cimaglia

Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Director of IR & Corporate Communications

* J. Brendan Herron

Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP

* Jeffrey A. Lipson

Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Executive VP & CFO

* Jeffrey Walter Eckel

Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO

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Conference Call Participants

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* Anya A. Shelekhin

BofA Merrill Lynch, Research Division - Research Analyst

* Carter William Driscoll

B. Riley FBR, Inc., Research Division - VP & Equity Analyst

* Christopher Curran Souther

Cowen and Company, LLC, Research Division - Associate

* David Francis Katter

Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst

* Mark Wesley Strouse

JP Morgan Chase & Co, Research Division - Alternative Energy and Applied & Emerging Technologies Analyst

* Noah Duke Kaye

Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst

* Philip Shen

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to Hannon Armstrong's conference call on its Q4 and full year 2018 financial results. Management will be utilizing a slide presentation for this call, which is available now for download on their Investor Relations page at investors.hannonarmstrong.com.

Today's call is being recorded, and we have allocated 30 minutes for prepared remarks and Q&A. (Operator Instructions)

At this time, I would like to turn the conference call over to Amanda Cimaglia, Assistant Vice President, Investor Relations, for the company.

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Amanda Cimaglia, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Director of IR & Corporate Communications [2]

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Thanks, Jessica. Good afternoon, everyone, and welcome. Earlier this afternoon, Hannon Armstrong distributed a press release detailing its fourth quarter and full year 2018 results, a copy of which is available on our website. This conference call is being webcast live on the Investor Relations page of our website, where a replay will be available later today.

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 protections 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 posted earnings release and slide presentation.

Joining me on today's call are Jeffrey Eckel, the company's President and CEO; and Brendan Herron, our CFO.

With that, I'll turn the call over to Jeff, who'll begin on Slide 3. Jeff?

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [3]

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Thanks, Amanda, and good afternoon. Today, we are announcing that we grew GAAP earnings 32% year-over-year to $0.75. Core earnings are up 9% year-over-year to $1.38, above the high end of our 2018 guidance. Given our accretive additions to the balance sheet and the strong pipeline, we reiterate our guidance for 2019 and 2020 of 2% to 6% growth in core earnings from the 2017 base.

We also announced a 2% increase in the quarterly dividend to an annualized $1.34 per share. As previously discussed, we intend to grow the dividend but slower than the core earnings growth rate. We closed a record $1.2 billion of transactions for the year, with balance sheet transactions around the same level as 2017 and securitizations up compared to 2017. The combination of higher portfolio yields from the balance sheet investments and higher securitizations in 2018 allowed us to increase our core return on equity above 11%.

Our pipeline remained strong at more than $2.5 billion, especially in behind-the-meter assets.

In Q4, we renegotiated our primary credit facility at lower rates and extended the maturity, both good things. 0.5 million metric tons of CO2 will be reduced annually from our 2018 investments, a CarbonCount score of 0.42.

The business is in great shape, and as our business has grown, our need for talent has grown. This is the perfect time to be making a transition. Brendan has done an outstanding job as our Chief Financial Officer, including coming up with the idea and strategy for taking the company public in 2013. Effective March 1, Brendan will assume a new leadership role focusing on strategy and our growth initiatives. This is not an exit for Brendan, but a new role to use his considerable business skills and acumen to help us capture the very large climate finance opportunity in front of us.

We're seeing increasing ways to partner with leading companies to meet the growth objectives, such as the previously announced SunStrong and Hannon Armstrong sustainable real estate collaborations. Brendan will have a leadership role in making sure these and our other initiatives are successful.

Welcome Jeff Lipson, a 30-year corporate finance and banking veteran, who joined us last month that will become CFO effective March 1. Jeff will take over leadership of our finance and accounting teams as we look to continue to grow the business. You'll be hearing from Jeff later in the presentation, and I look forward to introducing him in person when we hit the road for investor meetings.

Turning to Slide 4. We'd like to address some of the key questions that are top of mind for our investors. The market opportunity continues to grow and evolve in the 10-or-so niche markets we invest in. We are continuing to see better risk-adjusted returns and assets that are Behind the Meter as opposed to grid-connected assets. This further reinforces the overarching themes we've discussed before, the 3 Ds of the future electric power system: decentralization, digitalization and decarbonization. This evolution is happening faster than we expected.

The competitive landscape remains largely the same in our various niche markets, and we continue to believe if we stay committed to long-term programmatic client relationships, these relationships will continue to work, as they did in 2018.

