Good afternoon, and welcome to Hannon Armstrong's Conference Call on its Q1 2019 Financial Results. Management will be utilizing a slide presentation for this call, which is available now for download on their 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. [Operator Instructions] At this time, I'd like to turn the conference call over to Kate McGregor Dent, Vice President and Deputy General Counsel for the Company..

Thank you, Operator. Good afternoon, everyone, and welcome. Earlier this afternoon, Hannon Armstrong distributed a press release detailing its first quarter 2019 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-Q 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 Jeffrey Eckel, the Company's President and CEO; and Jeffrey Lipson, our CFO and Brendan Herron our EVP. With that, I'd like to turn the call over to Jeff Eckel, who will begin on Slide 3.

Jeff?.

Thanks, Kate, and good afternoon everyone. 2019 has started with strong originations and earnings. Today we're announcing GAAP earnings of $0.21 per share and core earnings of $0.33 per share. For the quarter we invested $319 million, increased revenue by 18% year-over-year and earned a core return on equity of 10.2%.

We reiterate our previously provided three-year guidance through 2020 of 2% to 6% growth in core earnings from the 2017 base. Importantly, our Q1 investments will embold 96,000 metric tons of CO2 annually, a CarbonCount of 0.3. We're also pleased to have published our 2018 ESG report available now on our website.

I’d like to call your attention to our presentation of TCFD or the task force on climate related financial disclosures in the report. We've expanded upon our climate change scenario analysis originally presented in our 2018 10-K and welcome your feedback.

Turning to Slide 4, we want to emphasize how the diversity and originations drives portfolio diversity. With approximately 10 target markets spread across Behind the Meter grid-connected and sustainable infrastructure sectors. Our annual investments will continue to be diverse over time.

If we invest $1 billion annually, let's say securitizing some portion of that investment away from the portfolio. We should continue to increase portfolio diversification. As you will note, federal state and local or governmental projects are the single largest target market at 31% of the portfolio across 55 separate projects.

Solar land is the second largest at 22% across approximately 60 grid-connected solar projects. In total we have over 190 investments or a $10 million average investment. In reality, the number of individual assets can be substantially greater in each investment.

For instance, we count residential solar, which is 16% of the portfolio as 19 investments even though it is 90,000 individual residential solar customers. In another example, we count C&I solar as seven investments despite it being over 200 individual C&I projects.

The net effect is that our reporting is conservative and portfolio diversity is even greater than it may seem. Further, we enjoy geographic diversity in our portfolio across the U.S. for example, some public wind companies have reported lower wind for the quarter.

Our portfolio might be more geographically diverse than those firms and thus our portfolio of wind assets was off only a fraction of what was reported by them. And since we're generally senior in the capital stack to those investors, the impact of low wind to us is even more muted.

Finally, if any one asset class becomes too large as a percentage of the portfolio, we may look to our syndication and securitization capabilities to maintain diversity, maintain deep relationships with a variety of capital market participants should we ever need a partner to further diversify some portfolio exposure.

Turning to Slide 5, we continue to see growth in Behind the Meter target markets like efficiency, distributed generation, solar plus storage. The pipeline remains strong at more than 2.5 billion. Turning to our portfolio on the right, it remains balanced between behind-the-meter and grid-connected totaling $1.9 billion with a 6.9% yield.

If you go back to Q1 2017, eight quarters ago, it was also $1.9 billion but with a 6.2% forward-looking yield. Our portfolio management group has been working hard to ensure that the assets in the portfolio include the best risk-adjusted returns for our business and in several cases realizing value for the ones that are better held by someone else.

As a reminder, while our pipeline is strong and guidance is reconfirmed, any one quarter can vary based on volume and mix of investments. I'll now turn it over to Jeff Lipson to detail our financial performance..

Thanks Jeff. Turning to Slide 6. For the quarter, total GAAP revenue increased by approximately $5 million or 18%, as compared to the same quarter last year. The increase was a result of higher yields in our portfolio and higher gain on sale and fee income due to the increased securitization volume.

Interest expense decreased by approximately $3.3 million to $15.4 million compared to this quarter last year, as a result of lower fixed rate debt and lower leverage.

As discussed during our last earnings call, we completed a series of transactions in the second half of 2018, which lowered our interest costs by reducing our debt balance and our corresponding leverage. Compensation and general and administrative expenses increased by approximately $2.4 million for the quarter, as compared to this quarter last year.

As a result of increased equity-based compensation expense resulting from differences in vesting periods for certain annual grants and the higher 2018 compensation due to company performance.

