Katherine Dent - Vice President and Deputy General Counsel Jeffrey Eckel - President, Chief Executive Officer and Chairman Brendan Herron - Executive Vice President and Chief Financial Office.

Paul Strigler - Esplanade Philip Shen - ROTH Capital Partners Tyler Frank - Robert Baird Matt Wyatt - Avondale Partners Charles Nabhan - Wells Fargo Ken Bruce - Bank of America Merrill Lynch.

Greetings and welcome to Hannon Armstrong's second quarter 2015 earnings call. [Operator Instructions] It is now my pleasure to introduce your host, Katherine Dent. Thank you, Ms. Dent, you may begin..

Thank you, operator. Good afternoon, everyone. By now you should have received a copy of the earnings release for the company's 2015 second quarter results. On the call today, we have Jeffrey Eckel, our President and CEO; and Brendan Herron, our CFO.

As a reminder, a replay of this call will be available later today on the Investor Relations page of our website.

Before we begin, I would like to remind you that some of the comments made on today's 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 factor 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.

With that, I'd like to turn the call over to Jeff, who will begin on Slide 3.

Jeff?.

Thank you, Kate. Good afternoon, everyone. We are announcing core earnings of $8.1 million for the quarter or $0.26 per share, which when annualized is approximately 5.3% dividend yield. We closed over $350 million of transactions in Q2, and year-to-date volume is up 38% over this time last year.

The strong quarter help us maintain core earnings, despite the 12% increase in weighted average shares outstanding from our capital raise in May. We reaffirm our annual earnings growth guidance in the 14% to 16% range for both 2015 and 2016. Turning to Slide 4, I'd like to highlight developments in the quarter.

In the efficiency market, we are now executing on a pipeline of paced transactions with top 10 REIT. This is a market we have been developing for years, and is now starting to bear fruit. We also have had recent successes in the industrial energy efficiency market.

Historically, a difficult market for the industry, and foresee a future flow of business. And finally, we've added several new platform ESPC clients in the federal state and local markets, which continue to drive our organic originations.

We completed the first follow-on wind transaction with JPMorgan, and believe the seasoned operating wind projects will continue to bear fruit for us, regardless of what happens with PTC going forward.

On the solar front, we continue to execute by growing our solar land portfolio, which now stands at over 14,000 acres and closing on a follow on residential solar portfolio, SunPower.

It is important to note that we are seeing spreads wide in many asset classes, which is quite supportive of our growth, and will help preserve margins in a arising rate environment. In short, we continue to execute on our business plan and remain confident that we are on a positive course.

Turning to Slide 5, we show the three large markets we participate in, which looks a lot like the President's recently announced Clean Power Plan. As we have said many times, however, our business is built to finance the clean energy market independent of federal energy policy.

And so the President's Clean Power Plan is a nice to have wind at our back, but we are in no way dependent on its ultimate implementation. The chart on the right shows where Hannon fits in the industry. The follow-on wind transaction with JPMorgan demonstrates the point that we're complementing the industry's encumbrance.

Our flexibility and deal size and tenor is one of our competitive advantages, in addition to our relatively low cost of capital compared to say BDCs and hedge funds. We will attempt to demonstrate what we mean by clear-eye view of the risk and returns beginning on Slide 6.

Please bear with me, as I walk through the somewhat complicated, but we hope illuminating slides addressing why we invest where we do. Let's start with a traditional utility model. We think it is important to note that the sources of all revenues for utilities, YieldCos and Hannon, are the residential, commercial and industrial energy consumers.

Traditionally, energy consumers only paid a utility for kilowatt hours consumed and utility in turn paid it's operating cost, like PPAs, and then a debt, preferred equity, and its regulated rate of return to the common equity investors. Building on the previous slide, Slide 7 shows two markets on the retail side of utility meter.

The upper right of the chart represents the efficiency market. Instead of a commercial or industrial customer paying 100% of the energy cost of the utility, many customers are choosing to reduce the amount of kilowatt hours used and instead doing ESPC or pace transaction.

And in fact, Hannon is monetizing this choice to convert kWh purchases from the utility to money saving, so called megawatt purchases. Our clients such as Johnson Controls are leading this market by engineering the solutions we finance.

Perhaps the ESPC and pace markets are one of the reasons utility kilowatt hour sales are not increasing, despite GDP growth. Distributed solar on the left has many of the same financial characteristics as efficiency, but choosing to put solar on a rooftop, consumer is choosing to send less money to the utility and more to a company like SunPower.

