HA Sustainable Infrastructure Capital, Inc. annual report, FY2015

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Business context and reporting period

Hannon Armstrong Sustainable Infrastructure Capital, Inc. (NYSE: HASI) filed this Form 10-K for the fiscal year ended December 31, 2015. The company provides debt and equity financing for energy-efficiency, renewable-energy and other sustainable-infrastructure projects, operating as a REIT. It reported one business segment. The filing also provides fourth-quarter results; amounts below are in U.S. dollars.

Financial and operating highlights

  • Revenue and earnings: 2015 revenue was $58.7 million, up 30% from $45.3 million in 2014. Net income was $8.0 million, down from $9.8 million; net income attributable to controlling shareholders was $8.0 million, or $0.21 per diluted share, versus $9.6 million, or $0.43 per share.
  • Q4 results: Revenue net of investment interest expense and credit-loss provision was $8.8 million; net income attributable to controlling shareholders was $2.2 million and diluted EPS was $0.05.
  • Margins and supplemental measure: Net investment margin increased to 3.3% from 2.7%. Management-defined Core Earnings were $33.5 million, or $1.04 per share, versus $20.3 million, or $0.93 per share. Core Earnings is non-GAAP and includes adjustments, notably an effective-interest-method adjustment for wind investments; it is not a measure of cash available for distributions.
  • Cash flow: Operating cash flow was $18.5 million, versus $5.1 million in 2014. Investing activities used $361.1 million and financing activities provided $327.0 million. Cash and cash equivalents ended the year at $42.6 million, down from $58.2 million.
  • Balance sheet and leverage: Total assets were $1.47 billion, total liabilities $1.04 billion and equity $432.1 million. On-balance-sheet borrowings comprised $247.4 million under the credit facility, $563.2 million of asset-backed nonrecourse debt and $100.6 million of other nonrecourse debt. The reported debt-to-equity ratio was about 2.1x, including match-funded debt; excluding that debt, it would have been 1.9x. The credit facility had a $500 million borrowing limit and $1.5 billion maximum total advances.
  • Portfolio: The company reported approximately $1.3 billion of on-balance-sheet portfolio assets and $3.2 billion of managed assets, including $1.8 billion held in unconsolidated securitization trusts. It completed approximately $935 million of transactions in 2015, compared with $875 million in 2014, and reported a pipeline exceeding $2.5 billion. The pipeline is not a commitment to close.
  • Distributions and financing: Quarterly dividends rose from $0.26 per share to $0.30 for the distribution declared in December 2015 and paid in January 2016. Two 2015 follow-on stock offerings generated approximately $181 million net proceeds.

Material changes versus 2014

  • Revenue growth reflected a larger average portfolio, higher financing-receivable interest income and increased rental income from real estate. These gains were partly offset by a $4 million decline in gains on asset sales.
  • Investment interest expense rose to $26.4 million from $16.7 million as average debt balances increased, despite the average borrowing rate declining to 3.4% from 4.0%.
  • Other expenses increased to $24.1 million from $18.8 million, principally because compensation and benefits rose, including higher equity-based compensation. Net income consequently declined despite growth in revenue net of interest expense and credit-loss provision.
  • Portfolio growth included expansion of wind equity investments and real estate. The company increased its leverage target in March 2015 to 2.5x from below 2.0x and reported fixed-rate debt at approximately 71% at year-end, above its stated 50%–70% target range.

Outlook, risks and unusual items

  • Management described long-term market opportunities but cited near-term uncertainty, including lower commodity prices, wider credit spreads and potential effects on merchant renewable-power economics. U.S. benchmark oil prices fell 53% and average natural-gas prices fell 41% in 2015 compared with 2014.
  • Management expects to pursue portfolio growth and financing diversification. It reported no formal earnings or revenue guidance; the $2.5 billion-plus pipeline may not be completed.
  • Key risks include reliance on government incentives and policies, interest-rate and refinancing exposure, leverage and liquidity, illiquid assets and subjective fair-value estimates, obligor and project credit/performance risk, and regulatory or tax changes affecting REIT qualification or the company’s 1940 Act exception.
  • Wind-project contingency: A $13 million investment in debt securities tied to a wind project was affected by indenture defaults and an acceleration/foreclosure process. The project owner agreed to the proposed foreclosure, subject to regulatory approvals; a sale was expected in the first half of 2016. Management expected proceeds to repay the bonds in full but stated there could be no assurance, and concluded the securities were not impaired at year-end.
  • Credit history and prior loss: No financing receivables, investments or leases were on nonaccrual at year-end, and no credit-loss provision was recorded in 2015. A prior geothermal-loan loss was fully resolved through a final $0.8 million recovery and charge-off of the remaining allowance, with no 2015 income-statement effect.
  • The company reported no legal proceedings expected to have a material adverse effect, and management concluded disclosure controls and internal control over financial reporting were effective. The auditor issued an unqualified opinion on the financial statements but did not attest to internal control effectiveness.

Important facts for investors to verify

  1. Review the wind-project foreclosure, regulatory approvals, sale outcome and repayment of the company’s $13 million debt investment.
  2. Reconcile reported leverage and fixed-rate debt percentages, including the treatment of match-funded debt and off-balance-sheet securitizations.
  3. Assess the quality, concentration and performance of portfolio exposures, including internally rated residential solar loans and commercial obligations.
  4. Compare Core Earnings with GAAP net income and cash generation, focusing on the wind-investment adjustment and equity-based compensation.
  5. Confirm the sustainability of distributions against taxable income, operating cash flow, financing needs and REIT requirements.
  6. Monitor government incentives, natural-gas and power prices, interest rates, credit spreads, refinancing availability and REIT/1940 Act compliance.