HANNON ARMSTRONG SUSTAINABLE INFRASTRUCTURE CAPITAL, INC. The following discussion should be read in conjunction with our financial statements and accompanying notes included in Item 8. Financial Statements and Supplementary Data, of this Form 10-K. Refer to 'Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations' on our Form 10-K for the year endedDecember 31, 2018 for a discussion of our results for the year endedDecember 31, 2017 and a comparison of our results of operations for the fiscal years endedDecember 31, 2018 andDecember 31, 2017 . Overview We make investments in climate change solutions by providing capital to leading companies in energy efficiency, renewable energy and other sustainable infrastructure markets. We believe we are one of the firstU.S. public companies solely dedicated to such climate change investments. Our goal is to generate attractive returns from a diversified portfolio of projects with long-term, predictable cash flows from proven technologies that reduce carbon emissions or increase resilience to climate change. We are internally managed, and our management team has extensive relevant industry knowledge and experience, dating back more than 30 years. We have long-standing relationships with the leading energy service companies ("ESCOs"), manufacturers, project developers, utilities, owners and operators. Our origination strategy is to use these relationships to generate recurring, programmatic investment and fee-generating opportunities. Additionally, we have relationships with leading banks, investment banks, and institutional investors from which we are referred additional investment and fee generating opportunities. We completed approximately$1.3 billion of transactions during 2019, compared to approximately$1.2 billion during 2018. As ofDecember 31, 2019 , we held approximately$2.1 billion of transactions on our balance sheet, which we refer to as our "Portfolio." For those transactions that we choose not to hold on our balance sheet, we transfer all or a portion of the economics of the transaction, typically using securitization trusts, to institutional investors in exchange for cash and/or residual interests in the assets and in some cases, ongoing fees. As ofDecember 31, 2019 , we managed approximately$4.1 billion in these trusts or vehicles that are not consolidated on our balance sheet. When combined with our Portfolio, as ofDecember 31, 2019 , we manage approximately$6.2 billion of assets, which we refer to as our "Managed Assets". Our investments have taken many forms, including equity, joint ventures, land ownership, lending, or other financing transactions. We also generate ongoing fees through gain-on-sale securitization transactions, services, and asset management. We use borrowings as part of our strategy to increase potential returns to our stockholders and have available a broad range of financing sources including non-recourse or recourse debt, equity and off-balance sheet securitization structures. See Item 1. Business for a further discussion of our business, investing strategy, and financing strategy. Market Conditions As a result of increasing global awareness of and aversion to climate change impacts, we believe the sustainable infrastructure markets in which we invest, and investment in climate change solutions more broadly, will continue to grow as the impact of climate change increases. InJanuary 2020 ,National Oceanic and Atmospheric Administration reported that the global average temperature has risen approximately one degree Celsius as of 2019 compared to twentieth century averages, with all five of the hottest years on record having occurred since 2015. Further, communities across the globe are increasingly experiencing the destructive economic impacts of climate change, which are only expected to worsen going forward. Given that climate change tends to exacerbate the impact and increase the frequency of natural disaster events, physical assets are at significant risk. According to theU.S. National Oceanic and Atmospheric Administration ("NOAA"), there were 14 natural disaster events inthe United States in 2019, with an estimated individual cost of greater than$1 billion and an aggregate cost of approximately$45 billion .NOAA reports, the average annual number of such events over the last five years has more than doubled as compared to the same metric between 1980 and 2019. In addition, the estimated cost of these events over the last five years is estimated at approximately$525 billion . Climate change is also expected to have meaningful productivity impacts. On a global basis, theMcKinsey Global Institute projects in its 2019 Climate Risk and Response report that by 2050 between$4 trillion and$6 trillion in productive working hours could be lost. It is estimated that aggregate annual energy efficiency and renewable energy spending exceeds$500 billion globally and$100 billion inthe United States alone. In its Energy Efficiency 2019 report, theInternational Energy Agency ("IEA") estimates global spending on energy efficiency at approximately$240 billion with the subset of that inNorth America at$47 billion . In addition, BloombergNEF ("BNEF") reported inJanuary 2020 , that global renewables investment exceeded$280 billion , with more than$55 billion invested inthe United States . Given that many projects are often self-financed (especially energy efficiency), we believe our total addressable market is likely a subset of these overall industry estimates. However, we believe these estimates are reliable indicators of market trends. - 48 - -------------------------------------------------------------------------------- These positive industry trends coupled with the increasing environmental and economic imperative to reduce carbon emissions are expected to further broaden our investable universe. Investments in energy efficiency as a service allow organizations to avoid the upfront costs of efficiency investments by paying for efficiency-enabled cost savings as operating rather than capital expenses. In its Annual Energy Outlook 2020, theU.S. Energy Information Administration ("EIA") estimates that decreasing energy intensity resulting from energy efficiency improvements will keepU.S. energy consumption for residential and commercial buildings growing at a level far below that of theU.S. economy. In addition, Lazard's 2019 Levelized Cost of Energy Analysis shows that renewables continue to outperform traditional generation sources on a new-built cost basis with certain renewable technologies achieving competitiveness with existing conventional generation technologies on a marginal basis, making renewables even more attractive investment targets. Further, in its New Energy Outlook 2019, BNEF expects wind and solar generation to provide nearly 50% of the world's electricity by 2050, with renewables attracting$10 trillion of aggregate investment over this time period. Despite trends supporting further growth, certain actions taken by the federal government could limit the growth of the renewable energy market, such as the phase out of the production and investment tax credits, tariffs on solar imports in the Section 201 solar trade case, the currently planned 2020 withdrawal of theU.S. from the Paris Climate Accords (the " Paris Accords") and the MinimumOffer Price Rule issued by theFederal Energy Regulatory Commission , the effect of which is to establish price floors that advantage fossil fuel generation over that from renewables. While these federal policies in isolation may reduce the short-term growth in theU.S. renewable energy markets, we believe growth will continue given the strength of offsetting factors such as continued interest from state and local governments and corporations to address climate change. State governmental agencies are responding to climate change risks through the implementation of renewable portfolio standards ("RPS") as well as energy reduction targets such as energy efficiency resource standards. According to the EIA, by the end of 2019, 29 states and theDistrict of Columbia had adopted a RPS while six of these states had passed laws committing to achieve 100 percent zero-carbon electricity by a target date. Similar 100% RPS commitments are expected to be introduced in additional states in 2020. Cities are also introducing policies expected to increase demand for energy efficiency. For example,New York City's Local Law 97 establishes building emissions requirements whileChicago recently created a C-PACE program to facilitate investment in energy efficiency improvements in commercial buildings. Corporates are also responding to climate change risks - often through renewable energy sourcing commitments. In its 2019 Annual Report, the RE 100, a global corporate leadership initiative bringing together influential businesses committed to 100% renewable electricity, reported that over 200 multinational companies have pledged to achieve 100% renewable energy with an average target date of 2028. Federal Energy Savings Performance Contracts ("ESPCs") are an example of a public-private partnership that eliminate the need for a federal agency to find appropriated funds to replace, operate, and maintain energy-intensive equipment while also providing multiple ancillary benefits, including saving taxpayer dollars currently spent on energy consumption, improving conditions for federal workers and service men and women, and creating private sector jobs. In total, according to theDOE , the federal government has identified, as ofFebruary 2020 , over$8 billion of energy conservation measures that could be implemented at existingU.S. federal buildings. Support for ESPCs remain bipartisan as the 2019 John S. McCain National Defense Authorization Act requires the military to address climate and energy resiliency in its planning, withCongress encouraging the use of ESPCs to this end.DOE announced that fiscal year 2019 was the most successful year in the history of the ESPC program, with over$819 million invested in qualifying projects. While we believe that the long-term growth prospects for our business remain positive, volatility in financial markets and commodity prices along with interest rate movements could impact the markets we serve. Further, the current interest rate environment of low yields coupled with increasing investor acceptance of our markets has increased competitive pressure. In 2019, theFederal Reserve Board of Governors lowered the rate at which banks lend to one another (known as the federal funds rate) by a cumulative 75 basis points. See "Item 7A. Quantitative and Qualitative Disclosures about Market Risk-Interest Rate and Borrowing Risks" for an analysis of the impact of rates on our business. According to theDepartment of Energy , average annualHenry Hub natural gas prices decreased by approximately 40% from 2014 to 2019, and its 2020 outlook forecasts that prices will stay below pre-2010 levels through 2050. As wholesale electricity prices are closely tied to wholesale natural gas prices in many parts ofthe United States , lower natural gas prices have negatively impacted, and are expected to continue to negatively impact, renewable energy projects that sell wholesale power on a "merchant" basis at spot prices. For more detail on commodity price impacts, see "Item 7A. Quantitative and Qualitative Disclosures about Market Risk-Commodity Price Risk". We attempt to mitigate our exposure to these low commodity prices and future volatility, as well as any credit risk associated with these prices, by acquiring projects with contracted revenues, negotiating certain structural protections such as preferred returns, and through active asset management and portfolio monitoring. Similarly, we seek to manage credit risk that might arise from commodity price declines through our due diligence and underwriting processes, strong structural protections in our transaction agreements with customers, and active asset management and portfolio monitoring. - 49 - -------------------------------------------------------------------------------- Notwithstanding any concerns that current market conditions have raised for our business, we believe significant opportunities exist for us to grow our business. As a long-term participant committed to providing capital for sustainable infrastructure, we plan to continue to fund projects that meet our underwriting standards and look for opportunities to expand our business. 