S-11 1 d433652ds11.htm FORM S-11 Form S-11
Table of Contents

As filed with the Securities and Exchange Commission on February 15, 2013

Registration Statement No.            

 

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-11

 

 

FOR REGISTRATION

UNDER

THE SECURITIES ACT OF 1933

OF CERTAIN REAL ESTATE COMPANIES

 

 

Hannon Armstrong Sustainable Infrastructure Capital, Inc.

(Exact name of registrant as specified in its governing instruments)

 

 

Hannon Armstrong Sustainable Infrastructure Capital, Inc.

1906 Towne Centre Blvd

Suite 370

Annapolis, MD 21401

(410) 571-9860

(Address, including Zip Code, and Telephone Number, including Area Code, of Registrant’s Principal Executive Offices)

Steven Chuslo, Esq.

Executive Vice President, General Counsel

Hannon Armstrong Sustainable Infrastructure Capital, Inc.

1906 Towne Centre Blvd

Suite 370

Annapolis, MD 21401

(410) 571-6161

(Name, Address, including Zip Code, and Telephone Number, including Area Code, of Agent for Service)

Copies to:

 

Jay L. Bernstein, Esq.

Andrew S. Epstein, Esq.

Clifford Chance US LLP

31 West 52nd Street

New York, New York 10019

Tel (212) 878-8000

Fax (212) 878-8375

 

Paul D. Tropp, Esq.

Fried, Frank, Harris, Shriver & Jacobson LLP

One New York Plaza

New York, New York 10004

Tel (212) 859-8000

Fax (212) 859-4000

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

If any of the Securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box:  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ¨   Accelerated filer ¨    Non-accelerated filer x   Smaller reporting company ¨

(Do not check if a smaller reporting company)

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of Securities to be Registered   Proposed Maximum
Aggregate Offering
Price(1)(2)
  Amount of
Registration Fee(1)

Common Stock, $0.01 par value per share

  $100,000,000   $13,640

 

 

 

(1) Estimated solely for purposes of calculating the registration fee in accordance with Rule 457(o) under the Securities Act of 1933, as amended.
(2) Includes the offering price of common stock that may be purchased by the underwriters upon the exercise of their option to purchase additional shares.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. We may not sell these shares until the registration statement filed with the Securities and Exchange Commission becomes effective. This prospectus is not an offer to sell these shares and it is not soliciting an offer to buy these shares in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion

Preliminary Prospectus, dated February 15, 2013

PROSPECTUS

             Shares

(logo)

Hannon Armstrong

Sustainable Infrastructure Capital, Inc.

Common Stock

 

 

Hannon Armstrong Sustainable Infrastructure Capital, Inc. is a specialty finance company that provides debt and equity financing for sustainable infrastructure projects that increase energy efficiency, provide cleaner energy sources, positively impact the environment or make more efficient use of natural resources.

This is our initial public offering and no public market currently exists for shares of our common stock. We are offering our shares as described in this prospectus. We expect the initial public offering price of our shares of common stock to be between $         and $         per share. We intend to apply to have our shares listed on the New York Stock Exchange under the symbol “        .”

We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act.

We intend to elect and qualify to be taxed as a real estate investment trust, or REIT, for U.S. federal income tax purposes, commencing with our taxable year ending December 31, 2013. To assist us in qualifying as a REIT, among other purposes, stockholders are generally restricted from owning more than 9.8% by value or number of shares, whichever is more restrictive, of the outstanding shares of our common or capital stock. In addition, our charter contains various restrictions on the ownership and transfer of our shares, see “Description of Capital Stock—Restrictions on Ownership and Transfer.”

Investing in shares of our common stock involves risks that are described in the “Risk Factors” section beginning on page 21 of this prospectus.

 

 

 

      

Per share

    

Total

Initial public offering price

     $      $

Underwriting discount

     $      $

Proceeds, before expenses, to us

     $      $

We have granted the underwriters the option to purchase up to              additional shares of our common stock from us at the initial public offering price, less the underwriting discount, within 30 days after the date of this prospectus.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these shares or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The shares sold in this offering will be ready for delivery on or about                     , 2013.

 

 

Joint Book Running Managers

 

BofA Merrill Lynch   UBS Investment Bank   Wells Fargo Securities

 

 

The date of this prospectus is                     , 2013


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TABLE OF CONTENTS

 

     Page  

Market and Industry Data and Forecasts

     ii   

Prospectus Summary

     1   

Risk Factors

     21   

Forward-Looking Statements

     53   

Use of Proceeds

     55   

Distribution Policy

     56   

Capitalization

     57   

Dilution

     58   

Selected Pro Forma and Historical Financial and Operating Data

     60   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     62   

Business

     88   

Our Management

     117   

Principal Stockholders

     131   

The Structure and Formation of Our Company

     133   

Certain Relationships and Related Transactions

     136   

Description of Capital Stock

     139   

Shares Eligible for Future Sale

     145   

Certain Provisions of the Maryland General Corporation Law and Our Charter and Bylaws

     147   

Hannon Armstrong Sustainable Infrastructure, L.P. Partnership Agreement

     153   

U.S. Federal Income Tax Considerations

     156   

ERISA Considerations

     183   

Underwriting

     184   

Legal Matters

     190   

Experts

     191   

Where You Can Find More Information

     192   

Index to Financial Statements

     F-1   

You should rely only on the information contained in this prospectus, any free writing prospectus prepared by us or information to which we have referred you. We have not, and the underwriters have not, authorized anyone to provide you with additional information or information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of shares of our common stock.

 

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MARKET AND INDUSTRY DATA AND FORECASTS

Certain market and industry data included in this prospectus has been obtained from third party sources that we believe to be reliable. Market estimates are calculated by using independent industry publications, government publications and third party forecasts in conjunction with our assumptions about our markets. We have not independently verified such third party information. While we are not aware of any misstatements regarding any market, industry or similar data presented herein, such data involves risks and uncertainties and is subject to change based on various factors, including those discussed under the headings “Forward-Looking Statements” and “Risk Factors” in this prospectus.

 

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PROSPECTUS SUMMARY

This summary highlights some of the information in this prospectus. It does not contain all of the information that you should consider before investing in shares of our common stock. You should read carefully the more detailed information set forth under “Risk Factors” and the other information included in this prospectus. Except where the context suggests otherwise, the information in this prospectus assumes the completion of our formation transactions described in this prospectus and set forth under “The Structure and Formation of Our Company.” Except where the context suggests otherwise, the terms “company,” “we,” “us” and “our” refer to (1) Hannon Armstrong Capital, LLC and its consolidated subsidiaries or “Hannon Armstrong,” the company through which we currently operate our business and which will become our subsidiary upon the completion of the formation transactions, and (2) Hannon Armstrong Sustainable Infrastructure Capital, Inc., a Maryland corporation that was recently formed to allow Hannon Armstrong to continue its business as a REIT following this offering, together with its consolidated subsidiaries, including Hannon Armstrong Sustainable Infrastructure, L.P., a Delaware limited partnership, which we refer to as “our operating partnership.”

Overview

We are a specialty finance company that provides debt and equity financing for sustainable infrastructure projects. We focus on profitable sustainable infrastructure projects that increase energy efficiency, provide cleaner energy sources, positively impact the environment or make more efficient use of natural resources. We began our business more than 30 years ago, and since 2000, using our direct origination platform, we have provided or arranged over $3.9 billion of financing in more than 450 sustainable infrastructure transactions. Over this period, we have become the leading provider of financing for energy efficiency projects for the U.S. federal government, the largest property owner and energy user in the United States. Upon completion of this offering, we plan to change our organizational structure by contributing Hannon Armstrong Capital, LLC to Hannon Armstrong Sustainable Infrastructure Capital, Inc., a Maryland corporation organized on November 7, 2012, in order to allow us to continue our business as a REIT. Our strategy in converting to a REIT and in undertaking this offering is to expand our proven ability to serve the rapidly growing sustainable infrastructure market by increasing our capital resources, enhancing our financial structuring flexibility, expanding the types of projects and end-customers we pursue, and selectively retaining a larger portion of the economics in the financings we originate, while delivering attractive risk-adjusted returns to our stockholders.

Our management team has extensive industry knowledge and long-standing relationships with leading originators, institutional investors and other intermediaries in the markets we target. We originate many of our investment opportunities through our relationships with global industrial companies that develop and install sustainable infrastructure projects, such as Chevron, Honeywell International, Ingersoll-Rand, Johnson Controls, Schneider Electric, Siemens and United Technologies as well as a number of U.S. utility companies. We have traditionally financed our business by accessing the securitization market, primarily utilizing our relationships with insurance companies and commercial banks. We also have strong relationships with a variety of key intermediaries such as investment banks, private equity and infrastructure funds, other institutional investors and industry service providers, which complement our origination and financing activities.

We provide and arrange debt and equity financing primarily for three types of sustainable infrastructure projects:

 

   

Energy Efficiency Projects: projects, typically undertaken by energy services companies, or ESCOs, which reduce a building’s or facility’s energy usage or cost through the design and installation of improvements to various building components, including heating, ventilation and air conditioning systems, or HVAC systems, lighting, energy controls, roofs, windows and/or building shells;

 

 

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Clean Energy Projects: projects that deploy cleaner energy sources, such as solar, wind, geothermal and biomass as well as natural gas; and

 

   

Other Sustainable Infrastructure Projects: projects, such as water or communications infrastructure, that reduce energy consumption, positively impact the environment or make more efficient use of natural resources.

A number of macro-economic and geopolitical trends and other factors are increasing the demand for the sustainable infrastructure projects we finance. We also believe that the potential for rising or increasingly volatile commodity prices such as during inflationary periods will further spur investment in our industry and drive our growth. According to a November 2011 report from McKinsey & Co., or McKinsey, entitled Resource Revolution: Meeting the World’s Energy, Materials, Food And Water Needs, or McKinsey’s 2011 report, the estimated average annual capital investment needed (using constant 2010 dollars) to meet rising energy and water usage will grow from approximately $1.3 trillion in 2010 to approximately $2.0 to $2.2 trillion in 2030. This report also identified real property energy efficiency improvements as presenting the single highest resource productivity gain potential over the period from 2010 to 2030 of the more than 130 opportunities studied.

We are highly selective in the projects we target. Our goal is to select projects that generate recurring and predictable cash flows or cost savings that will be more than adequate to repay the debt financing we provide or will deliver attractive returns on our equity investments. Our projects are typically characterized by revenues from contractually committed obligations of government entities or private high credit quality obligors and are often supported by additional forms of credit enhancement, including security interests and supplier guaranties. Our projects also generally employ proven technologies which minimize performance uncertainty, enabling us to more accurately predict project revenue and profitability over the term of the financing or investment. As a result of our highly selective approach to project targeting, the credit performance of our originated assets has been excellent. Since 2000, there has been only one incidence of realized loss, amounting to approximately $7.0 million (net of recoveries) on the more than $3.9 billion of transactions we originated during that time. This transaction, in an asset class in which we no longer participate, represents an aggregate loss of less than 0.2% on cumulative transactions originated over this time period.

We have traditionally financed our business primarily through the use of securitizations, including the Hannon Armstrong Multi-Asset Infrastructure Trust, or Hannie Mae. In these transactions, we transfer the loans or other assets we originate to securitization trusts or other bankruptcy remote special purpose funding vehicles. Large institutional investors, primarily insurance companies and commercial banks, have historically provided the financing needed for a project by purchasing the notes issued by the trust or vehicle. The securitization market for the assets we finance has remained active throughout the financial crisis due to investor demand for high credit quality, long-term investments.

As of December 31, 2012, approximately $1.6 billion of the outstanding financings we own or manage for sustainable infrastructure projects were held on our balance sheet or in securitization trusts. We refer to this entire $1.6 billion outstanding portfolio (including any residual interests we retain) as our managed assets. In most cases, we treat the transfer of loans or other assets to non-consolidated securitization trusts as sales for accounting purposes and recognize gain or loss based on the transfer pricing of the contributed assets. We fund such transactions with securitized debt whereby we seek to match the maturities of the debt obligations with the maturities of the assets. We normally retain residual economic stakes in the transferred assets and continue to manage and service these assets in exchange for fees and other payments. In some cases, we structure our transactions as financings for accounting purposes and continue to carry the assets and the corresponding liabilities on our balance sheet in special purpose funding vehicles. We also generate fee income for arranging financings that are held directly on the balance sheet of other investors or by providing broker/dealer or other services to project developers.

