HA Sustainable Infrastructure Capital, Inc.

Good afternoon and welcome to Hannon Armstrong's conference call on its Q3 2020 financial results. Leadership will be utilizing a slide presentation for this call, which is available now for download on the company's 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. All participants will be in a listen-only mode. If you need Any operator assistance, please press star zero on your telephone keypad. At this time, I would like to turn the conference call over to Chad Reed, Vice President, Investor Relations, and ESG.

Thank you, operator. Good afternoon, everyone, and welcome. Earlier this afternoon, Hinton Armstrong distributed a press release detailing our third card 2020 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 take 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 Jeff Echol, 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 begin on slide three. Jeff?

Thank you, Chad, and good afternoon, everyone. Today, we are announcing that we've grown core earnings year-to-date 18% to $1.19 per share with $0.36 core earnings for the quarter. closed 716 million of transactions in Q3. This is inclusive of the previously announced $500 million investment with Engie, which puts us at a $1.1 billion of investments year-to-date. We've lowered our cost of corporate debt and extended its duration through our successful issuance of more than half a billion dollars of green bonds, which Jeff will describe in more detail later. We recorded our highest quarterly avoided carbon emissions with an estimated 1.2 million metric tons representing a carbon count score of 1.67. Finally, we declared a dividend of 34 cents per share. We're pleased to report these results and also note that since the global pandemic and resulting economic recession erupted in March, we've raised and committed to invest over $1 billion in climate change solutions. while our portfolio continues to perform and generate historically strong earnings. Our teamwork has been excellent during this extraordinary period, and we remain, thankfully, in good physical health. Furthermore, we're continuing our ESG leadership. We've been using carbon count since 2013 in order to measure the efficiency with which our capital is reducing carbon. With our recent membership in the Partnership for Carbon Accounting Financials, or PCAF, we have joined with over 70 financial institutions to help drive the development of a global, transparent standard that will build on the carbon count concept. We've also continued to move forward on a number of social initiatives, which we'll discuss in the subsequent slide. Before we move on, a few words about the election. The resiliency of the Hannon Armstrong business model to political changes has been proven over the last 40 years, and particularly over the last four years. We expect our clients to continue to drive the low-carbon energy future independent of what happens with federal climate policy. As an example, the recent formation of the American Clean Power Association indicates the clean energy industry is showing its strength and maturity to create a powerful and unified voice for the industry in advocacy efforts going forward. A special recognition to our Susan Nickey for her leadership in helping form the ACPA. To conclude, given the likely congressional election results, it is clear the private clean energy sector working with states will have to continue our leadership to decarbonize the U.S. power system. Let's turn to slide four. We provide an update on our 12-month pipeline, which remains greater than $2.5 billion, even as we converted the $500 million energy transaction from the pipeline to an investment. We continue to see strong growth in virtually every one of the approximately 10 end markets where we invest. The behind-the-meter portion of our pipeline remains very strong and has weighted toward energy efficiency opportunities in the governmental and industrial sectors. In addition, residential, CNI and community solar pipelines remain strong and increasingly include a storage component. The grid-connected portion is similarly well balanced between wind and solar, including solar land. Finally, we continue to source climate resilience opportunities as reflected in our sustainable infrastructure pipeline. On slide five, we detail our $2.2 billion balance sheet portfolio at the end of the third quarter. The expected portfolio yield of 7.7% is derived from more than 200 diverse investments with an average size of approximately $11 million and a weighted average life of approximately 16 years. And please note that as of 9.30, we've funded four of the 13 projects of the energy portfolio investment we announced in July, and the balance will be added in the coming months. The behind-the-meter market represents nearly 60% of our portfolio investment. and generates a forward-looking yield of 8.1%. The strong credit profile and attractive yield of these assets is driven by the fact that virtually all of these assets save money for the obligor, and that consumers and organizations are increasingly focused on the sustainability and the reliability and resiliency of power where they live and work. 40% of our portfolio, and generating a forward-looking yield of 7.1%, The grid-connected market continues to be driven primarily by wind and solar. We expect next quarter to add a new category called utility-scale solar projects once we start to fund some of those projects from the NG portfolio. We remain very pleased with the technological and geographic diversity of our portfolio and believe this is a key driver of our consistently strong portfolio performance. Now I will turn it over to Jeff Lipson to detail our financial performance.

