HA Sustainable Infrastructure Capital, Inc.

Good afternoon and welcome to Hannon Armstrong's conference call on its fourth quarter and four-year 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 for the company.

Thank you, operator. Good afternoon, everyone, and welcome. Earlier this afternoon, Hannon Armstrong distributed a press release detailing our fourth quarter and full year 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 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 Jeff Eichel, the company's chairman and CEO, and Jeff Lifson, our CFO and COO. 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 reporting that 2020 distributable earnings, previously known as core earnings, total $1.55 per share, an increase of 11% over 2019, and a 7% three-year compound annual growth rate, exceeding the high end of our previous guidance. We grew our portfolio 38% year-over-year to $2.9 billion, We closed 1.9 billion of transactions in 2020, a record including almost 800 million in Q4. And finally, we're providing three-year guidance of 7 to 10 percent compound annual growth in distributable earnings. Let's turn to page four and discuss guidance and dividend in more detail. Given the earnings trajectory of our existing portfolio and the strength of the pipeline, We are guiding, as I said, to a 7 to 10 percent growth in distributable earnings per share through 2023 relative to a 2020 baseline of $1.55 per share. If you look at the chart, this is equivalent to a 2023 midpoint of $1.98 per share. To be clear, there may be lumpiness in the yearly earnings, but we expect at the end of 2023 to be within our guidance range. Given the expectation for accelerated earnings growth, we intend to grow the dividend at a rate of 3% to 5% annually from 2021 to 2023. With distributable earnings growing faster than our dividend, we can continue to retain capital for accretive investments and remain attractive on a total return basis. Today, we're also announcing a 3% increase in our dividend to $0.35 per share for the first quarter of 2021. Now, turning to slide five, we would like to address some of the key macro themes that are top of mind for our investors and analysts. First, evidence of a changing climate continues to mount, 2020 tied for the warmest year on record. In addition, there were 416 natural disasters across the globe last year, resulting in economic losses of approximately $250 billion. The deep freeze in Texas causing the massive power outages may be an example of climate change-induced extreme weather events. But regardless of the cause, we are concerned for the people affected and hope power is restored as soon as possible. We're also grateful for our partners operating our wind and solar assets in Texas for their commitment and competence in managing through this disaster. Clean energy assets have generally performed well in 2020, and our portfolio has proven very resilient despite the pandemic and recession. Our portfolio of long-duration, non-cyclical, climate-positive assets has performed as expected. While it is too early to fully understand the net impacts of the Texas events on our portfolio, we are confident our diversity and preferred structures mitigate the impact of this week's events. The climate solutions market continues to grow, as does our pipeline. Our deep relationships with large clean energy and infrastructure clients combined with our flexible permanent capital solutions have led to a greater volume of investment opportunities and attractive risk-adjusted returns. In addition, the demand for ESG equities is growing, driven by institutional investor mandates and the strong performance of proven ESG leaders. We continue to believe that ESG reporting is a material disclosure all companies should make. We also support the efforts for global standardized performance metrics to prevent green and social washing. As ESG investing matures, we believe that the competitive advantages of ESG leaders will become more apparent and that this will be reflected in their market performance. Finally, for the first time in several years, federal policy is acting as a tailwind rather than a headwind for our industry and our business. As the competitiveness of renewables, energy efficiency, and sustainable infrastructure improves, corporates and governments are setting ever more aggressive clean energy and net zero targets. In addition, from rejoining the Paris Agreement to the appointment of key personnel, the Biden administration is taking aggressive action across the executive branch to move policy in a climate positive direction. We also believe there is momentum for a price on carbon by way of a carbon dividend plan we have long advocated for. Turning to slide six, we provide an update on our 12-month pipeline, which we are reporting as greater than $3 billion, up from the prior quarter of $2.5 billion. It is notable that we increased the pipeline from last quarter, even as we converted almost $800 million from that pipeline to closings in Q4. We continue to help our clients grow by striving to make the financing transactions as aerodynamic as possible through programmatic relationships. We see strong growth in virtually every one of the approximately 10 end markets where we invest. The bulk of our pipeline remains behind the meter and is weighted toward energy efficiency opportunities in the government and industrial sectors. We do expect President Biden to drive the federal ESPC program to return to the levels achieved during the Obama administration. In addition, the behind-the-meter solar pipeline remains strong, including residential, CNI, and community solar projects, an increasing number of which include a storage component. The grid-connected portion is similarly well-balanced between onshore wind, grid-connected solar, and solar land. Lastly, we continue to see interesting climate resilience opportunities as reflected in our sustainable infrastructure pipeline. On slide seven, we detail the $663 million preferred equity transaction we closed at the end of last year alongside Clearway Energy in a two gigawatt grid-connected portfolio of seven onshore wind, solar, and solar plus storage projects. The portfolio enjoys highly contracted generation, predominantly investment-grade counterparties, a 14-year weighted average contract life, and significant geographic diversity. The portfolio also represents our first grid-connected solar plus storage investment and provides the potential for continued programmatic deal flow with Clearway, a large, ambitious partner focused on the U.S. market. As of the end of last year, we had funded $200 million of this larger commitment, and we anticipate funding the balance as remaining projects achieve commercial operation over the next few years. On slide eight, we provide an overview of our $93 million preferred equity investment and a 78 megawatt behind-the-meter portfolio of more than 60 distributed solar plus storage projects. Co-investors include Morgan Stanley as tax equity and Engie as sponsor equity. With a weighted average contract life of 24 years, the portfolio is with highly creditworthy consumer, CNI, and rural electric co-op off-takers. We also highlight the unique structure of this transaction, which provides combines tax equity financing and a forward flow of projects. With $37 million funded to date, we anticipate funding the balance of the commitment as projects reach completion milestones over the next year or so. Turning to slide nine, what these investments also highlight is our quarterly and annual headline closed transaction number is perhaps not the most useful metric for evaluating our performance going forward. Historically, we've said that we expect to close at least $1 billion of transactions each year. And last year, we announced $1.9 billion in closed transactions. However, as of December 31st, nearly $600 million of that headline number will be funded in future periods under forward flow funding commitments. We would suggest that portfolio growth and NII growth will perhaps be more useful metrics for tracking our performance. We will still disclose closed transactions for the foreseeable future, but think these additional metrics may prove useful. Now I'll turn it over to Jeff L. to discuss our portfolio performance and financial results.

