DBRS Confirms Hannon Armstrong at BBB (low), Trend Changed to Positive

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. At the same time, DBRS has revised the trend on these ratings to Positive. The Company’s Intrinsic Assessment is BBB (low), while its Support Assessment is SA3.

KEY RATING CONSIDERATIONS
In confirming the ratings and revising the trend to Positive, DBRS recognizes the Company’s long track record of providing financing to a niche but growing industry, and strong credit performance. HASI continues to increase its investment portfolio, which is diverse across asset classes that are largely uncorrelated, while maintaining a strong pipeline of potential new transactions. Supporting its strong balance sheet, HASI maintains a high level of capitalization. Furthermore, the Company’s progress in reducing its reliance on secured forms of wholesale funding, while also diversifying its funding channels and investor base, is viewed positively.

Also considered in the ratings is 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 ratings also incorporate the Company’s increasingly riskier portfolio mix, which now includes higher levels of mezzanine debt, real estate and equity investments. Nonetheless, DBRS sees HASI as having strong underwriting capabilities and the expertise necessary to appropriately evaluate risk/reward opportunities.

RATING DRIVERS
The Company has consistently generated a return on assets above 3.0% on a core earning basis over the most recent three years. If this sustained strength in earnings continues without materially altering the risk profile, the ratings would likely be upgraded.

While not expected, deterioration in access to funding that impacts HASI’s ability to originate transactions, or a decline in operating results, could result in the trend reverting to Stable.

RATING RATIONALE
HASI’s franchise is strong, 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 in these niche markets, 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. HASI’s management team is experienced having navigated through several business and economic cycles, has deep industry knowledge, and long-standing client relationships. During 2018, HASI originated $1.2 billion of new transactions, up from $972 million in 2017. This strong growth trajectory continued into 2019 with $523 million of transactions closed in 1H19 as compared to $308 million in 1H18. At June 30, 2019, the Company had a pipeline of potential new opportunities of more than $2.5 billion. This pipeline is strong and diversified by project type.

HASI’s earnings generation ability is solid and continues to strengthen as the investment portfolio grows. The Company’s earnings can experience some volatility with gain on sale income related to securitizations, though this is manageable. Earnings benefit from the long-term nature of the investment portfolio, which had a weighted average life of 14 years (excluding the match funded transactions), as of June 30, 2019. This combined with a strong investment pipeline provides for predictable revenue generation and gives good near-term earnings visibility. While provisions for credit losses have been minimal since inception, DBRS considers HASI’s ability to absorb an unexpected loss through earnings as modest but strengthening.

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 1H19, the Company reported Core Earnings of $40.7 million, up from $35.1 million a year earlier. This compares to GAAP earnings of $26.4 million in 1H19, up from $16.0 million in the prior year.

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 modest credit loss on over $4.0 billion of originated transactions. DBRS sees this robust performance of the portfolio as benefitting from the Company’s historical focus on senior or preferred positions in the capital structure of its investments, as well as the diversification of the portfolio by technology, geography, operator and obligor. HASI has increasingly been taking on riskier exposures via mezzanine debt, real estate and equity investments. While DBRS sees the Company as having strong capabilities and expertise to evaluate/reward related to these investments, it does elevate HASI’s credit risk profile at a potentially late stage of the credit cycle. DBRS notes that as of June 30, 2019, HASI had just two investments on nonaccrual status that totaled $8.0 million, or 0.45% of the total investment portfolio.

HASI’s funding is well-aligned with the investment portfolio. Its reliance on secured forms of wholesale funding has been reduced with the recent senior unsecured issuance, benefitting DBRS’s view of the Company’s funding profile. HASI benefits 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. Meanwhile, the Company’s liquidity is appropriately managed with HASI maintaining sufficient funding capacity to meet upcoming originations.

HASI continues to display prudent capital management deploying a modest amount of balance sheet leverage. Capital is maintained at levels that provide an ample cushion against losses given the low credit risk profile of the investment portfolio. At June 30, 2019, the Company’s debt-to-equity was 1.24x, below HASI’s target limit of 2.5x. With no preferred stock, goodwill or intangible assets on the balance sheet, HASI’s $884.7 million of shareholder’s equity is comprised entirely of common equity, At June 30, 2019, HASI’s tangible common equity-to-tangible assets (TCE) ratio was a very strong 37.3%. As a specialty finance REIT, HASI is required to distribute at least 90% of its taxable income, which limits the Company’s ability to generate capital through retained earnings. However, DBRS notes that HASI has been able to consistently access the equity markets for additional capital ahead of periods of higher origination volumes.

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

The applicable methodology is Global Methodology for Rating Non-Bank Financial Institutions (November 2018), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and S&P Global Market Intelligence. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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.

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