Thanks, Jeff, and good afternoon. Summarizing our results on slide six, we recorded core earnings per share prior to any CECL provisions of 36 cents in the second quarter compared to 38 cents in the third quarter last year. Higher revenue from both the portfolio and gain on sale was partially offset by higher interest expense resulting from the recent green bond issuances. Note that for the quarter, in accordance with CECL, we increased our allowance on receivables by $2 million, primarily as a result of additional loan commitments made during the period, which resulted in core earnings per share of 33 cents. On a year-to-date basis, core earnings prior to CECL provision is up 18 percent versus last year to $1.19, as we remain on pace to exceed the midpoint of our three-year guidance. I'll also note that year-to-date core net investment income increased 16 percent year-over-year to $67 million. This increase was despite the fact we maintained an outsized, low-yielding cash balance during the second and third quarters. In addition, we recorded another quarter of solid gain-on-sale income as our access to private capital remained strong. Including over $18 million in the third quarter, our year-to-date gain-on-sale income is over $47 million. With significant year-to-date growth in both NII and gain-on-sale, Our dual revenue model continues to generate strong results despite the ongoing recession. As we turn to slide seven, we highlight that this continued growth we've seen in core NII has been driven in large part due to growth in our portfolio and our ability to maintain an attractive portfolio yield of 7.7% despite a low yield environment. In addition, we continue to prudently manage our leverage. Turning to slide eight, We display the dynamic that capital markets continue to favor clean energy and ESG companies, including Han and Armstrong. For us, this has translated into a higher share price of our equity and tighter spreads on our debt. As of the end of the third quarter, we've nearly doubled the S&P 500 in total shareholder return over the last five years. In addition, our corporate debt is trading below 4%, about half the level of the S&P U.S. High Yield Energy Index. With this attractive capital markets backdrop, we highlight our very successful recent debt issuances on slide nine. In August, we issued $375 million of 10-year unsecured corporate green bonds at a 3.75 percent coupon and $144 million of three-year convertible green bonds at a zero percent coupon. Both will fund anticipated identified investment opportunities. Our research indicates that we are one of the few dividend-paying companies ever to issue zero-coupon convertible bonds. As part of the issuance process, our BB Plus credit rating was reaffirmed by both S&P and Fitch. The 10-year issuance further extends and ladders our corporate debt maturities. We continue to have no material recourse debt maturities until September 2022, when our first series of convertible bonds mature. Given these may be settled in shares, this maturity does not necessarily reflect a cash need. Year to date, we've raised $1.1 billion across capital markets, which further demonstrates that all of our funding sources remain open and accessible to us, even during a prolonged pandemic and recession. And finally, we have limited interest rate risk, as the vast majority of our assets and liabilities are fixed rate. On slide 10, we provide an update on our balance sheet, which expanded to $3.3 billion in the third quarter as we continue to maintain a more liquid profile in this period with over $880 million of cash. We expect to convert a significant portion of this cash into earning investments over the next few quarters, including funding the majority of the remainder of the NG portfolio by the end of this year. Our portfolio expanded 8 percent to $2.2 billion this quarter as we funded assets originated in both this and previous quarters. Finally, as we continue to reduce our cost of capital, we utilize a small portion of our cash to voluntarily prepay high rate debt. As we turn to slide 11, our portfolio of high quality assets have continued to perform within our expectations despite the ongoing recession. This performance is driven in part by the credit quality of our counterparties and the structure of our investments. All of our government and the vast majority of our commercial obligors enjoy investment grade ratings. In addition, the obligors of our residential solar assets include over 158,000 high credit quality consumers located across 22 states. And in our equity method investments, we are typically preferred in the investment structure, which reduces our exposure to any periodic underperformance. Finally, as our portfolio has grown and we have not witnessed an increase in credit losses, our cumulative credit losses have dropped to just 20 basis points. In summary, Even as the current recession has persisted, our earnings, liquidity, and asset quality have remained resilient. And with that, I will turn the call back over to Jeff.