Thanks, Jeff. Welcome everyone to the call. Turning to slide 10, we detail our balance sheet portfolio at year-end 2020 and compare it to year-end 2019. First, the portfolio is significantly larger. It's grown by approximately 38 percent from 2.1 billion to 2.9 billion over the last year, as we've added approximately 50 incremental investments. We've achieved this growth while maintaining our portfolio yield of 7.6 percent and with no meaningful change in average investment size, which stands at 12 million. Secondly, our portfolio diversity is stronger than ever. No asset class comprises more than 28 percent of the portfolio, and we've added a new asset class, grid-connected solar. Finally, our portfolio is even longer dated as we've extended our weighted average life to 17 years. We remain very pleased with the quality and diversity of our portfolio and believe this is a key driver of its consistently strong performance and resilience. As we turn to slide 11, our high quality assets have continued to perform within our expectations throughout 2020. This performance is driven in part by the structural seniority of our investments and the credit quality of our obligors. This quarter we've added a table detailing the structural seniority and obligor credit attributes associated with each of our asset classes. In nearly all of our investments, we are in a preferred senior or super senior position. In addition, our obligors are typically investment grade government or corporate entities or credit worthy consumers. The structure of our investments, most notably our structural seniority, has a very meaningful impact in reducing our exposure to both operating and commodity price risk. Moving to slide 12, let's begin with a quick explanation of the transition to distributable earnings, which is summarized in the bottom left. Prior to 2020, we utilized core earnings as our primary non-GAAP performance measure. In 2020, we implemented the current expected loss standard, known as CECL, and we utilize core earnings pre-CECL as our primary non-GAAP earnings metric, which we had communicated would be a transitional metric. However, the SEC has recently clarified that REITs, subject to certain conditions, may use distributable earnings as their primary non-GAAP performance measure, which excludes most CECL provisions, and we have elected to use distributable earnings as our primary non-GAAP measure. For simplicity, please think of distributable earnings as equivalent to the core earnings pre-CECL metric that we used in the first three quarters of 2020. Fundamentally, we believe that distributable earnings, as we have defined it, remains the best indicator of our economic performance and is useful to both our investors and the leadership team in evaluating our performance and calibrating our dividend. Summarizing our results, we recorded distributable earnings per share of $1.55 in 2020, an 11 percent increase compared to the $1.40 in 2019. Higher revenue from both gain on sale and our larger portfolio was only partially offset by higher interest expense. I'll also note that distributable net investment income increased 7% year-over-year to $88 million in 2020. This increase was despite the fact we maintained an outsized low-yielding cash balance during much of the year. In addition, we recorded significant gain on sale income in 2020 as our access to private institutional debt remained strong. Our cash collected on equity method investments was also robust in 2020 as we continue to receive both return of and return on capital from the portfolio. To conclude, our dual revenue model continued to generate strong results in 2020 despite the pandemic and recession. As we turn to slide 13, we reflect multi-year growth rates at or above 15% in managed assets and NII. We achieved this while continuing to generate a steady portfolio yield and a return on equity above 10%. Our closed transactions have averaged 1.3 billion over the last five years, 30% above the previously disclosed target. Although the chart on the bottom right is a good reminder that our volumes can be lumpy, which is one of the reasons why we think three-year guidance is appropriate for our business. Moving to slide 14, we detail our balance sheet as of year-end 2020. In the fourth quarter, we funded $739 million of investments, resulting in a 30% increase in the portfolio as compared to 930. We anticipate these fundings will result in significant net investment income growth in 2021. Even after this elevated level of investment, we had nearly $300 million of cash on our balance sheet at year end for scheduled fundings and further organic growth in the portfolio. On slide 15, we highlight our continued access to the capital markets. In 2020, we raised $1.2 billion in debt and equity, including $775 million in unsecured green bonds, $144 million in zero-coupon convertible green bonds, and nearly $300 million in equity. Following the filing of our year-end financials, we intend to refresh our at-the-market equity issuance registration up to $500 million. We are also excited to announce the closing just last week of a $50 million unsecured sustainably sustainability-linked revolving credit facility with JPMorgan. We anticipate expanding this facility in the future by adding additional relationship banks, which will further provide funding flexibility. So during a prolonged pandemic and recession, we actually enhanced our ability to flexibly access the capital markets and other sources of capital. In addition, we continue to manage our leverage, maturity profile, and interest rate risk at prudent levels. In summary, We were pleased with our 2020 performance, including our earnings, funding platform, and asset quality, and we remain poised to take advantage of favorable market conditions. With that, I'll turn the call back over to Jeff.