 

 

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We are undertaking this offering to expand our proven ability to serve the rapidly growing sustainable infrastructure market. We plan to deploy approximately $         of the net proceeds from this offering to retire notes collateralized by certain of our projects in order to allow us to retain a larger portion of the economics of these projects. We will also utilize the net proceeds from this offering and our permanent equity capital base to continue to broaden the types of projects we undertake and enhance our financial structuring flexibility, while retaining a larger share of the economics for future projects we finance. We plan to extend our market leading position of financing energy efficiency and clean energy projects for U.S. federal government agencies to include projects undertaken by state and local governments, universities, schools and hospitals, which we refer to as state and local markets, as well as privately owned commercial projects. Additionally, we plan to expand the range and type of equity and debt financings we provide to clean energy and other sustainable infrastructure projects. We believe our strategy will allow us to target attractive opportunities while maintaining our asset quality and risk management parameters.

We are organized as a Maryland corporation and intend to elect, and operate our business so as to qualify, to be taxed as a REIT for U.S. federal income tax purposes, commencing with our taxable year ending December 31, 2013. We generally will not be subject to U.S. federal income taxes on our taxable income to the extent that we annually distribute all of our taxable income to stockholders and maintain our intended qualification as a REIT. We intend to operate our business through, and serve as the sole general partner of, our operating partnership subsidiary, Hannon Armstrong Sustainable Infrastructure, L.P. We also intend to operate our business in a manner that will permit us to maintain our exemption from registration as an investment company under the Investment Company Act of 1940, as amended, or the 1940 Act.

Market Opportunities

We believe the market for the financings we provide is in the midst of a prolonged expansion, driven by several macro-economic and geopolitical trends, including:

 

   

global population growth and concerns about its impact on natural resources;

 

   

higher commodity prices arising from increasing global per capita consumption and the ongoing depletion of conventional natural resources;

 

   

national security risks associated with energy procurement that threaten energy supply and increase the potential for price volatility;

 

   

governmental policies that seek to protect the environment and support job creation;

 

   

fiscal challenges and budgetary constraints facing U.S. federal, state and local governments; and

 

   

changes in global banking regulations which increase banks’ capital requirements for financing long-lived projects thus reducing the amount of available bank financing for such projects.

We believe that the rising demand for capital to address these and other sustainable infrastructure trends will help to fuel our growth and positively impact our business.

The following is a brief description of the customers we target within the markets we serve.

U.S. Federal Government

The U.S. federal government, which is the largest property owner and energy user in the United States, is actively involved in numerous sustainable infrastructure projects. Our U.S. federal government energy

 

 

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efficiency financings (which are not subject to the normal government budgeting process) provide capital to enhance the energy efficiency of U.S. federal government buildings and installations. Examples of projects we finance include ESCOs installing or replacing various building components, including HVAC systems, lighting, energy controls, roofs, windows and/or building shells. A 2011 Department of Energy analysis entitled “Covered Facility Evaluation Progress (Government-wide)” identified more than $8.0 billion of energy conservation measures that could be implemented at existing U.S. federal buildings. The U.S. federal government is also increasingly evaluating clean energy projects, including those that may result from the U.S. Army Corps of Engineers July 2012 Request for Proposals to procure up to $7 billion of clean or alternative energy generation over the next ten years.

State and Local Markets

While historically we have focused our energy efficiency financing efforts on the U.S. federal government, we believe that the state and local markets represent a much larger portion of the ESCOs’ overall market. Pike Research in its publication entitled The U.S. Energy Service Company Market has estimated that the state and local markets account for more than 70% of the estimated 2011 revenue of ESCOs. Many institutions in state and local markets are focused on reducing costs in part by increasing energy efficiency while preserving overall financing capacity. As a result, and due, in part, to legislative initiatives and incentives, many of the institutions are considering the implementation of sustainable infrastructure solutions. Governments at the state and local levels also operate a large portion of the clean water production facilities and other infrastructure, such as street lighting, that face significant rebuilding challenges over the next decade, creating additional opportunities for the financing solutions we provide. We believe that the financing solutions we have developed for state and local markets will be attractive to our traditional ESCO relationships which should enable us to effectively capture state and local market opportunities and generate further growth.

Private Sector Owners and Developers

Private entities are increasingly investing in sustainable infrastructure projects such as energy efficiency and clean energy projects to lower costs, generate new sources of revenue, meet regulatory requirements or increase the value of their assets. According to a 2009 McKinsey report, commercial buildings with improved energy efficiency have an estimated 6% higher effective rent and a 16% premium in valuation over similar non-energy efficient buildings. In response to state level renewable portfolio standards, which specify the portion of the power utilized by local utilities that must be derived from clean energy sources such as renewable energy, developers have entered into long-term power purchase agreements with utilities for various clean energy projects. We believe that we are well positioned to finance this market based upon our relationships with the ESCOs and other leading global industrial companies which will supply equipment and services to these projects. We also believe our relationships and proven project development history provide us with the credibility that will make us an attractive financing partner for the developers and investors of these projects.

Our Competitive Strengths

We believe our direct origination platform, coupled with the knowledge and strength of the relationships of our management team, position us to capitalize on future opportunities in an expanding and underserved market.

Market Leading, Highly Scalable Platform with a Long Operating History

We have a well-established, market leading and highly scalable platform with over 30 years of history and a combination of an experienced team, strong relationships, deep industry knowledge and an industry leading position in financing U.S. federal government energy efficiency and clean energy projects. Attaining attractive returns from the assets we target requires direct origination capabilities, sound investment decision-making, efficient transaction processes and prudent asset management. Our platform allows us to source and identify high

 

 

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quality financing opportunities within our broad areas of expertise, apply our rigorous underwriting processes to our assets, develop innovative structuring and financing solutions and access highly attractive funding from our long-standing relationships.

Strong Direct Transaction Sourcing and Financing Relationships

Our management team has extensive industry knowledge and long-standing relationships with leading originators, institutional investors and other intermediaries in the markets we target. Many of our originations have been sourced through relationships with global industrial companies that develop and install sustainable infrastructure projects, such as Chevron, Honeywell International, Ingersoll-Rand, Johnson Controls, Schneider Electric, Siemens and United Technologies as well as a number of U.S. utility companies. These companies are active in multiple segments of our target markets and we believe the strength of our relationships with them will allow us to expand our offerings to cover a broader range of their projects such as state and local markets projects, commercial energy efficiency projects, clean energy projects and other sustainable infrastructure projects.

Our relationships with our financing sources, such as insurance companies and commercial banks, provide us with market intelligence, best practices and co-investment opportunities. We also have strong relationships with a variety of key intermediaries such as investment banks, private equity and infrastructure funds, other institutional investors and industry service providers, which complement our origination and financing activities. Our registered broker-dealer subsidiary that provides advisory services and arranges financing for various project developers on a fee basis also exposes us to new market opportunities and relationships.

Experienced and Fully Dedicated Management Team

Our industry leading senior management and origination teams average over 20 years of industry experience and our senior management team has worked, on average, approximately 10 years at Hannon Armstrong. Our chief executive officer, Jeffrey Eckel, whose career spans more than 30 years in various energy-related businesses, including 17 years at Hannon Armstrong, has served as president of an independent power producer and an ESCO. In addition, members of our management team have had executive responsibility for developing alternative and conventional power plants. We believe our highly experienced management team is well-positioned to capitalize on the opportunities in the markets we target and to grow our business.

We are structured as a fully-integrated, self-administered and self-managed finance company in which members of our management team serve as our full-time executive officers. We do not employ an external advisor to manage our affairs and do not compete with other entities separately sponsored by our management team for assets or for financing. Upon completion of this offering and the formation transactions, our directors, executive officers and other employees will collectively own approximately     % of our common stock outstanding, giving them a significant stake in our growth and continuing success.

Highly Differentiated Finance Company

Our business model is highly differentiated from that of other lenders in terms of the assets we finance and the type of financing solutions we provide. We believe the specific underwriting and structuring knowledge, as well as the origination and financing relationships required to compete in this market sector, represent a significant barrier to entry for most traditional lenders. The market for opportunities in sustainable infrastructure projects is underserved by traditional commercial banks and other financing sources. Financing sustainable infrastructure projects requires a sound understanding of a range of industrial technologies, the economics of energy costs and savings and the impact of various federal, state and local governmental policies. The cash flows

 

 

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from the assets we finance come from diverse sources, including actual energy savings and long-term power purchase agreements. The structuring of each of our financings is tailored to the specific project, affording us the flexibility to provide the appropriate amount and mix of debt and equity financing.

We expect that our differentiated business model will enable us to maintain a portfolio of debt assets with obligors of high credit quality that generate recurring and predictable cash flows and to opportunistically make equity investments that provide current cash flow with potential upside.

High Credit Quality of Obligors and Assets

We believe, given our focus on the higher end of the credit spectrum, the strength of our underwriting process and the quality of our origination team, that the credit performance of our originated assets has been excellent. Since 2000, there has been only one incidence of realized loss, amounting to approximately $7.0 million (net of recoveries) on the more than $3.9 billion of transactions we originated during that time. This transaction, in an asset class in which we no longer participate, represents an aggregate loss of less than 0.2% on cumulative transactions originated over this time period. We expect our strong credit underwriting process to support the growth of our business as we retain a larger portion of the economics in certain of the financings we originate and seek to expand the obligors we work with, the types of projects we undertake and the structure of the financings we provide.

Our Assets

As of December 31, 2012, our managed assets totaled more than $1.6 billion in more than 225 sustainable infrastructure transactions, all of which we originated. Approximately 58% of this portfolio was financings for energy efficiency projects, approximately 33% was financings for clean energy projects such as solar, biomass or other renewable resources as well as combined heat and power, while the remaining 9% of this portfolio was financings for other sustainable infrastructure projects such as water or communication projects. As of December 31, 2012, our managed portfolio consisted of fixed rate amortizing loans or direct financing leases with approximately 99% of the portfolio consisting of U.S. federal government obligations. The following chart sets forth our managed portfolio by project type as of December 31, 2012.

LOGO

Total Managed Assets: $1.6 billion

As part of our expansion strategy, we plan to deploy approximately $         of the net proceeds from this offering to retire notes collateralized by certain of our projects in order to allow us to retain a larger portion of the

 

 

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economics of these projects. As of December 31, 2012, the projects consisted of              energy efficiency projects with estimated fair market value of approximately $         million and             projects that involve both clean energy and energy efficiency with an estimated fair market value of approximately $         million. The U.S. federal government is the primary credit obligor on these              projects. As of December 31, 2012, these notes consisted of fixed rate amortizing loans with weighted average unlevered yield-to-maturity of     % and a weighted average remaining life of      years. For additional information regarding the calculation of weighted average yield-to-maturity and weighted average remaining life, see “Business—Our Assets.” We expect to make additional financings consistent with our investment strategy with the balance of the net proceeds of this offering. See “Use of Proceeds.”

Our Investment Strategy

We provide financing to a large and diverse market of sustainable infrastructure projects. We are highly selective in the projects we target. Our goal is to select projects that generate recurring and predictable cash flows or cost savings that will be more than adequate to repay the debt financing we provide or will deliver attractive returns on our equity investments. Our projects are typically characterized by revenues from contractually committed obligations of government entities or private high credit quality obligors and are often supported by additional forms of credit enhancement, including security interests and supplier guaranties. Our projects also generally employ proven technologies which minimize performance uncertainty, enabling us to more accurately predict project revenue and profitability over the term of the financing or investment.

