HA Sustainable Infrastructure Capital, Inc. quarterly report, Q3 FY2019

Business context and reporting period

Hannon Armstrong Sustainable Infrastructure Capital, Inc. (NYSE: HASI) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2019. It invests in energy efficiency, renewable energy and other sustainable infrastructure, using equity, lending, real estate and securitization structures. The company operates as a REIT and reports one business segment.

Financial performance and position

Amounts below are in millions of dollars except per-share data and percentages.

• Q3 net margin was approximately 23.6%, versus 46.8% a year earlier; nine-month net margin was approximately 34.5%, versus 32.8%. These are calculated as net income divided by revenue.
• Q3 interest income was $19.3 million, rental income $6.5 million, gain on asset sales $7.7 million and fee income $5.3 million. Nine-month amounts were $54.3 million, $19.4 million, $16.7 million and $12.9 million, respectively.
• Q3 interest expense was $16.6 million and the provision for receivable losses was $8.0 million. Nine-month interest expense was $46.9 million, also with an $8.0 million loss provision.
• At September 30, total assets were $2.279 billion, liabilities $1.397 billion and stockholders’ equity $882.5 million. Cash and cash equivalents were $186.2 million; cash, cash equivalents and restricted cash totaled $229.0 million.
• Nine-month investing cash flow was positive $0.5 million and financing cash flow positive $137.5 million, producing a $169.6 million increase in cash, cash equivalents and restricted cash.
• Reported debt included $664.7 million of non-recourse debt, $505.5 million carrying value of senior unsecured notes and $147.6 million carrying value of convertible notes, plus $37.8 million drawn on credit facilities. Management reported total debt of $1.356 billion and debt-to-equity of 1.5:1. Debt excludes off-balance-sheet securitizations.
• The company issued $500 million principal amount of 5.25% senior unsecured notes due 2024. It reported 97% fixed-rate debt, compared with its stated target range of 60%–85%, and leverage below its 2.5:1 target limit. The two revolving credit facilities have combined commitments of $450 million; $38 million was drawn at quarter end. Covenants were reported in compliance.

Material changes versus prior comparable periods

• Q3 revenue increased 10% year over year, but net income fell 45%; nine-month revenue rose 4% and net income rose 9%.
• The principal Q3 earnings drag was the $8.0 million receivables provision following a court ruling concerning two land-lease receivables. Interest expense declined $3.1 million in Q3 and $10.6 million over nine months, mainly reflecting lower average borrowings.
• Nine-month interest and rental income increased by a combined $9 million, while gains on sales and fee income together declined by approximately $6 million, which management attributed primarily to securitization mix and rotating lower-yielding assets off the balance sheet.
• Equity-method investment income decreased to $6.0 million in Q3 from $11.7 million, and to $18.1 million for nine months from $20.0 million. Management cited a prior-year power purchase agreement settlement as a primary factor.
• Equity issuance increased weighted-average basic shares for nine months to 63.5 million from 52.2 million. Nine-month GAAP EPS consequently declined despite higher net income.
• Portfolio assets were approximately $1.9 billion, up from $1.7 billion at December 2018; managed assets, including assets in unconsolidated securitization trusts, were $5.7 billion versus $5.3 billion. Unlevered portfolio yield was 7.7%, up from 6.8%.

Outlook, management commentary, risks and unusual items

• Management reported a pipeline exceeding $2.5 billion of potential opportunities that could close within 12 months; 76% was behind-the-meter and 11% grid-connected. The filing cautions that pipeline transactions may not close. No specific earnings or revenue guidance was provided.
• Management said it expects identified liquidity sources and cash on hand to meet short- and long-term needs, while planning to continue financing through debt, equity and on- and off-balance-sheet securitizations. The company’s current quarterly dividend was $0.335 per share; future distributions remain subject to board discretion, cash generation and REIT requirements.
• The court decision was received in October 2019 and indicated that project owners were contractually entitled to terminate leases underlying two receivables. The company recorded a full allowance of approximately $8 million as of September 30, is reviewing the decision and expects to appeal. The receivables had been on non-accrual since 2017.
• Portfolio credit exposure includes $517 million classified as commercial non-investment-grade debt and real estate, including mezzanine loans to residential solar companies. The filing describes growing credit exposure as the strategy expands into mezzanine debt, real estate and equity investments.
• Other key risks include refinancing and interest-rate exposure, illiquid assets, obligor and geographic concentration, natural disasters, commodity prices and regulatory or tax changes. A 50-basis-point LIBOR increase was estimated to raise quarterly interest expense on $38 million of floating-rate borrowings by $0.1 million.
• The company reported no legal proceedings expected to have a material adverse effect and no securitization credit losses in the nine-month period. It adopted the new lease standard on January 1, 2019, with no material impact. The expected-credit-loss standard was scheduled for adoption in 2020; the impact on non-government receivables remained under evaluation.
• Management reported disclosure controls were effective as of September 30, 2019, with no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

• Track the appeal and recoverability of the fully reserved $8 million land-lease receivables, and whether additional losses arise.
• Assess credit performance and concentration within non-investment-grade mezzanine and project exposures, including counterparties in which HASI also holds equity interests.
• Monitor conversion of the $2.5 billion-plus pipeline into completed investments, and the portfolio yields and returns actually realized.
• Review financing costs, refinancing needs, covenants, fixed-versus-floating debt and the impact of off-balance-sheet securitization activity.
• Compare cash generation and taxable income with dividends, given REIT distribution requirements and management’s stated financing plans.
• Distinguish GAAP earnings from non-GAAP core earnings: nine-month 2019 core earnings were $66.0 million, or $1.01 per share, versus GAAP net income attributable to controlling stockholders of $35.5 million, or diluted EPS of $0.54. Core earnings is not a measure of operating cash flow or liquidity.