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HASI > SEC Filings for HASI > Form 10-Q on 13-May-2014All Recent SEC Filings

Show all filings for HANNON ARMSTRONG SUSTAINABLE INFRASTRUCTURE CAPITAL, INC.

Form 10-Q for HANNON ARMSTRONG SUSTAINABLE INFRASTRUCTURE CAPITAL, INC.


13-May-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

In this Quarterly Report on Form 10-Q, unless specifically stated otherwise or the context otherwise indicates, references to "we," "our," "us," "HASI," and "our company" refer to Hannon Armstrong Sustainable Infrastructure Capital, Inc., a Maryland corporation, Hannon Armstrong Sustainable Infrastructure, L.P., and any of our other subsidiaries. Hannon Armstrong Sustainable Infrastructure, L.P. is a Delaware limited partnership of which we are the sole general partner and to which we refer in this Quarterly Report on Form 10-Q as our "Operating Partnership."

Hannon Armstrong Capital, LLC, a Maryland limited liability company, the entity that operated our historical business prior to the consummation of our IPO and which we refer to as the "Predecessor," became our subsidiary upon consummation of our IPO. To the extent any of the financial data included in this Quarterly Report on Form 10-Q is as of a date or from a period prior to the consummation of our IPO, such financial data is that of the Predecessor. The financial data for the Predecessor for such periods do not reflect the material changes to the business as a result of the capital raised in the IPO including the broadened types of projects undertaken, the enhanced financial structuring flexibility and the ability to retain a larger share of the economics from the origination activities. Accordingly, the financial data for the Predecessor is not necessarily indicative of our company's results of operations, cash flows or financial position following the completion of the IPO.

The following discussion is a supplement to and should be read in conjunction with the accompanying condensed consolidated financial statements and related notes and with our 2013 Form 10-K, that was filed with the SEC.

Our Business

We provide debt and equity financing for sustainable infrastructure projects that increase energy efficiency, provide cleaner energy sources, positively impact the environment or make more efficient use of natural resources. We began our business more than 30 years ago, and since 2000, using our direct origination platform, have provided or arranged over $4.6 billion of financing in more than 475 sustainable infrastructure transactions. Over this period, we have become the leading provider of financing for energy efficiency projects for the U.S. federal government, the largest property owner and energy user in the United States.

We provide and arrange debt and equity financing primarily for three types of projects, which we refer to together as sustainable infrastructure projects:

Energy Efficiency Projects: projects, typically undertaken by ESCOs, which reduce a building's or facility's energy usage or cost through the design and installation of improvements to various building components, including heating, ventilation and air conditioning systems, or HVAC systems, lighting, energy controls, roofs, windows and/or building shells;

Clean Energy Projects: projects that deploy cleaner energy sources, such as solar, wind, geothermal and biomass as well as natural gas; and

Other Sustainable Infrastructure Projects: projects, such as water or communications infrastructure, that reduce energy consumption, positively impact the environment or make more efficient use of natural resources.

We are highly selective in the projects we target. Our goal is to select projects that generate recurring and predictable cash flows or cost savings that will be more than adequate to repay the debt financing we provide or will deliver attractive returns on our equity investments. Our projects are typically characterized by revenues from contractually committed obligations of government entities or private high credit quality obligors and are often supported by additional forms of credit enhancement, including security interests and supplier guaranties. Our projects also generally employ proven technologies which minimize performance uncertainty, enabling us to more accurately predict project revenue and profitability over the term of the financing or investment. As of March 31, 2014, approximately 97% of the transactions held on our balance sheet are considered investment grade.

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On April 23, 2013, we completed our IPO in which we sold 13,333,333 shares of common stock at $12.50 per share. The common stock is listed on the NYSE under the symbol "HASI." The net proceeds from our IPO were approximately $160.0 million, after deducting underwriting discounts and commissions and IPO and formation transaction costs of approximately $4.9 million, which amount includes net proceeds of approximately $9.5 million received by us upon the exercise by the underwriters of their option to purchase an additional 818,356 shares of common stock on May 23, 2013. On April 29, 2014, we sold in a public offering 5,750,000 shares of our common stock at $13.00 per share, less the underwriting discount and estimated expenses, for net proceeds of $70.3 million.

Our strategy in undertaking the public offerings was to expand our proven ability to serve the rapidly growing sustainable infrastructure market by increasing our capital resources, enhancing our financial structuring flexibility, expanding the types of projects and end-customers we pursue, and selectively retaining a larger portion of the economics in the financings we originate. Prior to our IPO, we had traditionally financed our business by accessing the securitization market, primarily utilizing our relationships with institutional investors such as insurance companies and commercial banks. By utilizing the net proceeds from our offerings and our anticipated continued access to the public markets, our strategy is to hold a significantly larger portion of the loans or other assets we originate on our balance sheet, using our own capital in conjunction with both securitizations and other borrowings.

