Q3 2023 Hannon Armstrong Sustainable Infrastructure Capital Inc Earnings Call

Thomson Reuters StreetEvents

Fri, Nov 3, 2023, 7:05 AM31 min read

In this article:

Participants

Jeffrey A. Lipson; President, CEO & Director; Hannon Armstrong Sustainable Infrastructure Capital, Inc.

Marc T. Pangburn; Executive VP & CFO; Hannon Armstrong Sustainable Infrastructure Capital, Inc.

Neha Gaddam; Senior Director of IR & Capital Markets; Hannon Armstrong Sustainable Infrastructure Capital, Inc.

Susan D. Nickey; MD; Hannon Armstrong Capital, LLC

Benjamin Joseph Kallo; Senior Research Analyst; Robert W. Baird & Co. Incorporated, Research Division

Christopher Curran Souther; Research Analyst; B. Riley Securities, Inc., Research Division

Jeffrey David Osborne; MD & Senior Research Analyst; TD Cowen, Research Division

Jonathan Mark Windham; Executive Director & Equity Research Analyst of Utilities; UBS Investment Bank, Research Division

Julien Patrick Dumoulin-Smith; Director and Head of the US Power, Utilities & Alternative Energy Equity Research; BofA Securities, Research Division

Mark Wesley Strouse; Alternative Energy and Applied & Emerging Technologies Analyst; JPMorgan Chase & Co, Research Division

Noah Duke Kaye; Executive Director & Senior Analyst; Oppenheimer & Co. Inc., Research Division

Presentation

Operator

Greetings, and welcome to HASI's Third Quarter Earnings Conference Call and Webcast. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Neha Gaddam, Senior Director, Investor Relations and Corporate Finance. Please go ahead.

Neha Gaddam

Thank you, operator. Good afternoon, everyone, and welcome. Earlier this afternoon, HASI distributed a press release detailing our third quarter 2023 results, a copy of which is available on our website. This conference call is being webcast live on our Investor Relations page of the website, where a replay will be available later today. Some of the comments made on this call are forward-looking statements, which are subject to risks and uncertainties described in the Risk Factors section of the company's Form 10-K and other filings with the SEC. Actual results may differ materially from those stated. This discussion also include some non-GAAP financial measures. 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 Jeff Lipson, the company's President and CEO; Marc Pangburn, CFO; and Susan Nickey, our Chief Client Officer. Susan will be available for the Q&A portion of our presentation. Now I'd like to turn the call over to Jeff, who will begin on Slide 3.