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 mix of transactions which we hold in our Portfolio, the income we receive from securitizations, syndications and other services, our Portfolio's credit risk profile, changes in market interest rates, commodity prices, 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 exemption from registration as an investment company under the 1940 Act. Portfolio Size The size of our Portfolio will be a key revenue driver. Generally, as the size of our Portfolio on our balance sheet grows the amount of our revenue will increase. Our Portfolio may grow at an uneven pace as opportunities to originate new assets may be irregularly timed, and the timing and extent of our success in such originations cannot be predicted. To the extent the size of our Portfolio changes due to equity method investment activity, the income or loss from such investments will not be included in revenue but are reflected as income (loss) from equity method investments in our income statement and will vary over time. In addition, we may decide for any particular asset that we should securitize or otherwise sell a portion, or all, of the asset, which would result in gain on sale of receivables and investments or fee income as described below. The level of portfolio activity will fluctuate from period to period based upon the market demand for the capital we provide, our view of economic fundamentals including interest rates, the present mix of our Portfolio, our ability to identify new opportunities that meet our investment criteria, the volume of projects that have advanced to stages where we believe a transaction is appropriate, seasonality in our activities and in the various projects where we may provide debt or equity and our ability to consummate the identified opportunities, including as a result of our available capital. The level of our new origination activity, the percentage of the originations that we choose to retain on our balance sheet and the related income, will directly impact our interest and rental revenue and income from equity method investments. Income from Securitization, Syndication and Other Services We will also earn gain on sale of financial assets or fee income by securitizing or selling all or a portion of certain transactions. For transactions that we securitize to a non-consolidated trust, we recognize a gain on the securitization. The gain may be comprised of both cash received and a retained interest in securitization assets. We may also recognize additional income from servicing fees from these securitization assets over the life of the asset. In many cases, we arrange the securitization of the loan or other asset prior to originating the transaction and thus have avoided exposure to credit spread and interest rate risks that are typically associated with traditional capital markets conduit transactions. In these cases, we avoid funding risks for these financings or other assets given that our securitization partners contractually agree to fund such assets before the origination transaction is completed. We also generate fee income for syndications where we arrange financings that are held by other investors or if we sell existing transactions to other investors. In these transactions, unless we decide to hold a portion of the economic interest of the transaction on our balance sheet, we have no exposure to risks related to ownership of those financings. We may charge advisory, retainer or other fees, including through our broker dealer subsidiary. The gain on sale income and our other sources of fee income will also vary depending on the level of our new origination activity and the portion of our originated assets we decide to transfer to other investors. We view this revenue from such activities as a valuable component of our earnings and an important source of franchise value. The total amount of income from securitizations, syndications, and other services will vary on a quarter to quarter basis depending on various factors, including the level of our originations, the duration, credit quality and types of assets we originate, current and anticipated future interest rates, the impact on our leverage, the potential income from a securitization or syndication, the mix of our Portfolio and our need to tailor our mix of assets in order to allow us to qualify as a REIT forU.S. federal income tax purposes and maintain our exemption from registration under the 1940 Act. - 50 - -------------------------------------------------------------------------------- Credit Risks We source and identify quality opportunities within our broad areas of expertise and apply our rigorous underwriting processes to our transactions, which, we believe, will generally enable us to minimize our credit losses and maintain our current level of financing costs. In the case of various renewable energy and other sustainable infrastructure projects, we will be exposed to the credit risk of the obligor of the project's PPA or other long-term contractual revenue commitments, as well as to the credit risk of certain suppliers and project operators. While we do not anticipate facing significant credit risk in our assets related to government energy efficiency projects, we are subject to varying degrees of credit risk in these projects in relation to payment guarantees provided by ESCOs that are required in the event that certain energy savings are not realized by the customer. We are also exposed to credit risk in our other projects that do not benefit from governments as the obligor such as on balance sheet financing of projects undertaken by universities, schools and hospitals, as well as privately owned commercial projects. Our level of credit risk has increased, and is expected to continue to increase, as our strategy contemplates new investments in mezzanine debt and equity. We seek to manage credit risk through thorough due diligence and underwriting processes, strong structural protections in our transaction agreements with customers and continual, active asset management and portfolio monitoring. Nevertheless, unanticipated credit losses could occur and during periods of economic downturn in the global economy, our exposure to credit risks from obligors increases, and our efforts to monitor and mitigate the associated risks may not be effective in reducing our credit losses. See Item 7A. Quantitative and Qualitative Disclosures about Credit Risks for further information on our credit risks and see Note 6 of our audited financial statements included in this Form 10-K for additional detail of the credit risks surrounding our Portfolio. Changes in Market Interest Rates and Liquidity Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. We are subject to interest rate risk in connection with new asset originations and our borrowings, including our credit facilities, and in the future, any new floating rate assets, credit facilities or other borrowings. See Item 7A. Quantitative and Qualitative Disclosures about Market Risk for further information on interest rates risks and liquidity. Commodity Prices When we make investments in a project that act as a substitute for an underlying commodity, we may be exposed to volatility in prices for that commodity. For example, the performance of renewable energy projects that produce electricity can be impacted by volatility in the market prices of various forms of energy, including electricity, coal and natural gas. This is especially true for utility scale projects that sell power on a wholesale basis such as many of our Grid-Connected projects as opposed to Behind-the-Meter projects which compete against the retail or delivered costs of electricity which includes the cost of transmitting and distributing the electricity to the end user. See Item 7A. Quantitative and Qualitative Disclosures about Market Risk for further information on the impact of commodity prices. Government Policies We make investments in renewable energy projects that typically depend in part on various federal, state or local governmental policies that support or enhance the project's economic feasibility. Such policies may include governmental initiatives, laws and regulations designed to reduce energy usage and impact the use of renewable energy or the investment in, and the use of, sustainable infrastructure. Policies and incentives provided by theU.S. federal government may include tax credits (with some of these tax credits that are related to renewable energy scheduled to be reduced or eliminated in the future), tax deductions, bonus depreciation, federal grants and loan guarantees, and energy market regulations. The value of tax credits, deductions and incentives may be impacted by changes in tax laws rates or regulations, including as a result of the TCJA. Incentives provided by state and local governments may include a RPS or similar clean energy standard, which specify the portion of the power utilized by local utilities that must be derived from renewable or clean energy sources as well as the state or local government sponsored programs where the financing of energy efficiency or renewable energy projects is repaid through an assessment in the property tax bill in a program commonly referred to as PACE. Additionally, certain states have implemented feed-in or net metering tariffs, pursuant to which electricity generated from renewable energy sources is purchased at a higher rate than prevailing wholesale rates. Other incentives include tariffs, tax incentives and other cash and non-cash payments. Governmental agencies, commercial entities and developers of sustainable infrastructure projects frequently depend on these policies and incentives to help defray the costs associated with, and to finance, various projects. Government regulations also impact the terms of third party financing provided to support these projects. If any of these government policies, incentives or regulations are adversely amended, delayed, eliminated, reduced, retroactively changed or not extended beyond their current expiration dates or there is a negative impact from the recent federal law changes or proposals, the operating results of the projects we finance and the demand for, and the returns available from our investments may decline, which could harm our business. - 51 - --------------------------------------------------------------------------------U.S. Federal Income Tax Legislation The TCJA made significant changes to theU.S. federal income tax laws applicable to businesses and their owners, including REITs and their stockholders. Certain key provisions of the TCJA could impact us and our stockholders. See Note 10 of our audited financial statements in this Form 10-K for further information on the TCJA. Prospective investors are urged to consult with their tax advisors regarding the effects of the TCJA or other legislative, regulatory or administrative developments on an investment in our common stock. Impacts of climate change on our future operations As our business is focused on reducing carbon emissions and increasing resiliency to climate change, we are impacted by the effects of climate change and various related regulatory responses. In managing our business, we consider the potential impacts to our operations that may result in certain climate-related scenarios. In 2018, we began to implement the recommendations of the TCFD. The TCFD provides a framework to consider and disclose our processes for managing the risks and opportunities associated with climate change. We have disclosed the components of the TCFD framework throughout this document. The following tables highlight our evaluation of potential impacts to our business in two climate related scenarios as well as our resilience and strategy to handling the potential impacts. - 52 - -------------------------------------------------------------------------------- Transition Risks and Opportunities - We believe our investment portfolio will be impacted by the transition risks and opportunities contemplated by theParis Accords and the achievement of its objectives. Scenario 1 - Global action is taken to limit the global temperature increase to 1.5 degrees Celsius above pre-industrial levels Considerations of Quantitative and impact on our Assumption Qualitative impacts impacts management strategy The price of Increased expected If the overall We may identify Renewable Energy cash flows and price level of RECs more investment Credits ("RECs") or financial returns increased by 5% we opportunities similar structures for certain of our would not expect a resulting from the increase as more investments to the material impact to increased REC aggressive renewable extent the RECs are the overall cash value. In addition, portfolio standards sold at higher flows from our to the extent that and corporate market prices. existing our investments renewable energy investments. The is become more targets are largely due to the valuable we would implemented Increased lower value of RECs consider whether it debt/lease service in comparison to would be more coverage ratio for power prices in economical to our the obligors of our most of the markets stockholders to renewable energy where our either monetize the debt investments investments are investment given and solar real located. the increase in estate leases that value or continue sell RECs at higher to hold in our market pricing. Portfolio and The resulting maximize our increase in cash returns from adding flows may also additional leverage allow us to apply to our financing. greater financial leverage to these investments and enhance our profitability. If there was a material increase in value associated with RECs, it is likely that more renewable energy projects would be developed in geographic areas where the RECs were more valuable, leading to more potential investment opportunities for us. - 53 -
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Considerations of
Quantitative and impact on our
Assumption Qualitative impacts impacts management strategy
A carbon tax or Increased cash A portion of our In relation to new
similar carbon flows and financial portfolio is business, there is
pricing mechanism is returns from exposed to changes the potential that
implemented by certain investments in the market price more competitors
governmental to the extent power of power. Whether enter our markets
authorities which is sold at higher it is due to sales and put pressure on
may cause an market prices due of energy at the our asset pricing
increase to (i) to the increase in then current market strategies as
power prices, (ii) cost imposed on price or through a renewable energy
operating costs for fossil fueled re-contracting of and energy
certain entities, energy projects. fixed price power efficiency projects
and (iii) the purchase become more cost
competitiveness of agreements. competitive with
renewable energy, fossil fuel
energy efficiency Under a scenario electricity
and storage projects where a carbon tax generation assets.