We've been able to provide resi solar providers with capital than senior to their equity and the deal. Unlike efficiency, senior in the waterfall to the utility investors, in a sense that this is money that never even gets to the utility. Moving to utility scale, solar and utility scale wind, which is seen on Slide 8.

The source of revenue to these projects are power purchase agreements with utilities. On the solar side to date, we have found the best value in the land leases, which are senior to both the senior debt and sponsor equity, which might be from the YieldCo.

Finally, the utility scale wind business has two slices of investable capital for us, the tax equity tales like our JPMorgan transactions and the sponsor equity.

We like the senior preferred return position in the tax equity tales, but would certainly a look at equity structures alongside the sponsor, if the return is there to compensate for variations in wind resources and equipment performance.

In summary, our four asset classes, efficiency, distributed solar, utility scale solar and utility scale wind, all relate to the cash flow that comes from the energy consumer. Some of which goes through the utility and gets paid to us, ahead of investors in the utility capital to stock, and some that never even gets to the utility or to investors.

And within those asset classes, we are generally senior to another slice of capital such as the sponsor equity. We like that position. Additionally, we benefit from the diverse portfolio of clients and projects that insulated from the vagaries of any one client, project or asset class.

We hope this chart gives investors a better understanding of the financial characteristic of our investments, relative to the utility and YieldCo capital stack. Moving to Slide 9. We note that our pipeline remains robust in excess of $2.5 billion for the next 12 months with a balance mix between wind and solar to go with our efficiency business.

And now that climate changing greenhouse gases are back in the national dialog, we thought we would move sustainability data to the midsection of the presentation instead of leading it in the back. As we have since the IPO, we calculate the metric tons of greenhouse gases reduced in every investment we make.

This quarter, our investments reduced approximately 140,000 metric tons of greenhouse gases annually, equivalent to a reduction of 69,000 tons of coal.

And under the premise that have carbon counts and capital is scarce, we go one step further in our analysis by calculating a reduction of greenhouse gases per $1,000 of investment, which shows that efficiency investments were the most impactful per dollar invested followed by wind and then solar.

Now, I will turn it over to Brendan to detail our financial performance and credit quality..

Thanks, Jeff. Turning to the Q2 results. We generated $14.5 million of core investment revenue over a 100% increase from Q2 last year. The core investment income increase is due to an increase in the size of our portfolio to approximately $1.1 billion at the end of Q2 from just under $600 million at the same time last year.

The investment in core investment revenue -- the increase in core investment revenue was partially offset by higher interest expense, as we increased our leverage to 1.8 to 1 from 1.2 to 1 at the same time last year. And we ended the quarter with 32% of our non-match funded debt at fixed rates.

We also realized fee income of $2.4 million in the quarter, a decline from last year, as we held more transactions on our balance sheet. Our core total revenue, net of investment interest expense was $10.8 million in Q2, an increase from $7.6 million in the same quarter last year.

Other expenses core were flatted approximately $2.8 million, despite an 83% increase in the balance sheet. This is the power of our internally managed platform, with no overhangs from IDRs. We remain very efficient as total headcount is approximately 30 people. Core earnings grew to $8.1 million compared to $4.8 million in the same quarter last year.

Core EPS grew 18% from Q2 2014 to $0.26 per share in Q2 2015. This reflects the impact of the dilution of the approximately $0.1 to $0.2 from the May equity raise that we discussed last call.

On a look-forward basis, as of June 30, 2015, our average portfolio yield is approximately 6% with energy efficiency yielding approximately 4.4% and renewable energy yielding approximately 6.6%. These numbers are largely consistent with previous quarters and will vary slightly based on portfolio mix.

The chart on the right makes the case, as we have discussed, that originations in our business are lumpy. And while we have a strong pipeline, any one quarter does not make a trend. Despite the lumpiness in originations, you see the stableness of the earnings.

In addition, you will note that the timing of last two raises proceeded large quarters of origination, which is a reflective of our desire to avoid excessive dilution. A quick update on our wind equity investments. Included in core earnings year-to-date, it's $6.4 million of earnings from our wind equity investments.

The projects are tracking to our projections. And this year, we have collected $14.6 million in cash from these investments. Turning to Slide 11. One of the things that makes our business unique is our focus on the diversified portfolio of high credit quality assets.

Our real estate and debt portfolio continues to be 99% investment-grade rated at June 30, 2015. This consists of 40% of our assets from government obligors and 59% commercial transactions with only 1% or $13 million not considered investment-grade. Given the nature of the wind equity investments, we do not include them in analysis.