Jeffrey A. Lipson

Thank you, Neha, and good afternoon, everyone, and thank you for joining the call. We had an outstanding quarter as measured by nearly every meaningful metric, and the business remains positioned for future success. Before we discuss the quarter, I'll address an item of recent market perception. A sentiment has emerged recently, which has been weighing heavily on stocks related to the energy transition. This perception assumes renewables and other clean energy sources are no longer economically viable due to the higher cost of capital, driven by the higher for longer outlook for interest rates and that this impact will cause a substantial slowdown in project development and deployment of clean energy.
We believe this view is not accurate. In fact, the energy transition is in its early stages and continues to grow on a steady long-term trajectory. Just this week, the American Clean Power Association reported record-breaking third quarter U.S. capacity installations and 10% year-over-year growth in the utility scale wind, solar and storage project pipeline. Although not every project remains viable, clean energy demand remains elevated and the levelized cost of renewable energy remains competitive or less expensive than the alternatives.
As one example, the AI-driven build-out of data centers has created significant incremental demand for renewable electricity. Likewise, the higher cost of capital and other input costs are being passed on to the end user due to the ongoing growth in demand, particularly from corporate buyers with ambitious net zero goals and utility off-takers. These economic dynamics continue to validate our business model as a provider of capital to the energy transition. The energy transition is a long-term noncyclical macro trend, and our team is well situated, enthusiastic and capable of continuing to work with our clients to meet the demands of this transition.
Further evidence of the strength of our business model is in our third quarter and year-to-date results. We are reporting record quarterly distributable earnings of $0.62; record quarterly volume of almost $1 billion; and year-to-date total volume of $1.8 billion, which is similar to annual volume over the prior 3 years. In addition, consistent with our objectives discussed throughout this year, we are reporting investment yield on new balance sheet investments year-to-date of greater than 9%, well above the expense of our incremental year-to-date debt, resulting in continued healthy market.
These results and the outlook for the business allow us to affirm our existing guidance of 10% to 13% EPS growth and 5% to 8% dividend growth through 2024. As Marc will discuss, we have deployed a thoughtful, diverse and strategic capital plan in 2023 despite challenging markets. The $1.5 billion of debt and equity we have raised has resulted in a strong balance sheet and liquidity position and has allowed us to continue to operate the business with a strategic long-term focus rather than under any short-term direct. This capital raising in 2023, coupled with the substantial investment volumes, has also situated the business such that we do not require incremental equity to achieve our guidance.
We always have and remain focused on diversifying our liquidity sources, including our recent initiatives to develop incremental channels of off-balance sheet growth that we refer to as capital-light.
Turning to Slide 4. I would like to discuss how well positioned we are to achieve our EPS guidance in the range of $2.27 to $2.53 per share in 2024. In part due to our success in 2023, increasing the portfolio by $1.2 billion so far this year, we are well situated for earnings growth in 2024. In fact, we can attain the guidance level of EPS without any new equity issuance nor any new balance sheet investments. No incremental debt is necessary, and our gain on sale and fees can be consistent with the annual levels over the past 3 years. Therefore, our path to achieving guidance has limited variables.
Turning to Slide 5. I believe the company should always have an executable plan to focus the organization. Our action plan in this period of volatile capital markets is displayed here. General capital scarcity has provided an investment opportunity at even higher level of return than we've seen in 2023 year-to-date. The average yield of investments in the pipeline is greater than 10%, and these are investments consistent with the risk profile of our existing portfolio. We intend to fund these new attractive investments with balance sheet rotation of these investments and debt issued outside the capital markets.
We also plan to expand our securitization program. We've utilized to fund $6 billion of investments off balance sheet. The final item in the action plan is to make further progress executing transactions with private capital providers that allow us to continue investing, utilizing off-balance sheet sources of capital. All of our success in 2023 closing a large volume of transactions at an attractive yield has positioned the business to expand our capital-light initiatives at a reasonable pace.
It is important to note that our company has a long history of executing on these action plan items. We have a demonstrated track record of adapting our capital and funding structure in a way that allows us to continue to actively invest and grow our earnings per share. Therefore, this action plan fits well within our comfort zone.
Slide 6 is a good summary of our year-to-date investment activity highlighted by our $1.8 billion of value at an average yield greater than 9%. Notably, our Fuels, transport and Nature segment has been very active, producing 38% or over $600 million of the 2023 volume. We remain very disciplined regarding margins and expect future investments to be at an attractive margin to our cost of funds.
On Slide 7, our investment pipeline of greater than $5 billion is well diversified among noncyclical and uncorrelated end markets. Customer demand for renewable power continues to drive more opportunities and higher PPA prices at our projects to pass on higher costs. As discussed earlier, energy transition assets remain economic and strongly preferred by many users due to climate goals and cost competitiveness versus alternatives.
I will also reiterate that the return profile on these pipeline investments is well above our current portfolio yield and had a strong margin to our cost of funds. Now I'll turn the call over to Marc Pangburn to detail our financial results.