Thanks. Turning to slide 17, we highlight our ESG initiatives. With regard to the E, in 2020, we achieved the highest carbon reduction in our history, almost seven times greater than 2019. This was driven in part by our elevated transaction volumes, but also by the higher efficiency with which we use capital to reduce carbon, reflected in a carbon count of 1.03 for the year. With regard to the S in ESG, we're pleased to declare a social dividend of $1 million to capitalize our newly formed Hannon Armstrong Foundation. The foundation will provide a long-term strategic focus for our philanthropic efforts to find the intersection of climate change and social justice. I hope to provide more updates on this effort in future earnings calls. Finally, with regard to governance, as our company grows, it's important to grow our board of directors in number, competencies, and diversity. As you may have seen in yesterday's press release, I'm pleased to welcome two new board members, Clay Armbruster, president of Johnson C. Smith University, and Nancy Floyd, founder of one of the first clean energy venture capital platforms 30 years ago. With our new board members and our previously announced leadership realignment, we are well positioned to best serve our clients, investors, and employees to deliver on our climate positive investing vision. We'll conclude on slide 17. I want to summarize why we believe we offer a compelling value proposition to investors. Our programmatic growth platform is backed by a robust pipeline of projects developed by the leading clean energy and infrastructure companies. That drives our diversified and high-quality portfolio that's been tested in 2020 and performed quite well. With a durable capital structure backed by a prudent approach to leverage an array of funding sources, and our transparent and quantitative carbon reporting provides confidence to ESG investors. And we have a proven track record as a public company for nearly eight years, along with a stable and growing dividend. For these reasons, we've significantly outperformed the S&P 500 ESG index as well as REIT and YieldCo indices over the last five years. To sum up, we're thrilled about the accomplishments in 2020 and the opportunities in front of us and confident in our ability to execute on them in the months and years ahead. And I would like to close by thanking the staff of Hannon Armstrong for their outstanding efforts in 2020, truly a remarkable group. Operator, please open the line for questions.

We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question today comes from Mark Strauss with JP Morgan.