We expect to see, in comparison to historical periods, a much larger portion of our total revenue derived from net investment revenue and other recurring and predictable revenue sources. While we expect our investment interest expense to increase, we also expect that our net investment revenue, which represents the margin, or the difference between income from investment interest income and investment interest expense, will increase due to a higher average margin on a per asset basis as well as growth in the overall amount of our investments. We expect our average margin will increase as a result of increased use of equity in place of debt as well as lower anticipated interest rates on our borrowings.

In our securitization transactions, including Hannie Mae, we transfer the loans or other assets we originate to securitization trusts or other bankruptcy remote special purpose funding vehicles. Large institutional investors, primarily insurance companies and commercial banks, historically provided the financing needed for a project by purchasing the notes issued by the trust or vehicle. The securitization market for the assets we finance has remained active throughout the financial crisis due to investor demand for high credit quality, long-term investments. We typically arranged such securitizations of loans or other assets prior to originating the transaction and thus have avoided exposure to credit spread and interest rate risks that are normally associated with traditional capital markets conduit transactions. Additionally, we have typically avoided funding risks for these loans or other assets given that our securitization partners contractually agree to fund such assets before the origination transaction is completed.

In most cases, the transfer of loans or other assets to non-consolidated securitization trusts qualify as sales for accounting purposes. In these transactions, we receive economics in the form of gain on sale income that is reflected in our statement of operations as gain on securitization of receivables. We also typically manage and service these assets in exchange for fees and other payments, which we record as fee income on our statement of operations. We may periodically provide other services, including arranging financings that are held on the balance sheet of other investors and advising various companies with respect to structuring investments.

From April 23, 2013, the date of our IPO, through March 31, 2014, we completed approximately $760 million of transactions, of which 52% are held on our balance sheet and 48% were securitized or syndicated. Approximately 62% of these transactions financed energy efficiency projects; approximately 33% financed clean energy projects, while the remaining 5% financed other sustainable infrastructure projects. The transactions that are held on our balance sheet have an average transaction size of approximately $17 million, a weighted average remaining life as of March 31, 2014, of approximately 9 years and are typically secured by the installed improvements that are the subject of the financing.

As of March 31, 2014, our on balance sheet portfolio, from which we earn investment income, was approximately $487 million. Approximately 94% of our on balance sheet portfolio consisted of fixed rate loans, direct financing leases or debt securities with the remaining 6% consisting of floating rate debt. Approximately 47%

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of our on balance sheet portfolio consisted of U.S. federal government obligations, 15% of obligations of state or local government or other institutions such as hospitals and universities and 38% were commercial obligations. In total, as of March 31, 2014, we managed approximately $2.1 billion of assets, which consisted of our on balance sheet portfolio plus approximately $1.6 billion of assets held in non-consolidated securitization trusts. We refer to this $2.1 billion of assets collectively as our managed assets.

We have a large and active pipeline of potential new financing opportunities that are in various stages of our investment process. We refer to projects as being part of our pipeline if we have determined that the projects fit within our investment strategy and exhibit the appropriate risk/reward characteristics through an initial credit analysis, including a quantitative and qualitative assessment of the investments, as well as research on the market and sponsor. Our pipeline consists of projects for which we will either be the lead financier or projects in which we will participate that are originated by other institutional investors or intermediaries. As of March 31, 2014, our pipeline consisted of more than $2.0 billion in new financing opportunities. There can, however, be no assurance that any or all of the transactions in our pipeline will be completed.

Factors Impacting our Operating Results

We expect that our results of operations will be affected by a number of factors and will primarily depend on the size of our portfolio, including the portion of our portfolio which we hold on our balance sheet, the income we receive from securitizations, syndications and other services, our portfolio's credit risk profile, changes in market interest rates, commodity prices, U.S. federal, state and/or municipal governmental policies, general market conditions in local, regional and national economies and our ability to qualify as a REIT and maintain our exception from registration as an investment company under the 1940 Act.

Critical Accounting Policies and Use of Estimates

The preparation of financial statements in accordance with U.S. GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a summary of our significant accounting policies under "Note 2-Summary of Significant Accounting Policies" in our 2013 Form 10-K.

We have identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition. These critical accounting policies govern:

Financing receivables and the related accounting for allowance for credit losses and impairments

Investments and the related accounting for impairments

Securitization of receivables

Valuation of financial instruments

Revenue recognition

Income taxes

Equity-based compensation

Earnings per share

We evaluate our critical accounting estimates and judgments on an ongoing basis and update them, as necessary, based on changing conditions.