We provide and arrange debt and equity financing for energy efficiency projects, which reduce their energy usage or cost of energy use. We often work with ESCOs, which design and install improvements to various building components, including HVAC systems, lighting, energy controls, roofs, windows and/or building shells. We are assigned the payment stream and other contractual rights often using our pre-existing master purchase agreements with the ESCOs. Our financing is generally also secured by the installed improvements. The following chart illustrates a typical commercial arrangement in relation to energy efficiency financings with ESCOs and property owner obligors:

Energy Efficiency Financing Arrangement

 

LOGO

 

 

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We provide debt and equity financing for projects that deploy cleaner energy sources, such as solar, wind, geothermal and biomass as well as natural gas. We focus on financing clean energy projects which use proven technology and that have contractually committed agreements with high credit quality utilities or large electricity users to enter into power purchase agreements under which the utility or user purchases the power produced by the project at a minimum price with potential price escalators. These projects are building or facility specific and may be combined with other energy efficiency projects or are standalone projects designed to sell power to electric utilities or large users. Developers, including many of the ESCOs, acquire a specific site and the applicable permits and negotiate the construction and maintenance contracts and the power purchase agreement. The following chart illustrates our typical commercial arrangement in our financings for clean energy projects:

Clean Energy Financing Arrangement

 

LOGO

We provide debt and equity financing for other sustainable infrastructure projects such as water or communications infrastructure that reduce energy consumption, positively impact the environment or make more efficient use of natural resources. We intend to invest in other sustainable infrastructure projects that provide an essential public service or benefit to society, that have a strategic competitive advantage, demonstrate inelastic demand characteristics or have contractually committed revenues and have a low sensitivity to cyclical volatility. We primarily target developers and infrastructure funds that have completed projects with long-term contractually committed revenues in place but which require additional financing to achieve targeted returns.

We will seek to manage the diversity of our portfolio of financings by, among other factors, project type, type of financing, commitment size, geography, obligor and maturity. In addition, we will seek to manage the diversity of the underlying properties by, among other factors, technology type and manufacturer. Our target mix of projects which we hold on our balance sheet is expected over time to range from approximately 30% to 50% energy efficiency projects, 25% to 45% clean energy projects and 20% to 30% other sustainable infrastructure projects. Our target mix of assets held on our balance sheet is expected over time to range from 85% to 95% debt financings and 5% to 15% equity financings. We will not invest more than 15% of our assets in any individual project without the consent of a majority of our independent directors. We will 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 to maintain our REIT qualification and our exemption from registration under the 1940 Act.

 

 

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We believe that our long history of financing sustainable infrastructure projects, the experience, expertise and relationships of our management team, the anticipated credit strength of the obligors of our financings and the size and growth potential of our market, position us well to capitalize on our strategy and provide attractive risk-adjusted returns to our stockholders over the long term, through both distributions and capital appreciation.

Our Financing Strategy

We expect to use leverage to increase potential returns to our stockholders. We have traditionally financed our business primarily through the use of securitizations, such as Hannie Mae, or other special purpose funding vehicles. Large institutional investors, primarily insurance companies and commercial banks, have historically provided the financing needed for a project by purchasing the notes issued by the funding vehicle. As of December 31, 2012, the outstanding principal balance of our managed assets financed through the use of securitizations was $1.4 billion and the outstanding principal balance held on our balance sheet and financed by nonrecourse debt was approximately $200 million. We expect we will continue to use securitizations or other special purpose funding vehicles to finance our business and continue to maintain and potentially expand our relationships with various securitization investors. We also believe we will be able to customize securitized tranches to meet the investment preferences of these investors.

Going forward, we plan to selectively retain a larger portion of the economics in the financings we originate on our balance sheet and broaden our financing sources to include other fixed and floating rate borrowings in the form of bank credit facilities (including term loans and revolving facilities), warehouse facilities, repurchase agreements and public and private equity and debt issuances, in addition to transaction or asset specific funding and match-funded arrangements. The decision on how we finance specific assets or groups of assets will largely be driven by capital allocations and portfolio management considerations, as well as prevailing credit spreads and the terms of available financing and market conditions. We have ongoing discussions with a number of financial institutions regarding warehouse or other bank credit facilities. Over time, as market conditions change, we may use other forms of leverage in addition to these financings arrangements.

Although we are not restricted by any regulatory requirements to maintain our leverage ratio at or below any particular level, the amount of leverage we may employ 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 and financing counterparties. Historically, we have financed our transactions with U.S. federal government obligors with more than 95% debt. We anticipate reducing our overall leverage on both individual assets classes and our entire portfolio for which we have the primary economic exposure. We expect that we will generally target up to two times leverage on our overall portfolio, with individual allocations of leverage based on the mix of asset types and obligors. For example, we may deploy higher leverage on debt-financings made to U.S. federal and other high quality government obligors and lower leverage on other types of assets and obligors. We believe our target leverage ratios will be significantly lower than our historical leverage. 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. To the extent that our board of directors approves a material change to our leverage policy, we anticipate advising our stockholders of this change through disclosure in our periodic reports and other filings under the Securities Exchange Act of 1934, as amended, or the Exchange Act.

 

 

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Risk Management

Our ongoing 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 real-time receivables management. See “Business—Investment Process.” Subject to maintaining our qualification as a REIT, we will 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 there has been only one incidence of realized loss, amounting to approximately $7.0 million (net of recoveries) on the more than $3.9 billion of transactions we originated since 2000, which represents an aggregate loss of less than 0.2% on cumulative transactions originated over this time period, there can be no assurance that we will continue to be as successful, particularly as we invest in more credit sensitive assets or more equity positions. 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.

 

 

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Summary Risk Factors

An investment in shares of our common stock involves various risks. You should consider carefully the risks discussed below and under “Risk Factors” before purchasing shares of our common stock. If any of the following risks or risks discussed under “Risk Factors” occurs, our business, financial condition or results of operations could be materially and adversely affected. In that case, the trading price of our shares of common stock could decline, and you may lose some or all of your investment.

 

   

Our business depends in part on U.S. federal, state and local government policies and a decline in the level of government support could harm our business.

 

   

A change in the fiscal health, level of appropriations or budgets of U.S. federal, state and local governments could reduce demand for the projects we finance and the financing we provide.

 

   

If the cost of energy generated by traditional sources of energy declines, demand for the projects we finance may decline.

 

   

We operate in a competitive market and future competition may impact the terms of the financing we offer.

 

   

The lack of liquidity of our assets may adversely affect our business, including our ability to value and sell our assets.

 

   

The debt financings we provide are subject to delinquency, foreclosure and loss, any or all of which could result in losses to us.

 

   

Our equity investments, many of which are illiquid with no readily available market, involve a substantial degree of risk.

 

   

Some of our projects may require substantial operating or capital expenditures in the future.

 

   

The projects we finance rely on third parties to manufacture quality products or provide reliable services in a timely manner and the failure of these third parties could cause project performance to be adversely affected.

 

   

We may change our operational policies (including our investment guidelines, strategies and policies) with the approval of our board of directors but without stockholder consent at any time, which may adversely affect the market value of our common stock and our ability to make distributions to our stockholders.

 

   

We expect to use leverage as part of our investment strategy but do not have a formal policy limiting the amount of debt we may incur. Our board of directors may change our leverage policy without stockholder consent.

 

   

An increase in our borrowing costs relative to the interest we receive on our leveraged assets may adversely affect our profitability and our cash available for distribution to our stockholders.

 

   

We have entered and may in the future enter into hedging transactions that could expose us to contingent liabilities in the future and adversely impact our financial condition.

 

   

We have limited experience hedging the interest rate risk of our assets and such hedging may adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.

 

   

We cannot assure you of our ability to make distributions in the future. Although we currently do not intend to do so, until our portfolio of assets generates sufficient income and cash flow, we could be required to sell assets, borrow funds or make a portion of our distributions in the form of a taxable stock distribution or distribution of debt securities.

 

 

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Qualifying as a REIT involves highly technical and complex provisions of the Internal Revenue Code, and our failure to qualify or remain qualified as a REIT would subject us to U.S. federal income tax and applicable state and local tax, which would reduce the amount of cash available for distribution to our stockholders.

 

   

Our management has no prior experience operating a REIT or a public company and therefore may have difficulty in successfully and profitably operating our business, or complying with regulatory requirements.

 

   

Complying with REIT requirements may force us to liquidate or forego otherwise attractive investments.

 

   

Loss of our 1940 Act exemption would adversely affect us, the market price of shares of our common stock and our ability to distribute dividends.

The Structure and Formation of Our Company

We currently conduct all of our business through Hannon Armstrong. In connection with our decision to continue our business as a REIT beginning with our taxable year ending December 31, 2013, prior to or concurrently with the closing of this offering, we will engage in a series of transactions, which we refer to as our formation transactions, that will enable us to qualify as a REIT and will result in Hannon Armstrong becoming our subsidiary. The agreements relating to our formation transactions may be subject to customary closing conditions, including the closing of this offering.

The significant elements of our formation transactions include:

 

   

the formation of our company and our operating partnership;

 

   

the distribution in December 2012 to the current owners of Hannon Armstrong of our equity interest in HA EnergySource Holdings, LLC, or HA EnergySource, which we determined would not be suitable for inclusion as part of our plan to continue our business as a REIT. Prior to and as part of the transaction, we provided a $3.4 million capital commitment to HA EnergySource to be used by HA EnergySource for general corporate purposes, future investments or dividends to HA EnergySource owners. The historical book value, as of December 31, 2012, of HA EnergySource, taking into account the $3.4 million capital commitment, was approximately $3.9 million;

 

   

the exchange by the current owners of Hannon Armstrong, by merger or equity contribution, of the equity interests in the entities that own Hannon Armstrong for shares of our common stock or units of limited partnership interest in our operating partnership, or OP units, which are structured to be economically equivalent to, and exchangeable on a one for one basis for, shares of our common stock; and

 

   

the retirement, through the application of a portion of the net proceeds of this offering, of the notes that financed identified projects in order to allow us to retain a larger portion of the economics of these projects. See “Business—Our Assets.”

 

 

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The following diagram illustrates our structure upon completion of this offering and the formation transactions:

 

LOGO

Dividend Reinvestment Plan

In the future, we may adopt a dividend reinvestment plan that will permit stockholders who elect to participate in the plan to have their cash dividends reinvested in additional shares of our common stock.

Operating and Regulatory Structure

REIT qualification

In connection with this offering, we intend to elect to qualify as a REIT under the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, commencing with our taxable year ending on December 31, 2013. We believe that we have been organized in conformity with the requirements for qualification and taxation as a REIT under the Internal Revenue Code, and that our intended manner of operation will enable us to meet the requirements for qualification and taxation as a REIT on an ongoing basis. To qualify, and maintain our qualification, as a REIT, we must meet on a continuing basis, through our organization and actual investment and operating results, various requirements under the Internal Revenue Code relating to, among other things, the sources of our gross income, the composition and values of our assets, our distribution levels and the diversity of ownership of shares of our capital stock. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate rates and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we failed to qualify as a REIT. Even if we qualify for taxation as a REIT, we may be subject to some U.S. federal, state and local taxes on our income or property. Any distributions paid by us generally will not be eligible for taxation at the preferential U.S. federal income tax rates that currently apply to certain distributions received by individuals from taxable corporations.

 

 

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1940 Act exemption

We intend to conduct our operations so that we are not required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. federal government securities and cash items) on a non-consolidated basis, which we refer to as the 40% test. Excluded from the term “investment securities,” among other things, are U.S. federal government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.

We are organized as a holding company and conduct our businesses primarily through our subsidiaries. We intend to conduct our operations so that we comply with the 40% test. The securities issued by any wholly-owned or majority-owned subsidiaries that we may form in the future that are excepted from the definition of “investment company” based on Section 3(c)(1) or 3(c)(7) of the 1940 Act, together with any other investment securities we may own, may not have a value in excess of 40% of the value of our total assets on a non-consolidated basis. We will monitor our holdings to ensure continuing and ongoing compliance with this test. In addition, we believe that we will not be considered an investment company under Section 3(a)(1)(A) of the 1940 Act because we will not engage primarily or hold our self out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, we will be primarily engaged in the non-investment company businesses of our subsidiaries.

We anticipate that one or more of our subsidiaries will qualify for an exception from registration as an investment company under the 1940 Act pursuant to Section 3(c)(5)(C) of the 1940 Act, which is available for entities which are not primarily engaged in issuing redeemable securities, face-amount certificates of the installment type or periodic payment plan certificates and which are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. This exception generally requires that at least 55% of such subsidiaries’ portfolios must be comprised of qualifying assets and at least another 80% of each of their portfolios must be comprised of qualifying assets and real estate-related assets under the 1940 Act. We intend to treat as qualifying assets for this purpose, loans secured by projects where the collateral is real property or where the fair value of the real property does not exceed the carrying value of our loan. We intend to treat as real estate-related assets, non-controlling co-investments in joint ventures that own projects whose assets are primarily real property. In general, with regard to our subsidiaries relying on Section 3(c)(5)(C), we intend to rely on other guidance published by the SEC or its staff or on our analyses of guidance published with respect to other types of assets to determine which assets are qualifying real estate assets and real estate-related assets. For our subsidiaries that do maintain this exception, our interests in these subsidiaries will not constitute “investment securities.”

We anticipate that one or more of our subsidiaries, will qualify for an exception from registration as an investment company under the 1940 Act pursuant to either Section 3(c)(5)(A) of the 1940 Act, which is available for entities which are not engaged in the business of issuing redeemable securities, face-amount certificates of the installment type or periodic payment plan certificates, and which are primarily engaged in the business of purchasing or otherwise acquiring notes, drafts, acceptances, open accounts receivable, and other obligations representing part or all of the sales price of merchandise, insurance, and services, or Section 3(c)(5)(B) of the 1940 Act, which is available for entities primarily engaged in the business of making loans to manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise, insurance, and services. These exceptions generally require that at least 55% of such subsidiaries’ portfolios must be comprised of

 

 

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qualifying assets that meet the requirements of the exception. We intend to treat energy efficiency loans where the loan proceeds are specifically provided to finance equipment, services and structural improvements to properties and other facilities and clean energy and other sustainable infrastructure projects or improvements as qualifying assets for purposes of these exceptions. In general, we also expect, with regard to our subsidiaries relying on Section 3(c)(5)(A) or (B), to rely on guidance published by the SEC or its staff or on our analyses of guidance published with respect to other types of assets to determine which assets are qualifying assets under the exceptions.

Although we intend to monitor the portfolios of our subsidiaries relying on the Section 3(c)(5)(A), (B) or (C) exceptions periodically and prior to each acquisition, there can be no assurance that such subsidiaries will be able to maintain their exceptions. To the extent that the SEC or its staff publishes new or different guidance with respect to the exceptions under Section 3(c)(5)(A), (B) or (C), we may be required to adjust our strategy accordingly. Any additional guidance from the SEC or its staff could provide additional flexibility to us, or it could further inhibit our ability to pursue the strategies we have chosen. In addition, we may be limited in our ability to make certain investments and these limitations could result in a subsidiary holding assets we might wish to sell or selling assets we might wish to hold.

We also expect that our majority-owned subsidiaries that hold controlling stakes in clean energy and other sustainable infrastructure projects will also not be relying on exceptions under Section 3(c)(1) or Section 3(c)(7). Accordingly, our interests in these subsidiaries will not constitute “investment securities.”

Because we expect that most of our other majority-owned subsidiaries will not be relying on exceptions under either Section 3(c)(1) or 3(c)(7) of the 1940 Act and because our interests in these subsidiaries will constitute a substantial majority of our assets, we expect to be able to conduct our operations so that we are not required to register as an investment company under the 1940 Act.

The determination of whether an entity is a majority-owned subsidiary of our company is made by us. The 1940 Act defines a majority-owned subsidiary of a person as a company 50% or more of the outstanding voting securities of which are owned by such person, or by another company which is a majority-owned subsidiary of such person. The 1940 Act further defines voting securities as any security presently entitling the owner or holder thereof to vote for the election of directors of a company. We treat companies in which we own at least a majority of the outstanding voting securities as majority-owned subsidiaries for purposes of the 40% test. We have not requested the SEC to approve our treatment of any company as a majority-owned subsidiary and the SEC has not done so. If the SEC were to disagree with our treatment of one or more companies as majority-owned subsidiaries, we would need to adjust our strategy and our assets in order to continue to pass the 40% test. Any such adjustment in our strategy could have a material adverse effect on us.

Qualification for exceptions from registration under the 1940 Act will limit our ability to make certain investments. For example, these restrictions will limit the ability of our subsidiaries to make loans that are not secured by real property or that do not represent part or all of the sales price of merchandise, insurance, and services.

Restrictions on Ownership and Transfer of Our Capital Stock

To assist us in complying with the limitations on the concentration of ownership of a REIT imposed by the Internal Revenue Code, among other purposes, our charter prohibits, with certain exceptions, any stockholder from beneficially or constructively owning, applying certain attribution rules under the Internal Revenue Code, more than 9.8% by value or number of shares, whichever is more restrictive, of any of the outstanding shares of our common stock, the outstanding shares of any class or series of our preferred stock, or the outstanding shares of our capital stock. Our board of directors may, in its sole discretion, subject to such conditions as it may determine and the receipt of certain representations and undertakings, waive any or all of these 9.8% ownership

 

 

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limits with respect to a particular stockholder if such ownership will not then or in the future jeopardize our qualification as a REIT. We expect that, before the completion of this offering, our board of directors will establish an exemption from this ownership limit which permits our current stockholder, MissionPoint HA Parallel Fund, L.P., or MissionPoint, and certain of its affiliates to collectively hold up to        shares of our outstanding common stock. Our charter also prohibits any person from, among other things, beneficially or constructively owning shares of our capital stock that would result in our being “closely held” under Section 856(h) of the Internal Revenue Code (without regard to whether the ownership interest is held during the last half of a taxable year), or otherwise cause us to fail to qualify as a REIT.

Our charter provides that any ownership or purported transfer of our capital stock in violation of the foregoing restrictions will result in the shares so owned or transferred being automatically transferred to a charitable trust for the benefit of a charitable beneficiary, and the purported owner or transferee acquiring no rights in such shares. If a transfer of shares of our capital stock would result in our shares of capital stock being beneficially owned by fewer than 100 persons or the transfer to a charitable trust would be ineffective for any reason to prevent a violation of the other restrictions on ownership and transfer of our capital stock, the transfer resulting in such violation will be void.

Implications of Being an Emerging Growth Company

We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and we are eligible to take advantage of certain specified reduced disclosure and other requirements that are otherwise generally applicable to public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved.

Although we have not made a determination whether to take advantage of any or all of these exemptions, we expect to remain an “emerging growth company” for up to five years, or until the earliest of (1) the last day of the first fiscal year in which our annual gross revenues exceed $1.0 billion, (2) December 31 of the fiscal year that we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the last business day of our most recently completed second fiscal quarter and we have been publicly reporting for at least 12 months or (3) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the preceding three-year period. In addition, we have irrevocably opted-out of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. As a result, we will comply with new or revised accounting standards on the same time frames as other public companies that are not “emerging growth companies.”

 

 

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The Offering

 

Common stock offered by us

             shares (plus up to an additional              shares of our common stock that we may issue and sell upon the exercise of the underwriters’ option to purchase additional shares).

 

Common stock and OP units to be outstanding after this offering

             shares and              OP units(1)

 

Use of proceeds

We estimate that we will receive net proceeds from this offering of approximately $         million, or approximately $         million if the underwriters’ option to purchase additional shares is exercised in full, after deducting the underwriting discounts and commissions, and estimated expenses of this offering. We will contribute the net proceeds of this offering to our operating partnership, which will subsequently use the net proceeds as follows:

 

   

$         million to retire the notes collateralized by              of our projects in order to allow us to retain a larger portion of the economics of these projects; and

 

   

$         million to repay our existing credit facility.

The net proceeds remaining after the uses described above, which are estimated to be $         million, or approximately $         million if the underwriters’ option to purchase additional shares is exercised in full, will be used to acquire additional assets and for general corporate and working capital purposes. See “Use of Proceeds.”

 

Dividend policy

We intend to make regular quarterly distributions to holders of our common stock. 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 pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its taxable income. Our current policy is to pay quarterly distributions, which on an annual basis will equal all or substantially all of our taxable income.

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. For more information, see “Distribution Policy.”

 

(1) 

Includes (1)              shares of common stock and              OP units which we intend to issue as part of the formation transactions as further described under “The Structure and Formation of Our Company” and (2)              shares of common stock issuable upon exchange of restricted limited partner profits interests, or LTIP units, and              shares of our restricted common stock which we intend to grant to our independent directors, officers and employees upon consummation of this offering under our equity incentive plan, as described under “Our Management—Equity Incentive Plan.” Excludes              shares of our common stock that we may issue and sell upon the full exercise of the underwriters’ option to purchase additional shares.

 

 

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  We cannot assure you that we will make any distributions to our stockholders.

 

Proposed New York Stock Exchange symbol

“    ”

 

Ownership and transfer restrictions

To assist us in complying with the limitations on the concentration of ownership of a REIT imposed by the Internal Revenue Code, among other purposes, our charter generally prohibits, among other prohibitions, any stockholder from beneficially or constructively owning more than 9.8% by value or number of shares, whichever is more restrictive, of any of the outstanding shares of our common stock, the outstanding shares of any class or series of our preferred stock or the outstanding shares of our capital stock. See “Description of Capital Stock—Restrictions on Ownership and Transfer.”

 

Risk factors

Investing in our common stock involves a high degree of risk. You should carefully read and consider the information set forth under “Risk Factors” and all other information in this prospectus before investing in our common stock.

Our Corporate Information

Our principal executive offices are located at 1906 Towne Centre Blvd, Suite 370, Annapolis, Maryland 21401. Our telephone number is (410) 571-9860. Our website is www.hannonarmstrong.com. The information on our website is not intended to form a part of or be incorporated by reference into this prospectus.

Summary Financial Data

The following table sets forth summary financial and operating data on a historical basis for Hannon Armstrong and on a pro forma basis for us giving effect to the formation transactions (including the distribution of our equity interest in HA EnergySource) and the application of the net proceeds of this offering. We have not presented historical information for our company because we have not had any corporate activity since our formation other than the issuance of shares of common stock in connection with the initial capitalization of our company and because we believe that a discussion of the results of our company would not be meaningful.

The following historical and pro forma financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical financial statements and related notes thereto and our unaudited pro forma combined consolidated financial statements included elsewhere in this prospectus. Hannon Armstrong’s fiscal year ends on September 30 of each year. Our fiscal year is expected to end on December 31 of each year, beginning with the year ended December 31, 2013. The historical combined consolidated balance sheet information as of September 30, 2012 and 2011 of Hannon Armstrong and the consolidated statements of operations information for the years ended September 30, 2012, 2011 and 2010 of Hannon Armstrong have been derived from the historical audited consolidated financial statements and related notes appearing elsewhere in this prospectus. The historical combined consolidated balance sheet information as of September 30, 2010, 2009 and 2008 of Hannon Armstrong and the consolidated statements of operations information for the years ended September 30, 2009 and 2008 of Hannon Armstrong have been derived from our historical consolidated financial statements not included in this prospectus. The historical condensed consolidated balance sheet information as of December 31, 2012, and condensed consolidated statements of operations information for the three-month periods ended December 31, 2012, and December 31, 2011 have been

 

 

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derived from the unaudited historical condensed consolidated financial statements of Hannon Armstrong, which we believe include all adjustments (consisting of normal recurring adjustments) necessary to present the information set forth therein under accounting principles generally accepted in the United States. The results of operations for the interim periods ended December 31, 2012 and December 31, 2011 are not necessarily indicative of the results to be obtained for the full fiscal year.

The summary unaudited condensed pro forma combined consolidated balance sheet data as of December 31, 2012 is presented as if this offering and our formation transactions all had occurred on December 31, 2012, and the unaudited pro forma condensed combined statement of operations and other data for the three-month period ended December 31, 2012 and the unaudited pro forma condensed combined statement of operations and other data for the year ended September 30, 2012, are presented as if this offering and our formation transactions all had occurred on October 1, 2011. The pro forma information is not necessarily indicative of what our actual financial position or results of operations would have been as of or for the period indicated, nor does it purport to represent our future financial position or results of operations.

 

 

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    Three Months Ended December 31,     Year Ended September 30,  
    Pro Forma     Historical     Pro Forma     Historical  
    2012     2012     2011     2012     2012     2011     2010     2009     2008  
    (unaudited )      (unaudited )      (unaudited )      (unaudited )           
    (In Thousands, except share and per share data)  

Net Investment Revenue:

                 

Income from financing receivables

  $                   $ 2,834      $ 3,350      $        $ 11,848      $ 11,739      $ 10,904      $ 11,435      $ 8,902   

Investment interest expense

      (2,347     (2,821       (9,852     (9,442     (9,606     (10,593     (8,595
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Investment Revenue

      487        529          1,996        2,297        1,298        842        307   

Other Investment Revenue:

                 

Gain on securitization of receivables

   

 

2,534

  

    1,940          3,912        4,025        6,322        9,990        4,108   

Fee income

      254        288          11,380        877        7,716        933        1,215   

(Loss) income from equity method investment in affiliate

      (448     (799       (1,284     (5,047     8,663        (405     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Investment Revenue

      2,340        1,429          14,008        (145     22,701        10,518        5,323   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenue, net of investment interest expense

      2,827        1,958          16,004        2,152        23,999        11,360        5,630   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
                 

Compensation and benefits

      (1,157     (1,065       (7,697     (4,028     (7,191     (4,391     (3,302

General and administrative

      (584     (626       (3,901     (2,506     (1,856     (1,875     (1,293

Depreciation and amortization of intangibles

      (105     (113       (440     (431     (685     (816     (761

Other interest expense

      (56     (83       (287     (295     (369     (489     (599

Other income

      1        14          52        61        70        67        48   

Unrealized gain (loss) on derivative Instruments

      23        29          73        35        113        (94     (91
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Expenses, net

      (1,878     (1,844       (12,200     (7,164     (9,918     (7,598     (5,998
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

  $        $ 949      $ 114      $        $ 3,804      $ (5,012   $ 14,081      $ 3,762      $ (368
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance Sheet Data (at Period End):

                 

Investments in financing receivables

    $ 191,399          $ 195,582      $ 143,776      $ 159,210      $ 159,000      $ 184,742   

Cash and marketable securities

      8,024            20,948        2,139        5,784        10,272        6,112   

Total assets

      212,786            232,463        174,594        192,226        188,037        210,707   

Nonrecourse debt

      195,952            200,283        148,177        163,889        163,766        188,045   

Credit facility

      4,170            4,599        6,895        4,336        5,524        7,009   

Total liabilities

      206,935            213,301        158,309        169,797        173,166        197,677   

Total equity

      5,851            19,162        16,285        22,429        14,871        13,030   

Total liabilities and equity

      212,786            232,463        174,594        192,226        188,037        210,707   

Per Share Data:

                 

Pro forma basic and diluted earnings per share

                 

Pro forma weighted average shares outstanding—basic and diluted

                 

Other Data (unaudited):

                 

Net investment revenue

    $ 487      $ 529        $ 1,996      $ 2,297      $ 1,298      $ 842      $ 307   

Gain on securitization of receivable

      2,534        1,940          3,912        4,025        6,322        9,990        4,108   

Fee income

      254        288          11,380        877        7,716        933        1,215   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Investment Revenue from Ongoing Business Operations

    $ 3,275      $ 2,757        $ 17,288      $ 7,199      $ 15,336      $ 11,765      $ 5,630   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Investments in financing receivables

    $ 191,399          $ 195,582      $ 143,776      $ 159,210      $ 159,000      $ 184,742   

Plus Assets held in securitization trusts

      1,431,635            1,412,693        1,394,750        1,422,919        1,290,243        1,130,501   
   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Managed Assets

    $ 1,623,034          $ 1,608,275      $ 1,538,526      $ 1,582,129      $ 1,449,243      $ 1,315,243   
   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from financing receivables

    $ 2,834          $ 11,848      $ 11,739      $ 10,904      $ 11,435      $ 8,902   

Income from assets held in securitization trust

      20,670            84,582        82,176        72,126        60,534        60,755   
   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Investment Income from Managed Assets

    $ 23,504          $ 96,430      $ 93,915      $ 83,030      $ 71,969      $ 69,657   
   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Credit losses as a percentage of assets under management

      0.0         0.0     0.0     0.0     0.0     0.0

 

 

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RISK FACTORS

An investment in shares of our common stock involves a high degree of risk. Before making an investment decision, you should carefully consider the following risk factors, together with the other information contained in this prospectus. If any of the risks discussed in this prospectus occurs, our business, financial condition, liquidity and results of operations could be materially and adversely affected. If this were to happen, the price of our common stock could decline significantly and you could lose a part or all of your investment.

Risks Related to Our Business and Our Industry

Our business depends in part on U.S. federal, state and local government policies and a decline in the level of government support could harm our business.

The projects we finance typically depend in part on various U.S. federal, state or local governmental policies and incentives that support or enhance project economic feasibility. Such policies may include governmental initiatives, laws and regulations designed to reduce energy usage, encourage the use of clean energy or encourage the investment in and the use of sustainable infrastructure. Incentives provided by the U.S. federal government may include tax credits (with some of these tax credits that are related to clean energy having recently expired), tax deductions, bonus depreciation as well as federal grants and loan guarantees. Incentives provided by state governments may include renewable portfolio standards, which specify the portion of the power utilized by local utilities that must be derived from clean energy sources such as renewable energy. Additionally, certain states have implemented feed-in tariffs, pursuant to which electricity generated from clean 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. In addition, U.S. federal, state and local governments provide regulatory, tax and other incentives to encourage the development and growth of sustainable infrastructure.

Governmental agencies and other owners of real estate 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 or not extended beyond their current expiration dates the demand for, and the returns available from, the financing we provide may decline, which could harm our business. Changes in government policies, support and incentives, including retroactive changes, could also negatively impact the operating results of the projects we finance and the returns on the financings we provide.

U.S. federal, state and local government entities are major participants in the sustainable infrastructure industry and their actions could be adverse to our projects or our company.

The projects we finance are, and will continue to be, subject to substantial regulation by U.S. federal, state and local governmental agencies. For example, many projects require government permits, licenses, concessions, leases or contracts. Government entities, due to the wide-ranging scope of their authority, have significant leverage in setting their contractual and regulatory relationships with third parties. In addition, government permits, licenses, concessions, leases and contracts are generally very complex, which may result in periods of non-compliance, or disputes over interpretation or enforceability. If the projects we finance fail to obtain or comply with applicable regulations, permits or contractual obligations, they could be prevented from being constructed or subjected to monetary penalties or loss of operational rights, which could negatively impact project operating results and the returns on the financings we provide.

Contracts with government counterparties that support the projects we finance may be more favorable to the government counterparties compared to commercial contracts with private parties. For example, a lease, concession or general service contract may enable the government to modify or terminate the contract without requiring the payment of adequate compensation. Typically, our contracts with government counterparties

 

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contain termination provisions including prepayment amounts. In most cases, the prepayment amounts provide us with amounts sufficient to repay the financing we have provided, but may be less than amounts that would be payable under “make whole” provisions customarily found in commercial lending arrangements.

In addition, government counterparties also may have the discretion to change or increase regulation of project operations, or implement laws or regulations affecting project operations, separate from any contractual rights they may have. These actions could adversely impact the efficient and profitable operation of the projects we finance.

Government entities may also suspend or debar contractors from doing business with the government or pursue various criminal or civil remedies under various government contract regulations. Our ability to originate new financings could be adversely affected if one or more of our ESCO relationships are so suspended or debarred.

Changes in the terms of energy savings performance contracts could have a material and adverse impact on our business.

We derive a significant amount of our income from the assignment to us of payment streams under energy savings performance contracts with property owners, including government customers, in which the scope and cost of improvements and services are specified. While U.S. federal, state and local government rules governing such contracts vary, such rules may, for example, permit the funding of such contracts through long-term financing arrangements, permit long-term payback periods from the savings realized through such contracts, allow units of government to exclude debt related to such contracts from the calculation of their statutory debt limitation, allow for award of contracts on a “best value” instead of “lowest cost” basis and allow for the use of sole source providers. To the extent these rules become more restrictive in the future, our ability to provide financing to support these projects could be adversely impacted, which could harm our business. Changes in these rules, including retroactive changes, could also negatively impact the operating results of the projects we finance and the returns on the financings we provide.

A change in the fiscal health, level of appropriations or budgets of U.S. federal, state and local governments could reduce demand for the projects we finance and the financing we provide.

Although the energy efficiency financings we provide do not normally require direct governmental appropriations and instead are paid for out of general operating and maintenance appropriations based on the energy savings derived from the improved facility, a significant decline in the fiscal health, level of appropriations or budgets of government customers may make it difficult or undesirable for them to make existing payments or to enter into new energy efficiency improvement projects. This could have a material and adverse effect on the repayment of our financings for existing projects and on our ability to originate new financings for projects. Moreover, other changes in resources available to governments may also impact their willingness to undertake energy efficiency projects. For example, an increase in money set aside for government expenditures for energy efficiency projects may reduce demand for financing.

In addition, to the extent we provide financings for projects that are in part also funded out of direct appropriations, we will depend on approval of the necessary spending in order for the projects to move forward. The repayment of the financing we provide to any such project could be adversely affected if appropriations for any such projects are delayed or terminated.

Many of our projects depend on revenues from relevant contractual arrangements.

Many of the projects we finance rely on revenue from contractual commitments of end-customers. There is a risk that these customers will default under their contracts. We cannot provide assurance that one or more of such customers will not default on their obligations or that such defaults will not have a material and adverse effect on the project’s operations, financial position, future results of operations, or future cash flows. Furthermore, the bankruptcy, insolvency or other liquidity constraints of one or more customers may reduce the

 

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likelihood of collecting defaulted obligations. Some projects rely on one customer for their revenue and thus the project could be materially and adversely affected by any material change in the financial condition of that customer. While there may be alternative customers for such a project, there can be no assurance that a new contract on the same terms will be able to be negotiated for the project.

Certain of our projects with contractually-committed revenues under a small number of long term contracts will be subject to re-contracting risk in the future. We cannot provide assurance that we will be able to re-negotiate these contracts once their terms expire on equally favorable terms or at all. If we are unable to renegotiate these contracts on favorable terms, our business, financial condition, results of operation and prospects could be materially and adversely affected.

Revenues at some of the projects we finance depend on reliable and efficient metering, or other revenue collection systems, which are often specified in the contract. There is a risk that, if one or more of such projects are not able to operate and maintain the metering or other revenue collection systems in the manner expected, if the operation and maintenance costs, or O&M costs, are greater than expected, or if the customer disputes the output of the revenue collection system, the ability of the project to repay or provide a return to us on the financing we have provided could be materially and adversely affected.

Because our business depends to a significant extent upon relationships with key industry players, our inability to maintain or develop these relationships, or the failure of these relationships to generate business opportunities, could adversely affect our business.

We will rely to a significant extent on our relationships with key industry players in the markets we target. We originate investment opportunities through our relationships with global industrial companies or various U.S. utility companies, which develop and install sustainable infrastructure projects. In addition to the net proceeds from this and future offerings, we have traditionally financed our business by accessing the securitization or syndication market, primarily utilizing our relationships with insurance companies and commercial banks. We also maintain other relationships, which complement our origination and financing activities, with a variety of key intermediaries such as investment banks, private equity and infrastructure funds, other institutional investors and industry service providers. Our inability to maintain or develop these relationships, or the failure of these relationships to generate business opportunities, could adversely affect our business. In addition, individuals and entities with whom we have relationships are not obligated to provide us with business opportunities, and, therefore, there is no assurance that such relationships will generate business opportunities for us.

We are exposed to the credit risk of ESCOs and others.

While we do not anticipate facing significant credit risk in our financings related to U.S. federal 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 energy savings. We will also be exposed to credit risk in projects we finance that do not depend on funding from the U.S. federal government. We expect to increasingly target such projects as part of our strategy. We will seek to mitigate this credit risk by employing a comprehensive review and asset selection process and careful ongoing monitoring of acquired assets. Nevertheless, unanticipated credit losses could occur which could adversely impact our operating results. 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.

If the cost of energy generated by traditional sources of energy declines, demand for the projects we finance may decline.

Many traditional sources of energy such as coal, petroleum based fuels and natural gas are highly influenced by the price of underlying or substitute commodities. While we believe the potential for rising or

 

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increasingly volatile commodity prices and inflation will spur investment in our industry, decreases in such prices may reduce the demand for energy efficiency projects or other projects, including clean energy facilities, that do not rely on traditional energy sources. For example, we believe the current low prices in natural gas may reduce the demand for other projects like renewable energy which are a substitute for natural gas. Technological progress in electricity generation or in the production of traditional fuels or the discovery of large new deposits of traditional fuels could reduce the cost of energy generated from those sources and consequently reduce the demand for the types of projects we finance, which could harm our new business origination prospects. In addition, volatility in commodity prices, including energy prices, may cause building owners and other parties to be reluctant to commit to projects where repayment is based upon a fixed monetary value for energy savings that would not decline if the price of energy declines. Any resulting decline in demand for our financing could adversely impact our operating results.

If the market for various types of sustainable infrastructure projects or the financings techniques related to such projects do not develop as we anticipate, new business generation in this target area would be adversely impacted.

The market for various types of sustainable infrastructure projects such as clean energy projects and commercial office building energy efficiency projects are emerging and rapidly evolving, leaving their future success uncertain. Similarly, various financing techniques, such as using taxable debt for state and local energy efficiency financings, are emerging and the future success of these financing techniques is also uncertain. If some or all of these market segments or financing techniques prove unsuitable for widespread commercial deployment or if demand for such projects fails to grow sufficiently, the demand for the financing solutions we expect to provide to these markets may decline or develop more slowly than we anticipate. Many factors will influence the widespread adoption and demand for such projects, including general and local economic conditions, commodity prices of traditional energy sources, the cost-effectiveness of such projects, performance and reliability of such technologies compared to conventional power sources and technologies, the extent of government subsidies to support sustainable infrastructure and regulatory developments in the power and natural resource industries. In addition, clean energy projects rely on electric and other types of transmission lines, pipelines and facilities owned and operated by third parties to obtain their inputs or distribute their output. Any substantial access barriers to these lines and facilities could make projects which depend on them more expensive, which could adversely impact the demand for such projects and the financing we provide.

Clean energy and other sustainable infrastructure projects are subject to performance risks that could impact the repayment of and the return on the financings we provide.

Clean energy and other sustainable infrastructure projects are subject to various construction and operating delays and risks that may cause them to incur higher than expected costs or generate less than expected amounts of output such as electricity in the case of a clean energy project. These risks include construction delays, a failure or degradation of our, our customers’ or utilities’ equipment; an inability to find suitable equipment or parts; labor shortages; less than expected supply of a project’s source of clean energy, such as geothermal steam or biomass; or a faster than expected diminishment of such supply. Any extended interruption in the project’s construction or operation, any cost overrun or failure of the project for any reason to generate the expected amount of output, could have a material adverse effect on the repayment of and the return on the financings we provide.

Sustainable infrastructure projects that involve the generation, transmission or sale of electricity such as clean energy projects may be subject to regulation by the Federal Energy Regulatory Commission under the Federal Power Act or other regulations that regulate the sale of electricity, which may adversely affect the profitability of such projects.

Sustainable infrastructure projects that involve the generation, transmission or sale of electricity such as clean energy projects may be “qualifying facilities” that are exempt from regulation as public utilities by the Federal Energy Regulatory Commission, or the FERC, under the Federal Power Act, or the FPA, while certain

 

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other such projects may be subject to rate regulation by the FERC under the FPA. FERC regulations under the FPA confer upon these facilities key rights to interconnection with local utilities, and can entitle qualifying facilities to enter into power purchase agreements with local utilities, from which the qualifying facilities benefit. Changes to these U.S. federal laws and regulations could increase our regulatory burdens and costs, and could reduce our revenue. In addition, modifications to the pricing policies of utilities could require clean energy systems to achieve lower prices in order to compete with the price of electricity from the electric grid and may reduce the economic attractiveness of certain energy efficiency measures. To the extent that the projects we finance are subject to rate regulation, the project owners will be required to obtain FERC acceptance of their rate schedules for wholesale sales of energy, capacity and ancillary services. Any changes in the rates projects owners are permitted to charge could raise credit risks in the clean energy projects we finance.

In addition, the operation of, and electrical interconnection for, our clean energy projects may be subject to U.S. federal, state or local interconnection and federal reliability standards, some of which are set forth in utility tariffs. These standards and tariffs specify rules, business practices and economic terms to which the projects we finance are subject and which may impact on a project’s ability to deliver the electricity it produces to its end customer. The tariffs are drafted by the utilities and approved by the utilities’ state and U.S. federal regulatory commissions. These standards and tariffs change frequently and it is possible that future changes will increase our administrative burden or adversely affect the terms and conditions under which the projects we finance render services to their customers.

In addition, under certain circumstances, we may also be subject to the reliability standards of the North American Electric Reliability Corporation, or the NERC. If project owners fail to comply with the mandatory reliability standards, they could be subject to sanctions, including substantial monetary penalties, which could also raise credit risks for, or lower the returns available from, the clean energy projects we finance.

Unfavorable publicity or public perception of the industries in which we operate could adversely impact our operating results and our reputation.

The sustainable infrastructure industry, including various forms of clean energy receive significant media coverage that, whether or not directly related to our business or our projects, can adversely impact our reputation and the demand for our financing solutions. Similarly, negative publicity or public perception of the broader energy-related industries in which we operate, including through media coverage of environmental contamination and climate change concerns, could reduce demand for our financial solutions and our projects’ services. Any reduction in demand for sustainable infrastructure projects or for the financing we provide could damage our reputation or could have a material adverse effect on our results of operations and business prospects.

Future litigation or administrative proceedings could have a material and adverse effect on our business, financial condition and results of operations.

We may become involved in legal proceedings, administrative proceedings, claims and other litigation that arise in the ordinary course of business. In addition, we may be subject to legal proceedings or claims arising out of the projects we finance. Adverse outcomes or developments relating to these proceedings, such as judgments for monetary damages, injunctions or denial or revocation of permits, could have a material adverse effect on the projects we finance, which could adversely impact the repayment of or the returns available under the financing we provide. See “Business—Legal Proceedings.”

We operate in a competitive market and future competition may impact the terms of the financing we offer.

We compete against a number of parties who may provide alternatives to our financings including specialty finance companies, savings and loan associations, banks, private equity, hedge or infrastructure investment funds, insurance companies, mutual funds, institutional investors, investment banking firms, financial institutions, utilities, project developers, pension funds, governmental bodies and other entities. We also

 

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encounter competition in the form of potential customers or our origination partners electing to use their own capital rather than engaging an outside provider such as us. In addition, we may also face competition based on technological developments that reduce demand for electricity, increase power supplies through existing infrastructure or that otherwise compete with our sustainable infrastructure projects. Our anticipated competitors may be significantly larger than we are, have access to greater capital and other resources than we do and may have other advantages over us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than we can. In addition, many of our competitors are not subject to the operating constraints associated with REIT tax compliance or maintenance of an exemption from the 1940 Act. These characteristics could allow our competitors to consider a wider variety of investments, establish more relationships and offer better pricing and more flexible structuring than we can offer. We may lose business opportunities if we do not match our competitors’ pricing, terms and structure. If we are forced to match our competitors’ pricing, terms and structure, we may not be able to achieve acceptable risk-adjusted returns on the financing we provide or we may be forced to bear greater risks of loss. A portion of our competitive advantage stems from the fact that the market for opportunities in sustainable infrastructure projects is underserved by traditional commercial banks and other financing sources. A significant increase in the number and/or the size of our competitors in this market could force us to accept less attractive terms on the financings we provide. As a result, competitive pressures we face could have a material adverse effect on our business, financial condition and results of operations.

Initially, we will participate in a significant portion of the economics of a limited number of projects, which could subject us to a risk of loss if any of these projects defaults.

As of December 31, 2012, our managed assets totaled more than $1.6 billion in more than 225 sustainable infrastructure transactions, all of which we originated. As of December 31, 2012, a significant portion of these financings were held in securitization trusts where we retained only residual economic stakes or were held on our balance sheet and secured by nonrecourse debt. In order to allow us to retain a larger portion of the economics in selected projects, we plan to deploy approximately $         of the net proceeds from this offering to retire notes, which were issued by these trusts or vehicles, collateralizing      of our existing projects. As a consequence, we will be subject to concentration risk and could incur significant losses if any of these projects perform poorly or if we are required to write down the value of any these projects.

Our business is affected by seasonal trends and construction cycles, and these trends and cycles could have an adverse effect on our operating results.

The volume and timing of our originations are subject to seasonal fluctuations and construction cycles, particularly in climates that experience colder weather during the winter months, such as the northern United States, or at educational institutions, where large projects are typically carried out during summer months when their facilities are unoccupied. In addition, government customers, many of which have fiscal years that do not coincide with ours, typically follow annual procurement cycles and appropriate funds on a fiscal-year basis even though contract performance may take more than one year. Further, government contracting cycles can be affected by the timing of, and delays in, the legislative process related to government programs and incentives that help drive demand for sustainable infrastructure projects. As a result of such fluctuations, we may occasionally experience fluctuations in the timing of new investments or declines in revenue or earnings as compared to the immediately preceding quarter, and comparisons of our operating results on a period-to-period basis may not be meaningful.

Risks Related to Our Assets

Interest rate fluctuations and increases in interest rates could adversely affect the value of our assets which could result in reduced earnings or losses and negatively affect our profitability.

Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Many of the financings we provide pay a fixed rate of interest or a fixed preferential return.

 

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With respect to our business operations, increases in interest rates, in general, may over time cause: (1) project owners to be less interested in borrowing or raising equity and thus reduce the demand for our investments; (2) the interest expense associated with our borrowings to increase; (3) the value of our fixed rate or fixed return investments to decline; and (4) the value of our interest rate swap agreements to increase, to the extent we enter into such agreements as part of our hedging strategy. Conversely, decreases in interest rates, in general, may over time cause: (1) project owners to be more interested in borrowing or raising equity and thus increase the demand for our investments; (2) prepayments on our investments, to the extent allowed, to increase; (3) the interest expense associated with our borrowings to decrease; (4) the value of our fixed rate or fixed return investments to increase; and (5) the value of our interest rate swap agreements to decrease, to the extent we enter into such agreements as part of our hedging strategy. Adverse developments resulting from changes in interest rates could have a material adverse effect on our business, financial condition and results of operations.

The lack of liquidity of our assets may adversely affect our business, including our ability to value and sell our assets.

Turbulent market conditions could significantly and negatively impact the liquidity of our assets. Illiquid assets typically experience greater price volatility, as a ready market does not exist, and can be more difficult to value. In addition, validating third-party pricing for illiquid assets may be more subjective than more liquid assets. The illiquidity of our assets may make it difficult for us to sell such assets if the need or desire arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our assets. To the extent that we utilize leverage to finance our purchase of assets that are or become liquid, the negative impact on us related to trying to sell assets in a short period of time for cash could be greatly exacerbated. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited, which could adversely affect our results of operations and financial condition.

We may experience a decline in the fair value of our assets.

A decline in the fair market value of our securitization assets, or other assets which we may carry at fair value in the future, may require us to recognize an “other-than-temporary” impairment, or OTTI, against such assets under generally accepted accounting principles in the United States, or U.S. GAAP, if we were to determine that, with respect to any assets in unrealized loss positions, we do not have the ability and intent to hold such assets to maturity or for a period of time sufficient for a forecasted market price recovery to rise to or beyond the cost of such assets. If such a determination were to be made, we would recognize unrealized losses through earnings and write down the amortized cost of such assets to a new cost basis, based on the fair value of such assets on the date they are considered to be OTTI. Such impairment charges reflect non-cash losses at the time of recognition; subsequent disposition or sale of such assets could further affect our future losses or gains, as they are based on the difference between the sale price received and adjusted amortized cost of such assets at the time of sale.

Some of the assets in our portfolio will be recorded at fair value (as determined in accordance with our pricing policy as approved by our board of directors) and, as a result, there will be uncertainty as to the value of these assets.

The financings we provide and the other assets we hold are not publicly traded. The fair value of assets that are not publicly traded may not be readily determinable. As required under and in accordance with U.S. GAAP, we will value these assets quarterly at fair value, which may include unobservable inputs. Because such valuations are subjective, the fair value of certain of our assets may fluctuate over short periods of time and our determinations of fair value may differ materially from the values that would have been used if a ready market for these assets existed. The value of our common stock could be adversely affected if our determinations regarding the fair value of these assets were materially higher than the values that we ultimately realize upon their disposal. Additionally, our results of operations for a given period could be adversely affected if our

 

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determinations regarding the fair value of these investments were materially higher than the values that we ultimately realize upon their disposal. The valuation process has been particularly challenging in recent periods as market events have made valuations of certain assets more difficult, unpredictable and volatile.

We may not realize income or gains from our assets, which could cause the value of our common stock to decline.

We seek to provide attractive risk-adjusted returns to our stockholders. However, our assets may not appreciate in value and, in fact, may decline in value, and the loans and other financings we provide or acquire may default or not perform in accordance with our expectations. Accordingly, we may not be able to realize gains or income from our assets. Any gains that we do realize may not be sufficient to offset any other losses we experience. Any income that we realize may not be sufficient to offset our expenses.

Most of our assets are not rated which may result in an amount of risk, volatility or potential loss of principal that is greater than that of alternative investments.

Most of our assets are not rated by any rating agency and we expect that the debt financings we originate and acquire in the future will not be rated by any rating agency. Although we intend to focus on assets with high credit quality obligors, some of the projects we finance may include obligors that, if rated, would be rated below investment grade, due to speculative characteristics of the obligor’s capacity to pay interest and repay principal or pay dividends. Some of our assets may result in an amount of risk, volatility or potential loss of principal that is greater than that of alternative investments.

Any credit ratings assigned to our assets will be subject to ongoing evaluations and revisions and we cannot assure you that those ratings will not be downgraded.

To the extent the assets we hold or their underlying obligors are rated by credit rating agencies, such assets will be subject to ongoing evaluation by credit rating agencies, and we cannot assure you that any ratings will not be changed or withdrawn in the future. If rating agencies assign a lower-than-expected rating or reduce or withdraw, or indicate that they may reduce or withdraw, their ratings of our assets or the underlying obligors in the future, the value of these assets could significantly decline and could result in losses upon disposition or the failure of borrowers to satisfy their debt service obligations to us.

The debt financings we provide are subject to delinquency, foreclosure and loss, any or all of which could result in losses to us.

The debt financings we provide are subject to risks of delinquency, foreclosure and loss. In many cases, the ability of a borrower to repay our financing is dependent primarily upon the successful operation of the underlying project. If the cash flow of the project is reduced, the borrower’s ability to repay the debt financing we provide may be impaired. We will make certain estimates regarding project cash flows or savings during our underwriting of such loans. These estimates may not prove accurate, as actual results may vary from estimates. The cash flows or cost savings of a project can be affected by, among other things: the terms of the power purchase or other use agreements used in such project; the creditworthiness of the power off-taker or project user; the technology deployed; unanticipated expenses in the operation of the project and changes in national, regional or local economic conditions; and environmental legislation, acts of God, terrorism, social unrest and civil disturbances.

In the event of any default under the debt financings we provide, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the debt financing, which could have a material adverse effect on our cash flow from operations. In the event of the bankruptcy of a project owner or other borrower, the loan to such borrower will be deemed to be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law. Foreclosure proceedings against a project can be an expensive and lengthy process which could have a substantial negative effect on our anticipated return on the foreclosed loan.

 

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We generally will not control the projects that we finance.

Although the covenants in our financing or equity documentation will generally restrict certain actions that may be taken by project owners, we generally will not control the projects we finance. As a result, we are subject to the risk that the project owner may make business decisions with which we disagree or take risks or otherwise act in ways that do not serve our interests.

Our sustainable infrastructure projects may incur liabilities that rank equally with, or senior to, our investments in such projects.

We provide a range of financing structures, including various types of debt and equity securities, senior and subordinated loans, mezzanine debt, preferred equity and common equity. Our projects may have, or may be permitted to incur, other liabilities that rank equally with, or senior to, our positions or investments in such projects or businesses, as the case may be, including with respect to grants of collateral. By their terms, such instruments may entitle the holders to receive payment of interest or principal on or before the dates on which we are entitled to receive payments with respect to the instruments in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of an entity to which we have provided financing, holders of instruments ranking senior to our investment in that project or business would typically be entitled to receive payment in full before we receive any distribution. After repaying such senior stakeholders, such project may not have any remaining assets to use for repaying its obligation to us. In the case of securities ranking equally with instruments we hold, we would have to share on an equal basis any distributions with other stakeholders holding such instrument in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant project.

Our mezzanine loans are generally subject to losses.

We may make or acquire mezzanine loans, which are loans made to project owners for sustainable infrastructure projects that are secured by pledges of the borrower’s ownership interests in the project and/or the project owner, which are subordinate to senior secured loans secured on the project but senior to the project owner’s equity in the project. The loan to value and last dollar of exposure of the mezzanine loans will not differ greatly from the loans we originate or acquire, with the key distinction being that the most senior portion of the loan with the least credit risk is owned by a third party lender. In the event a borrower defaults on a loan and lacks sufficient assets to satisfy our mezzanine financing, we may suffer a loss of principal or interest. In the event a borrower declares bankruptcy, we may not have full recourse to the assets of the borrower, or the assets of the borrower may not be sufficient to satisfy our mezzanine loan. In addition, mezzanine loans are by their nature structurally subordinated to more senior project level financings. If a borrower defaults on our mezzanine loan or on debt senior to our loan, or if a borrower declares bankruptcy, our mezzanine loan will be satisfied only after the project level debt and other senior debt is paid in full. Significant losses related to our mezzanine loans would result in operating losses for us and may limit our ability to make distributions to our stockholders.

Our equity investments, many of which are illiquid with no readily available market, involve a substantial degree of risk.

We may make equity investments which may fail to appreciate and may decline in value or become worthless and our ability to recover our investment will depend on the success of the project in which we make such equity investment. Equity investments involve a number of significant risks, including:

 

   

any equity investment we make in a project could be subject to further dilution as a result of the issuance of additional equity interests and to serious risks because equity interests are subordinate to all indebtedness (including trade creditors) and any senior securities in the event that the issuer is unable to meet its obligations or becomes subject to a bankruptcy process;

 

   

to the extent that a project in which we invest requires additional capital and is unable to obtain it, we may not recover our investment; and

 

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in some cases, equity investments will not pay current dividends, and our ability to realize a return on our investment, as well as to recover our investment, will be dependent on the success of the project in which we invest. The project may face unanticipated costs or delays or may not generate projected cash flows which could lead to the project generating lower rates of return than we expected when we decided to fund the project. Further, many projects in which we make equity investments will be subject to competitive risks and to volatility in commodity prices including the price of energy. Even if the project is successful, our ability to realize the value of our investment may be dependent on our ability to renew commercial contracts for a project or on the occurrence of a liquidity event.

We may invest in joint ventures that subject us to additional risks.

We anticipate that some of our projects will be structured as joint ventures, partnerships and securitization, syndication and consortium arrangements. Part of our strategy is to participate with other institutional investors in consortiums and in partnerships on various sustainable infrastructure transactions. These arrangements are driven by the magnitude of capital required to complete acquisitions and the development of sustainable infrastructure projects and other industry-wide trends that we believe will continue. Such arrangements involve risks not present where a third party is not involved, including the possibility that partners or co-venturers might become bankrupt or otherwise failing to fund their share of required capital contributions. Additionally, partners or co-venturers might at any time have economic or other business interests or goals different from us.

Joint ventures, partnerships and securitization, syndication and consortium investments generally provide for a reduced level of control over an acquired project because governance rights are shared with others. Accordingly, decisions relating to the underlying operations, including decisions relating to the management, operation and the timing and nature of any exit, are often made by a majority vote of the investors or by separate agreements that are reached with respect to individual decisions. In addition, such operations may be subject to the risk that the project owners may make business, financial or management decisions with which we do not agree or the management of the project may take risks or otherwise act in a manner that does not serve our interests. Because we may not have the ability to exercise control over such operations, we may not be able to realize some or all of the benefits that we believe will be created from our involvement. If any of the foregoing were to occur, our business, financial condition and results of operations could suffer as a result.

In addition, we anticipate that some of our joint ventures, partnerships, securitization or syndication or consortium arrangements may subject the sale or transfer of our interests in these projects to rights of first refusal or first offer, tag along rights or drag along rights and some agreements provide for buy-sell or similar arrangements. Such rights may be triggered at a time when we may not want them to be exercised and such rights may inhibit our ability to sell our interest in an entity within our desired time frame or on any other desired basis.

Some of the projects we finance may require substantial operating or capital expenditures in the future.

Many of the projects we finance are capital intensive and require substantial ongoing expenditures for, among other things, additions and improvements, and maintenance and repair of plant and equipment related to project operations. Any failure to make necessary operating or capital expenditures could adversely impact project performance. In addition, some of these expenditures may not be recoverable from current or future contractual arrangements.

The use of real property rights for our sustainable infrastructure projects may be adversely affected by the rights of lienholders and leaseholders that are superior to those of the grantors of those real property rights to us.

The projects we finance often require large areas of land for construction and operation or other easements or access to the underlying land. The rights to use the land can be obtained through freehold title, leases and other rights of use. Although we believe that our projects have valid rights to all material easements,

 

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licenses and rights of way, not all of such easements, licenses and rights of way are registered against the lands to which they relate and may not bind subsequent owners. Some of our projects generally are, and are likely to continue to be, located on land occupied pursuant to long-term easements and leases. The ownership interests in the land subject to these easements and leases may be subject to mortgages securing loans or other liens (such as tax liens) and other easement and lease rights of third parties (such as leases of oil or mineral rights) that were created prior to, or are superior to, our projects’ easements and leases. As a result, the rights under these easements or leases may be subject, and subordinate, to the rights of those third parties. We typically obtain representations or perform title searches or obtain title insurance to protect our investments in our projects against these risks. Such measures may, however, be inadequate to protect against all risk of loss of rights to use the land on which these projects are located, which could have a material and adverse effect on our projects and their financial condition and operating results.

Performance of projects we finance may be harmed by future labor disruptions and economically unfavorable collective bargaining agreements.

A number of the projects we finance could have workforces that are unionized or that in the future may become unionized and, as a result, are required to negotiate the wages, benefits and other terms with many of their employees collectively. If these projects were unable to negotiate acceptable contracts with any of their unions as existing agreements expire, they could experience a significant disruption of their operations, higher ongoing labor costs and restrictions on their ability to maximize the efficiency of their operations, which could have a material and adverse effect on our business, financial condition and results of operations. In addition, in some jurisdictions where our projects have operations, labor forces have a legal right to strike which may have a negative impact on our business, financial condition and results of operations, either directly or indirectly, for example if a critical upstream or downstream counterparty was itself subject to a labor disruption which impacted the ability of our projects to operate.

The projects we finance rely on third parties to manufacture quality products or provide reliable services in a timely manner and the failure of these third parties could cause project performance to be adversely affected.

The projects we finance typically rely on third parties to select and manage various equipment and service providers. These third parties may be responsible for choosing vendors, including equipment suppliers and subcontractors. Project success often depends on third parties who are capable of installing and managing projects and structuring contracts that provide appropriate protection against construction and operational risks. In many cases, in addition to contractual protections and remedies, project owners may seek guaranties, warranties and construction bonding to provide additional protection.

The warranties provided by the third parties and, in some cases, their subcontractors, typically limit any direct harm that results from relying on their products and services. However, there can be no assurance that a supplier or subcontractor will be willing or able to fulfill its contractual obligations and make necessary repairs or replace equipment. In addition, these warranties generally expire within one to five years or may be of limited scope or provide limited remedies. If projects are unable to avail themselves of warranty protection or receive the expected protection under the terms of the guaranties or bonding, we may need to incur additional costs, including replacement and installation costs, which could adversely impact the repayment of or the returns available under the financing we provide.

Liability relating to environmental matters may impact the value of properties that we may acquire or the properties underlying our assets.

Under various U.S. federal, state and local laws, an owner or operator of a project may become liable for the costs of removal of certain hazardous substances released from the project of any underlying real property. These laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances.

