DBRS Assigns BBB (low) LT Issuer Rating to Hannon Armstrong Sustainable Infrastructure Capital

DBRS, Inc. (DBRS) has assigned a Long-Term Issuer Rating of BBB (low) to Hannon Armstrong Sustainable Infrastructure Capital, Inc. (HASI or the Company). The trend on the rating is Stable.

The rating reflects the strength of the Company’s franchise in a niche, but growing industry, as well as the strengthening earnings power derived from the investment portfolio. The rating also considers the Company’s solid balance sheet, which is supported by strong credit performance of the investment portfolio, as well as ample capital. Conversely, HASI’s reliance on secured forms of wholesale funding and the Company’s status as a real estate investment trust (REIT) constrain the rating.

The Stable trend considers DBRS’s expectations that HASI will continue to grow its investment portfolio and earnings accordingly through 2017 and into 2018. Further, DBRS anticipates that HASI will continue to diversify its funding profile by channel, as well as by investor, and make modest progress in further unencumbering its balance sheet.

DBRS considers HASI’s franchise as sound, benefiting from its well-established presence in providing financing to the energy efficiency and renewable energy markets. HASI maintains a leading market position, which is underpinned by its long standing relationships with large global energy service companies (ESCOs), as well as with renewable energy manufacturers, developers, and operators. Origination volumes in 1H17 totaled $690 million, up 47% year-on-year (YoY), which follows sound 2016 volumes of $1.1 billion, up 18% from 2015. Meanwhile, the Company’s more than $2.5 billion pipeline of potential future business was solid and diversified by project type as of June 30, 2017. The franchise also benefits from an experienced management team that has deep industry knowledge and has managed HASI through a number of business and economic cycles. HASI is an internally managed REIT, which minimizes potential conflicts of interest, given that management is focused solely on the performance of HASI and no other investment vehicles.

HASI’s earnings generation ability continues to strengthen as the investment portfolio grows. The long-term nature of the investment portfolio, which (excluding the match funded transactions) had a weighted average life of 12 years, as of June 30, 2017, provides for predictable revenue generation, which along with the investment pipeline, give good near-term earnings visibility. Importantly, gains on sale income continues to be less of a contributor to revenue as the Company’s on-balance sheet investment portfolio expands. For 1H17, the Company reported U.S. GAAP (GAAP) net income of $19.5 million, compared to $6.9 million a year ago, and ahead of 2016 results of $14.7 million, which was up from $8.0 million in 2015. DBRS notes that the accounting treatment for the Company’s equity method investments in flip partnerships results in a notable difference between GAAP income and cash received. As a result, the Company reports “Core Earnings” that adjusts the results of the equity investments such that the cash received reflects both a return of capital and a return on investment. For 2016, the Company’s Core Earnings was $50.5 million, up from $33.5 million in 2015. Subsequently, HASI generated Core Earnings of $33.4 million in 1H17, a 34% YoY improvement.

The strong credit performance of the Company’s investment portfolio since 2000 is a key factor underpinning the ratings. Since 2000, the Company has realized only $18 million of net credit losses on over $6.0 billion of originated transactions. DBRS considers the granularity of the portfolio, as well as the diversification of the portfolio by technology, geography, operator and obligor as all supportive of the strong performance to date. Further, DBRS notes that projects financed by HASI have little correlation to the U.S. economy further supporting the portfolio’s strong asset quality. DBRS notes that as of June 30, 2017, HASI had just $10 million of loans on non-accrual status, compared to no loans on non-accrual status at each of the past three year-ends. Moreover, DBRS considers the risk management and corporate governance measures put in place as sound.

HASI’s reliance on secured forms of wholesale funding is generally considered a rating constraint. DBRS notes that HASI does benefit from a diverse lending group of insurance companies that purchase the Company’s securitizations. Positively, the majority of its securitizations have long-dated maturities. The rating also considers the Company’s liquidity, which is appropriately managed with the Company maintaining sufficient funding capacity to meet upcoming originations. DBRS also views favorably HASI’s consistency in accessing the equity markets for additional capital ahead of periods of higher origination volumes.

As a specialty finance REIT, HASI is required to distribute at least 90% of its taxable income, weakening the Company’s capital retention capabilities, which constrains the ratings. DBRS sees the Company’s well-developed and diversified equity investor base and sound capital levels as partially mitigating this risk. At June 30, 2017, the Company’s debt-to-equity was 2.0x, comfortably below the board established limit of 2.5x, and well within the covenant maximum of 4.0x.

RATING DRIVER
Although an upward movement in the ratings is not expected over the intermediate-term, diversification of funding; especially if resulting in lower asset encumbrance, would be viewed favorably. Additionally, sustained growth in earnings while reducing the contribution from gains on sale income and maintaining sound asset quality could result in an upgrade of the ratings. Conversely, a sustained weakening in origination volumes signaling the strength of the franchise has weakened, or a prolonged deterioration in operating results could result in the ratings coming under pressure. Weakening of the funding profile, or a notable increase in balance sheet leverage would result in a ratings downgrade.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Global Methodology for Rating Finance Companies and Global Methodology for Rating Banks and Banking Organisations, which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: David Laterza, Senior Vice President, Head of U.S. Non-Bank Financials, Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of North American FIG, Global FIG
Initial Rating Date: August 15, 2017
Last Rating Date: Not applicable as no last rating date.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

For more information on this credit or on this industry, visit www.dbrs.com.