For the quarter, income from equity method investments increased to $4.5 million from a $2.3 million loss reported in this quarter last year, due primarily to the HLBV income on a particular project.

We also recognized an approximately $2.1 million income tax benefit for the quarter, related to the allocation of tax attributes from one of our projects. In total, we have $13.6 million or $0.21 per diluted share of GAAP income for the quarter, compared to a loss of $1.2 million or $0.03 per share in 2018.

As a reminder, the GAAP earnings do not include the full effect of the cash we received from our equity method investments. In the first quarter of 2019, we collected $27 million in cash from our equity method investments.

Since we have based our investment on future cash flows discounted back to present value, the cash we received reflects both in earnings component and a return of investment.

This quarter, we've made a core adjustment of approximately $5 million, which when added to our $5 million GAAP earnings results in core earnings on this portfolio of $10 million and thus, the other $17 million of cash collected represents a return of investment.

The equity compensation adjustment was $3.6 million for the quarter, as compared to $1.8 million last year due to the higher equity compensation described earlier. In total core earnings were $20.9 million for the quarter or $0.33 a share, a 22% increase over this quarter last year.

Turning to Slide 7, our portfolio credit quality is largely consistent with our previous presentation of the 2018 results. And we continue to have less than 1% of the portfolio on nonaccrual status.

Moving onto our financing activities, we paid off a portion of one of our secured debt transactions scheduled to mature this year, which correspondingly lower the fixed rate debt to 72% or approximately the midpoint of our targeted range.

If we additionally consider equity as a funding source that does not create interest rate risk, our interest rate risk insensitive funding is 84% of our balance sheet. Our remaining maturities of 2019 nonrecourse debt are in the process of being paid off or extended. Leverage remains relatively flat compared to year-end at 1.5 to 1.

And our stock remains largely institutionally owned with insiders owning approximately 5%. Turning to Page 8, our business model includes both a gain on sale component and a recurring revenue component. This quarter, we wanted to highlight our growth in the recurring revenue component as measured by core net investment income.

As reflected on Page 8, core net investment income has grown significantly from $36 million to $66 million over 2015 to 2018, a 22% compound annual growth rate with the first quarter of 2019, reflecting a continued positive trend.

The long duration of our assets allows us to consistently add incremental core net investment income with only modest annual runoff in the portfolio. The recent increase in portfolio yield has also contributed to increased core net investment income, as is the aforementioned reduction in interest expense.

Even when calibrated on a per share basis, core net investment income has consistently increased over time. Recurring revenue remains a fundamental strength of our business model. Now I'll turn the call back over to Jeff..

Thanks. Turning to Slide 9. In closing, we believe our Q1 results are consistent with our investment thesis. We will earn superior risk-adjusted returns investing on the right side of the climate change line. And we do that by supporting the top tier clients who are engineering the decentralized, digitalized, and decarbonized future of energy.

Our core return on equity continues to meet or exceed our target of 10%. Investors enjoy an attractive 5% dividend yield, which is still above the utilities dividend yield of 3%, peers of 3.8% and REITs at 4.2%. This yield plus our 2% to 6% growth from a diversified portfolio, provides investors an attractive total return investment.

Finally, we have set a high bar for ourselves on investment choice and ESG disclosures that we hope other capital providers will someday fully integrate into their financial reporting. Thank you for joining us today. We'll now open it up for a few questions..

Thank you. [Operator Instructions] Our first question comes from Christopher Souther with Cowen and Company..

Hey, thanks for taking my question. First one, I saw that you guys added grid-connected storage to the target markets in the deck, whereas previously it was just behind-the-meter storage. And then also you changed the distributed solar to distributed generation for behind-the-meter.

Are there any new developments on there or was it just kind of overdo that they weren't on the deck, want to figure out if there’s like a new focus on any of this?.

That's a great question. So with distributed generation and behind-the-meter, what we're really saying is that inclusive of solar plus and we're seeing some natural gas cogeneration, I'm sure there's a few fuel cells in the portfolio as well. So there are lots of other technologies that are behind-the-meter.

But yes, solar is continues to be a prime one and storage is in a lot of the investments we've talked about in the past. On grid-connected, we are starting to see more solar plus storage type applications and wind plus storage. So we just – for completeness, we'd add it to the target market summary, that's where these technologies are going..

Understood. And then I saw that you noted on the deck that securitization was up.

Did you give the exact mix on that between balance sheet and securitization?.

I don't believe we did..

We did not..

Okay..

It was certainly a heavier securitization quarter than on balancing..

Okay.

Is that 75% or 90%?.

This quarter, it was closer to 90/10..