Yeah, good evening. Thank you very much for taking our questions. Jeff, yeah, hi. Jeff, I know you said that it's too early to kind of know the impact of what's happening in Texas. Two questions there. How do you go about kind of framing that potential risk, I guess? I mean, what is your exposure in your portfolio to Texas? And then bigger picture, you know, I think you're a good spokesperson for the industry. I mean, what hearing a lot of different debate going on about who's to blame for what's happening. Just curious for your high-level thoughts.

Thanks, Mark. As I said, it's too early to know the net impact. You've got some generators that are selling power at high rates and others that are not. I would say our clients, and this is a very real-time situation, We have daily calls with them. They are doing a phenomenal job getting the plants restarted in truly difficult conditions. We're very grateful to have them as partners. I think the third piece, and we've mentioned it in the script, is the preference features in our investments mitigate the impacts from the Texas events. It's just really not that meaningful. being kind of conservative folks, we have a worst case estimate that assumes everything goes bad and nothing goes well. And what we've found is the impact is not material. And I think the best evidence of that is we're issuing three-year guidance even in light of the ERCOT issues we've seen this week. It's It's just, to us, the strongest possible statement we can make that we feel very good about where we are even with the impacts of Texas. On the ERCOT issues, you know, I've always been perplexed by their desire to remain island, having done island power solutions in the 90s. It's a tough way to run a utility. I think – I'm certainly hoping the American Clean Power Association will be getting the true story out there. I think the other thing, Mark, that I would say is I've never been a big fan of people saying 100 percent clean energy. I get the aspiration in that comment, but that's not how utility systems work. You need a mix of generation, and this – I think just reinforces it. So, you know, obviously you're going to be fingers pointing for a long time. This is a real disaster for a lot of people, and it just should not happen. So with that, why don't I stop and see if I've answered your question.

Yeah, yeah, that was very helpful. Thank you. One more follow-up for Jeff L., The guidance obviously points to higher growth for earnings than it does for the dividends, so payout ratio coming down. Just given your balance and your proven ability to access capital markets, I mean, even during 2020, can you just kind of give a bit more color into the rationale for being a bit more conservative with the payout ratio? Thank you.

Sure, Mark. So we've been previewing for some time that EPS will grow faster than DPS. And I think we've been saying that very consistently for at least a couple of years. This new guidance just reinforces that message in a more quantitative way. And we just think it's a more prudent way to run the business to retain more capital when we have such a good pipeline and expect to have a strong pipeline. for a long time. So you're right, we could just reaccess that capital and recycle it and remain confident in our capital markets platform. But there's a balance there, and retaining some capital we do think makes sense. And we are putting forth an accelerated growth in DPS, just not quite as high as EPS.

Great. Yep, makes sense. Thank you very much.

Thank you.

Our next question comes from Philip Shin with Ross Capital Partners.

Hi, everyone. Thank you for taking my questions. I wanted to touch base with you guys on the outlook for originations. Jeff, I know you talked about having maybe a bit of a shift in focus to overall portfolio growth and NII. But that said, originations still, I think, are important and was wondering if you could share what the implied originations might be embedded in the three-year guidance. So if you're at this $1.9 billion a year, should we be thinking more along the lines of $1.5 billion, or do you think 2021, for example, could be higher than the $1.9 billion? Thanks.

Thanks, Phil. You know, I think you said you still think originations are important. So do we. we've averaged $1.3 billion over five years. That's not a bad number. I think we've proven we can do, you know, $1.9 billion. We're certainly not... We don't need to do that to hit our guidance numbers. So, you know, I mean, I think something on the order of $1 billion to $1.5 billion, you know, that's in that range. And there's always this... this tension between can you originate more and take a lower return? And the answer is, yeah, you could. But ultimately, we're running the business for the long-term return on equity and stability of the business. So hopefully that answers your question, Phil.

And Phil, if I could add that answer a little bit. Yeah, just to reinforce our at least slight movement away from that number, keep in mind As Jeff said in his comments, or implied in his comments, there's a big difference between originating, let's say, a billion three in a year and at all funds and originating a billion three, which includes a future flow component and perhaps only half of it funds. And so that's why that number as a standalone number is not quite as meaningful as we think people have been using it. And that's the reason why we're de-emphasizing it just a little bit.

And if you look at the billion nine, but we still haven't funded 600, that's to a billion three, which I think makes your point, Jeff.

Great. Yep, that's very helpful. Thanks, guys. Shifting over to gain on sale, from a modeling standpoint, you guys have been pretty consistent in this kind of mid-teens type level. Is this something we should be counting on going forward? I know there are lots of puts and takes in the market, and it depends on a lot of factors, but in the near term, coming quarters, do you expect that to remain kind of in the mid-teens, millions?