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We provide additional information on our critical accounting policies and use of estimates under "MD&A-Critical Accounting Policies and Use of Estimates" in our 2013 Form 10-K.

Results of Operations

Our strategy in undertaking our IPO was to expand our proven ability to serve the rapidly growing sustainable infrastructure market by increasing our capital resources, enhancing our financial and structuring flexibility, expanding the types of projects and end-customers we pursue, and selectively retaining a larger portion on balance sheet of the economics in the financings we originate. Thus, we expect over time to see significant increases in both investment interest income and investment interest expense. We also expect that our net investment revenue, which represents the margin, or the difference between investment interest income and investment interest expense, will increase due to a higher average margin on a per asset basis as well as growth in the overall amount of our investments. We expect our average margin will increase as a result of increased use of equity in place of debt as well as lower anticipated interest rates on our borrowings. We also expect to continue our practice of securitizing certain transactions, in which we transfer the loans or other assets we originate to securitization trusts or other bankruptcy remote special purpose funding vehicles.

As of March 31, 2014, our on balance sheet portfolio, from which we earn investment income, was approximately $487 million. Approximately 94% of our on balance sheet portfolio consisted of fixed rate loans, direct financing leases or debt securities with the remaining 6% consisting of floating rate debt. Approximately 47% of our on balance sheet portfolio consisted of U.S. federal government obligations, 15% of obligations of state or local government or other institutions such as hospitals and universities and 38% were commercial obligations. In total, as of March 31, 2014, we managed approximately $2.1 billion of assets, which consisted of our on balance sheet portfolio plus approximately $1.6 billion of assets held in non-consolidated securitization trusts. We refer to this $2.1 billion of assets collectively as our managed assets.

To the extent any of the financial data presented below is as of a date or from a period prior to April 23, 2013, such financial data is that of the Predecessor. The financial data for the Predecessor for such periods do not reflect the material changes to the business as a result of the capital raised in our IPO including the broadened types of projects historically undertaken, the enhanced financial structuring flexibility and the ability to retain a larger share of the economics from the origination activities. Thus the financial data for the Predecessor is not necessarily indicative of our results of operations, cash flows or financial position following the completion of our IPO transaction and in the future.

Our Portfolio

As of March 31, 2014, we held approximately $486.8 million of financing receivables and investments on our balance sheet, which we refer to as our portfolio. The financing receivables and investments are typically collateralized contractually committed debt obligations of government entities or private high credit quality obligors and are often supported by additional forms of credit enhancement, including security interests and supplier guaranties.

The following is an analysis of financing receivables and investments by type of obligor and credit quality as of March 31, 2014.

                                                                           Investment Grade
                                                                                                                   Commercial
                                                            State, Local,                Commercial                   Rated             Commercial
                                       Federal(1)          Institutions (2)         Externally Rated (3)          Internally(4)          Other(5)           Total
                                                                             (amounts in millions, except for percentages)
Financing receivables                 $      228.5        $             73.5        $                  -         $          92.7        $       0.8        $ 395.5
Investments                                     -                         -                          76.2                     -                15.1           91.3

Total                                 $      228.5        $             73.5        $                76.2        $          92.7        $      15.9        $ 486.8

% of Total Portfolio                          46.9 %                    15.1 %                       15.7 %                 19.0 %              3.3 %          100 %
Average Remaining Balance (6)         $        9.8        $             24.5        $                25.4        $          18.5        $      15.1        $  13.8

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(1) Transactions where the ultimate obligor is the Federal Government. Transactions may have guaranties of energy savings from third party service providers, the majority of which are investment grade rated entities.

(2) Transactions where the ultimate obligors are state or local governments or institutions such as hospitals or universities where the obligors are rated investment grade (either by an independent rating agency or based upon our credit analysis). Transactions may have guaranties of energy savings from third party service providers, the majority of which are investment grade rated entities.

(3) Transactions where the projects or the ultimate obligors are commercial entities that have been rated investment grade by one or more independent rating agencies. This includes an investment grade rated debt security with a carrying value of $37.0 million that matures in 2035 whose obligor is an entity whose ultimate parent is Berkshire Hathaway Inc. and an investment grade rated debt security with a carrying value of $34.4 million that matures in 2033 whose obligor is an entity whose ultimate parent is Exelon Corporation. In each case, the carrying value approximates the estimated fair value.

(4) Transactions where the projects or the ultimate obligors are commercial entities that have been rated investment grade using our internal credit analysis.

(5) Transactions where the projects or the ultimate obligors are commercial entities that have ratings below investment grade either by an independent rating agency or using our internal credit analysis. Financing receivables are net of an allowance for credit losses of $11.0 million. Investments include a senior debt investment of $15.1 million on a wind project that is owned by NRG Energy, Inc.