Marc T. Pangburn

Thank you, Jeff. I'll begin on Slide 8 by summarizing our financial performance. Simply put, our third quarter and year-to-date execution continues to prove our adaptability to a rapidly changing macroeconomic environment. In the third quarter, we are reporting record distributable EPS of $0.62. We closed a record amount of new transactions of $973 million, and these transactions were at record yields. Over the last year, we grew our portfolio by 41%, $5.5 billion and managed assets 22% to $11.5 billion. Continued growth of our portfolio translated to a 20% increase in year-to-date distributable NII to $160 million, meaningfully increasing our long-term recurring income. Amplifying Jeff's comments earlier around our existing capital-light activities, we also recorded $69 million of gain on sale, fees and securitization income for year-to-date 2023, reflecting an 8% increase year-over-year and a notable increase in our securitization income, which is now $13 million in the same period.
This included a balance sheet rotation where we were able to securitize an on-balance sheet portfolio seasoned and assets at a gain.
Turning to Slide 9. Our portfolio yield increased for the second quarter in a row from 7.7% to 7.9%. Year-to-date, our yield on the portfolio increased by 40 basis points after being relatively constant for 4 years. In the third quarter, we funded $855 million. We anticipate funding additional commitments of $645 million through 2024. Year-to-date, our portfolio has grown at a record pace 1.2 billion compared to a 700 million average over the prior 3 years. And reiterating Jeff's comments on the business mix, FTN has grown from 4% of the portfolio at year-end '22. And to 13% as of Q3 '23 driven primarily by RNG.
I'd like to take a moment to reiterate a few common characteristics of our portfolio. We typically invest with some form of preference. Not only do we have preference, we also invest at the asset level. This creates a noncyclical dynamic where changes in interest rates or client growth have minimal impacts on portfolio performance. It also mitigates corporate risk as the various service providers to project can be replaced based on performance or disruption at the corporate level. Another common attribute of our investment profile is we typically do not take development risk. We invest based on asset collateral and the economic value of any particular project that has been established.
Certain segments of the energy transition are more or less economic today. For example, energy efficiency, solar and RNG continue to have strong viability. And to briefly address recent industry news, we have no offshore wind in our pipeline or portfolio.
On Slide 10, we're pleased to report growth in margins due to a faster growth in our portfolio yield at 7.9% compared to interest expense of 4.9%. We will continue our disciplined investing strategy on pricing new assets at a margin to our current cost of funds. Last quarter, we provided additional context to address questions on our 25 and 26 bond refinancings. As a reminder, the base rate or the expected bond refinancings are currently hedged around 3%. Based on the market spreads updated yesterday, theoretical refinancing would result in a blended cost of debt of 5.7%. While we continue to evaluate higher-yielding new investment opportunities, even if we close no additional transactions, the spread would result in a greater than 11.5% ROE.
Turning to Slide 11. Our liquidity remains robust, and I'm pleased to provide additional specificity around our debt raising activities. Starting on the top left, our liquidity is strong with a total of over $710 million of cash and undrawn revolver capacity. The total liquidity includes $165 million, which relates to an upsize of our unsecured term loan A, which was closed after quarter end. Our current leverage is 1.7x, which provides additional room to utilize debt to fund further portfolio growth while operating within our leverage target. 88% of our debt is either fixed or hedged and the process around the REIT tax conversion is proceeding smoothly.
Now I'd like to highlight recent debt raises, all at rates well below our investment yields. Recently, we have upsized and extended a secured debt facility with a hedged interest rate of 6.9%, upsized our TLA, which carries a hedged interest rate of 6.5% and issued convertible debt with a total cost of 5.6%, inclusive of an option premium to increase the conversion price. Looking ahead, an example of a path to attractively priced incremental debt, we expect to raise secured debt on our portfolio of solar assets based on an expected rating of BBB minus.
In the quarter, we raised more than $770 million of incremental debt, including the TL Year-to-date, we've raised approximately $1 billion of debt at a blended rate of 6.5%, driving spreads that resulted in a ROE of greater than 13%. In summary, record EPS, record closings and record asset yields leading to attractive spreads, positioning us well to achieve guidance with no additional equity capital. With that, I'll turn the call back to Jeff.

Jeffrey A. Lipson

Thanks, Marc. Turning to Slide 12. We update our sustainability initiatives, including 2 items related to the measurement and reporting of the impact of our investments and a recognition that our team remains active in climate justice community service. .
I'll wrap up on Slide 13. We continue to execute on our business plan, producing consistent earnings growth despite challenging capital markets. The long-term fundamentals of our business are very powerful. We continue to operate in growing noncyclical investment markets, working with active partners providing capital at the asset level. Our consistent results over several cycles and operating environments provide a demonstrated track record that we intend to replicate. And we have a specific action plan to thrive during this period of volatility.
We are very proud of our success in the first 3 quarters of 2023 and have positioned the business for additional prosperity. I thank our dedicated and talented team for continuing to execute on our goals. That concludes our prepared remarks. Operator, please open the line for questions.

Question and Answer Session

Operator

(Operator Instructions) Our first question comes from Noah Kaye with Oppenheimer.

Noah Duke Kaye

There were a lot of great details in this presentation and congrats on the great quarter. I want to ask you about the balance sheet rotation to start. You called out the real estate securitization, and we can see that movement in the balance sheet. Can you talk a little bit about the profiles of additional assets and both sort of the magnitude of those rotation opportunities and potential incremental lift in average yield you would get from such a rotation?