It's tough to say. That is the lumpiest part of the business, as you know. You start every quarter at zero, pretty much, and we have had some very successful quarters, including the fourth quarter, and some with a little bit less of gain on sales. You know, in total, I view the $66 million we did in 2020 as a bit of an outsized number. I don't think we want to promise that that's a number that will be consistent as it relates to gain on sale going forward. But I think you should expect some lumpiness. I think you should expect it to continue to be material, though, as there are several asset classes that we do remain active in and have a bullish outlook for. that lend themselves well to securitization. And likewise, our securitization partners continue to express strong demands for that type of investment. So it'll continue to be material, but lumpy.

Okay, thanks, Jeff. One last one, if I may. On slide 11, you guys have a really nice depiction of how well performing your asset base has been through this challenging past year. And then your commentary, Jeff, on the challenges in Texas, still kind of in spite of that, you're issuing robust three-year guidance. And so with that, that's yet another shock to arguably your portfolio, and it sounds like you'll likely perform well. So as I think through your credit situation and the potential for an investment-grade rating. Can you talk us through what the potential of that might be for this year? I know the rating agencies, they can't signal exactly, but just from your perspective, if you could update us on the potential, that would be fantastic. Thanks.

It's difficult to handicap, Phil. I wouldn't characterize it in terms of likely or unlikely or reasonably likely. I would only say that it's a conversation we'll have in detail this year, and I think performing well in a recession will certainly work in our favor. The business is also achieving more scale, which is something the agencies look to. We've achieved more unsecured credit, particularly with this new JP Morgan facility, which again is a positive attribute for the rating agency. So I think we have a good case, but I would hesitate to handicap it in terms of likelihood.

Okay, great. Thanks, Jeff L. Jeff, and I'll pass it on.

I like that Jeff L. is catching on here.

And our next question will come from Noah K. with Oppenheimer.

Good afternoon. How are you? For the first time in a while, the 12-month pipeline has increased to $3 billion. So just a question, does that include or is that inflated by versus a traditional $2.5 billion number you've given in the past has been inflated by the announced investments that have yet to be funded? would you call that out as unusually inflating this year's pipeline, or do you feel like this is just structurally what we could anticipate in the future, a larger pipeline?

First of all, we went from more than $2.5 billion to more than $3 billion, and that more than $3 billion subtracts the approximately $800 million that we closed on in Q4, so we would never double count. if that's an aspect of your question. No, we think, as we said on the, I think the third slide, climate solutions investing is growing and our pipeline is growing. So this is just a fundamental good news that there's more business out there.

Your pipeline is just structurally expanded because of the investment and opportunities in climate. Yep. Great. I think the yield curve finally steepening, good time to have 99% fixed rate debt going into that. I think it certainly has been impacting equities today, but can you remind investors of how a steepening yield curve could impact your business in terms of spreads and deal flow, how do you think your position now for potential interest rate increases relative to say, you know, where you were in the past?

So I think, you know, the duration of our liabilities we've extended, you know, particularly with the most recent 10-year deal. I think there was a time you'd look at this business and you would say the duration of the liabilities was a bit shorter than the duration of the assets. So the steepening yield curve would help. By the same token, we'd have some risk in doing that. I think we've taken out some of that risk, but that's also in some ways reduced the benefit of a steepening yield curve. So I don't think it'll have a big benefit for the business. I think it's more a second tier impact that a steepening yield curve is usually indicative of a strong economy. It's usually indicative of you know, some movement in credit spreads, and I think ultimately it's the credit spread differential between our investments and our debt that drives profitability, not the yield curve itself.

Yep, makes sense. I want to come at the impacts of Texas in a little bit of a different way. In the past, whether it's been Superstorm Sandy or the PG&E wildfires, So the arc of investments in the power industry has been tending to bend towards increased resiliency, localization, distributed energy, energy plus, you know, renewables on site plus storage. Obviously too early to tell, but, you know, do you see potential for this week's event to spur on those types of funding opportunities and that kind of pipeline? Because certainly I think resiliency, increased resiliency on the grid is paramount given what we're seeing this week.

