DBRS Confirms Hannon Armstrong Sustainable Infrastructure Capital, Inc. at BBB (low), Trend Stable

DBRS, Inc. (DBRS) confirmed the BBB (low) Long-Term Issuer Rating of Hannon Armstrong Sustainable Infrastructure Capital, Inc. (HASI or the Company), as well as the BBB (low) rating of the Company’s Convertible Senior Notes. The trend on all ratings is Stable. The Company’s Intrinsic Assessment is BBB (low), while its Support Assessment is SA3.

KEY RATING CONSIDERATIONS
The confirmation of the ratings and the Stable trend reflect the Company’s sound franchise in a niche, but growing industry. The ratings also consider the Company’s solid balance sheet, which is anchored by the strong credit performance of the investment portfolio, as well as ample capital and prudently managed funding and liquidity. The ratings also consider HASI’s reliance on secured forms of wholesale funding and the Company’s status as a real estate investment trust (REIT), which requires HASI to distribute almost all of its income, limiting organic capital retention.

The Stable trend considers DBRS’s expectations that HASI will continue to grow its investment portfolio and earnings accordingly through the remainder of 2018. DBRS also anticipates that HASI will continue to diversify its funding profile by channel, as well as by investor, and that asset quality will remain consistent with historical performance.

RATING DRIVERS
Sustained growth in earnings, including consistently generating return on assets above 3.0% on a core earning basis, while reducing the contribution from gains on sale income and maintaining sound asset performance could result in an upgrade of the ratings. Diversification of funding, especially if resulting in secured funding becoming less than 70% of total funding and lowering asset encumbrance, could result in positive rating pressure.

A prolonged weakening in origination volumes signaling the strength of the franchise has deteriorated, or a sustained decline in operating results could lead to the ratings coming under pressure. Deterioration in access to funding that impacts HASI’s ability to originate transactions, or a notable increase in leverage would result in negative pressure on the ratings.

RATING RATIONALE
HASI’s franchise is sound, benefiting from its well-established presence in the energy efficiency and renewable energy markets where it provides flexible, tailored financing solutions to its sizeable client base. 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 2017 totaled $972 million, down 8.6% year-on-year (YoY). Meanwhile, the Company’s more than $2.5 billion pipeline of potential future business was solid and diversified by project type as of March 31, 2018.

HASI’s management team is experienced having managed through several business and economic cycles, has deep industry knowledge, and long-standing client relationships. Given that management is focused solely on the performance of HASI and no other investment vehicles, which minimizes potential conflicts of interest, DBRS views favorably HASI’s internally managed REIT operating model.

HASI’s earnings generation ability is solid but is expected to be moderately more volatile over the near-term, given the Company’s plan to securitize a higher level of originations in 2018, which should result in gain on sale income becoming a larger component of revenues. Over time, DBRS expects that the Company’s earnings generation ability will continue to strengthen as the investment portfolio grows. Earnings also benefit from the long-term nature of the investment portfolio, which had a weighted average life of 12 years (excluding the match funded transactions), as of March 31, 2018. This combined with a strong investment pipeline provides for predictable revenue generation and gives good near-term earnings visibility. 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 1Q18, the Company reported a net loss of $1.2 million, on a U.S. GAAP basis, while Core Earnings totaled $14.3 million, 7.9% lower YoY.

The strong credit performance of the Company’s investment portfolio is a key consideration underpinning the ratings. Since 2012, the Company has experienced only one credit loss resulting in just $11 million of credit losses, net of recoveries, on over $4.0 billion of originated transactions. DBRS considers this robust performance of the portfolio as reflective of the Company’s senior or preferred position in the capital structure of the investments, as well as the diversification of the portfolio by technology, geography, operator and obligor. DBRS notes that as of March 31, 2018, HASI had just two investments on nonaccrual status that totaled $8.0 million, or 0.40% of the total investment portfolio.

HASI’s funding is well-aligned with the investment portfolio, but the reliance on secured forms of wholesale funding is generally considered a rating constraint. DBRS notes that HASI does benefit from a diverse group of large institutional investors, primarily insurance companies and commercial banks that provide financing for non-recourse and off-balance sheet financings. Funding maturities are well-laddered with no maturities until 2019, excluding match funded transactions. The rating also considers the Company’s liquidity, which is appropriately managed with HASI maintaining sufficient funding capacity to meet upcoming originations.

As a specialty finance REIT, HASI is required to distribute at least 90% of its taxable income, which DBRS sees as limiting the Company’s capital flexibility. However, DBRS notes that HASI has been able to consistently access the equity markets for additional capital ahead of periods of higher origination volumes. At March 31, 2018, the Company’s debt-to-equity was 2.3x, below the board established limit of 2.5x, and well within the covenant maximum of 4.0x.

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

The applicable methodology is Global Methodology for Rating Finance Companies (November 2017), 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
Rating Committee Chair: Michael Driscoll, Managing Director, Head of North American FIG
Initial Rating Date: August 15, 2017
Last Rating Date: August 16, 2017

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

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