Marc T. Pangburn

Sure. So I'd say the profile of the type of investment that would be on our balance sheet and then we could look to securitize would be something that we are likely currently already securitizing. But before it became an asset class that we could reliably securitize, we would close those assets onto our balance sheet. And they've largely sat on our balance sheet, but they have now been seasoned to a point and proven from a securitization perspective, that we can look to pull from that.
We do have additional opportunities to pursue balance sheet rotations. As you might imagine, it's ultimately pulling from a static portfolio, so there is a limit to that. I wouldn't put an exact number on it right now, but I wouldn't be surprised to continue more of that activity.

Jeffrey A. Lipson

And I think just to add to that, Noah, thanks for the question. On the bottom right of Page 11, where Marc referenced, additional secured debt, that's an example of assets that sit on our balance sheet that we can obtain a rating on, which makes them that much easier to securitize and rotate off. So that's good live evidence of that activity.

Noah Duke Kaye

And that would be sitting within equity method? .

Jeffrey A. Lipson

Not necessarily. It could either be debt or equity. .

Noah Duke Kaye

Okay. Okay. Very helpful. I think just one more. It looks certainly as though RNG has become a significant part of the growth story for the company. You talked a little bit at your Investor Day about additional asset classes, maybe 2 to 3 years down the pike. Maybe you could talk a little bit about where you have conviction or greater interest in those opportunities today, how those asset classes are maturing. I certainly would love to hear from Susan as well, if you don't mind.

Susan D. Nickey

Sure. Thanks, Noah. Yes, renewable natural gas has been a growth market, and we had strong projections for sort of a 25% market continued growth. But with corporate demand also looking to decarbonize across all their different sectors, there's increasing demand and also economies of scale from other renewable fuels or transport and decarbonization of different parts of the industrial sector.
So we continue to monitor those and watch as we're still waiting for guidance on some of the tax credits that are expected to come out at the end of this year, which will also help support the growth and scaling of some of those new sectors.

Noah Duke Kaye

Yes, we're all hoping for those clarifications. And hopefully, that's something we can revisit in future calls.

Operator

Our next question comes from the line of Mark Strouse with JPMorgan.

Mark Wesley Strouse

I wanted to go to the comments about the yields being above 10% for the pipeline. Can you talk about how kind of broad-based that might be versus how much of that is driven by kind of maybe an increasing mix towards FTN?

Jeffrey A. Lipson

I would characterize it, Mark, as broad-based. I think we're seeing yields at that level given where markets and capital are right now in really all 3 of our segments. That's not overly driven by FTN.

Mark Wesley Strouse

Okay. And then I appreciate the commentary about the 2024 targets being able to be met without or I guess, sorry, with the gain on sales being kind of in line with where they've been in the last few years. How are you thinking about that model, though? I mean maybe that represents maybe a downside scenario, but are you thinking that 2024 could be a higher year for that line item than what you got this year?

Jeffrey A. Lipson

Well, it certainly could be a higher line item. That's one that you need to recreate every year. I think our forward pipeline of assets that can be securitized gives us strong confidence that where we're tracking towards this year, we'll be able to achieve again next year and thereby able to achieve our guidance. And remember, those parameters to achieving guidance that we laid out are meant to be sort of the bare minimum.
It's not actually our plan, of course. So I think we, from a gain on sale perspective, remain confident that we'll be able to replicate this year again next year, and there is some chance we'll exceed it.

Operator

Our next question is from Chris Souther with B. Riley Securities.

Christopher Curran Souther

So essentially, it seems like we're saying with today's balance sheet and kind of normal gain on sale, we're already at next year's guidance. But there's obviously kind of a big pipeline of opportunities here that you guys are looking to execute on.
Can you kind of just walk through puts and takes around the impact that rotation of assets would have on the balance sheet size and, therefore, what we would get as far as net investment income next year versus kind of the new debt that's coming on. I just wanted to kind of square away. It sounds like you're saying there's potentially kind of good upside to the guidance for next year.

Jeffrey A. Lipson

Sure. Thanks, Chris. And I'll start, and maybe Marc will add to this answer. But I would start by saying the portfolio balance, given all of the volume we did this year and a decent amount of it in the back half of the year, of course, creates a dynamic where the average portfolio balance next year is already going to be unambiguously higher than this year. So that creates earnings growth in and of itself.
In terms of executing on the pipeline, as we talked about some of these balance sheet rotation ideas and some of the things we're developing in terms of other off-balancing channels will help us on that pipeline. But we'll obviously be in a somewhat, call it, capital first mode, where we want to make sure we've identified the source of funds before we move forward too actively on the forward pipeline. So I think that's the dynamic that's turning now given volatility. But we remain confident in developing these sources and actually executing on some of that pipeline.