No, I don't see how it couldn't. Particularly as the U.S. continues to electrify We need a much more reliable grid, and we need more distributed, decentralized energy resources. I just – that's a trend that's been going on for a long time, where our pipeline is dominated by behind-the-meter solutions, in part because it is a different quality of power service. And, you know, this is just a hideous event in Texas. It should not be happening. But, yeah, it would be hard for me to see why it wouldn't expand the shift to distributed energy resources.

All right. Thank you very much. Take care.

Thanks, Noah.

Our next question comes from Greg Lewis with BTIG.

Yeah, hey, thank you, and good afternoon. And I guess I just want to follow up on Noah's question. You know, clearly the pipeline is expanding, and looking at the behind the meter, you know, as a percentage basis, it went down a little bit, but on an absolute basis, it went up. Is there kind of any way to understand, and knowing that you mentioned California earlier from last year, this event, is there a growing demand pipeline of battery storage behind the meter that is just kind of quietly accelerating. Is that kind of what's helping grow out the pipeline?

I wouldn't say it's necessarily storage, but if you listen to Sunrun or SunPower or Nova or anybody in the CNI markets, storage is increasingly part of the solution. I think we'd be hard-pressed to say that's why our pipeline is up. But, you know, it just makes solar that much more valuable.

Okay, great. And then just thinking about, you know, the opportunity cycle, clearly it's growing, you know, grid-connected, which is, as we think about, is, you know, the subtractive yield is a little bit lower than behind the meter. Like, as we think about putting the portfolio with a an eye on maximizing yield. Is some of the grid connected just not going to be as attractive as we need it to be to sort of throw it into the, invest in it in the portfolio?

No, that's quite possible. And we've always said when there are very large common equity positions that are highly competitive with global institutional investors, you know, that's that's probably not a great opportunity for us and somebody else should win that business. We certainly like a little bit more structure and more of a partnership feel than an auction. I certainly see GridConnected as needing a lot of capital. There's a lot of capital chasing those investments and that's a good thing for our clients. Whether they have the best risk-adjusted return for us, we take case by case.

Okay. Perfect. Thank you very much. Thank you.

Our next question comes from Chris Souther with B. Riley.

Hey, guys. Thanks for taking my question here. Maybe you could just touch on, to piggyback on the question around gain on sale, you know, how should we think about the impact, you know, not necessarily in the shorter term where it's tougher to predict, but, you know, in the three-year targets that you're giving out, how much should we think about that being baked in as part of the growth there?

Well, I think we're clearly, given the fundings we did in the fourth quarter, going to grow NII next year. I think that's fairly obvious. In terms of the gain on sale, we're not going to disclose specific growth targets, but what I said earlier in terms of you should expect it to continue to be a material contributor to our earnings, and our earnings are going to be growing 7 to 10 percent, you should logically conclude that that's going to remain a very active part of the business.

I would add, though, that we've always wanted to drive to higher NII relative to gain on sale. just because gain on sale can be more episodic. It's just a more reliable business. We seem to be well positioned from 2020 to do that. And I've always said I want a gain on sale to be earnings noise to the upside. And I think we're in a marginally better position for that to be true. Incrementally better position for that to be true.

That makes a lot of sense. So looking at the other side, do you think you'd be able to talk about you know, the balance sheet growth that we should be thinking about, you know, to get to the low or high end of the targets that you've given today, you know, in kind of broad strokes maybe, or is that not something you'd want to provide at this point?

We're not going to disclose growth targets specifically on the portfolio, but I think, again, you can probably triangulate that a bit when you think about the – that we are guiding towards a relatively flat yield. You can see where we're guiding to on earnings. You know, Jeff mentioned, you know, roughly a billion to a billion five of new investments per year. I think there's an ability with the numbers we've put out for you to triangulate what portfolio growth will look like without us disclosing that specifically.

Okay. That's helpful. And maybe just the last one on the operating expenses, just, you know, how should we think about you know, the trend there, you know, throughout this year and then going forward would be helpful.

I think on a percentage increase basis, you should think about fairly significant increases in operating expenses because we are increasing our staffing materially to keep up with this growth. But as a percent of revenue, I think you should envision that coming down, which is actually the more important metric. I think we will be growing revenues faster than we're growing expenses, despite expenses growing on a percentage basis at a somewhat significant clip.

Awesome. Thanks, guys.

Our next question comes from Ben Callow with Baird.

Hey, Jeff and Jeff. I'm going to ask three questions. The first is a business fundamental. The second is about technology. The third is bigger picture. So business fundamentals, financials. The ROE, so we've got asset yield steady. Your capital costs are going down. You've got leverage in your model. So where should the ROE go forward? How should we think about that going forward? That's my first question.