drives the price of We are constantly
power up by 10%, reviewing our
our wind equity pricing strategies
investments may and would continue
generate to do so in this
approximately 4% in scenario to
Increases in the additional understand how we
debt/lease service cashflows over can continue to
coverage ratio for their life as make investments
the obligors of our compared to the with acceptable
renewable energy cashflow the risk adjusted
debt investments investments are returns.
and solar real expected to
estate leases that generate under the In addition, to the
sell power at current baseline extent that our
higher market scenario. investments become
pricing. more valuable we
The resulting We would not expect would consider
increase in cash a material impact whether it would be
flows may also to our solar more economical to
allow us to apply equity, renewable our stockholders to
greater financial energy debt, solar either monetize the
leverage to these real estate or investment given
investments and energy efficiency the increase in
enhance our investments. value or continue
profitability. to hold in our
Increased energy portfolio and
cost savings from maximize our
energy efficiency returns from adding
solutions. additional leverage
to our financing.
Increased
competitiveness of
renewable energy
projects with
fossil fueled power
plants, due to an
increase in power
prices.
An increase in the
items mentioned
above may increase
the volume of
assets available in
which we can
invest.
However, the
implementation of a
carbon tax may also
have a negative
impact on the
financial health of
utilities and
corporate entities
who also happen to
purchase power from
renewable energy
projects in which
we have invested.
The credit ratings
of these entities
may be downgraded
due to additional
operating expenses
resulting from a
carbon tax. A
credit rating
downgrade may
reduce the amount
of financial
leverage we are
able to utilize. If
this were to occur,
our overall
profitability could
decline.
- 54 ---------------------------------------------------------------------------------
Considerations of
Quantitative and impact on our
Assumption Qualitative impacts impacts management strategy
A significant Continued decreases Given the nature of In the development
increase in research in cost could make our business of our investment
and re-development renewable energy, activities and strategies we would
investment in energy storage, and focus on consider investment
renewable energy, energy efficiency structuring in different
energy storage, and technologies more transactions to technologies that
energy efficiency cost competitive. meet the capital we may not have
technologies by As a result, we may needs of our historically
public and private experience an clients, it is invested based upon
entities increase in difficult to the additional
investment reliably quantify development and
opportunities the positive impact maturation gained
available to us. on our investment through the
opportunities. prospective
However, we would increase in
expect to achieve research and
accretive economics development.
from this Additionally, the
assumption. lower cost of
projects may
influence the
amount of
investment we would
make in each
opportunity.
Significant growth Increased demand Given the nature of An increased demand
in positive public for investment in our business for sustainable
sentiment for sustainable activities and infrastructure may
sustainable infrastructure focus on increase
infrastructure increase the volume structuring competition and
investment of transactions in transactions to influence our
which we may meet the capital pricing strategy.
invest, reduce our needs of our We would continue
overall cost of clients, it is to review our
capital and difficult to pricing strategies
increase our reliably quantify with these
profitability. the positive impact opportunities.
on our investment
opportunities.
However, we would
expect to achieve
accretive economics
from this
assumption.
Sc
- 55 -
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enario 2 - Global temperatures increase more than 2 degrees Celsius above
pre-industrial levels
Considerations of
Quantitative and impact to our
Assumption Qualitative impacts impacts management strategy
No meaningful Given current Given the nature of The increased
government policy to trends, even our business demand in climate
shift the trajectory without an increase activities and change solutions
of global climate in government focus on may increase
change support, we might structuring competition and
expect increased transactions to influence our
demand for climate meet the capital pricing strategy.
change solutions needs of our
due to the clients, it is
improving economics difficult to
and cost reliably quantify
competitiveness of the impact on our
these technologies. investment
opportunities.
However, we would
expect to achieve
accretive economics
Such growth in from this
demand may increase assumption.
the volume of
investment
opportunities
available to us.
An increase in Flooding and storm Given the nature of The increased
demand for climate surges may become our business demand in climate
change resiliency more frequent, activities and change solutions
solutions resulting in an focus on may increase
increase in demand structuring competition and
for storm water transactions to influence our
management assets. meet the capital pricing strategy.
needs of our
clients, it is
difficult to
reliably quantify
the positive impact
on our investment
opportunities.
Greater instability However, we would
in the power grid expect to achieve
may increase the accretive economics
demand for on-site from this
and distributed assumption.
power generation
systems and battery
storage.
If the above events
occur, we may
experience an
increase in the
volume of
investment
opportunities
available to us.
Greater variability Potential increases We believe any We currently have
and instability in in the price of mentioned impacts risk management
the commodity commodities (e.g., that are realized, processes which
markets natural gas) due to are short-term in include a recurring
climate change nature and we would review of our
induced supply not expect a investments through
chain and transport material impact on our portfolio
disruptions, such our investments. management function
as a major to assess any
hurricane striking increasing
a series of gulf operational costs
coast pipelines, of our investments.
may drive power For our existing
prices higher, thus portfolio, we will
increasing actively manage the
financial returns risk to make
from certain of our appropriate
investments to the adjustments to
extent the power is budget approvals,
sold at market operational
prices rather than approvals, and
under fixed price other asset
contracts. management tasks.
For any new
investments, we
make conservative
assumptions to
protect our
investments from
such types of
pricing volatility
and will continue
to do so, including
new assumptions
around commodity
However, climate volatility as
change-related relevant.
impacts to the
amount of potable
water supplies,
such as irregular
rainfall and salt
water intrusion,
may drive increases
in the price of
water. These
increases in cost
may increase the
demand for assets
that increase water
use efficiency,
resulting in an
increase in the
volume of
investment
opportunities
available to us.