Our portfolio is widely diversified with over 95 projects and an average outstanding balance of approximately $11 million per project. Turning to slide 12. We wanted to focus on the potential impact of higher rates.

Presently, 65% of our assets are fixed rate debt, with the remaining consisting of floating rate debt, equity method investments and real estate. As we have discussed, new assets are originated at current rates, which is in effect similar to a bond ladder.

On the debt side, we remain at approximately 32% of our non-matched funded debt at fixed rates and are releveraging from our equity raise back to our 2.5 to 1 leverage target and presently sit at 1.8 to 1.

We have discussed that given the continued low short-term rates, we continue to focus on increasing our fixed rate debt to be 50% to 70% fixed rate. This week, we announced another step in this process, with the kick-off of an approximately $125 million rated asset-backed securitization transaction.

The fixed rate bonds have been preliminary rated with an A rating and a 25-year maturity. And we would expect subject to market conditions to complete this transaction over the quarter. Assuming we close this transaction, we would have bid at approximately 50% fixed rate debt.

Even without this or other future fixed rate transactions, we estimate that a 25 basis point increase in LIBOR when increased quarterly interest expense by about $300,000 or less then $0.01 a share, certainly a manageable number. With that, I'll turn it back to Jeff, who will wrap up the presentation..

Thanks, Brendan. Turning to Slide 13. Chart on the left shows yield as of Tuesday in a variety if asset classes.

Given our generally senior position in the capital stack, minimal exposure to fossil fuel price risk and assets that are diverse with low asset concentration, we continue to believe the Hannon dividend yield and growth guidance is attractive relative to our other investment options. To close, we are excited by the depth of opportunities in front us.

We will continue to be thoughtful about raising capital and we will use that capital to execute on our investment proposition, deliver an attractive dividend yield from long-term, contracted cash flow and grow that dividend from a large, growing, clean energy market, all with the diverse portfolio of high credit quality obligors.

Once again, it is an honor to work with my colleagues and co-investors at Hannon. And I thank them publicly for another outstanding quarter. We appreciate you listening to our update. And we'll now open the call for a few questions..

[Operator Instructions] Our first question is from Paul Strigler from Esplanade..

So now that the YieldCo space realizes that the cost of equity is actually higher than cost of debt, are you seeing any new opportunities in that space to help these guys hit their very aggressive growth targets that they intended to finance largely with equity, nut now that the cost of that has skyrocketed in the past few weeks, is this an opportunity for Hannon here..

We've always said that our growth potential was inclusive of the YieldCo growth potential. In that, they've always needed leverage to we think make their numbers work. And so to the extent they value our capital more than they might have in the past, I think the answer is, yes. But early days we see how this changes in the market, we'll go.

But yes, it's certainly supportive of our business..

Our next question is from the line of Philip Shen from ROTH Capital Partners..

So in your release, you highlighted growth in residential solar.

Can you give us a little bit more color on the structure of those transactions and how you see resi playing out for you going forward?.

Well, I mean we've said, Sun Power transactions is quite similar to the prior two transactions we've announced and I think consistent with our origination strategy of doing programmatic agreements with some of the best players in the business.

These are transactions that have three elements of capital in them, they have tax equity, they have sponsor equity, and then we fit in the middle with capital that's in back of the tax equity, but in front of SunPower's equity..

And as a follow-up to Paul's question there.

Given that's some tumult in the YieldCo and solar stock in recent weeks and given your experience, how do you expect this to play out over the next six months?.

Well, obviously, we can only talk about how it affects our market. I've joked in the past that I'm glad our name isn't Solar Armstrong, and we have a nice, 150% of our pipeline is efficiency. So if the entire YieldCo opportunity went away we still have a nice business, but it doesn't go away.

I think those are sound businesses with nice cash flowing projects, with well-rated obligors and we think we'll be able to put some capital to work with those projects..

Our next question is in the line of Tyler Frank from Robert Baird..

Could you comment a little bit more on the spreads that you see rising in the different asset classes and maybe provide a little bit more color on how rapidly you've been seeing them rise? And do you expect these spreads to continue to increase, if the U.S.

were to start raising interest rates?.

Well, most of the rise we're seeing in spreads is on the long end. We don't really do much on the short-end, except borrow a little bit. So I think you do see institutional investors demanding more and getting it. Obviously, supply and demand in each of our submarkets is different and that affects the pricing power that we or any investor has.