Thanks. Let's now turn to slide 12, where I will highlight notable recent developments on the ESG front. In addition to our recent PCAF membership and green bond issuances, our renewed commitment to racial justice, diversity, and inclusion continues. We made meaningful contributions in the third quarter to the NAACP Legal Defense and Education Fund, Campaign Zero, and the Baltimore Action Legal Team. Our diversity, equity, and inclusion consultant continues to help us develop a multi-year plan for impact on these persistent challenges. In addition, we're pleased to report that our ESG score was recently upgraded by MSCI by two notches to single A. We'll conclude on slide 13. The ongoing pandemic and recession has tested the business models of companies across the spectrum, and the resilience of our business model has once again proven strong. We've remained poised for growth with a robust pipeline from leading energy and infrastructure clients and recent strategic investments in people and systems to support our increasing scale. Finally, our ESG leadership is being increasingly recognized by others, and we expect that to continue as we're We ramp up our social initiatives while also leading the industry to report on the carbon intensity of investments. Our investment thesis, earning better risk-adjusted returns investing on the right side of the climate change line, continues to be proved out. Thank you for joining us today. Stay well. And, Operator, I think we'll take some questions.

Thank you. We'll now begin the question-and-answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. The first question comes from Noah Kay from Oppenheimer and Company.

Please go ahead. Hi, good afternoon, everyone. Thanks for taking the questions. Hello. To start with, you know, if I correct, I think this might have been a record quarter for originations. So feel free to correct me. But just want to understand, Jeff, I think you mentioned that, you know, a large portion of the NG investments are going to hit the balance sheet over here in 4Q. I'm assuming they're included in the originations you reported for this quarter. If not, please correct me again. But essentially, you reported this large number of investments, but a lot of them have to hit the balance sheet here in 4Q and then possibly a little bit into 1Q, and that's going to absorb the majority of the cash balance. Is that correct?

That is a very good assessment. I did not research if it were a record quarter, but clearly it's one of the largest quarters we've had. It is. And then, yes, the way we announced transactions in that 716 number, those are transactions closed, but not necessarily funded. And you accurately described that we expect much of it to fund in the fourth quarter, and that will be a large utilization of the existing cash. We did add recently, I think it was last quarter, on what's page 10 of the earnings presentation, a balance sheet reconciliation as to what funds in the quarter. So that's the best way to track what's been funding.

That's great. I mean, I think if you back out, Angie, from the transactions, it looks like you still did a healthy volume. It would be in sort of the 200 to 300 range of originations. That's right.

You know, as I said, and this is the other Jeff, you have so many Jeffs to choose from on this call, but... As I said, virtually every one of our 10 origination markets is performing quite well. So strong quarter even without the NG investment.

Okay. And that leads me to the final question here, which is it looks like the percentage of your portfolio that's performing to metrics at least based on You know, the framework shift report, did that actually improve by a point? But just, you know, do you see any potential trouble spots in the portfolio as we get late in the year here, either on the consumer or the commercial side? You know, what, if anything, has you worried? Do you need, you know, further stimulus, or do you feel comfortable with, you know, these performance metrics continuing to hold up?

Go ahead. You have a very good answer on this that I appreciate.