- 56 --------------------------------------------------------------------------------- Physical Risks and Opportunities - Given the assessments of the United Nation'sIntergovernmental Panel on Climate Change and other leading climate research organizations regarding the probability of a 1.5 Celsius increase in global temperature and serious climatic impacts even with the most aggressive emissions reduction initiatives, we believe our portfolio will be impacted by physical risks regardless of the actions taken as discussed above. We assume the types of risks to which our portfolio is exposed are similar under either Scenario 1 or 2 (albeit at varying degrees of severity). Scenario 1 - Global action is taken to limit the global temperature increase to 1.5 degrees Celsius above pre-industrial levels and Scenario 2 - Global temperatures increase more than 2 degrees Celsius above pre-industrial levels. Considerations of Quantitative and impact to our Assumption Qualitative impacts impacts management strategy Increased (i) Our existing We would not expect When underwriting flooding events due investments in low a material risk to our investments we to heavier rainfalls lying areas are the cash flows from negotiate and increased storm exposed to our investments as structural surge due to rising potential flooding we typically protections to sea levels, (ii) the events and other require insurance mitigate any loss probability and storm damage and coverage for these we may incur from severity of such events may events where the operations or wildfires and (iii) cause construction project owner bears inability of the increased frequency delays, operational this cost. Refer to projects to operate and severity of shutdowns, and more later discussion on (this includes storms and other significant site the impacts of the project insurance). weather-related damage. increase in For any new events insurance costs. investment opportunities we would evaluate the exposure to rising sea levels and structure our investment terms such that we protect our invested capital. A portion of our We would not expect When underwriting investments are a material risk to our investments we located in high the cash flows from negotiate wildfire risk our investments. structural regions and are protections to exposed to mitigate any loss catastrophic damage we may incur from from wildfire operations or events. inability of the projects to operate (this includes project insurance). For any new investment opportunities we would evaluate the exposure to wildfires and structure our investment terms such that we protect our invested capital. Solar energy assets The potential To the extent this that are not in the impact of became a material direct path of additional soiling issue we would seek wildfires but are of panels or ash out protections to within the clouds was assessed mitigate any impact proximity thereof is not expected to of this, such as may have reduced have a material adding panel power production impact on the washing due to ash soiling cashflows and value requirements to on the panels or of our portfolio. contracts. reduced solar insolation due to ash clouds. If the events above were to occur, we may experience reduced cash flows and financial returns from these investments, which may cause us to reduce the amount of financial leverage we utilize and cause a decline in our overall profitability. - 57 -
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Considerations of
Quantitative and impact to our
Assumption Qualitative impacts impacts management strategy
Operational A decrease in Solar portfolio When underwriting
performance of the performance and production can be our investment
projects in which we power generation of affected by an opportunities we
invest are impacted the solar and wind increase in global make conservative
by the global energy assets temperature assumptions
temperature increase related to our depending on the regarding
investments, as the geography. If solar performance and
performance of production operational
these assets vary decreases by 5% we expenses that
based upon the may expect there to protect our returns
ambient be a 14% decrease from some level of
temperatures (in in expected cash unexpected
the case of solar) flows from our performance or
and air density (in solar equity operation issues in
the case of wind). investments. the future. We will
Both conditions may continue to adjust
be caused by High temperatures our assumptions as
increases in global have a significant additional risks
temperatures. efficiency impact and severity of
on wind turbines as climate risk are
high temperature assessed. We
faults create more actively manage our
wear and tear on existing portfolio
equipment. If wind to preemptively and
production proactively address
decreases by 5% we any operational or
would not expect a maintenance issues.
material impact to
our wind equity
investments. We
would not expect a
material impact on
our renewable
energy debt, solar
real estate and
energy efficiency
investments.
Increased wind An increase in
variability and operating expenses
increased wear on would result and if
wind turbine there was 5% higher
components, which operating expenses
may increase the cash flows from
operating costs. our wind equity
investments would
be expected to
decrease by 2%.
Increased operating If there were both
costs and lower a decrease in
generation from the production of 5%
increase in and higher
temperatures may operating expenses
reduce our expected of 5% our cash
cash flows and flows from our wind
financial returns equity and solar
from our equity investments
investments, which would be expected
may cause us to to decline by 5%
reduce the amount and 16%,
of financial respectively.
leverage we utilize
and cause a decline We would not expect
in our overall a material impact
profitability. on our renewable
energy debt, solar
real estate and
energy efficiency
investments.
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Considerations of
Quantitative and impact to our
Assumption Qualitative impacts impacts management strategy
An increase in water Water is used to The impact of water To the extent this
scarcity potentially clean the panels on scarcity and becomes a material
resulting in an solar energy assets increased prices to matter we would
increase in the to maintain their our existing seek out
price of water efficiency. An portfolio is not protections to
increase in water expected to have a mitigate any impact
prices may reduce material impact on of additional water
the cash flows and the cash flows of related costs.
financial returns our investments.
from our related
investments, which
may cause us to
reduce the amount
of financial
leverage we utilize
and cause a decline
in our overall
profitability.
Climate change The increased
related impacts to demand in these
the amount of projects may
potable water increase
supplies, such as competition and
irregular rainfall influence our
and salt water pricing strategy.
intrusion, may
drive increases in
the price of water.
These increases in
cost may increase
the demand for
assets that
increase water use
efficiency
resulting in an
increase in the
volume of
investment
opportunities
available to us.
An increase in the In anticipation of Insurance policies We require that the
cost, or a change in climate change are executed on an projects in which
the availability of related physical annual basis and in we invest are
insurance risks, projects some regions the insured against
related to our price of insurance casualty events
investments in could increase such that could impact
particularly that the cashflow our cash
vulnerable regions, and value of our distributions. We
such as low-lying projects in high continually
coastal areas, may risk geographic evaluate whether
face increases in regions are there are superior
insurance costs. An affected. This asset or portfolio
increase in increase in level policies that
insurance costs may insurance cost are available that
reduce the cash would drive an optimize our
flows and financial increase in total insurance coverage
returns from these operating expenses. and premium costs.
investments and may We have estimated
cause us to reduce that an increase in
the amount of operating expenses
financial leverage of 5% would be
we utilize and expected to reduce
cause a decline in our cash flows from
our overall wind equity and
profitability. solar equity
projects by 2%.
We would not expect
a material impact
on our renewable
energy debt, solar
real estate and
energy efficiency
investments.
Critical Accounting Policies and Use of Estimates
Our financial statements are prepared in accordance with GAAP, which requires
the use of estimates and assumptions that involve the exercise of judgment and
use of assumptions as to future uncertainties. The following discussion
addresses the accounting policies that we use including areas that involve the
use of significant estimates. Our most critical accounting policies involve
decisions and assessments that could affect our reported assets and liabilities,
as well as our reported revenues and expenses. We believe that all of the
decisions and assessments upon which our financial statements are based are
reasonable at the time made and based upon information available to us at that
time. Our critical accounting policies and accounting estimates may be expanded
over time. Those material accounting policies and estimates that we expect to be
most critical to an investor's understanding of our financial results and
condition and require complex management judgment are discussed below. See Note
2 of the audited financial statements in this Form 10-K for further details on
our accounting policies.
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We evaluate our critical accounting estimates and judgments on an ongoing basis
and update them, as necessary, based on changing conditions. Additionally, there
were certain newly issued accounting pronouncements that may be relevant to our
business. See Note 2 of the audited financial statements in this Form 10-K for
further details on these newly issued accounting pronouncements.
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.
Consolidation and Equity Method Investments
We account for our investment in entities that are considered voting or variable
interest entities under ASC 810, Consolidation. We perform an ongoing assessment
and make judgments to determine the primary beneficiary of each entity as
required by ASC 810, which includes an assessment of the type of control we have
over the entity. If we would conclude that certain of these entities should be
consolidated, we would include the entities assets, liabilities and related
activity in our financial statements. Refer to discussion below relating to
consolidation considerations for the securitization of receivables. We further
discuss our process for evaluating these judgments in Note 2 of the audited
financial statements of this Form 10-K.
For those transactions not consolidated, we generally determine our income
allocations under the equity method of accounting based on the change in our
claim on net assets of the investee entity using a method commonly referred to
as the hypothetical liquidation at book value method or ("HLBV"). This method
uses a hypothetical liquidation scenario that may require judgment in its
application and could have a material impact on our reported financial results.
Any changes in this method of application or in certain assumptions could either
increase or decrease our net income. We further discuss our process for applying
this method of income allocations in Note 2 of the audited financial statements
of this Form 10-K.
Impairment of our Portfolio
We evaluate the various assets in our Portfolio on at least a quarterly basis,
and more frequently when economic or other conditions warrant such an
evaluation, for potential delinquencies or other events that may indicate a
potential impairment of the such asset. If an asset is determined to be
impaired, any impairment charges would be recorded in the income statement and
reduce our net income. We further discuss our process for evaluating these
judgments in Note 2 of the audited financial statements in this Form 10-K.
In June 2016 , the FASB issued ASU No. 2016-13, Financial Instruments-Credit
Losses-Measurement of Credit Losses on Financial Instruments ("Topic 326").