But I guess, we would say, we feel like we found a bottom and in certain markets it's starting to go up and we think that's appropriate..

And I think I'd add to that, Tyler, that we like many financial institutions expect -- it's hard to add big spread on a small base rate. So a base rate rise, you typically would see spreads rise also. So I think there is a combination there and the spreads are probably rising in part, because people are expecting the base rates to go up..

And then with the strong transactions during the quarter, was there one or two large transactions that sort of underscore that or can you provide a little more color on how that breaks down?.

No, it was a pretty diversified group of transactions in across all categories. So I think all the markets were working well for us in the quarter..

Our next question is in the line of Michael Morosi from Avondale Partners..

Matt Wyatt here filling in for Michael. Just a quick question on efficiency yields. Last quarter you had mentioned a potential bottom in those.

With a slight decline this quarter, do you think this is kind of maybe the bottom?.

Yes, I think we give the rates every quarter going forward. It's very difficult to look at the mix of any one quarter if it moves 10 basis points or something on that chart. A lot of its mix, so lot of its surrounding, so I think any one quarter doesn't make the trend.

So I think it's just that we expect that looking forward we'll see some things rising, so its hard to characterize on any one thing, because there is lot of things, again, the duration of the assets, so on and so forth can all affect the mix that we post for any one quarter.

But I think our view is that as Jeff indicated that there's potential now for the spread increase and a lot of the things we're looking at..

Our next question is in the line of Charles Nabhan from Wells Fargo..

I was hoping you could comment more broadly on the C-PACE opportunity.

Specifically, I know that some states are ahead of others in the regulatory process, but are you starting to see more progress on that front? And if you could give some specifics around some of your more recent investments as far as where you're seeing the most activity geographically?.

Well, I think the usual answer of these questions is California and that they're the leader in most of these things. But PACE is in something like 70% of the U.S. jurisdiction, so that doesn't mean the all the PACE legislation is functional or something we'd invest in, but generally it's there.

For us the bigger question, Charles, was what's our go-to-market strategy for PACE? It's probably not a traditional ESCO-type market in the commercial office building sector and that's what's really taken us some time.

And I would think with this top-10 REIT, we've figured out one model that we would really like to continue to invest in and expand it, just as we did with ESPC 15 years ago when we had one or two clients and now we have more then 15. We think that same potential is there in PACE.

That said, in term of the legislation, Connecticut has got a nice program; Ohio has got a nice program; I think Texas is working on a good program. And it almost takes the property owners, like this top-10 REIT to go to the local jurisdiction, say this is really what we want.

It's a far more effective way for us to see changes in the market than us going in and asking somebody to pass the law..

And the thing to add there is we did close transactions in multiple states this quarter, so I think that those show the continued growth..

And as a follow-up, I was hoping you could comment on yields across your portfolio. I know you gave the average size about $11 million and the average yields of 6.6% and 4.4%.

But if we were to look across the portfolio, how much deviation do you see away from those averages or do you see a lot or is it typically bunched up around those averages?.

I think it depends. You have to weigh in there and the duration of the individual asset and know that how we rate the asset. So when we look at them, we maybe step back and talk about how we price to start. So when we price, we look at how long they've been assets and that helps us determine the base rate. We use treasuries or swap rates as a base rate.

And then we put a spread on top and the spread is really a credit analysis spread and a market condition spread. So within a portfolio, you'll see some assets that are higher priced and some assets that are lower priced.

And I'll pick on energy efficiency, for example, the federal government assets are going to tend to be on the lower end of the [ph] 44, because of the credit of the federal government, and long-term make sure that structure and things.

Other transactions are going that are either an industrial or same local or PACE or something else maybe on the higher end to that. So it really depends on the mix of who were originating transactions or there is some variability in that based on that..

Our next question is from the line of Ken Bruce from Bank of America Merrill Lynch..

My first question relates to some of the discussion that you were having around wider spreads.

I guess, the specific question I have is, how does the spread action color your decision to either put assets on the balance sheet or to prefer securitization, if in fact those are in anyway related or if they're mutually exclusive just in terms of what is coming through the pipeline?.

I think as we've talked about in the past, the poster child for securitization is a really long-dated federal ESPC. The insurance companies like the paper, they have a lower cost of funds. So that's attractive to them. It's attractive to us, because we can get the fee and we can mange the duration of our portfolio.

So that's kind of the poster child for what gets held or sold. We use securitization as part of our portfolio management tool. So we're trying to keep the average duration somewhere around 10 years to 13 years, which is where we've kind of been running, so we use securitization.