You should think about a steady to upward trajectory in ROE. I think, you know, again, you laid out most of the variables that impact ROE. Some of them are steady. Some are improving. So I don't expect it suddenly to be a 15% ROE business, but I think we'll see some steady increases in ROE. And the thing that really –

Well, I was going to say, Ben, the thing that really changes ROE in any one period is the amount of gain on sale. And, you know, the NII is going to produce a steadier ROE, and the noise is going to be around gain on sale.

Okay. On the technology part, fuel cells, Jeff and Jeff, what are your views on that? My third one is the bigger picture.

Well, I wish I'd bought plug power when I had a chance. I kind of missed that one by a mile. Ben, we always look at things from a carbon lens first. I think the amount of progress in the hydrogen fuel cells is outstanding. We would fundamentally figure out what the carbon count on it is. I think they're proving to be, you know, after almost 30 years of trying, this technology seems quite viable now. So I congratulate those companies. They've been at this a long time and, you know, have really built something that can work. You know, to us it should be part of – microgrids and distributed generation future. And again, so long as it's got an acceptable carbon story for us.

Thank you. The bigger picture, I guess, was, and I think I've asked this before, but if I go to slide 16, I was asked last night, I was doing something and a young person coming into the field asked about when do investors start valuing ESG and metrics like that. And, you know, you guys have always, you know, put out your carbon avoidance and you've been a leader on that front. And just from your perspective, how do we start valuing that? Or do people do that? Or is that already being valued? And I know that's my job, but from your perspective, what's the tipping point there?

Well, I would argue that we may have reached it. It's fundamental to our strategy, Ben, that having a verifiable and transparent carbon story would someday reduce our cost of capital as investors increasingly recognize the risk to investing in when they disregard carbon. I don't think they are disregarding carbon or climate change anymore. And I think we've seen it on the equity side and the fixed income side. What I don't think is happening is a real refined analysis of the carbon impact of companies. If you're green, you're really green. And I think over time, a metric like carbon count can be useful. I think on governance, to me, it's more binary. You either have good governance or you've got lousy governance. And it's harder to say, but I think a lot of companies run away from poorly governed businesses. The S is clearly harder. We are all learning how to... to value it. We have implicitly valued the social aspects as it relates to our employees because for the same reasons climate change matters to them and why they want to work here, the social aspect of the business matters as well. And I think every company has work to do and we are you know, I think well advanced and starting on that work.

Maybe just jumping in there, where is the SEC and do you think they're going in reporting this and these different metrics? I hear, you know, different things out there. So what do you think is going to happen?

Well, we do have a new disclosure on our 10-K that will be filed at some point in the future soon. Yes, very soon. On human capital. That's a new SEC requirement. I think we are going beyond what the SEC required and adding a few more dimensions to the human capital question. I think it's just absolutely great that the SEC is doing it. Could they do more? Sure. Under their new leadership, I suspect they will.

Great. Thank you, guys.

Thank you, Ben.

Our next question comes from Julian DeMoulin Smith with Bank of America.

Hey, good afternoon team. Thanks for the time and the opportunity to connect. Hey, congrats on this guidance. Let me try to leave it a little open ended, but I'd be curious how you would describe things. So this three year view, when we get there, what does that mix look like with regards to your portfolio? And what kind of yield do you think you have? But more importantly, what does that mix look like, right? When you think about where this, you know, whether it's $1 billion or $1.5 per year, what's the net size of that portfolio that you're aspiring to? Maybe ask a little bit differently from Philip. And then separately, what's the composition here, really, critically?

You know, I don't – we certainly don't have any – goal for any specific portfolio mix other than we don't want to be over-concentrated in any one asset class. And a few years ago, everyone was worried that we were going to have only residential solar. Well, we don't have only residential solar. And perhaps now people will worry we'll have too much onshore wind. We're not going to tilt the or unbalance the portfolio here in those ways. I think one of the great advantages of our business model, Julian, is the ability to look at all sorts of asset classes, whether in the power sector or not, both for getting incremental returns, but also diversity. I think we love having more than 230 total investments in our pipelines. I've been saying this for a long time. There's no one asset or asset class that's going to bring us down. So don't have any prescription as to what it's going to look like. If I had to venture a guess, I would say probably not going to look a whole lot different than it does now.

Got it. Excellent. And then I'm thinking a little bit more broadly here. As you think about this trajectory right now and perhaps into the future and otherwise, how do you think about the REIT status, right? And does that matter or not over time relative to the portfolio as you see it evolve, specifically in direct renewable investments that may not qualify? I'm just curious how sustainable the trajectory is if you don't invest in renewables and how you think about that balance of, Do we bother with the REIT status relative to the opportunity set in renewables directly versus maybe some of the more historical investments you guys have made?

Good question. Jeff L?

So I would, Julian, say, you know, reiterate to some extent in answering that what Jeff just said, which is, to use some slightly different words, we have multiple paths to achieving this guidance. We have many, many different paths. which will take us to $2 or more per share in 2023, in terms of the portfolio, in terms of the yield, in terms of the amount of gain on sale, and then also to your question, in terms of corporate status. So there's not one path to getting there, there's multiple. It is highly likely, as it relates to REIT status, that'll be a path that allows us to continue to be a REIT. But I also think there are scenarios where we're not a REIT, what we really don't want to do is miss out on some really good investment opportunities that we perhaps couldn't do, you know, if we're a REIT or couldn't do too much of. So I think it's likely we'll be a REIT over this three years, but it's not 100%, and that's one of those several elements of there are multiple paths to achieving this guidance.

Okay, all right, fair enough. But let me maybe ask it this way. You know, obviously you have over $4 billion of securitization assets on the balance sheet. How much latitude do you even have left over the next three years? It sounds like there's probably still some amount, again, obviously depending on the path you choose. But there is latitude today, and more importantly, I think as you say, there's probably a good amount of latitude still left then, depending on the securitization asset portfolio relative to the rest of the balance sheet.

Yes, and just to correct one thing, I think you said securitization assets on the balance sheet. I think you meant to say off the balance sheet. But yes, there still remains material flexibility as it relates to the REIT test at this point. So I think without getting into too many specifics, I think that's the best way to characterize it.

And remember, Julian, the off-balance sheet assets are valued for REIT purposes at gross, and the bad REIT assets are valued at the net equity level. So, that's always been, I think, a misunderstood aspect and the power of having the efficiency assets as part of the business.

Yeah, I hear you. Jeff, one last question for you, if you don't mind. Super quick. Did I miss you on quantifying that mesquite impact in Texas, or did you not? I just want to make sure I heard you right there.

You heard it exactly the way we intended it to be told. We issued guidance with – it's just flat too early to say any specifics, Julian, but we have – given guidance with full knowledge of the impact of the Texas issues.

Right. Okay. Understood. I'll take it with that. Thank you, guys. Thank you, sir.

Our next question comes from Steven Berg with Morgan Stanley.

Hey, guys. Good afternoon. Hi, Steven. Hey, Steven. Hi, most of my questions have been addressed, maybe just one on potential further democratic legislation. We've been seeing various drafts and have some sense for the different elements that might be in another round of legislation and we're fairly bullish about the prospects for more support at the federal level. I guess when you look at the landscape of different areas of potential additional federal support, Is there anything that stands out to you as especially beneficial or sort of noteworthy as you think about your business in the context of the democratic support for clean energy?

You know, Steve, I was going to say I would wait to get a note from you that describes this in far more detail than I would ever be able to understand it. I congratulated you on your recent note and look forward to them all the time. Thank you. You know, the last four years were, you know, from a federal energy policy standpoint, were, you know, a bit of a dark period. And yet the business was good. I don't know what federal government will do and what is possible with a split Senate, but it's going to be a heck of a lot better than the last four years. You know, we certainly see the federal energy efficiency increase. and resiliency mandates as being completely in our wheelhouse. If President Biden can do what he and President Obama did, that is just a wonderful thing. That's a program that we still do business there, but it's atrophied without any executive branch leadership. And that's executive order type stuff. I continue to believe that a price on carbon and a dividend is the way to unlock markets to really attack carbon, not just in the electric sector, but in ag and industry and transport. You know, we hear things that, you know, that's not the craziest notion. I don't know what your mood ring says on that, but ours is turning a little more... What did we say, blue or green? Not black or yellow. And, Stephen, I actually do have a mood ring that I put on whenever we have debates. But anyway.

I use an eight ball, but same idea.

Ah, good.

Great. Well, thank you very much. Thanks, Stephen. Stay well.

This will conclude our question and answer session as well as today's conference call. Thank you for attending today's presentation. You may now disconnect.