Topic 326 significantly changes how entities will recognize and measure credit
losses and impairments for most financial assets and certain other instruments
that are not measured at fair value through net income. Topic 326 will replace
the "incurred loss" approach under existing guidance with an "expected loss"
model for instruments measured at amortized cost and require entities to record
allowances for expected losses from available-for-sale debt securities rather
than reduce the amortized cost, as currently required. It also simplifies the
accounting model for purchased credit-impaired debt securities and loans. Topic
326 is effective for fiscal years beginning after December 15, 2019 and is to be
adopted through a cumulative-effect adjustment to retained earnings as of the
beginning of the first reporting period in which the guidance is effective. The
Company has adopted the new standard as of January 1, 2020 . While we are
continuing to assess the impact Topic 326 will have on the consolidated
financial statements, the measurement of expected credit losses under the
current expected credit loss ("CECL") model will be based on relevant
information including historical experience, current conditions, and reasonable
and supportable forecasts that affect the collectability of the reported amounts
of the financial assets in scope of the model. We have pooled our assets by risk
characteristics and determined a methodology for each pool. We expect our
reserve to be less than $20 million upon adoption of the standard.
Securitization of Receivables
We have established various special purpose entities or securitization trusts
for the purpose of securitizing certain receivables or other debt investments.
We make judgments, based in part, on supporting legal opinions, on whether these
entities should be consolidated as a variable interest entity, as defined in ASC
810, Consolidation, and whether the transfers to these entities are accounted
for as a sale of a financial asset or a secured borrowing under ASC 860,
Transfers and Servicing. If we would conclude that certain of these special
purpose entities or securitization trusts should be consolidated, we would
include the assets and liabilities of the entity and their related activity in
our financial statements. If sale accounting is not met in these transactions it
would be treated as a secured borrowing rather than a sale in our financial
statements. We further discuss our process for evaluating these judgments in
Note 2 of the audited financial statements of this Form 10-K.
Results of Operations
For a comparison of our results of operations for the fiscal years ended
December 31, 2018 and December 31, 2017 , see "Part II, Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" of our
annual report on Form 10-K for the fiscal year ended December 31, 2018 , filed
with the SEC on February 22, 2019 .
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We make investments in climate change solutions by providing capital to the
leading companies in the energy efficiency, renewable energy and other
sustainable infrastructure markets. We believe that Hannon Armstrong is one of
the first U.S. public companies solely dedicated to such climate change
investments. Our goal is to generate attractive returns for our shareholders by
investing in a diversified portfolio of assets and projects that reduce carbon
emissions or increase resilience to climate change and generate long-term,
recurring and predictable cash flows or cost savings from proven commercial
technologies.
We completed approximately $1.3 billion of transactions during 2019, compared to
approximately $1.2 billion during 2018. Our strategy includes holding a large
portion of these transactions on our balance sheet. We refer to the transactions
we hold on our balance sheet as of a given date as our "Portfolio." Our
Portfolio was approximately $2.1 billion as of December 31, 2019 and $2.0
billion December 31, 2018 .
Portfolio
Our Portfolio totaled approximately $2.1 billion as of December 31, 2019 , and
included approximately $1.3 billion of BTM assets and approximately $0.8 billion
of GC assets. Approximately 23% of our Portfolio consisted of unconsolidated
equity investments in renewable energy related projects and approximately 18% of
our Portfolio was real estate leased to renewable energy projects under
operating leases. The remainder consisted of fixed-rate government and
commercial receivables and debt securities which we generally refer to as debt
investments. Our Portfolio consisted of over 180 transactions with an average
size of $11 million and the weighted average remaining life of our Portfolio
(excluding match-funded transactions) of approximately 15 years as of
December 31, 2019 .
Our Portfolio included the following as of December 31, 2019 :
• Equity investments in either preferred or common structures in
unconsolidated entities;
• Government and commercial receivables, such as loans for renewable energy
and energy efficiency projects;
• Real estate, such as land or other assets leased for use by sustainable
infrastructure projects typically under long-term operating leases; and
• Investments in debt securities of renewable energy or energy efficiency
projects.
The table below provides details on the interest rate and maturity of our debt
investments as of
Balance Maturity
(in millions)
Fixed-rate receivables, interest rates of less than 5.00% per annum
$ 255 2020 to 2045 Fixed-rate receivables, interest rates from 5.00% to 6.50% per annum
107 2020 to 2056 Fixed-rate receivables, interest rates greater than 6.50% per annum
805 2020 to 2069
Receivables 1,167
Less: Allowance for credit losses (8 )
Receivables, net of allowance 1,159
Fixed-rate investments, interest rates of less than 5.00% per annum
64 2027 to 2046 Fixed-rate investments, interest rates from 5.00% to 6.50% per annum
11 2030 to 2051
Total receivables and investments $ 1,234
The table below presents, for the loan and real estate related holdings of our
Portfolio and the related interest-bearing liabilities, the average outstanding
balances, income earned, the interest expense incurred, and average yield or
cost. Our earnings from our equity method investments are not included in total
revenue and thus we have excluded the income and related interest expense for
our equity method investments from these calculations. Our net investment margin
represents the difference between the interest and rental income generated by
our Portfolio and the interest expense, divided by the average balance of those
assets.
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Years Ended December 31,
2019 2018 2017
(dollars in millions)
Interest income, receivables $ 68 $ 68 $ 57
Average monthly balance of receivables $ 930 $ 1,001 $ 1,062
Average interest rate of receivables 7.3 % 6.8 % 5.3 %
Interest income, investments $ 6 $ 7 $ 5
Average monthly balance of investments $ 148 $ 163 $ 122
Average interest rate of investments 4.3 % 4.1 % 4.2 %
Rental income $ 26 $ 25 $ 20
Average monthly balance of real estate $ 364 $ 350 $ 284
Average yield on real estate 7.1 % 7.0 % 7.0 %
Average monthly balance of receivables,
investments, and real estate $ 1,442 $ 1,514 $ 1,468
Average yield from receivables, investments,
and real estate 6.9 % 6.5 % 5.6 %
Interest expense (1) $ 55 $ 62 $ 49
Average monthly balance of debt (1) $ 1,135 $ 1,275 $ 1,079
Average interest rate of debt (1) 4.9 % 4.9 % 4.6 %
Average interest spread (1) 2.1 % 1.6 % 1.0 %
Net investment margin (1) 3.1 % 2.4 % 2.2 %
(1) Excludes amounts related to the non-recourse debt used to finance the equity
method investments in the renewable energy projects because our earnings
from these equity investments are not included in total revenue.
The following table provides a summary of our anticipated principal repayments
for our receivables and investments as of
Payment due by Period
Less than More than
Total 1 year 1-5 years 5-10 years 10 years
(in millions)
Receivables $ 1,159 $ 116 $ 203 $ 149 $ 691
Investments 75 1 6 14 54
See Note 6 of our audited financial statements in this Form 10-K for information
on:
• the anticipated maturity dates of our receivables and investments and the
weighted average yield for each range of maturities as of December 31,
2019 ,
• the term of our leases and a schedule of our future minimum rental income
under our land lease agreements as of
• the credit quality of our Portfolio, and
• the receivables on non-accrual status.
For information on our residual assets relating to our securitization trusts,
see Note 5 of our audited financial statements in this Form 10-K. The residual
assets do not have a contractual maturity date and the underlying securitized
assets have contractual maturity dates until 2055.
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Comparison of the Year Ended December 31, 2019 to the Year Ended December 31,
2018
Years ended
December 31,
2019 2018 $ Change % Change
(dollars in millions)
Revenue
Interest income $ 76 $ 76 $ - - %
Rental income 26 25 1 4 %
Gain on sale of receivables and investments 24 33 (9 ) (27 )%
Fee income 16 6 10 167 %
Total revenue 142 140 2 1 %
Expenses
Interest expense 64 77 (13 ) (17 )%
Provision for loss on receivables 8 - 8 NM
Compensation and benefits 29 26 3 12 %
General and administrative 15 15 - - %
Total expenses 116 118 (2 ) (2 )%
Income before equity method investments 26 22 4 18 %
Income (loss) from equity method investments 64 22 42 191 %
Income (loss) before income taxes 90 44 46 105 %
Income tax (expense) benefit (8 ) (2 ) (6 ) 300 %
Net income (loss) $ 82 $ 42 $ 40 95 %
NM-Percentage change is not meaningful.
• Net income increased by approximately $40 million as a result of a $2
million increase in total revenue, a $2 million decrease in total
expenses, a $42 million increase in income from equity method
investments, and a $6 million increase in income tax expense. Theseresults do not include the Non-GAAP core earnings adjustment related to
equity method investments, which is discussed in the Non-GAAP Financial
Measures section.
• Interest and rental income increased by
assets offset by lower average balances.
• Interest income in the prior year included $13 million in income fromasset repayments on a residential solar transaction that did not recur in
the current year. Adjusting for this one-time event, interest and rental
income would increase by $14 million due to higher yielding assets that
were offset by lower total average balances.
• Interest expense for the year decreased by approximately
result of lower cost and outstanding balance of debt during the year.
• Provision for loss on receivables increased by $8 million due to a 2019
court ruling related to receivables that were previously placed on
non-accrual status in 2017.
• Compensation and benefits increased by
equity-based compensation expense resulting from the timing of vesting
and higher award valuations.
• Income from equity method investments increased by
due to the GAAP gain of
portfolio of wind projects in the fourth quarter of 2019 and additional
income resulting from the realization of tax attributes by our
co-investors.
• Income tax expense increased by
income largely due to the gain on the sale of the portfolio of wind
projects discussed above.
Non-GAAP Financial Measures
We consider the following non-GAAP financial measures useful to investors as key
supplemental measures of our performance: (1) core earnings and (2) Managed
Assets. These non-GAAP financial measures should be considered along with, but
not as alternatives to, net income or loss as measures of our operating
performance. These non-GAAP financial measures, as calculated by us, may not be
comparable to similarly named financial measures as reported by other companies
that do not define such terms exactly as we define such terms.
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Core Earnings
We calculate core earnings as GAAP net income (loss) excluding non-cash equity
compensation expense, certain non-cash provisions for loss on receivables,
amortization of intangibles, any one-time acquisition related costs or non-cash
tax charges and the earnings attributable to our non-controlling interest of our
Operating Partnership . We also make an adjustment to our equity method
investments in the renewable energy projects as described below. In the future,
core earnings may also exclude one-time events pursuant to changes in GAAP and
certain other non-cash charges as approved by a majority of our independent
directors.
Certain of our equity method investments in renewable energy and energy
efficiency projects are structured using typical partnership "flip" structures
where the investors with cash distribution preferences receive a pre-negotiated
return consisting of priority distributions from the project cash flows, in many
cases, along with tax attributes. Once this preferred return is achieved, the
partnership "flips" and the common equity investor, often the operator or
sponsor of the project, receives more of the cash flows through its equity
interests while the previously preferred investors retain an ongoing residual
interest. We have made investments in both the preferred and common equity of
these structures. Regardless of the nature of our equity interest, we typically
negotiate the purchase prices of our equity investments, which have a finite
expected life, based on our assessment of the expected cash flows we will
receive from these projects discounted back to the net present value, based on a
target investment rate, with the expected cash flows to be received in the
future reflecting both a return on the capital (at the investment rate) and a
return of the capital we have committed to the project. We use a similar
approach in the underwriting of our receivables.
Under GAAP, we account for these equity method investments utilizing the HLBV
method. Under this method, we recognize income or loss based on the change in
the amount each partner would receive, typically based on the negotiated profit
and loss allocation, if the assets were liquidated at book value, after
adjusting for any distributions or contributions made during such quarter. The
HLBV allocations of income or loss may be impacted by the receipt of tax
attributes, as tax equity investors are allocated losses in proportion to the
tax benefits received, while the sponsors of the project are allocated gains of
a similar amount. In addition, the agreed upon allocations of the project's cash
flows may differ materially from the profit and loss allocation used for the
HLBV calculations.
The cash distributions for our equity method investments are segregated into a
return on and return of capital on our cash flow statement based on the
cumulative income (loss) that has been allocated using the HLBV method. However,
as a result of the application of the HLBV method, including the impact of tax
allocations, the high levels of depreciation and other non-cash expenses that
are common to renewable energy projects and the differences between the agreed
upon profit and loss and the cash flow allocations, the distributions and thus
the economic returns (i.e. return on capital) achieved from the investment are
often significantly different from the income or loss that is allocated to us
under the HLBV method. Thus, in calculating core earnings, we further adjust
GAAP net income (loss) to take into account our calculation of the return on
capital (based upon the investment rate) from our renewable energy equity method
investments, as adjusted to reflect the performance of the project and the cash
distributed. We believe this core equity method investment adjustment to our
GAAP net income (loss) in calculating our core earnings measure is an important
supplement to the HLBV income allocations determined under GAAP for an investor
to understand the economic performance of these investments.
Our results related to our equity method investments in renewable energy and
energy efficiency projects for the last three years are as follows:
For the years ended December 31,
2019 2018 2017
(dollars in millions)
Income under GAAP $ 64 $ 22 $ 22
Core earnings $ 41 $ 41 $ 43
Return of capital $ 60 $ 74 $ 47
Cash collected $ 101 $ 115 $ 90
We believe that core earnings provides an additional measure of our core
operating performance by eliminating the impact of certain non-cash expenses and
facilitating a comparison of our financial results to those of other comparable
companies with fewer or no non-cash charges and comparison of our own operating
results from period to period. Our management uses core earnings in this way. We
believe that our investors also use core earnings, or a comparable supplemental
performance measure, to evaluate and compare our performance to that of our
peers, and as such, we believe that the disclosure of core earnings is useful to
our investors.
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However, core earnings does not represent cash generated from operating
activities in accordance with GAAP and should not be considered as an
alternative to net income (determined in accordance with GAAP), or an indication
of our cash flow from operating activities (determined in accordance with GAAP),
or a measure of our liquidity, or an indication of funds available to fund our
cash needs, including our ability to make cash distributions. In addition, our
methodology for calculating core earnings may differ from the methodologies
employed by other companies to calculate the same or similar supplemental
performance measures, and accordingly, our reported core earnings may not be
comparable to similar metrics reported by other companies.
We have calculated our core earnings for the years ended December 31, 2019 , 2018
and 2017. The table below provides a reconciliation of our GAAP net income to
core earnings:
For the Years Ended December 31,
2019 2018 2017
$ Per Share $ Per Share $ Per Share
(dollars in thousands, except per share amounts)
Net income attributable to
controlling stockholders $ 81,564 $ 1.24 $ 41,577 $ 0.75 $ 30,856 $ 0.57
Core earnings adjustments
Reverse GAAP income from
equity method investments (64,174 ) (22,162 ) (22,289 )
Add back core equity method
investments earnings 41,437 40,923 42,707
Non-cash equity-based
compensation charges 14,160 10,066 11,304
Non-cash provision for loss
on receivables 8,027 - -
Amortization of intangibles 3,285 3,207 2,622
Non-cash provision (benefit)
for taxes 8,091 1,968 756
Current year earnings
attributable to
non-controlling interest 356 221 179
Core earnings (1) $ 92,746 $ 1.40 $ 75,800 $ 1.38 $ 66,135 $ 1.27 (1) Core earnings per share is based on 66,046,401 shares, 54,742,869 shares and
52,231,030 shares for the years ended
respectively, which represents the weighted average number of fully-diluted
shares outstanding including our restricted stock awards and restricted stock
units and the non-controlling interest in our Operating Partnership . We
include any potential common stock issuance in this calculation related to
our convertible notes using the treasury stock method and any potential
common stock issuances related to share based compensation units in the
amount we believe is reasonably certain to vest.
Managed Assets
As we both consolidate assets on our balance sheet and securitize assets,
certain of our receivables and other assets are not reflected on our balance
sheet where we may have a residual interest in the performance of the
investment, such as servicing rights or a retained interest in cash flows. Thus,
we present our investments on a non-GAAP "managed" basis, which assumes that
securitized receivables are not sold. We believe that our Managed Asset
information is useful to investors because it portrays the amount of both on-
and off-balance sheet receivables that we manage, which enables investors to
understand and evaluate the credit performance associated with our portfolio of
receivables, investments, and residual assets in securitized receivables. Our
non-GAAP Managed Assets measure may not be comparable to similarly titled
measures used by other companies.