And when we see long-dated fixed rate assets that make sense to securitize, we'll securitize rather than put on the balance sheet, and it's all part of our interest management strategy..

Just in the context of wider spreads today, I imagine that that would increase your appetite for Paper on the balance sheet?.

Its really depends on mix, and that's one thing we look at, and obviously, if you can hold paper that earns more, you'll hold more of it.

But if market pricing is such that we can make it attractive seeing it, it makes sense to do that, given where it sits into the duration and other alternatives we have to put on the balance sheet, then we'll take advantage of it..

But I would add that, as the balance sheet builds, the need to do fee generating securitization falls. It may still be the right choice, but at least now we have a choice to do it. Early on, when we were ramping, the fees were pretty important. And if you look at that percentage of our fees as part of our total income, it's falling and it should..

Well, having followed this company for a while, it has a complexion and the P&L has this changed a lot, and I believe taken out a lot of volatility. Obviously, there is few other things that has introduced some new volatility, but that relationship seems to have improved.

The next question related to just the investment grade, investments that you are making. There is pretty big tick up in the commercial investment grade, and you added a new disclosure or at least in the press release relating to what is rated investment grade externally versus internally.

And maybe you can just help me understand, if in fact there is any change in terms of the appetite for what's going on in the balance sheet in this area and maybe walk us through the exposure please?.

So we've actually disclosed in past quarters, what was rated internally versus what was rated externally. So I think that's consistent. We did add a disclosure about how much residential solar we had, it was subordinated to the tax equity. And we just wanted to call that out, so people were aware that we had that.

In that case, we're relying on the publicly traded residential solar provider on our certain tax equity indemnities that they've made, because we're subordinate to the tax equity. So there is a little bit more analysis there.

So we just wanted people to be aware of how much exposure we had of the portfolio, which is roughly 10% that we had to the residential solar area..

And lastly, I guess as we think about the build-out of the skill set for Hannon Armstrong.

I mean do you believe that you've got, as you're kind of entertaining more of commercial credit risk, did you feel like you've got the rate human capital on the team to mange that? Maybe just update us on the build-out of the infrastructure from that standpoint, please?.

That's a good question. We definitely have added people. We've added a Credit Manger from a commercial bank. We've really increased our in-house legal team as well as asset management people with more operating credit and compliance experience.

So it's never perfect, but we feel like we've really added some skills that we do need and they are really helping us make better decisions..

Our next question is a follow-up question from the line of Paul Strigler from Esplanade..

Just a quick follow-up. So you mention that spreads from the base line are increasing, which is great.

But when do you think we can expect to see the results of the sort of carnage in the YieldCo space flow through the asset pricing? So I think one of your competitors, I think NRG Yield mentioned that wind pricing had gotten crazy, uneconomic for those guys.

But I think we all know who the person driving those prices up was, now that that particular buyer is pretty compromised right now.

How essentially you see sort of flow-through and asset owners and sort of their expectations for debt and equity pricing flow-through?.

Paul, that's a terrific question. I don't have an answer, but it's a terrific question, and not dodging and it's just we were all kind of watching this stuff real-time. And I guess we stay pretty focused on execution and our clients. And it will be obvious to us probably, maybe after it's obvious to you, when those changes will hit.

But our clients are generally, they go through ups and downs and have been doing that for a very long time. And they still have to sell and they still need to embed our financing in their sales offers. So we don't worry about the disruption in one sectors equity market that much frankly..

Well, it's at least fair to say that you could have a double pronged tailwind, and that you have base rates going up, but spreads increasing modestly combined with just demands from equity and debt holders, are customers coming down?.

I think that where we play in growth markets, and so there's lots of opportunities. And I think that one thing we try to stay very disciplined on is finding the best risk adjusted returns. And so today that's been in land and senior debt and other places that puts us ahead of the equity.

If the equity pricing would change in a dramatic way that it makes sense for us to look at the equity, then we would look it, but today, we have the flexibility to go wherever. And today, we've tried to been very disciplined about being what we thought were the right risk adjusted returns. And I think we'll continue to focus on that.

I have one correction, the comments I made earlier, I just want to bring up is when the future ABS transaction, approximately $110 million of and the $125 million is A rated. The rest is a BBB rated slice..

There are no further questions at this time. I would like to turn the floor over to the management for closing comments. End of Q&A.

Thanks. You asked great questions once again. And we look forward to speaking with you again soon. Have a good day..

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation..