HANNON ARMSTRONG SUSTAINABLE INFRASTRUCTURE CAPITAL, INC. In this Form 10-Q, unless specifically stated otherwise or the context otherwise indicates, references to "we," "our," "us," and "HASI" refer toHannon Armstrong Sustainable Infrastructure Capital, Inc. , aMaryland corporation,Hannon Armstrong Sustainable Infrastructure, L.P. , and any of our other subsidiaries.Hannon Armstrong Sustainable Infrastructure, L.P. is aDelaware limited partnership of which we are the sole general partner and to which we refer in this Form 10-Q as our "Operating Partnership." Our business is focused on reducing the impact of greenhouse gases that have been scientifically linked to climate change. We refer to these gases, which are often for consistency expressed as carbon dioxide equivalents, as carbon emissions. The following discussion is a supplement to and should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and related notes and with our Annual Report on Form 10-K for the year endedDecember 31, 2019 , as amended by our Amendment No. 1 to our Annual Report on Form 10-K for the year endedDecember 31, 2019 , (collectively, our "2019 Form 10-K") that was filed with theSEC . Our Business 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. Our investments are focused on three areas: •Behind-The-Meter ("BTM"): distributed building or facility projects, which reduce energy usage or cost through the use of solar generation and energy storage or energy efficiency improvements including heating, ventilation and air conditioning systems ("HVAC"), lighting, energy controls, roofs, windows, building shells, and/or combined heat and power systems; •Grid Connected ("GC"): projects that deploy cleaner energy sources, such as solar and wind to generate power where the off-taker or counterparty is part of the wholesale electric power grid; and •Sustainable Infrastructure: upgraded transmission and distribution systems, water and storm water infrastructure, and other projects that improve water or energy efficiency, increase resiliency, positively impact the environment or more efficiently use natural resources. We prefer investments that use proven technology and that often have contractually committed agreements with an investment-grade rated off-taker or counterparties. In the case of BTM, the off-taker or counterparty may be the building owner or occupant, and we may be secured by the installed improvements or other real estate rights. In the case of GC, the off-taker or counterparty may be a utility or electric user who has entered into a contractually committed agreement, such as a power purchase agreement ("PPA"), to purchase power produced by a renewable energy project at a minimum price with potential price escalators for a portion of the project's estimated life. We completed approximately$716 million and$1.1 billion of transactions during the three and nine months endedSeptember 30, 2020 , compared to approximately$287 million and$810 million during the same periods in 2019. As ofSeptember 30, 2020 , pursuant to our strategy of holding transactions on our balance sheet, we held approximately$2.2 billion of transactions on our balance sheet, which we refer to as our "Portfolio." As ofSeptember 30, 2020 , our Portfolio consisted of over 205 assets and we seek to manage the diversity of our Portfolio by, among other factors, project type, project operator, type of investment, type of technology, transaction size, geography, obligor and maturity. 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 ofSeptember 30, 2020 , we managed approximately$4.2 billion in assets in these securitization trusts or vehicles that are not consolidated on our balance sheet. When combined with our Portfolio, as ofSeptember 30, 2020 , we manage approximately$6.4 billion of assets which we refer to as our "Managed Assets". In the third quarter, we invested$150 - 33 - -------------------------------------------------------------------------------- million and expect to invest up to a total of$540 million in a joint venture owning 2.3 gigawatts of renewable energy projects. See Note 6 to our financial statements in this Form 10-Q for further discussion. We make our investments utilizing a variety of structures including: •Equity investments in either preferred or common structures in unconsolidated entities; •Government and commercial receivables or securities, such as loans for renewable energy and energy efficiency projects; and •Real estate, such as land or other assets leased for use by sustainable infrastructure projects typically under long-term leases. Our equity investments in renewable energy and energy efficiency projects are operated by various renewable energy companies or by joint ventures in which we participate. These transactions allow us to participate in the cash flows associated with these projects, typically on a priority basis. Our energy efficiency debt investments are usually assigned the payment stream from the project savings and other contractual rights, often using our pre-existing master purchase agreements with the ESCOs. Our debt investments in various renewable energy or other sustainable infrastructure projects or portfolios of projects are generally secured by the installed improvements or other real estate rights. We also own, directly or through equity investments, or manage over 31,000 acres of land that are leased under long-term agreements to over 60 renewable energy projects, where our investment returns are typically senior to most project costs, debt, and equity. While we prefer investments in which we hold a senior or preferred position in a project, as our markets evolve and grow, we are seeing increasing opportunities to invest, and have invested, in mezzanine debt or common equity in projects where we are subordinated to project debt and/or preferred forms of equity. Investing greater than 15% of our assets in any individual project requires the approval of a majority of our independent directors. We may adjust the mix and duration of our assets over time in order to allow us to manage various aspects of our portfolio, including expected risk-adjusted returns, macroeconomic conditions, liquidity, availability of adequate financing for our assets, and the maintenance of our REIT qualification and our exemption from registration as an investment company under the 1940 Act. We have available to us a broad range of financing sources that allow us to use borrowings as part of our financing strategy to increase potential returns to our stockholders. We may finance our investments using non-recourse or recourse debt and equity. We may also decide to finance transactions through the use of off-balance sheet securitization structures where 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. We have worked to expand our liquidity and access to the debt and bank loan markets and inAugust 2020 completed our latest issuance of senior unsecured and convertible notes. We have a large and active pipeline of potential new opportunities that are in various stages of our underwriting process. We refer to potential opportunities as being part of our pipeline if we have determined that the project fits within our investment strategy and exhibits the appropriate risk and reward characteristics through an initial credit analysis, including a quantitative and qualitative assessment of the opportunity, as well as research on the market and sponsor. Our pipeline of transactions that could potentially close in the next 12 months consists of opportunities in which we will be the lead originator as well as opportunities in which we may participate with other institutional investors. Subsequent to our origination of the transaction discussed in Note 6 to the financial statements, our pipeline consisted of more than$2.5 billion in new equity, debt and real estate opportunities. Of our pipeline, 62% is related to BTM assets and 27% is related to GC assets, with the remainder related to other sustainable infrastructure. There can, however, be no assurance with regard to any specific terms of such pipeline transactions or that any or all of the transactions in our pipeline will be completed. As part of our investment process, we calculate the ratio of the estimated first year of metric tons of carbon emissions avoided by our investments divided by the capital invested to quantify the carbon impact of our investments. In this calculation, which we refer to as CarbonCount®, we use emissions factor data, expressed on a CO2 equivalent basis, 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. Refer to Environmental Metrics below for a discussion of the carbon emissions avoided as a result of our investments. In addition to carbon, we also consider other environmental attributes, such as water use reduction, stormwater remediation benefits and stream restoration benefits. We elected and qualified to be taxed as a REIT forU.S. federal income tax purposes, commencing with our taxable year endedDecember 31, 2013 and operate our business in a manner that will permit us to continue to maintain our exemption from registration as an investment company under the 1940 Act. - 34 - -------------------------------------------------------------------------------- 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, changes in climate, federal, state and/or municipal governmental policies, general market conditions in local, regional and national economies, our ability to qualify as a REIT and maintain our exemption from registration as an investment company under the 1940 Act, the impacts of climate change, and the impact of the novel coronavirus (COVID-19). We provide a summary of the factors impacting our operating results in our 2019 Form 10-K under MD&A - Factors Impacting our Operating Results as well as information on COVID-19 below. Impact of COVID-19 The current outbreak of the novel coronavirus (COVID-19) is having an ongoing impact on theU.S. , regional and global economies, theU.S. sustainable infrastructure market and the broader financial markets. Since March, in an attempt to control COVID-19 the Federal government and most states and/or local governments, including where we have our office (Maryland ) and in regions where our projects and other investments are located or where they are managed, have implemented various restrictions, rules, or guidelines including quarantines, restrictions on travel, "shelter in place", "stay at home", or "safer at home" rules, restrictions on types of business that may continue to operate, and/or restrictions on types of construction projects allowed. While some of these restrictions have been relaxed or phased out, many of these or similar restrictions remain in place, continue to be implemented, or additional restrictions are being considered. Although, in certain cases, exceptions may be available for certain essential operations and businesses which generally include the renewable energy projects in which we invest, there is no assurance that such exceptions will enable us to avoid adverse effects to our results of operations and business. Further, such actions create disruption in energy efficiency, renewable energy, real estate and other sustainable infrastructure markets and adversely impact a number of industries. We closed our office and moved to a remote workforce in early March to help ensure the safety and productivity of our employees and help prevent the spread of COVID-19 among our workforce and in the community. We took this action early as we recognized the seriousness of the situation and wanted to protect our employees and the members of the communities in which they live and work. We have spent significant time and resources over the last several years to update our IT infrastructure and our use of the cloud to allow us to take this action. Operating as a remote workforce has not materially impacted our ability to carry out day to day operations. We have announced donations totaling$300,000 to severalMaryland charities who are providing services during the pandemic as well as to charities addressing racial inequity. We have taken certain actions to increase liquidity, including issuing$188 million in common stock and issuing over$900 million of senior unsecured and convertible senior notes. We believe these actions give us ample liquidity to continue to operate our business and make investments in green projects as opportunities present themselves. See the Notes 7 and 8 to our financial statements and Liquidity and Capital Resources in this Form 10-Q for further discussion of our liquidity. Our financial results for 2020 have not been adversely impacted by COVID-19 to a material degree. We currently have no material loan delinquencies. We believe that the cost-savings attributes of the projects in which we invest provide incentive to borrowers and other obligors to continue to make their contractual payments. The rapid development and fluidity of the circumstances resulting from this pandemic preclude any prediction as to the ultimate adverse impact of COVID-19. Nevertheless, COVID-19 and the current financial, economic and capital markets environment, and future developments in these and other areas present material uncertainty and risk with respect to our performance, financial condition, volume of business, results of operations and cash flows. We expect to review and adjust our efforts as the circumstances and impacts of the pandemic develop and respond to the shifting business and financial landscape and heightened volatility in, among other things, financial markets as well as the general economy and the various federal, state and local guidelines on business operations. See the Risk Factors section of this Form 10-Q for additional discuss of certain potential risks to our business arising from COVID-19. 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. Understanding our accounting policies and the extent to which we make judgments and estimates in applying these policies is integral to understanding our financial statements. We believe the estimates and assumptions used in preparing our financial statements and related footnotes are reasonable and supportable based on the best information available to us as ofSeptember 30, 2020 . The uncertainty surrounding COVID-19 may materially impact the accuracy of the estimates and assumptions used in the financial statements and related footnotes and, as a result, actual results may vary significantly from estimates. - 35 - -------------------------------------------------------------------------------- We have identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition. These critical accounting policies govern Variable Interest Entity Consolidation, Equity Method Investments, Impairment or the establishment of an allowance under Topic 326 for our Portfolio, and Securitization of Receivables. We evaluate our critical accounting estimates and judgments on an ongoing basis and update them, as necessary, based on changing conditions. We provide additional information on our critical accounting policies and use of estimates under Item 7. MD&A-Critical Accounting Policies and Use of Estimates in our 2019 Form 10-K and under Note 2 to our financial statements in this Form 10-Q. Financial Condition and Results of Operations Our Portfolio Our Portfolio totaled approximately$2.2 billion as ofSeptember 30, 2020 and included approximately$1.3 billion of BTM assets and approximately$0.9 billion of GC assets. Approximately 52% consisted of fixed-rate government and commercial receivables and debt securities, which are classified as investments, on our balance sheet. Approximately 31% of our Portfolio consisted of unconsolidated equity investments in renewable energy related projects and approximately 17% of our Portfolio was real estate leased to renewable energy projects under lease agreements. Our Portfolio consisted of over 205 transactions with an average size of$11 million and the weighted average remaining life of our Portfolio (excluding match-funded transactions) of approximately 16 years as ofSeptember 30, 2020 . Our Portfolio included the following as ofSeptember 30, 2020 : •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 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 receivables and debt securities as ofSeptember 30, 2020 : Balance Maturity (in millions) Fixed-rate receivables, interest rates less than 5.00% per annum $ 242 2021 to 2045
Fixed-rate receivables, interest rates from 5.00% to 6.50% per annum
68 2022 to 2055
Fixed-rate receivables, interest rates greater than 6.50% per annum
821 2021 to 2069
Receivables 1,131
Allowance for loss on receivables
(31)
Receivables, net of allowance
1,100
Fixed-rate investments, interest rates less than 5.00% per annum 48 2035 to 2038
Fixed-rate investments, interest rates from 5.00% to 6.50% per annum
4 2030 to 2050
Total receivables and investments $ 1,152
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The table below presents, for the debt investments and real estate related
holdings of our Portfolio and our 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.
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
(dollars in millions)
Portfolio, excluding equity method investments
Interest income, receivables $ 23 $ 17 $ 68 $ 48
Average balance of receivables 1,148 906 1,152 901
Average interest rate of receivables 8.0 % 7.5 % 7.9 % 7.1 %
Interest income, investments - 1 2 5
Average balance of investments 44 126 59 160
Average interest rate of investments 4.0 % 4.5 % 4.3 % 4.3 %
Rental income 6 6 19 19
Average balance of real estate 360 363 361 364
Average yield on real estate 7.2 % 7.1 % 7.2 % 7.1 %
Average balance of receivables, investments,
and real estate 1,552 1,395 1,572 1,425
Average yield from receivables, investments, 7.7 % 7.2 % 7.6 % 6.8 %
and real estate
Debt
Interest expense 26 17 66 47
Average balance of debt 1,926 1,266 1,663 1,289
Average cost of debt 5.4 % 5.2 % 5.3 % 4.9 %
The following table provides a summary of our anticipated principal repayments
for our receivables and investments as of
Payment due by Period
Less than 1-5 5-10 More than
Total 1 year years years 10 years
(in millions)
Receivables $ 1,100 $ 121 $ 173 $ 270 $ 536
Investments 52 5 4 14 29
See Note 6 to our financial statements in this Form 10-Q for information on:
•the anticipated maturity dates of our receivables and investments and the
weighted average yield for each range of maturities as of September 30, 2020 ,
•the term of our leases and a schedule of our future minimum rental income under
our land lease agreements as of September 30, 2020 ,
•the Performance Ratings of our Portfolio, and
•the receivables on non-accrual status.
For information on our residual assets relating to our securitization trusts,
see Note 5 to our financial statements in this Form 10-Q. The residual assets do
not have a contractual maturity date and the underlying securitized assets have
contractual maturity dates until 2056.
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Results of Operations
Comparison of the Three Months Ended September 30, 2020 vs. Three Months Ended
September 30, 2019
Three months ended September 30,
2020 2019 $ Change % Change
(dollars in millions)
Revenue
Interest income $ 23 $ 19 $ 4 21 %
Rental income 7 7 - - %
Gain on sale of receivables and investments 14 8 6 75 %
Fee income 5 5 - - %
Total Revenue 49 39 10 26 %
Expenses
Interest expense 26 17 9 53 %
Provision for loss on receivables 3 8 (5) (63) %
Compensation and benefits 9 7 2 29 %
General and administrative 4 4 - - %
Total expenses 42 36 6 17 %
Income before equity method investments 7 3 4 133 %
Income (loss) from equity method
investments 17 6 11 183 %
Income (loss) before income taxes 24 9 15 167 %
Income tax (expense) benefit (2) - (2) NM
Net income (loss) $ 22 $ 9 $ 13 144 %
NM-Percentage change is not meaningful.
•Net income increased by $13 million due to a increase of $10 million in total
revenue and an increase in equity method investments income of $11 million ,
offset by a $6 million increase in total expenses and a $2 million increase in
income tax expense. These results do not reflect the non-GAAP core earnings
adjustment applied to our equity method investments, which is discussed in the
non-GAAP financial measures section below.
•Total revenue increased by $10 million due to a $4 million increase in interest
income resulting from higher yielding assets in the portfolio and a higher
average balance. There was a $6 million increase in gain on sale and fee income
primarily from a change in mix of assets being securitized.
•Interest expense increased by $9 million due primarily to higher average
outstanding borrowings. We recorded a $3 million provision for loss on
receivables in the current quarter due primarily to loan commitments made during
the period. The $8 million provision for loss on receivables in the prior period
was the result of a court ruling in the prior year resulting in a provision for
loss on receivables that were previously placed on non-accrual status in 2017.
•Compensation and benefit expense increased by $2 million as a result of an
increase in our employee headcount and incentive compensation.
•Income from equity method investments increased by $11 million , primarily due
to a higher realization of tax attributes by our co-investors which increases
our HLBV allocation of earnings.
•Income tax expense increased by $2 million primarily as a result of an increase
in income from our portfolio and the recognition of tax benefits in the prior
year that did not recur.
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Comparison of the Nine Months Ended September 30, 2020 vs. Nine Months Ended
September 30, 2019
Nine months ended September 30,
2020 2019 $ Change % Change
(dollars in millions)
Revenue
Interest income $ 71 $ 54 $ 17 31 %
Rental income 19 19 - - %
Gain on sale of receivables and investments 35 17 18 106 %
Fee income 13 13 - - %
Total Revenue 138 103 35 34 %
Expenses
Interest expense 66 47 19 40 %
Provision for loss on receivables 6 8 (2) (25) %
Compensation and benefits 27 21 6 29 %
General and administrative 11 11 - - %
Total expenses 110 87 23 26 %
Income before equity method investments 28 16 12 75 %
Income (loss) from equity method
investments 33 18 15 83 %
Income (loss) before income taxes 61 34 27 79 %
Income tax (expense) benefit (3) 1 (4) (400) %
Net income (loss) $ 58 $ 35 $ 23 66 %
NM-Percentage change is not meaningful.
•Net income increased by $23 million due to an increase of $35 million in total
revenue and $15 million of equity method investments income being offset by a
$23 million increase in total expenses and a $4 million increase in income tax
expense. These results do not reflect the non-GAAP core earnings adjustment
applied to our equity method investments, which is discussed in the non-GAAP
financial measures section below.
•Total revenue increased by $35 million due to a $17 million increase in
interest income resulting from higher yielding assets in the portfolio and a
higher average balance. There was a $18 million increase in gain on sale and fee
income primarily from a change in mix of assets being securitized.
•Interest expense increased by $19 million due to higher average outstanding
borrowings and higher cost of debt. We recorded a $6 million provision for loss
on receivables during the year primarily due to loans and loan commitments made
during the period. The $8 million provision for loss on receivables in the prior
period was the result of a court ruling in the prior year resulting in a
provision for loss on receivables that were previously placed on non-accrual
status in 2017.
•Compensation and benefit expense increased by $6 million as a result of an
increase in our employee headcount and incentive compensation.
•Income from equity method investments increased by $15 million , primarily due
to a higher realization of tax attributes by our co-investors which increases
our HLBV allocation of earnings.
•Income tax expense increased by $4 million primarily as a result of an increase
in income from our portfolio and the recognition of tax benefits in the prior
year that did not recur.
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, (2) core net
investment income, and (3) 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 provisions for loss on receivable, 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 those equity method investments where there is an
unequal allocation of tax attributes 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, for certain of these
investments where there are characteristics as described above, 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 where HLBV
income can differ substantially from the economic returns.
The following table provides results related to our equity method investments
for the three and nine months ended September 30, 2020 and 2019.
Three months ended September 30, Nine months ended September 30,
2020 2019 2020 2019
(in millions)
Income (loss) under GAAP $ 17 $ 6 $ 33 $ 18
Core earnings $ 13 $ 10 $ 40 $ 29
Return of capital 16 11 95 46
Cash collected 29 21 135 75
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
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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.
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 (loss) (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 adopted Topic 326 on January 1, 2020 which requires us to recognize a
provision for loss on receivables expected over the life of a receivable rather
than probable incurred losses. See Note 2 and Note 6 to our financial statements
in this Form 10-Q for a discussion of the adoption of Topic 326 and its impact.
We provide below core earnings which reflects the Topic 326 provision. To
provide comparable metrics to periods prior to the adoption of Topic 326, we
have also provided core earnings which adds back the Topic 326 provision for
loss on receivables. We believe that providing a comparable metric to prior
periods allows users of the financial statements to understand the impact this
new accounting standard will have on our results of operations.
The table below provides a reconciliation of our GAAP net income (loss) to core
earnings for the three and nine months ended September 30, 2020 and 2019.
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
Per Per Per Per
$ Share $ Share $ Share $ Share
(dollars in thousands, except per share amounts)
Net income (loss) attributable to
controlling stockholders (1)
$ 0.28 $ 9,102 $ 0.13 $ 57,491 $ 0.78 $ 35,487 $ 0.54 Core earnings adjustments: Reverse GAAP (income) loss from equity method investments (16,506) (5,984) (32,505) (18,114) Add back core equity method investments earnings 13,258 9,715 40,361 28,857 Non-cash equity-based compensation charges 4,091 3,395 11,615
10,384
Non-cash provision for loss on receivables before adoption of Topic 326 - 8,027 -
8,027
Amortization of intangibles 823 823 2,469
2,462
Non-cash provision (benefit) for income taxes 2,345 132 2,860
(1,304)
Current year earnings attributable to non-controlling interest 102 74 255
191
Core earnings (Including Topic 326 provision) (2)$ 25,288 $ 0.33 $ 25,284 $ 0.38 $ 82,546 $ 1.12 $ 65,990 $ 1.01 Add back provision for loss on receivables under Topic 326 (3) 2,458 - 5,629 - Core earnings (pre-Topic 326 provision) (2)$ 27,746 $ 0.36 $ 25,284 $ 0.38 $ 88,175 $ 1.19 $ 65,990 $ 1.01 (1)This is the GAAP diluted earnings per share and is the most comparable GAAP measure to our core earnings per share. (2)Core earnings per share are based on 77,041,509 shares and 73,819,517 shares and for the three and nine months endedSeptember 30, 2020 , respectively, and 66,785,779 shares and 65,425,114 shares for the three and nine months endedSeptember 30, 2019 , respectively, which represents the weighted average number of fully-diluted shares outstanding including our restricted stock awards, restricted stock units, long-term incentive plan units, and the non-controlling interest in ourOperating Partnership . We include any potential common stock issuance in this calculation related to our - 41 - -------------------------------------------------------------------------------- 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. We believe the use of the treasury stock method is an appropriate representation of the potential dilution when considering the economic behaviors of the holders of the instrument. (3)As discussed above, to provide a comparable metric to prior year metrics we are adding back the provision for loss on receivables recognized under Topic 326 in the year of adoption. Core net investment income We have a portfolio of investments in climate change solutions which we finance using a combination of debt and equity. We calculate core net investment income by adjusting GAAP net investment income for those core earnings adjustments described above which impact investment income. We believe that this measure is useful to investors as it shows the recurring income generated by our portfolio after the associated interest cost of debt financing. Our management also uses core net investment income in this way. Our non-GAAP core net investment income measure may not be comparable to similarly titled measures used by other companies. The following is a reconciliation of our GAAP net investment income to our core net investment income: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (in thousands) Interest income$ 23,508 $ 19,322 $ 71,046 $ 54,270 Rental income 6,469 6,469 19,408 19,415 GAAP investment revenue 29,977 25,791 90,454 73,685 Interest expense 26,085 16,561 65,884 46,861 GAAP net investment income 3,892 9,230 24,570 26,824 Core equity method earnings adjustment 13,258 9,715 40,361 28,857 Amortization of real estate intangibles 772 772 2,317 2,310 Core net investment income$ 17,922 $ 19,717 $ 67,248 $ 57,991 Managed Assets As we both consolidate assets on our balance sheet and securitize assets off-balance sheet, 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 Assets" 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 off-balance sheet securitized receivables. Our management also uses Managed Assets in this way. Our non-GAAP Managed Assets measure may not be comparable to similarly titled measures used by other companies. The following is a reconciliation of our GAAP Portfolio to our Managed Assets: As of September 30, 2020 December 31, 2019 (dollars in millions) Equity method investments $ 719 $ 499 Government receivables 251 263 Commercial receivables, net of allowance 849 896 Real estate 360 362 Investments 52 75 Assets held in securitization trusts 4,195 4,101 Managed Assets $ 6,426 $ 6,196 Losses on receivables as a percentage of assets under management (1) 0.0 % 0.0 %
(1) Losses include either receivables written off or specifically identified as where we have substantial doubt on our ability to recover our investment.
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Other Metrics
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 $2.2 billion as of September 30, 2020 .
Unlevered portfolio yield was 7.7% and 7.6% as of September 30, 2020 and
December 31, 2019 , respectively. See Note 6 to our financial statements and MD&A
- Our Business in this Form 10-Q for additional discussion of the
characteristics of our portfolio as of September 30, 2020 .
Environmental Metrics
As part of our investment process, we calculate the ratio of the estimated first
year of metric tons of carbon emissions avoided by our investments divided by
the capital invested to understand the impact our investments are having on
climate change. In this calculation, which we refer to as CarbonCount®, we apply
emissions factor data from the U.S. Government or the International 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 during the quarter ended September 30, 2020 , will
reduce annual carbon emissions by approximately 1,192,000 metric tons, equating
to a CarbonCount® of 1.67. We estimate that our investments made since 2013 have
cumulatively reduced annual carbon emissions by over 4 million metric tons.
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.
We believe we have substantial liquidity as of September 30, 2020 , with
unrestricted cash balances of $881 million compared to $6 million as of December
31, 2019 . We have been able to successfully access the equity markets, raising
approximately $188 million under our "at-the-market" equity distribution program
(our "ATM program") during the nine months ended September 30, 2020 . During
2020, we have issued $775 million principal amount of senior unsecured notes and
$144 million of convertible notes to further enhance our liquidity position. We
have no material maturities of non-amortizing recourse debt until 2022.
We have two senior secured revolving credit facilities ("Rep-Based Facility" and
"Approval-Based Facility") with several lenders with a combined maximum
commitment of $450 million . For additional information on our credit facilities,
see Note 7 to our financial statements in this Form 10-Q. As of September 30,
2020 , we had approximately $613 million of non-recourse borrowings. We have $1.3
billion of senior unsecured notes and $294 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. We have continued to
complete gain on sale securitization transactions with large institutional
investors such as life insurance companies throughout 2020. As of September 30,
2020 , the outstanding principal balance of our assets financed through the use
of these off-balance sheet transactions was approximately $4.2 billion .
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
financial statements of this Form 10-Q.
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,
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public and private debt issuances as a means of financing our business. We also
expect to use both on-balance sheet and off-balance sheet securitizations. We
may also consider the use of separately funded special purpose entities or funds
to allow us to expand the investments that we make or to manage the Portfolio
diversification.
The decision on how we finance specific assets or groups of assets is largely
driven by 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 financing
and market conditions. During periods of market disruptions, certain sources of
financing may be more readily accessible than others which may impact our
financing decisions. 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 2.0 to 1 as of
September 30, 2020 , below our leverage limit of 2.5 to 1. Our percentage of
fixed rate debt was approximately 99% as of September 30, 2020 , which is within
our targeted fixed rate debt percentage range of 75% to 100%.
The calculation of our fixed-rate debt and leverage is shown in the chart
below:
September 30, 2020 % of Total December 31, 2019 % of Total
(dollars in (dollars in
millions) millions)Floating-rate borrowings $ 23 1 % $ 33 2 % Fixed-rate debt 2,168 99 % 1,360 98 % Total debt (1) $ 2,191 100 % $ 1,393 100 % Equity $ 1,098 $ 940 Leverage 2.0 to 1 1.5 to 1 (1)Floating-rate borrowings include borrowings under our floating-rate credit facilities, and approximately$2 million of non-recourse debt with floating rate exposure as ofDecember 31, 2019 . Fixed-rate debt also includes the present 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. 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$905 million and$107 million of unrestricted cash, cash equivalents, and restricted cash as ofSeptember 30, 2020 andDecember 31, 2019 , respectively. Cash flows relating to operating activities Net cash provided by operating activities was approximately$52 million for the nine months endedSeptember 30, 2020 , driven primarily by net income of$58 million and adjustments for non-cash and other items of$6 million . The non-cash and other adjustments consisted of increases of$6 million related to provision for loss on receivables,$14 million related to equity method investments,$3 million of depreciation and amortization,$6 million of amortization of financing costs,$6 million in accounts payable and accrued expenses, and$12 million related to equity-based compensation. These were offset by$28 million related to gains on securitizations and$25 million related to other items. - 44 - -------------------------------------------------------------------------------- Net cash provided by operating activities was approximately$32 million for the nine months endedSeptember 30, 2019 , driven primarily by net income of$36 million , offset by adjustments for non-cash and other items of$4 million . The non-cash and other adjustments consisted of increases of$8 million related to the provision for loss on receivables,$4 million related to equity method investments,$3 million of depreciation and amortization,$5 million of amortization of deferred financing costs, and$10 million related to equity-based compensation. These were offset by$15 million related to gains on securitizations and$19 million related to changes in accounts payable and accrued expenses and other items. Cash flows relating to investing activities Net cash used in investing activities was approximately$138 million for the nine months endedSeptember 30, 2020 . We made$115 million of investments in receivables and fixed rate debt-securities, funded escrow accounts for$8 million and made$323 million of equity method investments. We collected$91 million from equity method investments representing the return of capital determined under GAAP,$97 million from receivables and fixed rate debt-securities,$110 million from the sales of financial assets, and received$10 million from escrow accounts and other items. Net cash provided by investing activities was approximately$1 million for the nine months endedSeptember 30, 2019 . We made$296 million of investments in receivables and fixed rate debt-securities, funded escrow accounts for$29 million , and made$48 million of equity method investments. We collected$53 million from equity method investments representing the return of capital determined under GAAP,$54 million from receivables and fixed rate debt-securities,$226 million from the sales of financial assets,$8 million from the sale of equity method investments, and received$32 million from escrow accounts and other items. Cash flows relating to financing activities Net cash provided by financing activities was approximately$885 million for the nine months endedSeptember 30, 2020 . We borrowed$126 million from our credit facilities, had non-recourse debt borrowings of$16 million , issued$771 million of senior unsecured notes and$144 million of convertible notes, and received$188 million of net proceeds from issuances of common stock. We made$119 million of principal payments on non-recourse debt,$135 million of principal payments on credit facilities, paid$17 million for withholding requirements as a result of the vesting of employee shares and paid$89 million of dividends, distributions and other items. Net cash provided by financing activities was approximately$138 million for the nine months endedSeptember 30, 2019 . We had non-recourse debt borrowings of$35 million , borrowings from our credit facilities of$102 million , issued$507 million of senior unsecured notes, and received$97 million of net proceeds from the issuance of common stock. We made$181 million of principal payments on non-recourse debt,$322 million of principal payments on credit facilities, and$19 million of payments on deferred funding obligations, spent$9 million to purchase shares related to employees withholdings, and paid$72 million of dividends, distributions and other. 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$147 million as ofSeptember 30, 2020 , that may be at risk in the event of defaults or prepayments in our securitization trusts and as discussed below, and except as disclosed in Note 9 to our financial statements in this Form 10-Q, 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 financial statements in this Form 10-Q. 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. - 45 - --------------------------------------------------------------------------------
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 TRS distributed to the REIT. See Note 10 to our financial statements in our Form 10-K regarding the amount of our distributions that have been 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 TRS. 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 allowU.S. individuals, trusts, and estates to deduct up to 20% of such amounts, subject to certain limitations, resulting in an effective maximumU.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 2020 are described under Note 11 to our financial statements in this Form 10-Q. Book Value Considerations As ofSeptember 30, 2020 , we carried only our investments 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 and the residual assets in securitized financial assets that are carried on our balance sheet at fair value as ofSeptember 30, 2020 , 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. Item 3. Quantitative and Qualitative Disclosures about Market Risk We anticipate that our primary market risks will be related to the credit quality of our counterparties and project companies, market interest rates, the liquidity of our assets, commodity prices, and environmental factors. We will seek to manage these risks while, at the same time, seeking to provide an opportunity to stockholders to realize attractive returns through ownership of our common stock. Many of these risks have been magnified due to the continuing economic disruptions caused by the COVID-19 pandemic; however, while we continue to monitor the pandemic its impact on such risks remains uncertain and difficult to predict. 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 access to attractive financing. In the case of various renewable energy and other sustainable infrastructure projects, we will be exposed to - 46 - -------------------------------------------------------------------------------- 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 guarantees provided by ESCOs where payments under energy savings performance contracts are contingent upon achieving pre-determined levels of energy savings. We are 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 additional 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 risks. We utilize a risk rating system to evaluate projects that we target. We first evaluate the credit rating of the obligors involved in the project using an average of the external credit ratings for an obligor, if available, or an estimated internal rating based on a third-party credit scoring system. We then estimate the probability of default and estimated recovery rate based on the obligors' credit ratings and the terms of the contract. We also review the performance of each investment, including through, as appropriate, a review of project performance, monthly payment activity and active compliance monitoring, regular communications with project management and, as applicable, its obligors, sponsors and owners, monitoring the financial performance of the collateral, periodic property visits and monitoring cash management and reserve accounts. The results of our reviews are used to update the project's risk rating as necessary. Additional detail of the credit risks surrounding our Portfolio can be found in Note 6 to our financial statements in this Form 10-Q. Interest Rate and Borrowing Risks 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. Because short-term borrowings are generally short-term commitments of capital, lenders may respond to market conditions, making it more difficult for us to secure continued financing. If we are not able to renew our then existing borrowings or arrange for new financing on terms acceptable to us, or if we default on our covenants or are otherwise unable to access funds under any of these borrowings, we may have to curtail our origination of new assets and/or dispose of assets. We face particular risk in this regard given that we expect many of our borrowings will have a shorter duration than the assets they finance. Increasing interest rates may reduce the demand for our investments while declining interest rates may increase the demand. Both our current and future credit facilities and other borrowings may be of limited duration and are periodically refinanced at then current market rates. We attempt to reduce interest rate risks and to minimize exposure to interest rate fluctuations through the use of fixed rate financing structures, when appropriate, whereby we seek to (1) match the maturities of our debt obligations with the maturities of our assets, (2) borrow at fixed rates for a period of time, or (3) match the interest rates on our assets with like-kind debt (i.e., we may finance floating rate assets with floating rate debt and fixed-rate assets with fixed-rate debt), directly or through the use of interest rate swap agreements, interest rate cap agreements or other financial instruments, or through a combination of these strategies. We expect these instruments will allow us to minimize, but not eliminate, the risk that we must refinance our liabilities before the maturities of our assets and to reduce the impact of changing interest rates on our earnings. In addition to the use of traditional derivative instruments, we also seek to mitigate interest rate risk by using securitizations, syndications and other techniques to construct a portfolio with a staggered maturity profile. We monitor the impact of interest rate changes on the market for new originations and often have the flexibility to negotiate the term of our investments to offset interest rate increases. Typically, our long-term debt is at fixed rates or we have used interest rate hedges that convert most of the floating rate debt to fixed rate. If interest rates rise, and our fixed rate debt balance remains constant, we expect the fair value of our fixed rate debt to decrease and the value of our hedges on floating rate debt to increase. See Note 3 to our financial statements in this Form 10-Q for the estimated fair value of our fixed rate long-term debt, which is based on having the same debt service requirements that could have been borrowed at the date presented, at prevailing current market interest rates. Our credit facilities are variable rate lines of credit with approximately$23 million outstanding as ofSeptember 30, 2020 . Increases in interest rates would result in higher interest expense while decreases in interest rates would result in lower interest expense. As described above, we may use various financing techniques including interest rate swap agreements, interest rate cap agreements or other financial instruments, or a combination of these strategies to mitigate the variable interest nature of these facilities. A 50 basis point increase in LIBOR would increase the quarterly interest expense related to the$23 million in variable rate borrowings by$28 thousand . Such hypothetical impact of interest rates on our variable rate borrowings does not consider the effect of any change in overall economic activity that could occur in a rising interest rate environment. Further, in - 47 - -------------------------------------------------------------------------------- the event of such a change in interest rates, we may take actions to further mitigate our exposure to such a change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the analysis assumes no changes in our financial structure. We record certain of our assets at fair value in our financial statements and any changes in the discount rate would impact the value of these assets. See Note 3 to our financial statements in this Form 10-Q. Liquidity and Concentration Risk The assets that comprise our asset portfolio are not and are not expected to be publicly traded. A portion of these assets may be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly-traded securities. The illiquidity of our assets may make it difficult for us to sell such assets if the need or desire arises, including in response to changes in economic and other conditions. Certain of the projects in which we invest have one obligor and thus we are subject to concentration risk for these investments and could incur significant losses if any of these projects perform poorly or if we are required to write down the value of any of these projects. Many of our assets, or the collateral supporting those assets, are concentrated in certain geographic areas, which may make those assets or the related collateral more susceptible to natural disasters or other regional events. See also "Credit Risks" discussed above. Commodity Price Risk When we make equity or debt investments for a renewable energy project that acts as a substitute for an underlying commodity, we may be exposed to volatility in prices for that commodity. 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 GC projects as opposed to BTM 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. Although we generally focus on renewable energy projects that have the majority of their operating cash flow supported by long-term PPAs or leases, many of our projects have shorter term contracts (which may have the potential of producing higher current returns) or sell their power in the open market on a merchant basis, the cash flows of such projects, and thus the repayment of, or the returns available for, our assets, are subject to risk if energy prices change. We also attempt to mitigate our exposure through structural protections. These structural protections, which are typically in the form of a preferred return mechanism, are designed to allow recovery of our capital and an acceptable return over time. When structuring and underwriting these transactions, we evaluate these transactions using a variety of scenarios, including natural gas prices remaining low for an extended period of time. Despite these protections, as low natural gas prices continue or PPAs expire, the cash flows from certain of our projects are exposed to these market conditions and we work with the projects sponsors to minimize any impact as part of our on-going active asset management and portfolio monitoring. In the case of utility scale solar projects, we focus on owning the land under the project where our rent is paid out of project operational costs before the debt or equity in the project receives any payments. We believe the current low prices in natural gas will increase demand for some types of our projects, such as combined heat and power, but may reduce the demand for other projects such as renewable energy that may be a substitute for natural gas. We seek to structure our energy efficiency investments so that we typically avoid exposure to commodity price risk. However, volatility in energy prices may cause building owners and other parties to be reluctant to commit to projects for which repayment is based upon a fixed monetary value for energy savings that would not decline if the price of energy declines. Environmental Risks Our business is impacted by the effects of climate change and various related regulatory responses. We discuss the risks and opportunities associated with the impacts of climate change in our Form 10-K Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Impact of climate change on our future operations. This discussion outlines potential qualitative impacts to our business, quantitative illustrations of sensitivity as well as our strategy and resilience to these risks and opportunities. Risk Management Our ongoing active asset management and portfolio monitoring processes provide investment oversight and valuable insight into our origination, underwriting and structuring processes. These processes create value through active monitoring of the state of our markets, enforcement of existing contracts and asset management. As described above, we engage in a variety of interest rate management techniques that seek to mitigate the economic effect of interest rate changes on the values of, and returns on, some of our assets. While we have either written off or specifically identified only two transactions amounting to approximately$19 million (net of recoveries) on the approximately$8 billion of transactions we originated since 2012, which represents an aggregate loss of approximately 0.2% on cumulative transactions originated over this time period, there can be no - 48 -
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assurance that we will continue to be as successful, particularly as we invest in more credit sensitive assets or more equity investments and engage in increasing numbers of transactions with obligors other thanU.S. federal government agencies. We seek to manage credit risk using thorough due diligence and underwriting processes, strong structural protections in our loan agreements with customers and continual, active asset management and portfolio monitoring. Additionally, we have established aFinance and Risk Committee of our board of directors which discusses and reviews policies and guidelines with respect to our risk assessment and risk management for various risks, including, but not limited to, our interest rate, counter party, credit, capital availability, and refinancing risks. As it relates to environmental risks, when we underwrite and structure our investments the environmental risks and opportunities are an integral consideration to our investment parameters. While we cannot fully protect our investments, we seek to mitigate these risks by using third-party experts to conduct engineering and weather analysis and insurance reviews as appropriate. Once a transaction has closed we continue to monitor the environmental risks to the portfolio. We further discuss our strategy to managing these risks in our Form 10-K, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Impact of climate change on our future operations. Item 4. Controls and Procedures The Company's Chief Executive Officer and Chief Financial Officer, based on their evaluation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that as ofSeptember 30, 2020 , the Company's disclosure controls and procedures were effective to give reasonable assurances to the timely collection, evaluation and disclosure of information relating to the Company that would potentially be subject to disclosure under the Exchange Act and the rules and regulations promulgated thereunder. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in our periodic reports. Changes in Internal Controls over Financial Reporting There have been no changes in the Company's "internal control over financial reporting" (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the three-month period endedSeptember 30, 2020 , that have materially affected, or was reasonably likely to materially affect, the Company's internal control over financial reporting.
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