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The following is a reconciliation of our GAAP Portfolio to our Managed Assets as
of
As of December 31,
2019 2018 2017
(dollars in millions)
Equity method investments $ 499 $ 471 $ 523
Government receivables (1) 263 497 535
Commercial receivables (2) 896 447 477
Real estate 362 365 341
Investments 75 170 151
Assets held in securitization trusts 4,101 3,334 2,709
Managed assets $ 6,196 $
5,284
(1) Includes receivables held-for-sale of
(2) Includes receivables held-for-sale of
Other Financial Measures
The following are certain other GAAP-based financial measures for the years
ended
Years Ended
December 31,
2019 2018 2017
Return on assets 3.6 % 1.9 % 1.5 %
Return on equity 9.4 % 5.7 % 5.1 %Average equity to average total assets ratio 38.4 % 32.9 % 30.5 %
Portfolio Yield We calculate portfolio yield as the weighted average underwritten yield of the investments in our Portfolio as of the end of the period. Underwritten yield is the rate at which we discount the expected cash flows from the assets in our Portfolio to determine our purchase price. In calculating underwritten yield, we make certain assumptions, including the timing and amounts of cash flows generated by our investments, which may differ from actual results, and may update this yield to reflect our most current estimates of project performance. We believe that portfolio yield provides an additional metric to understand certain characteristics of our Portfolio as of a point in time. Our management uses portfolio yield this way and we believe that our investors use it in a similar fashion to evaluate certain characteristics of our Portfolio compared to our peers, and as such, we believe that the disclosure of portfolio yield is useful to our investors. Our Portfolio totaled approximately$2.1 billion with a portfolio yield of 7.6% and 6.8% as ofDecember 31, 2019 and 2018, respectively. See Note 6 to our financial statements and MD&A - Our Business in this Form 10-K for additional discussion of the characteristics of our portfolio as ofDecember 31, 2019 . Environmental Metrics As discussed in Item 1. Business, as part of our investment process, we calculate the estimated metric tons of CO2 equivalent emissions, or carbon emissions avoided by our investments. In this calculation which we refer to as CarbonCount®, we apply emissions factor data from theU.S. Government or theInternational Energy Administration to an estimate of a project's energy production or savings to compute an estimate of metric tons of carbon emissions avoided. We estimate that our investments originated in 2019 will reduce annual carbon emissions by approximately 385 thousand metric tons. In assessing our performance and results of operations, we also consider the impact of our operations on the environment. We utilize the carbon emissions categorizations established by theWorld Resources Institute Greenhouse Gas Protocol Corporate Standards ("Standards") to set goals and calculate our estimated emissions. The categorizations are as follows: • Scope 1 GHG emissions - Direct emissions - Emissions from operations that are owned or controlled by the reporting company. - 66 -
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• Scope 2 GHG emissions - Indirect emissions - Emissions from the
generation of purchased or acquired energy such as electricity, steam,
heating or cooling, consumed by the reporting company.
• Scope 3 GHG emissions - Indirect emissions - All other indirect
emissions that occur in the value chain of the reporting company,
including both upstream and downstream emissions.
The table below illustrates our goals and performance for 2019 in metric tons
("MT").
Category Goal Performance
Scope 1 GHG emissions 0 MT 0 MT
Scope 2 GHG emissions 0 MT 0 MT1
Scope 3 GHG emissions 0 MT2 < 600 MT2
(1) Performance stated is market-based which includes the impact of purchasing
carbon offsets.
(2) Our stated actual performance for Scope 3 GHG emissions does not include
the carbon emissions reductions as a result of our investments. The first
year carbon emissions reductions as a result of our investments originated
in 2019 are 385 thousand MT.
Liquidity and Capital Resources Liquidity is a measure of our ability to meet potential short term (within one year) and long term cash requirements, including ongoing commitments to repay borrowings, fund and maintain our current and future assets, make distributions to our stockholders and other general business needs. We will use significant cash to make investments in sustainable infrastructure, repay principal and interest on our borrowings, make distributions to our stockholders and fund our operations. We use borrowings as part of our financing strategy to increase potential returns to our stockholders and have available to us a broad range of financing sources. We finance our investments primarily with non-recourse or recourse debt, equity and off-balance sheet securitization structures. During 2019, we issued our first senior unsecured notes at a total principal amount of$500 million , for total cash proceeds of$507 million . We believe that this access to the corporate debt markets has provided us an additional funding source when financing our Portfolio. In the fourth quarter of 2019, we issued$96 million of non-recourse debt with a legal maturity of 2047 with several of our land assets as collateral. We have two senior secured revolving credit facilities ("Rep-Based Facility" and "Approval-Based Facility") with several lenders with a combined maximum outstanding balance of$450 million . For additional information on our credit facilities, see Note 7 to our audited financial statements on this Form 10-K. As ofDecember 31, 2019 , we had approximately$700 million of non-recourse borrowings. We have$150 million of convertible notes outstanding. We also continue to utilize off-balance sheet securitization transactions, where we transfer the loans or other assets we originate to securitization trusts or other bankruptcy remote special purpose funding vehicles that are not consolidated on our balance sheet. As ofDecember 31, 2019 , the outstanding principal balance of our assets financed through the use of these off-balance sheet transactions was approximately$4.1 billion . During the year endedDecember 31, 2019 , we raised approximately$138 million of equity, including$129 million of utilizing our "at-the-market" equity distribution program (our "ATM program"), pursuant to which we can offer to sell, from time to time, up to an aggregate amount of$250 million of our common stock. We also raised$9 million through the exercise of the underwriters' option to purchase additional shares related to ourDecember 2018 equity offering. For additional information related to our equity raises see Note 11 to our audited financial statements of this Form 10-K. Large institutional investors have provided the financing for our on and off-balance sheet financings. We have worked to expand our liquidity and access to the debt and bank loan markets and have entered into transactions with a number of new institutional investors in the last year. For further information on the credit facilities, senior unsecured notes, asset backed non-recourse debt, convertible notes, and securitizations, see Notes 5, 7 and 8 to our audited financial statements of this Form 10-K. We plan to raise additional equity capital and continue to use fixed and floating rate borrowings which may be in the form of additional bank credit facilities (including term loans and revolving facilities), warehouse facilities, repurchase agreements and public and private equity and debt issuances as a means of financing our business. We also expect to use both on-balance sheet and non-consolidated securitizations and also believe we will be able to customize securitized tranches to meet investment preferences of different investors. We may also consider the use of separately funded special purpose entities or funds to allow us to expand our investments or to manage our Portfolio diversification. The decision on how we finance specific assets or groups of assets is largely driven by cost, availability of financing options, capital requirements and risk and portfolio and financial management considerations, including the potential for gain on sale or fee income, as well as the overall interest rate environment, prevailing credit spreads and the terms of available - 67 - -------------------------------------------------------------------------------- financing and market conditions. Over time, as market conditions change, we may use other forms of debt and equity in addition to these financing arrangements. The amount of leverage we may deploy for particular assets will depend upon the availability of particular types of financing and our assessment of the credit, liquidity, price volatility and other risks of those assets, the interest rate environment and the credit quality of our financing counterparties. As shown in the table below, our debt to equity ratio was approximately 1.5 to 1 as ofDecember 31, 2019 , which is below our leverage limit of up to 2.5 to 1. We will continue to evaluate the appropriate level of debt and may, over time, make additional changes to our targeted levels. Our percentage of fixed rate debt was approximately 98% as ofDecember 31, 2019 . InFebruary 2020 , our board of directors increased our targeted fixed-rate debt range from 60% to 85% to 75% to 100% due to the addition of senior unsecured note issuances and lower use of our floating rate credit facilities. The calculation of our fixed-rate debt and leverage as ofDecember 31, 2019 and 2018 is shown in the chart below: December 31, 2019 % of Total December 31, 2018 % of Total (dollars in millions) (dollars in millions) Floating-rate borrowings $ 33 2 % $ 317 26 % Fixed-rate debt 1,360 98 % 925 74 % Total debt (1) $ 1,393 100 % $ 1,242 100 % Equity $ 940 $ 805 Leverage 1.5 to 1 1.5 to 1
(1) Floating-rate borrowings include borrowings under our floating-rate credit
facilities and approximately
non-recourse debt with floating rate exposure as of
notional value of non-recourse debt that is hedged using interest rate swaps.
Debt excludes securitizations that are not consolidated on our balance sheet.