Okay, got it. And then the leverage, going down to 1.5, obviously you changed the target leverage to kind of a ceiling rather than the target recently. I just wanted to get an idea if there was like a new kind of band, where we should be modeling you guys going forward or – if you could kind of give any commentary on that..

Sure. So I think the 1.5 was consistent with year-end and we did changed the – as you mentioned, the target of 2.5 to an up to 2.5, when we did the last call. And I think the leverage is likely to remain even below 2, for an intermediate period of time here..

Okay.

So 1.5 to kind of 2 times maybe is the new band that you'd expect in the near to mid-term?.

Yes..

Okay. I appreciate it. I’ll hop in the queue. Thanks guys..

And next is Mark Strouse with J.P. Morgan..

Yes. Good evening. Thank you very much for taking our questions. So just a follow-up on that earlier question, regarding the securitizations, I think on the last call you had talked about over the course of 2019, the mix of on balance sheet deals being higher than it was in 2018.

Obviously more securitizations in 1Q, has something changed or is that just a function of timing and that's still your message as far as more on balance sheet this year?.

Yes. And I think – hi Mark. Nothing has changed from our Q4 messaging. I made the point on Slide 5 that transaction volume and mix in any quarter can be variable. And the mix is really what drives the level of securitization versus on balance sheet. So we're not changing any outlooks for 2019..

Okay. Makes sense. And then another point on Slide 5, can you just go back, excuse me, go back to the yield improvement that you talked about over the last couple of years. And just a bit more color into what's driving that.

And if you're at 6.9% today, I mean, is there room for further improvement, how should we think about that over the next two years?.

Let's see. I mean, I think there were some lower yielding assets that have left the balance sheet. And we've been able to find a better home for some of those than our balance sheet, which has the impact of increasing the portfolio yield. And then we've added some higher yielding assets.

I don't think the grid-connected assets have changed much but the behind-the-meter assets, particularly residential solar that we've talked about, some of those transactions are indeed higher yielding. So there's – really just a pretty steady progression over eight quarters to get rid of the lower yielding assets and add higher yielding assets..

Okay. And again, with as much granularity as we have, it's really – it's hard to move the numbers in any one quarter with any set of deals..

Yes. Understood. Okay. Thank you, Jeff..

Thank you..

And next will be Julien Dumoulin-Smith with Bank of America..

Hey, good afternoon everyone..

Hi, Julien..

Hi, Julien..

Hey, perhaps just to pick up a little bit on where others have been leaving off here. I just want to understand a little bit more on this increase in the behind-the-meter portion of the pipeline.

When you think about where that's going, I mean, obviously you've identified in the slide, you’ve talked a little bit more, we've seen some shift on the resi side already.

Can you talk a little bit conceptually where you think that incremental yields going to go and what that incremental yield looks like? As you look at the marketplace today, just elaborate if you can. I mean, maybe even if you can break down that 82%, a little bit more narrowly, maybe not precise percentages in the buckets.

I'd be curious on what that incremental shift has been from the 75..

So you clearly have federal, state and local assets in there. That's been our legacy business. And that continues to be a substantial portion of the pipeline. You talked about C&I solar, last quarter, we're really liking what we're seeing in the C&I solar. And we've converted a lot of the residential solar opportunities already.

So those are some thoughts on what's in there. We're not going to get into precise percentages, but I think from the bigger picture perspective, this is where the market is going, at least our addressable market. I think the solar folks are doing a fine job and the efficiency companies are doing a fine job in really penetrating the customer premise.

And that plays to our strength. I don't know, there's a whole lot more we really want to add in terms of the individual markets for competitive reasons, but I think that that's where we are..

All right. Fair enough.

And then can you comment a little bit about the fixed versus floating targets? And how you’re thinking about not necessarily in terms of like aggregate debt targets but just the composition now and your attitudes there?.

In terms of the fixed rate debt?.

Yes, yes, exactly..

I just want to make sure I understand your question….

Asset side or liability side?.

Sorry. Yes, the debt piece of it, the liability side..

Okay. Right. So the debt range that we've targeted is 60% to 85% being fixed rate. And as we mentioned, we're right in the midpoint of that target, roughly had about 72% right now. And we fully expect to remain within that targeted range and continue to take very limited interest rate risk..

Got it, but you're not – right.

So you would expect to maintain roughly the 70-ish range, you're not going to continue to raise that or whatever?.

Well, again, within that 60% to 85% would be the right way to think about it, may bounce around a little within that range..

Got it. Excellent. And then lastly, if I can ask you more conceptually, obviously we've seen additional staffing. And again, congrats Brendan.