On the PG&E question, we do not see any significant exposure to the PG&E bankruptcy. We own land under a number of grid-connected solar projects selling power to PG&E where our rents are current. We enjoy substantial asset and rent coverages and are well collateralized by assets and cash flow even if the PPAs are rejected in bankruptcy and the projects sell into the merchant market.

As we have said for several quarters, we like our position in the capital stack in these utility scale solar plants, senior to all other capital providers. While we like being senior in grid-connected transaction given the relatively low equity returns and higher perceived risks, we have increased our equity in mezzanine exposures in behind-the-meter assets, including residential solar. We've always said we will make equity investments if we thought we were getting paid for the risk, and we believe we are with our increased exposure to resi solar. We've managed about 1/3 of the assets for almost 5 years, giving us an informed view of the relative risk and believe we are getting paid appropriately for this diversified portfolio.

The yield curve continues to flatten, and although we might prefer a normal upward sloping yield curve and correspondingly higher long-term rates, we've demonstrated our business model as profitable in all interest rate environments and including this flat yield curve environment.

We had limited impact from the recent government shutdown. There were some payment delays for the approximately 30% of the agency shutdown, but we have always collected and expect 100% collection this time as well.

To conclude on this page, the green new deal has gotten people talking more about climate change, which is a very good thing in our view. While our business model will continue to prosper in virtually any public policy setting, we continue to believe the carbon tax and dividend plan is the most impactful and economically efficient of a policy approach.

Turning to Slide 5. We've laid out our pipeline, portfolio and credit profile. The continued growth in the Behind the Meter portfolio is driving portfolio additions and earnings. Of the more than 2.5 billion pipeline, about 75% is Behind the Meter, efficiency, solar and storage, whether it's in a government building, commercial business or residential property.

The $2 billion portfolio yield is up this quarter to 6.8% because of some of the balance sheet additions, which I will review in a minute, as well as the disposition of some lower yielding assets. The assets remained diversified with respect to asset, vendor and obligor concentrations.

Finally, on portfolio credit quality, we have rated the increased exposure to some of these newer assets, like resi solar and environmental restoration, as noninvestment grade, which increases the noninvestment-grade category to 15% from 6% last quarter. We will discuss this increase in more detail on the next slide.

In summary, we continue to have less than 1% of the portfolio on nonaccrual status.

Turning to Page 6. We profiled the 3 types of investments we made in noninvestment grade or equity transactions in the portfolio in Q3 and Q4. On the left side of the page, our residential solar portfolio is approximately $300 million at year-end, with 3 of the top sponsors in the industry. Approximately $270 million of the investments are in a mezzanine structure, with the balance of $30 million classified as equity. As I mentioned at the outset, we've managed about 1/3 of these assets for almost 5 years. The transactions we completed shift us deeper in the capital stack and, we believe, improve our relative risk-adjusted returns. As a note, the portfolio consists of 90,000 homeowners, with attractive average FICO scores of 750.

The center of the page profiles an equity investment we made with one of the leading commercial and industrial solar sponsors. This investment gives us a programmatic platform to expand this business more rapidly than we've been able to do in the past.

Finally, the right-hand side of the page profiles a 4-state wetland's mitigation and stream restoration investment we made in Q4, similar to our Q3 storm water remediation investment. We do expect more investments like these in the future.

All of these transactions were added to our balance sheet, thus positioning us well at the start of 2019 for recurring revenue.

Turning to Slide 7. We'd like to walk through how our record investment activity improves both 2018 ROE and future year portfolio returns. Top left, we show our growing programmatic client base that, in part, generated the $1.2 billion of investment activity. While some of these assets are a great fit for our balance sheet, as we just discussed, others are not in our best securitized. Either way, from our clients' perspective, we are providing a reliable capital solution.

In 2018, we securitized about 60% and put 40% on the balance sheet. This higher level of securitizations of approximately $700 million allowed us to generate fees from the growth in the $5.3 billion of managed assets. These additional fees contributed to our 11.1% core return on equity, which has continued an upward trend, although we would remind you that our target with a normalized level of securitization remains 10%.

And with 40% or approximately $5 billion going on the balance sheet with improved yields, largely in the last 1/3 of 2018, we have improved our ability to generate recurring revenues for 2019 and beyond and reduced the importance of securitizations to achieve our earnings growth.

I will now turn it over to Brendan to detail our financial performance.

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [4]

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Thanks, Jeff. Turning to Slide 8. For the year, total revenue grew by approximately $32 million or 31% as compared to 2017. The increase was the result of higher gain-on-sale and fee income of $15 million due to the increased securitization volume and higher yields on our portfolio. In the fourth quarter, approximately $300 million of residential solar assets and our related $250 million of debt was prepaid. Both revenues and interest expense were impacted by this transaction. We recorded approximately $13 million of interest income related to this prepayment. This was offset by approximately $9 million of expense recorded in interest expense related to the debt repayment.

Total revenue grew by approximately $12 million in the fourth quarter as compared to the same period last year as a result of the 15 -- sorry, total revenue for the year grew by approximately $12 million as compared to the same period last year as a result of the $15 million increase in investments due to higher yields and the prepayment described above -- excuse me. Total revenue by the -- grew by approximately $12 million for the fourth quarter as compared to the same period last year as a result of the $15 million increase in investment revenue due to higher yields and the prepayment described above. The increased investment revenue was offset by $3 million lower gain on sale and fee income for the quarter.

Interest expense grew to $77 million from $65 million last year as a result of higher fixed-rate debt and the prepayment described earlier. We completed a series of transactions in the second half of the year, which lowered our interest costs, such as refinancing our primary credit facility, reducing the level of our interest rate swaps and the $250 million debt repayment, which reduced our leverage. Interest expense for the quarter increased by approximately $1 million as these changes offset a large portion of the debt prepayment costs.

Comp and general administrative expenses increased by approximately $5 million for the quarter and approximately $9 million for the full year, primarily due to an increase in the size of the company as well as an additional bonus accrual in the fourth quarter to reflect the performance of the company.

For the quarter and the full year, income from equity method investments was largely consistent with the same period in 2017. The noncash income tax expense rose by approximately $1 million for the year and was largely flat for the quarter.

In total, we have $42 million or $0.75 per share of GAAP income for the year compared to $31 million or $0.57 per share in 2017. As a reminder, the GAAP income does not include the full effect of the cash we received from our equity investments. In 2018, we collected $115 million in cash from these equity investments as compared to GAAP income on these investments of approximately $22 million. Since we have based our investment on future cash flows, discounted back to a present value, we believe, the cash we received reflects both a return of capital and a return on the investment. Thus, we make a core adjustment of approximately $19 million to recognize return on our investment, which, year-to-date, when added to our GAAP $22 million income, gives a total core return of $41 million, and thus, the other $74 million represents a return of capital. It's important to note that the interest expense associated with the leverage on these investments is shown in the interest expense line above, as required under GAAP.

Stock comp and other adjustments were largely consistent for the quarter and the year as compared to last year. In total, core earnings were $76 million for the year, a 9% increase. For the quarter, core earnings were $21 million, an increase of $0.06 per share.

Just to know for modeling purposes, we would expect comp and G&A on a core basis to be consistent with the first 3 quarters of the year in 2019.

Turning to Slide 9. I will provide more comments on how our balance sheet has changed this year as we position for further growth. In the fourth quarter, we redeployed the $50 million of equity from the approximately $300 million of residential solar asset and our related $250 million of debt that was repaid. We also deployed the approximately $105 million primary equity raise and approximately $65 million from the ATM into new projects Jeff described earlier. As we have demonstrated, we raised equity to take advantage of good investment opportunities.

We successfully refinanced our primary credit facility, extending the maturity to 2023. The new credit facility has increased flexibility and should lower annual interest costs by approximately $1 million. We also diversified our credit facility lending group from 1 lender to a total of 6 lenders.

We lowered the fixed-rate debt to 74% or approximately the midpoint of our range as a result of the debt repayment, increased use of the floating rate facility and a reduction in the level of interest rate swaps. This lower level of fixed debt reflects the change in the Fed's outlook for interest rates.

Finally, the repayment of the $250 million of debt, plus the approximately $170 million in equity raises, lowers leverage to 1.5 to 1. While we would expect some releveraging, given our current and historic leverage, we are clarifying our leverage target to be more of a cap by inserting up to -- before the 2.5:1 as compared to the old fixed target of 2.5:1. These changes are expected to reduce interest expense by approximately $2 million a quarter in 2019 and, when combined with a higher yield on assets, is expected to allow us to achieve our guidance targets with lower gain-on-sale fees.

Our stock remains largely institutional owned, with employees owning approximately 5%.

Before I turn it over to Jeff Lipson, I would like to say that I'm looking forward to working with Jeff and to turning my attention to growing the business. Throughout my career, I have been fortunate enough to help businesses grow in several emerging industries. The market and the need to address climate change is enormous. I'm excited to be in my new role in focusing on how we can better address the opportunity.

I will now turn it over to Jeff Lipson to talk about what he will be focusing on.

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Jeffrey A. Lipson, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Executive VP & CFO [5]

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Thank you, Brendan. Allow me to begin by expressing my enthusiasm for joining Hannon Armstrong, and I look forward to working with all of our analysts and investors.

I joined the company at a perfect time. Jeff Eckel's leadership has resulted in a strong financial performance and pipeline, and Brendan's leadership has optimized the capital and liquidity structure of the company. My focus will be on expanding upon these successes and working with my colleagues to build a scalable platform, to facilitate further growth in earning assets and EPS.

Moving to Slide 10 of the presentation. We maintained a debt structure that has limited refinance risk, as most of our managed assets are either securitized or funded with amortizing nonrecourse debt. The 2019 nonrecourse maturities are being addressed, as we are currently negotiating extensions and term takeout financing. As previously disclosed, we are also currently evaluating corporate unsecured debt as part of our liquidity platform.

We also anticipate continuing to utilize regular way in the aftermarket equity offering programs to address liquidity needs, and we will be refreshing our shelf in the current ATM up to $250 million around the filing of our 10-K.

The graph at the bottom of Page 10 further reinforces the limited maturities over the next few years.

Now I'll turn the call back over to Jeff Eckel.

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [6]

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Welcome aboard, Jeff Lipson.

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Jeffrey A. Lipson, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Executive VP & CFO [7]

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Thank you.

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [8]

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Turning to Slide 11. We want to highlight some of our environmental, social and governance metrics and the progress we've made in the year. As we've discussed our investment thesis, is that in a world increasingly defined by carbon, we will earn superior risk-adjusted returns, investing on the right side of the climate change line. We have long operationalized the thesis by using CarbonCount, which calculates the carbon reduced per $1,000 of investment. This is under the theory that if carbon counts and capital is scarce, we should seek to make the most impactful investments.

As part of our commitment to transparently reporting the E in ESG, we published an annual sustainability report card, disclosing the CarbonCount of every investment we made in the year and which will show a 0.42 CarbonCount in 2018, representing avoided carbon emissions.

We have continued our industry leadership in TCFD disclosures by integrating much of the disclosure into the 10-K we will be filing in the next few days.

Our corporate culture is reflective of our commitment to ESG, which will be detailed in our forthcoming ESG report coming out in Q2. One example of this culture was the initiative of one of our young people to organize a team to install solar panels on low-income housing in D.C. Our employees' commitment to advancing these types of initiatives is inspiring, and I'm honored to work alongside them.

Turning to Slide 12. In closing, we couldn't be more optimistic about our business. We're investing in a large and growing market. Over the long term, estimates indicate our addressable market as a multitrillion dollar one. That's true. However, we estimate the current addressable opportunity for the next 5 years with assets we like, possessing attractive risk-adjusted returns and sponsored by a top-tier client in a programmatic effort to be closer to $100 billion, still substantial.

This lower addressable market estimate indicates that we are carefully navigating the large opportunity set to ensure we are getting the best risk-adjusted returns in these complex markets. Our client base is dominated by top-tier firms growing to capture the decentralized, digitalized and decarbonized future of energy. These firms are the key to any of our success in combating climate change, and we are grateful for the opportunity to support them.

By sticking with our programmatic focus, we will also benefit from additional operating leverage. Our assets are well diversified, relatively granular, yet similar in structure, giving us an excellent portfolio to manage.

We continue to have one of the most experienced teams in the industry. With our staff additions in 2018 and 2019, including Jeff Lipson, of course, we have deepened and broadened our skill.

Thank you for joining us today. We'll now open the call up for a few questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll go first to Julien Dumoulin-Smith of Bank of America.

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Anya A. Shelekhin, BofA Merrill Lynch, Research Division - Research Analyst [2]

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This is Anya, actually, filling in for Julien. So, I guess, my first question is I just wanted to get a sense of your strategy for the business model looking forward. How much in on balance sheet assets are you looking to hold on to versus securitizations? Specifically, what's a good estimate for the targeted split for 2019 and then, going forward, after that, more long term?

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [3]

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So this year, we did about 60% of securitizations and about 40% on balance sheet. We would expect that, that would continue at that level. Or probably depending on the assets we see, we may increase putting on balance sheet. As we've talked about in the past, our model, longer term, in a normal rate environment would be at a 70-30 on balance sheet. But given the flat yield curve, a lot of the assets we originate are best -- we best realize the value in those by securitizing them. Given the environment, we would expect to continue to have a fairly high-level securitization comparable to this year or maybe slightly inside of that.

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Anya A. Shelekhin, BofA Merrill Lynch, Research Division - Research Analyst [4]

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All right. Great. And second, what's your growth strategy in terms of resi solar market? And specifically on that, how much of that 75% of behind-the-meter pipeline over the next year, would you expect to include resi solar? Maybe any information on what markets you're looking to get into there. And then what kind of return profile are you aiming for, for resi solar?

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [5]

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Well, you've got quite a few questions into your second question. The 75% Behind the Meter is dominated by energy efficiency, our legacy market. Resi solar is relatively new. It's growing. Julien covers most of the companies that are out there and some of whom are our clients now. We expected to be an interesting pipeline. We would say that we're not going to become a residential solar finance company. We're going to continue to build a diversified portfolio on balance sheet. We like the assets we've got, we like the pipeline we've got, but really, the efficiency market is growing just as fast as the resi solar market. I'm not sure I answered all of your questions, but we haven't -- we've disclosed some of the returns on the resi solar portfolio, so I won't repeat those. And if we haven't disclosed it, we can't talk about them.

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Operator [6]

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We'll go next to Mark Strouse with JPMorgan.

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Mark Wesley Strouse, JP Morgan Chase & Co, Research Division - Alternative Energy and Applied & Emerging Technologies Analyst [7]

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So just starting off, Brendan, thank you very much for your help getting us up to speed, and congrats on the new role, and, Jeff, we look forward to working with you. So our first question, I mean, it sounds like the pipeline is still very well diversified, but just, in particular, looking at the 4Q strength and the beat versus your guidance on the EPS level, was there any particular end markets that led to that outperformance that you can call out?

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [8]

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Well, I think, it was last quarter, we used the phrase that we're hitting on all cylinders, and it's like a 10-cylinder engine. We've got 10 niche markets. It really does continue. Whether it's Q3, Q4 or Q1, we don't have that. We have no control over which cylinder fires. But in general, when half of them are hitting, things go well. When it's closer to all 10, it's pretty good business. And beyond that, it's a good time to have the position we have in behind-the-meter assets with the Behind the Meter clients that we have. I think this is where the market is going, and frankly, it's coming right towards us.

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Mark Wesley Strouse, JP Morgan Chase & Co, Research Division - Alternative Energy and Applied & Emerging Technologies Analyst [9]

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Okay. That's helpful. And then just a quick follow-up. So your originations in 2018 were a bit above your long-term targets of about $1 billion or so, but just how should we think about that in 2019? I know it's kind of hard to predict, but at this point, are you expecting kind of similar levels to '18 or should we be modeling closer to your longer-term targets?

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [10]

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Well, as you hinted that the business model still stands at $1 billion, I think, it's reasonable to think that if we're hitting on all 10 cylinders, there's a good chance it's more than that. At the same time, this is not a point in the business cycle where we want to reach for marginal assets, and we're going to continue to be careful about which ones we go for. So the market's good. We would prefer to optimize on picking the best risk-adjusted returns rather than going -- growing for growth's sake.

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Operator [11]

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We'll now take your question from Noah Kaye with Oppenheimer & Co.

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Noah Duke Kaye, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [12]

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I'll echo congratulations to Brendan on the evolution of your role. Welcome aboard, Jeff. I guess, we're going to have to start disambiguating by specifying which Jeff we're talking to. But, I guess, given the focus on Behind the Meter, I actually want to ask you about activity around microgrids. You've talked about some of the signature projects like the Paris Island microgrid. We've seen Hawaii began the proceeding to actually create a microgrid's tariff. It looks like California could follow. We understand these are typically long-cycle development projects, but just wondering if you're seeing an uptake in activity there. Yes, just comment -- if you can comment on that market?

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [13]

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Well, The White House was in the news this morning for their new task force that's looking at resiliency issues with DoD. And certainly, we continue to see DoD continue to invest through ESPCs in effectively microgrids for resiliency and cost reductions. I think all large campuses, whether they're DoD or not, are probably thinking that way. The best thing about these emerging trends is, with our client base, our clients are out there talking to the folks in Hawaii and the U.S. government and any of the other campuses. And we may not hear about them, but we have complete confidence that when those jobs go to execution time, we're going to be in the mix for financing that. So I think the kind of conclusion on microgrids is, if you have increasingly violent storms, having on-site generation is the only way you can ensure reliability. So, I guess, the bad news is we're going to have worse storms. The good news for Hannon Armstrong is that probably is positive for our future business.

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Noah Duke Kaye, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [14]

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Understood. And then, I guess, just a question around your comments on capping your leverage, really, kind of seeing that 2.5:1 as a cap. Can you maybe just elaborate on that a little bit in the context of how the portfolio is evolving, you called out the increase in noninvestment-grade exposure, and how we kind of square this with the efforts that the company is making to look at the possibility of corporate debt?

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [15]

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Sure. So a couple of comments on that, Noah. First of all, we've never really hit the 2.5:1. We got the 2.4:1, but we never really hit the 2.5:1. So that was 1 comment. The other comment, and especially as you start to think about things like corporate debt, and I'll take the transaction that was paid off this quarter, we had $300 million of assets. We had $250 million of debt. So net equity was only $50 million. So when you look at that on a leverage basis, that's pretty highly levered. And if you just were reporting the net equity number, you'd have a much lower leverage and enjoy the same, if not higher, return. So -- especially when you start to think about rating agencies and things, it makes sense to kind of look at where you're levered and are you levered in the appropriate way and do the assets be kind of put on the balance sheet at a gross versus a net level.

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Operator [16]

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We'll now take your question from Philip Shen with Roth Capital Partners.

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Philip Shen, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [17]

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Brendan, congratulations as well, and Jeff, looking forward to working with you.

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Jeffrey A. Lipson, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Executive VP & CFO [18]

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Thanks. Likewise.

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Philip Shen, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [19]

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Back to resi solar for a bit. A follow-up to Anya's question earlier. Jeff Eckel, I know you had mentioned you guys do not want to become a resi solar finance company, but when you look at these originators, SunPower, Vivint, Sunrun, et cetera, they are installing meaningful megawatts every year. Can you maybe give us a little bit more color on what that line might be? I think SunPower might be 300 megawatts this year. Vivint was 200 megawatts. And I think you mentioned that you are doing business with 3 resi solar companies, but I believe you may have only announced 2, Vivint and SunPower. Is it possible to talk about who that third one might be?

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [20]

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Thanks, Phil. On your last point, we always let our clients lead. So whenever that third company chooses to disclose, that's when it will be public. Let me clarify one of your question when you said line. What do you mean? Can you give us a view on the line? You talked about SunPower and Vivint, but I'm not sure what you're looking for.

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Philip Shen, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [21]

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Yes. So there's a line between being -- not being a resi solar finance company and being one. So is there a metric that you guys -- like at what point do you guys become too resi solar-heavy? And so how do you think about where that line might be on whatever metric you guys might use internally?

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [22]

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That's a good question. We clearly do not have a line that is quantitative. I think we're very comfortable with where we are now. We would probably be hesitant to add significantly more. At the same time, a lot of these transactions ended up in the last 1/3 of the year. We don't expect similar volumes in the first 1/3 of 2019. Instead, we'll see volumes in other markets. We've talked about wetlands and mitigations, stream restoration, those are coming on balance sheet, we believe, in the first 1/3 of the year, C&I solar. So kind of had a lump of resi solar at the end of the year, and now it's time for us to add some other asset classes as we always expect to, including PACE asset.

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Philip Shen, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [23]

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Great. One quick follow-up on resi solar. And forgive me, but I am straddling 2 different earnings calls, and I may have missed this in your prepared remarks. But I recall the SunStrong initial deal was $100-plus million for mezzanine debt and then $10 million for equity. And then now you guys are $270 million, plus an additional $30 million of equity, $270 million mezz debt. So incrementally, is there $170 million more of the mezz debt and $20 million more of equity? And can you just talk about who this might be with? And apologies if you guys have already addressed this.

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [24]

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Yes. So, Phil, in the call, we talked about $300 million. We talked about with 3 of the top sponsors. And $270 million of it is classified as debt and $30 million is classified as equity. We didn't give more detail. But the fact that the transaction you're referring to is one of the 3 sponsors, you can imagine that we did 2 other transactions that gave us the additional volume.

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Philip Shen, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [25]

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Okay. And then lastly, Jeff, you just mentioned C-PACE. Can you give us an update on how things stand there? Historically, it's been -- it's still on the horizon. Is there some development to think that maybe in 2019, we could see some degree of acceleration in that end market?

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [26]

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I would say it is still on the horizon, but we are obviously talking about it. We do think 2019 should be a pretty good year for C-PACE, and we're very much -- we've been investing in this platform. Those investments, we think, are starting to turn the corner and pay off. So again, we'll announce things when they're closed, not before, but we continue to think that's a sound market for us to invest in.

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Operator [27]

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We'll now take your question from Christopher Souther from Cowen and Company.

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Christopher Curran Souther, Cowen and Company, LLC, Research Division - Associate [28]

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Welcome, Jeff, and congrats on the new role, Brendan. First question, you suggested that 60-40 split between securitization and balance sheet transaction, given the industry environment might be something to kind of think of going forward as well. But you also said you expected to hit the midpoint of guidance without kind of an elevated gain on sale. Are those gain-on-sale trend thing pretty consistent? Just kind of curious if you're keeping the 2020 range for EPS despite kind of a strong 2018, want to get a sense if this is like conservatism, potential lumpiness or some other factor?

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [29]

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So I think to clarify that question a little bit, Chris, we said we -- the comment I made was we're going to -- thought interest rate expense would decrease by about $8 million, which would allow us to bring down gain on sale somewhat. So I don't think we're talking that gain on sale is disappearing or anything. But it was $37 million last year, so it's going to go down from that number as we put more assets on the balance sheet and recognize more net interest income -- or net investment income off of those assets. So I think it's a shifting or a sliding of the gain on sale versus a wholesale change. The other point that you made is, yes, certain transactions are, like anything else, certain transactions. The margins move around a little bit. In total, they've been relatively consistent, but they do move around a little bit, depending on the transaction that we're securitizing.

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [30]

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But we don't see any particular trend in securitization margins. It's more the mix in a quarter or in a year. But if you take a much longer view, it's pretty much the same.

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Christopher Curran Souther, Cowen and Company, LLC, Research Division - Associate [31]

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Okay, that's helpful. And then just kind of, to put the $300 million residential solar in context, do you guys know how much of that was kind of new leases type thing as opposed to one that were on the balance sheet of kind of these residential partners? Just to kind of get an idea of what the run rate is here, I think, might be helpful.

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [32]

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So I think the SunPower assets were disclosed. They were the 1/3 of assets we've had for -- roughly 1/3 of the assets we've had for 5 years that were refinanced, and we just entered at a different point in the capital stack. I don't know that we're prepared to talk about it for the other 2 providers.

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [33]

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But is it fair to say 2/3 are relatively new assets?

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [34]

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More current.

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [35]

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Yes.

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Operator [36]

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We'll now take questions from Carter Driscoll with B. Riley FBR.

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Carter William Driscoll, B. Riley FBR, Inc., Research Division - VP & Equity Analyst [37]

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Mr. Herron, who's going to explain HLBV to me any more? I'm going to have to...

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [38]

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I'm still around, Carter. I can still do that service for you.

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Carter William Driscoll, B. Riley FBR, Inc., Research Division - VP & Equity Analyst [39]

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Terrified me there for a moment. No, seriously. So maybe could you explain maybe a little more color your role? Are you looking at exploring new types of financing alternatives as kind of the composition of your portfolio slightly shifts? And would that be with some newer partners? Just trying to get a little bit of additional detail on how your role -- what your role really is morphing into.

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [40]

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So, Carter, a couple of things. I mentioned that we've got SunStrong and Hannon Armstrong sustainable real estate. These are platforms that are an evolution of our origination strategy. We've always talked about Johnson Controls having a master purchase agreement, that's 20 years old, and we just add new pages to it each year. What we're doing with SunStrong, HASRE and a few other efforts are significantly more complex. They're effectively joint ventures that are not as simple as adding another addendum to a master purchase agreement. So in looking at how the business is evolving, it's fantastic to have a great businessperson on staff, who can really step into these ventures as a businessperson, not just a transactor, not that we don't cherish our transactors. But there's an experience that we need to bring to bear in these joint ventures because our clients are big companies and they have a load of staff. We don't. So it's good to have Brendan now able to be our load of staff to match up with our client. And as you know, his intellect is more than 1 person. So we're just delighted to have him available now with Lipson coming onboard. With that, Brendan, do you want to expand on that?

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Carter William Driscoll, B. Riley FBR, Inc., Research Division - VP & Equity Analyst [41]

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I'm just going to say, so, I mean, it's a deepening of relationships in a different form. Is that the right characterization or...

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [42]

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I think it's part of that. And I think the other 2 things that we've talked about is -- is kind of goals is, how do we capture more of this emerging market opportunity? What is it? And how do you capture it? And then how do you do it in a more profitable way? So I think those are kind of the 3 things I'm going to be primarily focused on, is, how can we continue to grow and capture new -- and develop new niches either through partnerships or otherwise and how do we do it more profitably and enhance the business further.

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Carter William Driscoll, B. Riley FBR, Inc., Research Division - VP & Equity Analyst [43]

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If you're successful, is it just reasonable to assume a higher level of ROE over time?

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [44]

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Yes, I think so. I hope so.

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Carter William Driscoll, B. Riley FBR, Inc., Research Division - VP & Equity Analyst [45]

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Just a quick follow-up. So in terms of like rate normalization, do you have like a monitor that we could ourselves, whether it's a 2 and 10 or commercial paper and some other long-yielding instruments, where you get some level of spreads for some duration that would kind of tip the balance more towards on balance sheet versus securitization? Are there effective number of different metrics you utilize?

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [46]

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Yes. We do -- the first thing we do on every management meeting on Monday is look at interest rates, spreads, trends, so on and so forth. And so we look -- one of the things we look at is the 2 and 10. We look at also the 3 months and the 10. So if you look at the curve now and we compare it against last week and against last year, and you obviously see it's very flat, and in some places, it's actually inverted, so we look at that. Obviously, we'd like to see steepening. We pay attention to what the Fed says because they're the ones that determine things, but also look at other sources. So we look at a variety of things, but from a curve flattened standpoint, it's basically a 2, 10 or, as I said, a 3-month LIBOR to 10.

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Operator [47]

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We'll now take a question from David Katter with Baird.

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David Francis Katter, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [48]

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Quickly looking on guidance for next year. And I don't want too ahead of ourselves after a strong quarter, but can you talk about what happens to get you to the low end of guidance and the high end? Is that all volatility and gain-on-sale income? And then maybe speaking more long term, what can jump-start EPS growth rates in your view? Does it require a steepening of the yield curve or do you have -- what other levers do you have to kind of accelerate growth?

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [49]

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Do you want to...

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [50]

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Yes. So I think...

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [51]

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This is our last question, Brendan. This is your last day -- where are you? I know that you're here. Give me that blank....

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J. Brendan Herron, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - EVP [52]

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So a good question, David. I didn't give you a blank look. So I think, yes, gain on sale, obviously has a big impact because that's variable. And I think as we've always talked, we don't control closing. So if something slips to the right, especially on a gain on sale, has a much bigger impact on EPS than if a on balance sheet transaction slips. I think we can think we're continuing to do the right things in the business to set the business up for the future and to grow more. We think that we're in this through the long haul. As Jeff said, it's late cycle, so we don't necessarily -- don't want to be in a situation where we feel like we're reaching for things. So it's a matter of being disciplined in how we approach it. But we do think that there's lots of exciting opportunities. So we're going to continue that discipline, but also look for places where we can either grow origination or add more assets to the balance sheet or lower our cost of debt. So I think those 3 things, we've always talked about how we grow earnings, and growing earnings is new additional assets. It's increasing the net interest income. It's the -- continuing to work on our operating leverage. And we still have, I think, a lot of ability to increase our finance leverage also. So we continue to think and focus about those things, and that's how we'll be able to continue to grow earnings above kind of what we said.

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Operator [53]

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And it appears there are no further questions at this time. I'd like to turn the conference back to Mr. Jeff Eckel for any additional or closing remarks.

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Jeffrey Walter Eckel, Hannon Armstrong Sustainable Infrastructure Capital, Inc. - Chairman, President & CEO [54]

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Thank you. Once again, you asked good questions. We look forward to speaking with you all soon. Over and out.

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Operator [55]

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This concludes today's call. Thank you for your participation. You may now disconnect.