We intend to use leverage for the primary purpose of financing our Portfolio and business activities and not for the purpose of speculating on changes in interest rates. While we may temporarily exceed the leverage limit, if our board of directors approves a material change to this limit, we anticipate advising our stockholders of this change through disclosure in our periodic reports and other filings under the Exchange Act. While we generally intend to hold our target assets that we do not securitize upon acquisition as long term investments, certain of our investments may be sold in order to manage our interest rate risk and liquidity needs, to meet other operating objectives and to adapt to market conditions. The timing and impact of future sales of receivables and investments, if any, cannot be predicted with any certainty. Since we expect that our assets will generally be financed, we expect that in certain cases a significant portion of the proceeds from sales of our assets (if any), prepayments and scheduled amortization will be used to repay balances under our financing sources. We believe these identified sources of liquidity in addition to our cash on hand will be adequate for purposes of meeting our short-term and long-term liquidity needs, which include funding future investments, debt service, operating costs and distributions to our stockholders. To qualify as a REIT, we must distribute annually at least 90% of our REIT's taxable income without regard to the deduction for dividends paid and excluding net capital gains. These dividend requirements limit our ability to retain earnings and thereby replenish or increase capital for growth and our operations. Sources and Uses of Cash We had approximately$107 million and$59 million unrestricted cash, cash equivalents, and restricted cash as ofDecember 31, 2019 and 2018, respectively. Cash Flows Relating to Operating Activities Net cash provided by operating activities was approximately$29 million for the year endedDecember 31, 2019 , driven primarily by net income of$82 million , less adjustments for non-cash and other items of$53 million . The non-cash and other adjustments consisted of increases of$10 million of depreciation and amortization,$14 million related to equity-based compensation,$5 million related to accounts payable and accrued expenses,$13 million for gain on sale of receivables and investments, and$8 million for provision for loss on receivables. These increases were offset by$56 million related to non-cash gains on securitizations,$34 million related to equity method investments, and$13 million related to other items. Net cash provided by operating activities was approximately$59 million for the year endedDecember 31, 2018 , driven primarily by net income of$42 million , plus adjustments for non-cash and other items of$17 million . The non-cash and other adjustments consisted of increases of$15 million of depreciation and amortization,$13 million related to receivables held-for-sale,$10 million related to equity-based compensation,$7 million related to accounts payable and accrued expenses,$4 million - 68 - -------------------------------------------------------------------------------- related to equity method investments, and$9 million related to cost associated with the repayment of the residential solar related debt. These were offset by$26 million related to gains on securitizations and$15 million related to other items. Cash Flows Relating to Investing Activities Net cash used in investing activities was approximately$201 million for the year endedDecember 31, 2019 . We collected payments of$64 million from receivables and fixed rate debt securities and received$274 million from the sale of financial assets. We also collected$71 million from equity method investments which are considered return of capital determined under GAAP, received$81 million from the sale of equity method investments, withdrew$31 million from escrow accounts, and had other cash inflows of$2 million . These were offset by investments in receivables and fixed rate debt securities of$543 million , equity method investments of$152 million , and funding of escrow accounts of$29 million . Net cash provided by investing activities was approximately$51 million for the year endedDecember 31, 2018 . We collected$351 million from receivables and fixed rate debt securities, which includes the$300 million collected from the repayment of the residential solar assets. We also collected$88 million from equity method investments representing the return of capital determined under GAAP, received$36 million from the sale of equity method investments, and withdrew$33 million from escrow accounts. We made$318 million of investments in receivables and fixed rate debt-securities, made$28 million of investments in real estate, made$76 million of equity method investments, and funded escrow accounts for$35 million . Cash Flows Relating to Financing Activities Net cash provided by financing activities was approximately$219 million for the year endedDecember 31, 2019 . We received proceeds from credit facilities of$102 million , proceeds from non-recourse debt of$131 million , proceeds from the issuance of senior unsecured debt of$507 million , and net proceeds from common stock issuances of$138 million . These were partially offset by principal payments on credit facilities of$328 million , principal payments on non-recourse debt of$207 million , payments of deferred funding obligations of$19 million , and payments of dividends, distributions, and other financing activities of$105 million . Net cash used in financing activities was approximately$168 million for the year endedDecember 31, 2018 . We had non-recourse debt borrowings of$69 million , borrowings from our credit facilities of$172 million , and received$187 million of net proceeds from the issuance of common stock. We made$390 million of principal payments on non-recourse debt, which includes the$250 million debt repayment related to the repayment of the residential solar assets. We also made,$47 million of principal payments on credit facilities,$74 million of payments on deferred funding obligations, paid$71 million of dividends and distributions, and had other cash outflows of$14 million . Contractual Obligations and Commitments The following table provides a summary of our contractual obligations as ofDecember 31, 2019 : Payment due by
Period
Less than More than
Contractual Obligations Total 1 year 1 - 3 Years 3 - 5 Years 5 years
(in millions)
Credit facilities $ 31 $ - $ 8 $ 23 $ -
Interest on credit
facilities (1) 3 - 2 1 -
Non-recourse debt (2) 716 88 52 91 485
Interest on non-recourse
debt (2) 258 27 51 44 136
Senior unsecured
notes (3) 500 - - 500 - -
Interest on senior
unsecured notes 133 27 53 53 -
Convertible notes (4) 150 - 150 - -
Interest on convertible
notes 18 6 12 - -
Operating lease
obligations 4 1 1 1 1
Total $ 1,813 $ 149 $ 329 $ 713 $ 622 (1) Interest is calculated based on the interest rate in effect at
2019, and includes all interest expense incurred and expected to be incurred
in the future based on the current principal balance through the contractual
maturity of the credit facilities.
(2) These amounts exclude
Interest is calculated based on the interest rate in effect at
2019, including the effect of interest rate hedges as applicable.
(3) Excludes
unamortized issuance premium.
(4) Excludes
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Off-Balance Sheet Arrangements
We have relationships with non-consolidated entities or financial partnerships,
such as entities often referred to as structured investment vehicles, or special
purpose or variable interest entities, established to facilitate the sale of
securitized assets. Other than our securitization assets (including any
outstanding servicer advances) of approximately $124 million as of December 31,
2019 , that may be at risk in the event of defaults or prepayments in our
securitization trusts and as discussed below, we have not guaranteed any
obligations of non-consolidated entities or entered into any commitment or
intent to provide additional funding to any such entities. A more detailed
description of our relations with non-consolidated entities can be found in Note
2 of our audited financial statements included in this Form 10-K.
In connection with some of our transactions, we have provided certain limited
guaranties to other transaction participants covering the accuracy of certain
limited representations, warranties or covenants and provided an indemnity
against certain losses from "bad acts" including fraud, failure to disclose a
material fact, theft, misappropriation, voluntary bankruptcy or unauthorized
transfers. We have also guaranteed our compliance with certain tax matters, such
as negatively impacting the investment tax credit and certain other obligations
in the event of a change in ownership or our exercising certain protective
rights.
Dividends
U.S. federal income tax law generally requires that a REIT distribute annually
at least 90% of its REIT taxable income, without regard to the deduction for
dividends paid and excluding net capital gains, and that it pays tax at regular
corporate rates to the extent that it annually distributes less than 100% of its
REIT taxable income. Our current policy is to pay quarterly distributions, which
on an annual basis will equal or exceed substantially all of our REIT taxable
income. The taxable income of the REIT can vary from our GAAP earnings due to a
number of different factors, including, the book to tax timing differences of
income and expense recognition from our transactions as well as the amount of
taxable income of our TRSs distributed to the REIT. See Note 10 regarding the
amount of our distributions that are taxed as ordinary income to our
stockholders.
Any distributions we make will be at the discretion of our board of directors
and will depend upon, among other things, our actual results of operations.
These results and our ability to pay distributions will be affected by various
factors, including the net interest and other income from our portfolio, our
operating expenses and any other expenditures. In the event that our board of
directors determines to make distributions in excess of the income or cash flow
generated from our assets, we may make such distributions from the proceeds of
future offerings of equity or debt securities or other forms of debt financing
or the sale of assets. To the extent that in respect of any calendar year, cash
available for distribution is less than our taxable income, or our declared
distribution we could be required to sell assets, borrow funds, or raise
additional capital to make cash distributions or make a portion of the required
distribution in the form of a taxable stock distribution or distribution of debt
securities. We will generally not be required to make distributions with respect
to activities conducted through our domestic TRSs.
To the extent that we generate taxable income, distributions to our stockholders
generally will be taxable as ordinary income, although all or a portion of such
distributions may be designated by us as a qualified dividend or capital gain.
Beginning in 2018 (and through taxable years ending in 2025), a deduction is
permitted for certain pass-through business income, including "qualified REIT
dividends" (generally, dividends received by a REIT shareholder that are not
designated as capital gain dividends or qualified dividend income), which will
allow U.S. individuals, trusts, and estates to deduct up to 20% of such amounts,
subject to certain limitations, resulting in an effective maximum U.S. federal
income tax rate of 29.6% on such qualified REIT dividends. In the event we make
distributions to our stockholders in excess of our taxable income, the excess
will constitute a return of capital. In addition, a portion of such
distributions may be taxable stock dividends payable in our shares. We will
furnish annually to each of our stockholders a statement setting forth
distributions paid during the preceding year and their characterization as
ordinary income, return of capital, qualified dividend income or capital gain.
The dividends declared in 2019 and 2018 are described in Note 11 of the audited
financial statements in this Form 10-K.
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Book Value Considerations As ofDecember 31, 2019 , we carried only our investments, interest rate swaps and residual assets in securitized financial assets at fair value on our balance sheet. As a result, in reviewing our book value, there are a number of important factors and limitations to consider. Other than our investments, interest rate swaps and the residual assets in securitized receivables that are carried on our balance sheet at fair value as ofDecember 31, 2019 , the carrying value of our remaining assets and liabilities are calculated as of a particular point in time, which is largely determined at the time such assets and liabilities were added to our balance sheet using a cost basis in accordance with GAAP. As such, our remaining assets and liabilities do not incorporate other factors that may have a significant impact on their value, most notably any impact of business activities, changes in estimates, or changes in general economic conditions, interest rates or commodity prices since the dates the assets or liabilities were initially recorded. Accordingly, our book value does not necessarily represent an estimate of our net realizable value, liquidation value or our market value as a whole. Inflation We do not anticipate that inflation will have a significant effect on our results of operations. However, in the event of a significant increase in inflation, interest rates could rise and our projects and investments may be materially adversely affected.
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