How are you thinking about just expanding the overall size of the pie of the pipeline over time? Maybe let me ask it this way, right, you talk about $2.5 billion or greater than $2.5 billion, how do you think about at least one quarter in, shall we say.

I'm seeing that number go up in terms of total pipeline or Brendan, as you think about what you're seeing out there in the marketplace today is this about refining the composition of the pipeline in terms of your new role to find additional growth opportunities and perhaps finding a higher yielding or more attractive overall opportunities rather than increasing the gross preferred pipeline..

Thanks. Julien. I think in my new role, we continue to look at additional markets, and we added storm water a couple of quarters ago and we're continuing to look at other opportunities there. This is a large addressable market when you think about climate change. So we think there's lots of areas.

I think in anything we do as we've always done, we're very thoughtful about credit quality and risk-adjusted returns. So I don't know that there's an immediate increase in volumes or anything else, we'll go slow and make sure that we're doing it correctly..

And to add on Brendan, say I think one thing Julien, we want to emphasize is these are relatively small transactions at $10 million. They have to be programmatic. So we very much are driven by our clients' ability to commercialize successfully in new markets at scale.

And if we had to look at one thing that might constrain our growth, it is the difficulty that our clients have. And in commercializing new markets, it's not easy to be a pioneer and we follow them and support them as they develop those markets. And that takes time. We have examples of that with commercial pace. We continue to invest in commercial pace.

We believe in the market and new markets don't just fall in your lap overnight and produce fantastic returns and great volumes..

Understood. All right, well, I'll leave it there. Thank you all very much and best of luck. I'm sure, I'll see you soon..

Thanks Julien..

Thanks Julien..

And next will be Philip Shen with Roth Capital Partners..

Hi everyone. Thanks for the questions. One is start off with originations. Last quarter we talked about hitting on all 10 cylinders, with all your niche markets gaining momentum as well. Was wondering if you could provide us an update on that overall view.

Has anything slowed down? Do you feel like instead of 10 cylinders, there's a new one now? Maybe it's 11 in markets you're addressing, just some additional detail on the overall view of your all the different end markets would be great. Thank you..

Phil you can't have an odd number of cylinders in your engine. So with only cylinders and even numbers. I think we say approximately 10 and the difference is between them, are terribly historical, although we don't think they're correlated either.

If the business is good, I wouldn't change any of the narrative that we laid out in Q4 about any of the markets. Again, we're investing in 20 and 30 year assets and that view doesn't change in a 90 day time period very, very abruptly. So there's nothing that's, going through the roof and nothing that's falling through the floor.

It's really a nice, robust opportunities in all the markets..

Great. So let, let's dig into one in particular. You talked about resi solar a little bit so far. I know that that market is doing well. There's nice growth there. You were at 16%, I believe, of your portfolio being resi solar. And we've talked about some of this in the past, but I can imagine some of those partners of yours want to do more this year.

Do you expect to do some other big deals in resi solar as we get into the back half this year?.

Yes, we don't comment on individual transactions, but again, we're able to grow when they're able to grow. If the residential solar business is going well, if we've done a good job with our programmatic relationships and transacted with good execution, then we should get our fair share of that business.

That said, and one of the purposes of this chart on page four is to show that while we were active in residential solar in Q4, it's been, it's a relatively small asset class relative to the portfolio. And given that we see other assets classes going well, we think that's probably the right mix..

Okay, great. In terms of your Q1 one originations, just wanted to see if it was possible to get what the mix of those origination's might be. Perhaps not the precise percentage detail, but just directionally speaking, I'm guessing there was no resi solar in that $319 million.

But was it kind of 50% energy efficiency and then a mix of wind and if you can give us some color around the originations of the quarter, that would be great. I understand the question. That's not the kind of granularity we want to be getting into every quarter.

Again, we're managing the business for the long-term 20 and 30 year of assets, any over any 90-day period. I don't think any investor or any management team member could draw any meaningful conclusions from origination data over any 90-day period.

So, I don't think it's very useful as also, it's just not, we don't want to be measured by how well the federal efficiency market went in February. It's just not the way our business works. As we've always said. Phil's the biggest problem in our business is we don't control the timing of transactions.

We work with big obligors, we work with big engineering companies. We're there to support them. We don't dictate when transactions close. Our job is to be there with the money when it's time for the deals to close, for better or worse that's our business and we think it's a great way to work.

The best way to, the best antidote for that lack of control over timing is to have a lot of different uncorrelated markets and that's what we've got.

Does that make sense?.

Great. Absolutely. Jeff, thanks. Well, one last housekeeping question.

Apologies if I missed this, but can you share how much of the ATM you used in the quarter?.

Wait, do we disclose in the Q..

It will be in the queue. The Queue isn't filed yet. It should be in a day in the future, which will have it so a day in the very near future..

Very near future in the Q..

Okay, thanks. Thanks Jeff. Thanks. I'll pass it on. Great..

And moving on to Noah Kaye with Oppenheimer and Company..

Hey, thanks for taking the questions. Just a couple from me at the – someone brought up energy efficiency on the federal, I have anecdotally heard that just because of the shutdown there was a little bit of a timing delay on some of the, the big federal projects.

Did you see that at all show up or is, kind of the transaction financing for you're really at a lag that it wouldn't impact?.

It's the latter. So, if I know MRS go reported, I suspect, they're, if they're in the middle of negotiations on transactions with the government and it shuts down, that's going to slow them up. But there's always a lot of companies out there that are developing and negotiating these projects and we've not seen any impact from the shutdown..

Okay, great. Maybe more of a strategic question here. You called attention to, your efforts in reporting in line with the task force on climate financial disclosures. I think we understand conceptually that this is part of your investment strategy. But I'm wondering about how this might actually impact the business strategically going forward.

I noticed that some of your key programmatic partners have also endorsed, kind of the recommendations of the task force.

And so I'm just wondering, how do you think about how these efforts impact your strategic positioning and your ability to win business?.

Maybe I'm not sure whether you're talking about our clients like Ingersoll Rand or, other financial service companies..

Your programmatic partners, that you prefer to work with. And I'm talking about more the former for example..

Okay. I think it's completely a supportive, to the extent we've done a transaction with a counterparty and they want a TCFD disclosure and we've already crafted it beautiful.

So, I know it completely reinforces, I think our value proposition with these clients that we're looking at the business in exactly the same way, looking at the risks and the potential in exactly the same way and are speaking the same language. So that's a wonderful thing..

Well, I mean the corollary is and to what extent are you seeing that become more of an important criteria on for those clients?.

Well, Ingersoll Rand just – the reason I mentioned them, they just announced or sold the last of their non-climate solutions business, to really double down on the climate solutions engineering pocket. Bravo to them, they've been a long client and delighted to see them make those kinds of moves.

And I just called him out because the announcement was recent. Virtually every one of our clients has some form of that kind of a commitment to the kind of stuff we want to finance..

Much appreciated. Thanks..

Thanks Noah..

And moving on to Christopher Souther with Cowen and Company..

Hey, just a follow-up on one of the answers you guys had around securitization and how it's kind of the mix that was going to be driving a securitization.

Historically, my understanding was that it was mostly the energy efficiency side where you guys were doing that and the Behind the Meters, but you mentioned earlier that you’d also be using to kind of keep diversification in check.

So I was wondering, looking at kind of the Pi on Slide 4, should we think about kind of min max bands there or do you potentially see any shifts in that mix as you start to add to the balance sheet? Either next year or in five years, are those percentages going to be changing kind of drastically or how do you think of that?.

So maybe that gets to do we have a target portfolio mix? Kind of a question. And honestly, we don't, the investment processes, we confirm that it's neutral to negative on an incremental greenhouse gas emissions. And from there we're looking for the best risk adjusted returns.

Given that the markets are relatively uncorrelated, storm water remediation has nothing to do with the solar industry, which has nothing to do with, the grid-connected solar has nothing to do with a Behind the Meter energy efficiency.

If you believe in the randomness and of uncorrelated markets, we're going to continue to have some interesting diversity in mix of assets as to what this would look like in two quarters, 10 quarters, 20 quarters. We don't have a clue. And given that they're small investments, we don't think we need to have a particular view on that portfolio mix..

Okay. And then just as a max percentage, if resi solar for instance, or one of the potentially not rated type segments or is there a max there or is there a min on the federal state, local side that you guys would kind of think about or it's really just kind of as it evolves with the opportunities..

It's very much as it evolves and it's risk adjusted return. I believe we've said in some contexts we're not going to become a resi solar finance company. So, you can always expect that we will have a nice diverse portfolio. I don't want to give explicit, portfolio limits though..

Yes, I understand. Thanks guys..

Thank you..

And that does conclude the question-and-answer session, I’ll now turn the conference back over to Mr. Jeff Eckel for any additional or closing remarks..

Thanks. Thanks to the Hannon team and thanks to the analysts who dialed in and asked good questions once again. We'll talk to you on the road and talk with you next quarter. Thank you..

Thank you. That does conclude today's conference. We do thank you for your participation. Have a wonderful day..