(6) Average Remaining Balance excludes 13 transactions each with outstanding balances that are less than $1.0 million and that in the aggregate total $4.6 million.

The table below provides details on the interest rate and maturity of our portfolio as of March 31, 2014:

                                                         Amounts in
                                                          Millions             Maturity

Financing receivables:
Fixed-rate financing receivables, interest rates
from 2.42% to 5.00% per annum                           $    186,146          2014 to 2037
Fixed-rate financing receivables, interest rates
from 5.01% to 6.50% per annum                                 79,538          2014 to 2038
Fixed-rate financing receivables, interest rates
from 6.51% to 15.22% per annum                               140,878          2014 to 2031

                                                             406,562
Allowance for credit losses                                  (11,000 )

Financing receivables, net of allowance                      395,562
Fixed-rate investment in debt securities, interest
rates of 5.35% to 6.00% per annum                             91,277          2017 to 2035

Total Financing Receivables and Investments             $    486,839

The table below presents, for each major category of our interest-earning assets and interest-bearing liabilities, the average outstanding balances, interest income earned or interest expense incurred, and average yield or cost. Our net interest margin represents the difference between the yield on our interest-earning assets and the cost of our interest-bearing liabilities, including the impact of non-interest bearing funding, primarily equity.

                                                          Three Months ended March 31,
                                                      2014                             2013
                                                  (In thousands except for interest rate data)
Net Investment Revenue:
Financing receivables                         $              4,618             $              2,711
Investments                                                  1,294                               -

Total investments interest income                            5,912                            2,711
Investment interest expense                                 (3,530 )                         (2,236 )

Net investment revenue                                       2,382             $                475
Average monthly balance of financing
receivables                                   $            354,001             $            189,790
Average interest rate from financing
receivables                                                   5.22 %                           5.71 %
Average monthly balance of investments        $             91,463             $                 -
Average interest rate of investments                          5.66 %                             -
Average monthly balance of financing
receivables and investments                   $            445,464             $            189,790
Average interest rate from financing
receivables and investments                                   5.31 %                           5.71 %
Average monthly balance of debt               $            344,220             $            194,202
Average interest rate from debt                               4.10 %                           4.61 %
Average interest spread                                       1.21 %                           1.10 %
Net interest margin                                           2.14 %                           1.00 %

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The following table provides a summary of our anticipated principal repayments to our financing receivables and investments as of March 31, 2014:

                                                  Payment due by Period
                                        Less than                                      More than
                           Total         1 year        1-5 years       5-10 years       10 years
                                                  (amounts in thousands)

 Financing Receivables   $ 395,562     $    33,709     $  108,716     $     86,759     $  166,378
 Investments             $  91,277     $     2,452     $   24,982     $     17,726     $   46,117

The following table provides a summary of our anticipated maturity dates of our financing receivables and investments and the weighted average yield for each range of maturities as of March 31, 2014:

                                                      Less than                                          More than
                                        Total          1 year          1-5 years        5-10 years        10 years
                                                      (in thousands, except for interest rate data)
Financing Receivables
Payment due by period                 $ 395,562      $     1,253      $    96,065      $     16,348      $  281,896
Weighted average yield by period(1)        5.41 %           4.66 %           6.24 %            6.55 %          5.06 %
Investments
Payment due by period                 $  91,277      $        -       $    15,101      $         -       $   76,176
Weighted average yield by period           5.64 %             -              5.76 %              -             5.61 %

(1) Excludes yield on remaining $0.8 million loan balance which is on non accrual status after the $11.0 million allowance for loan loss recorded in December 2013.

We also have residual assets relating to our securitization trusts. The table below presents the carrying value and yields for those assets:

                                                              Weighted
                                   Carrying Value           Average Yield
                               (Amounts in thousands)

          March 31, 2014      $                  4,490                8.77 %
          December 31, 2013   $                  4,863                8.72 %

The residual assets do not have a contractual maturity date and the underlying securitized assets have contractual maturity dates ranging from 2014 to 2038.

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Comparison of the Three Months Ended March 31, 2014 vs. Three Months Ended
March 31, 2013



                                            Three Months Ended March 31,
                                             2014                  2013            $ Change        % Change
                                                       (amounts in thousands)

Net Investment Revenue:
Financing receivables                    $       4,618         $       2,711       $   1,907            70.3 %
Investments                                      1,294                    -            1,294              NM

Total investment interest income                 5,912                 2,711           3,201           118.1 %
Investment interest expense                     (3,530 )              (2,236 )        (1,294 )         (57.9 )%

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