Christopher Curran Souther

Okay. And then as we're looking at like the kind of leverage here, rotation of existing assets with $1.2 billion of receivables that are yielding below 8% be kind of the first lever there. And then as we're looking at new assets, can you kind of just walk through the decision tree between timing in the balance sheet, securitization, co-invest between specific projects that you're evaluating? Obviously, yields and kind of asset class are kind of the main 2 there, but just how you're kind of approaching that decision tree on new assets would be helpful.

Jeffrey A. Lipson

So it is, in some regard, an optimization exercise. So for example, if we have assets on the balance sheet that we could securitize at a gain and replace with new assets that are 300 basis points higher on yield, that's a bit of a no-brainer. And obviously, we'll execute on transactions that look like that. Likewise, as Marc said, leverage is 1.7, which gives us additional room for additional debt, then he laid out some prospective sources of debt that we think will be cost-effective, particularly given the yield on these investments in the pipeline. So that is another source there as well.
And then some of these off-balance sheet sources that we're working on with some new partners will be next in line behind those 2 as well. So again, that's how I think about the decision tree of raising additional funds to take advantage of this opportunity.

Marc T. Pangburn

I'd just add one comment, which is that the potential balance sheet rotation that could lead to securitization, for example, would generally be some of the lower-yielding, lower-risk assets because that is -- has generally been what's gone through our securitization program.

Christopher Curran Souther

Okay. And maybe just last one. How should kind of ROE evolve with some of these capital light activities picking up potentially for next year? And then I'll hop in the queue.

Jeffrey A. Lipson

So the long-term big picture answer to that question is these are enormously ROE-accretive initiatives because they use very little of our own capital. When you add the modifier impact next year, I would go back to my comment around piecing that some of these things we're working on will take some time. And I don't want to overpromise exactly in '24 what the impact will be. But long term, the ROEs will benefit from these type of balance sheet activities.

Operator

Our next question is from Ben Kallo with Baird.

Benjamin Joseph Kallo

Congrats on the results. Jeff, just a question we get a bunch just as we see the yields tick up as you're you taking on more risk. And if you could just address how that is, especially as you ship your asset prices. Then I've a follow-up.

Jeffrey A. Lipson

Yes. Thanks for the question, Ben. And we do get that question a lot as well. I think the natural inclination of folks that hear higher yield is to assume it's at higher risk. And so we need to keep reminding folks over and over again, in our case, it's not higher risk. It's really where the projects have gone, given base rates, given the capital dynamics in the market right now. .
These are, in many cases, the exact same investment in things like grid-connected solar, resi solar that we've done historically at significantly higher yields than we were doing, call it, 18 to 24 months ago. And in some of our new asset classes, as you referenced, we're underwriting them with the exact same criteria. We're seeking the exact same attributes in terms of client relationships, monetizing contractual cash flows such that they are identical risk to what we've done historically. So this is higher yield at the same risk. And thank you for asking because we want that to be very clear.

Benjamin Joseph Kallo

And just following up, when we think about just the guidance here, and I think this was asked before, but '24 onward, how do you think about the ability to grow without accessing capital markets beyond?

Jeffrey A. Lipson

So I think it's about having multiple levers, and we've historically had the securitization platform, access capital markets for the balance sheet. And we're working on balance sheet rotation and some of these additional levers that we're calling Capital 8. And I think we have a vision that eventually capital markets will come back as well and we'll be active there.
But until they do, we want to make sure we continue to utilize and develop new levers so that we can take advantage of this investment opportunity. As it relates specifically to the impact of all this on '25, again, as we've said before, we expect to talk about that more in February, but not on this call.

Benjamin Joseph Kallo

And you -- last question. You talked about the benefits of not being the REIT. We've heard about RA getting tax equity transfers. How do you play into all this evolving market? Is not being a REIT structure help you? Or what's the disadvantage?

Jeffrey A. Lipson

So the way to think about that is migrating away from REIT status removes the constraint that would have occurred a few years down the line since we remain primarily active in non-requalifying investments, the retest would have become a constraint. They haven't been constrained historically or not a constraint this year but would happen in the future. So for that and some other reasons that we articulated on last quarter's call, it makes perfect sense for us to seek an alternative tax election at this point. .

Operator

Our next question is from Julien Dumoulin-Smith with Bank of America.