We don't, you know, clearly to the first part of the question, if we saw something that we were specifically aware of, we would have to account for it now. So I think the clear answer to the first part of the question is no, we're not seeing anything. To the second part of the question, are we worried? Of course, we're always worried. But the portfolio has held up well. And again, as we always talk about, the portfolio is constructed in a way whereby the counterparty typically is incented to continue making payments. Particularly, I think part of your question was alluding to Resi Solar, where the counterparty is incented to make payments. It is a less costly form of energy for the home. And we're not seeing anything concerning yet. And obviously, the recession has been ongoing and high levels of unemployment have been ongoing since March. So with each passing month and quarterly reporting that we get, we continue to see a strong performance in the portfolio and don't have any specific reason to be concerned at this point.

Okay.

Well, thank you very much. I'll leave the election questions to my fellow analysts. Thank you.

Thanks, Al.

The next question comes from Julian Dumoulin-Smith from Bank of America. Please go ahead.

Hey, guys. This is Anya stepping in for Julian. So, yes, first off, I just wanted to ask, when do you expect to roll forward the EPS figure, and what other updates could come on that call in terms of your growth expectations?

Well, Anya, as we've said previously, We're reaching the end of our three-year guidance period. We'll discuss additional guidance with the board, and any extension of guidance will come out of those discussions. You should expect, if there is any, it would be in Q4, and that is also in the Q4 call, and that is also when we have, as a matter of practice, reconsidered the dividend level as well. So, you know, that's the quarter to look at without committing to any actual action.

Okay, thanks. And a follow-up, what kind of growth could you expect over the next few years potentially coming from energy efficiency installations for government facilities?

Good question. You know, presuming a Biden presidency and a Republican Senate, We don't expect any sweeping federal energy legislation. But back during the Obama-Biden years, the federal efficiency market really boomed to record levels, some of which we're still seeing through the Trump administration, due to executive orders. The executive order process is very meaningful to the energy management groups and they take them seriously. The lack of leadership on the White House on this issue, if it were to persist, would limit that market. But assuming Biden does win the presidency, you can expect he would be a strong supporter of expanding the ESPC, UASC, and other federal markets. You know, it looks promising, and I'll just reinforce that these programs have been enjoying, since they were first put in place during the Reagan administration, bipartisan support. Nobody doesn't like saving the government money, creating jobs in all 50 states, and approving conditions for the warfighter. So we generally get support on both sides of the aisle if necessary. if it was needed. But with executive orders, you really don't need it.

Okay, great. Thank you. I'll step back at the queue.

Thanks. The next question comes from Chris Souther from B. Reilly. Please go ahead.

Hey, guys. Thanks so much for taking the question here, and congrats on the quarter. On the guidance, you know, it implied just 24 cents for the fourth quarter to hit the midpoint that you've talked about exceeding there. Obviously, a lot of cash is still to deploy at the end of the quarter there, and then paying interest on the debt. But just curious, given there was high gain on sale this past quarter, are you seeing similar market conditions where we could expect that to maybe be elevated? Just realizing we're a month in, so maybe it might be coming later in the quarter. But I was curious how you feel about the gain on sale for this coming quarter here.

You know, maybe I've been watching so much politics on TV, I'll take a page from a politician and say, you know, it's too early to say, but we're feeling pretty good about things. Yeah, we have reaffirmed that we'll be at the high end of our guidance. So feeling pretty good about things, Chris.

Understood. As I'm looking at kind of the pipeline mix, It looks like grid connected was back up compared to the last quarter. And obviously, you had taken the NG portion out in the second quarter when you gave those metrics. But I believe it might have been in there in the first quarter. So we're seeing kind of similar percentage of the pipeline in that grid connected as we saw before the NG deal was announced. Do you see the potential for similar large types of deals like that in the grid connected space over the next a couple of months, quarters here. Just wanted to see if there was anything we should be pushing out there.

Yeah, no, I think you've made a correct observation. It is up somewhat. I think anybody in the developer side of the business is rushing to get projects developed should tax credits start to expire. So to me, it's not surprising that that pipeline remains strong.

I'll hop back in the queue. Thanks for taking the question, Derek.

Thank you, Chris.

Thanks. There are no more questions in the queue. This concludes our question and answer session, and the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.