 

 

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The presence of hazardous substances may adversely affect an owner’s ability to sell a contaminated project or borrow using the project as collateral. To the extent that a project owner becomes liable for removal costs, the ability of the owner to make payments to us may be reduced.

We typically have title to projects or their underlying real estate assets underlying our equity financings, or, in the course of our business, we may take title to a project or its underlying real estate assets relating to one of our debt financings, and, in either case, we could be subject to environmental liabilities with respect to these assets. To the extent that we become liable for the removal costs, our results of operation and financial condition may be adversely affected. The presence of hazardous substances, if any, may adversely affect our ability to sell the affected project and we may incur substantial remediation costs, thus harming our financial condition.

Our insurance and contractual protections may not always cover lost revenue, increased expenses or liquidated damages payments.

Although the projects we finance generally have insurance, supplier warranties, subcontractors performance assurances such as bonding and other risk mitigation measures, the proceeds of such insurance, warranties, bonding or other measures may not be adequate to cover lost revenue, increased expenses or liquidated damages payments that may be required in the future.

Risks Related to Our Company

We may change our operational policies (including our investment guidelines, strategies and policies) with the approval of our board of directors but without stockholder consent at any time, which may adversely affect the market value of our common stock and our ability to make distributions to our stockholders.

Our board of directors determines our operational policies and may amend or revise our policies, including our policies with respect to acquisitions, dispositions, growth, operations, compensation, indebtedness, capitalization and dividends, or approve transactions that deviate from these policies, without a vote of, or notice to, our stockholders at any time. We may change our investment guidelines, investment process in relation to the identification and underwriting of prospective financings and our strategy at any time with the approval of our board of directors but without the consent of our stockholders, which could result in our making or originating investments that are different in type from, and possibly riskier than, the investments contemplated in this prospectus. In addition, our charter provides that our board of directors may authorize us to revoke or otherwise terminate our REIT election, without approval of our stockholders, if it determines that it is no longer in our best interests to qualify as a REIT. These changes could adversely affect our business, financial condition, results of operations and our ability to make distributions to our stockholders.

Our management and origination teams depend on information systems and systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our common stock and our ability to make distributions to our stockholders.

Our investment process and our asset and financial management and reporting are dependent on our communications and information systems. Any failure or interruption of our systems could cause delays or other problems in our originating, financing, investing, asset and financial management and reporting activities, which could have a material adverse effect on our operating results.

We may seek to expand our business internationally, which will expose us to additional risks that we do not face in the United States, which could have an adverse effect on our operating results.

We generate a significant portion of our revenue from operations in United States, and although we are engaged in overseas projects for the U.S. federal government, we currently derive a small amount of revenue from outside of North America. We may seek to expand our revenue and projects outside of North America in

 

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the future. These operations will be subject to a variety of risks that we do not face in the United States, including risk from changes in foreign country regulations, infrastructure, legal systems and markets. Other risks include possible difficulty in repatriating overseas earnings and fluctuations in foreign currencies.

Our overall success in international markets will depend, in part, on our ability to succeed in different legal, regulatory, economic, social and political conditions. We may not be successful in developing and implementing policies and strategies that will be effective in managing these risks in each country where we decide to do business. Our failure to manage these risks successfully could harm our international projects, reduce our international income or increase our costs, thus adversely affecting our business, financial condition and operating results.

Risks Relating to Regulation

We cannot at the present time predict the unintended consequences and market distortions that may stem from far-ranging governmental intervention in the economic and financial system or from regulatory reform of the oversight of financial markets.

The U.S. federal government, the Federal Reserve Board of Governors, or the Federal Reserve, the U.S. Treasury, or the Treasury, the SEC, U.S. Congress and other governmental and regulatory bodies have taken, are taking or may in the future take various actions to address the financial crisis. Such actions could have a dramatic impact on our business, results of operations and financial condition, and the cost of complying with any additional laws and regulations could have a material adverse effect on our financial condition and results of operations. The far-ranging government intervention in the economic and financial system may carry unintended consequences and cause market distortions. We are unable to predict at this time the extent and nature of such unintended consequences and market distortions, if any.

Loss of our 1940 Act exemption would adversely affect us, the market price of shares of our common stock and our ability to distribute dividends.

We intend to conduct our operations so that we are not required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. Government securities and cash items) on a non-consolidated basis, which we refer to as the 40% test. Excluded from the term “investment securities,” among other things, are U.S. Government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.

We intend to conduct our businesses primarily through our subsidiaries and our operations so that we comply with the 40% test. The securities issued by any wholly-owned or majority-owned subsidiaries that we may form in the future that are excepted from the definition of “investment company” based on Section 3(c)(1) or 3(c)(7) of the 1940 Act, together with any other investment securities we may own, may not have a value in excess of 40% of the value of our total assets on a non-consolidated basis. We anticipate that one or more of our subsidiaries, will qualify for an exception from registration as an investment company under the 1940 Act pursuant to Section 3(c)(5)(C) of the 1940 Act, which is available for entities which are not primarily engaged in issuing redeemable securities, face-amount certificates of the installment type or periodic payment plan certificates and which are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. This exception generally requires that at least 55% of such subsidiaries’ portfolios must be comprised of qualifying assets and at least another 80% of each of their portfolios must be comprised of qualifying assets and real estate-related assets under the 1940 Act. We intend to treat as qualifying assets for this purpose loans secured by projects where the collateral is real property or where the fair value of the real property does not exceed the carrying value of our loan. We intend to treat as real estate-related assets

 

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non-controlling equity interests in joint ventures that own projects whose assets are primarily real property. In general, with regard to our subsidiaries relying on Section 3(c)(5)(C), we intend to rely on other guidance published by the SEC or its staff or on our analyses of guidance published with respect to other types of assets to determine which assets are qualifying real estate assets and real estate-related assets.

In addition, we anticipate that one or more of our subsidiaries, will qualify for an exception from registration as an investment company under the 1940 Act pursuant to either Section 3(c)(5)(A) of the 1940 Act, which is available for entities which are not engaged in the business of issuing redeemable securities, face-amount certificates of the installment type or periodic payment plan certificates, and which are primarily engaged in the business of purchasing or otherwise acquiring notes, drafts, acceptances, open accounts receivable, and other obligations representing part or all of the sales price of merchandise, insurance, and services, or Section 3(c)(5)(B) of the 1940 Act, which is available for entities primarily engaged in the business of making loans to manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise, insurance, and services. These exceptions generally require that at least 55% of such subsidiaries’ portfolios must be comprised of qualifying assets that meet the requirements of the exception. We intend to treat energy efficiency loans where the loan proceeds are specifically provided to finance equipment, services and structural improvements to properties and other facilities and clean energy and other sustainable infrastructure projects or improvements as qualifying assets for purposes of these exceptions. In general, we also expect, with regard to our subsidiaries relying on Section 3(c)(5)(A) or (B), to rely on guidance published by the SEC or its staff or on our analyses of guidance published with respect to other types of assets to determine which assets are qualifying assets under the exceptions.

Although we intend to monitor the portfolios of our subsidiaries relying on the Section 3(c)(5)(A), (B) or (C) exceptions periodically and prior to each acquisition, there can be no assurance that such subsidiaries will be able to maintain their exceptions. Qualification for exceptions from registration under the 1940 Act will limit our ability to make certain investments. For example, these restrictions will limit the ability of these subsidiaries to make loans that are not secured by real property or that do not represent part or all of the sales price of merchandise, insurance, and services.

There can be no assurance that the laws and regulations governing the 1940 Act, including the Division of Investment Management of the SEC providing more specific or different guidance regarding these exceptions, will not change in a manner that adversely affects our operations. For example, on August 31, 2011, the SEC issued a concept release (No. IC-29778; File No. SW7-34-11, Companies Engaged in the Business of Acquiring Mortgages and Mortgage-Related Instruments) pursuant to which it is reviewing the scope of the exception from registration under Section 3(c)(5)(C) of the 1940 Act. Any additional guidance from the SEC or its staff from this process or in other circumstances could provide additional flexibility to us, or it could further inhibit our ability to pursue the strategies we have chosen. If we or our subsidiaries fail to maintain an exception from the 1940 Act, we could, among other things, be required either to (1) change the manner in which we conduct our operations to avoid being required to register as an investment company, (2) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so or (3) register as an investment company, any of which could negatively affect the value of our common stock, the sustainability of our business model, and our ability to make distributions which could have an adverse effect on our business and the market price for our shares of common stock.

We have not requested the SEC to approve our treatment of any company as a majority-owned subsidiary and the SEC has not done so. If the SEC were to disagree with our treatment of one or more companies as majority-owned subsidiaries, we would need to adjust our strategy and our assets in order to continue to pass the 40% test. Any such adjustment in our strategy could have a material adverse effect on us.

Rapid changes in the values of our assets may make it more difficult for us to maintain our qualification as a REIT or our exemption from the 1940 Act.

If the market value or income potential of our assets changes as a result of changes in interest rates, general market conditions, government actions or other factors, we may need to adjust the portfolio mix of our real estate

 

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assets and income or liquidate our non-qualifying assets to maintain our REIT qualification or our exemption from the 1940 Act. If changes in asset values or income occur quickly, this may be especially difficult to accomplish. This difficulty may be exacerbated by the illiquid nature of any non-real estate assets we may own. We may have to make decisions that we otherwise would not make absent the REIT and 1940 Act considerations.

Because we expect to distribute substantially all of our taxable income to our stockholders, we will need additional capital to finance our growth and such capital may not be available on favorable terms or at all.

We may need additional capital to fund our growth. 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 pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its taxable income. Because we intend to grow our business, this limitation may require us to incur additional debt or raise additional equity at a time when it may be disadvantageous to do so. We cannot assure you that debt and equity financing will be available to us on favorable terms, or at all, and debt financings may be restricted by the terms of any of our outstanding borrowings. If additional funds are not available to us, we could be forced to curtail or cease new asset originations and acquisitions, which could have a material adverse effect on our business and financial condition.

The preparation of our financial statements involves use of estimates, judgments and assumptions, and our financial statements may be materially affected if our estimates prove to be inaccurate.

Financial statements prepared in accordance with U.S. GAAP require the use of estimates, judgments and assumptions that affect the reported amounts. Different estimates, judgments and assumptions reasonably could be used that would have a material effect on the financial statements, and changes in these estimates, judgments and assumptions are likely to occur from period to period in the future. Significant areas of accounting requiring the application of management’s judgment include, but are not limited to determining the fair value of our assets. These estimates, judgments and assumptions are inherently uncertain, and, if they prove to be wrong, then we face the risk that charges to income will be required. In addition, because our company is a newly formed entity formed in connection with the formation transactions, we have in some of these areas limited experience in making these estimates, judgments and assumptions and the risk of future charges to income may be greater than if we had more experience in these areas. Any such charges could significantly harm our business, financial condition, results of operations and the price of our securities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” for a discussion of the accounting estimates, judgments and assumptions that we believe are the most critical to an understanding of our business, financial condition and results of operations.

Risks Related to Borrowings

We use leverage in executing our business strategy, which may adversely affect the return on our assets and may reduce cash available for distribution to our stockholders, as well as increase losses when economic conditions are unfavorable.

We use leverage to finance our sustainable infrastructure projects. Our business has traditionally been financed primarily through the use of securitizations. We expect we will continue to use securitizations to finance our business. However, going forward, we expect our financing sources will also include other fixed and floating rate borrowings in the form of bank credit facilities (including term loans and revolving facilities), warehouse facilities, repurchase agreements and public and private debt issuances. Weakness in the financial markets and the economy generally could adversely affect one or more of our potential lenders and could cause one or more of our potential lenders or institutional investors to be unwilling or unable to provide us with financing or participate in securitizations or could increase the costs of that financing or securitization. The return on our assets and cash available for distribution to our stockholders may be reduced to the extent that market conditions prevent us from leveraging our assets or increase the cost of our financing relative to the income that can be derived from the assets acquired.

 

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Increases in our financing costs will reduce cash available for distributions to stockholders. We may not be able to meet our financing obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to liquidation or sale to satisfy the obligations.

An increase in our borrowing costs relative to the interest we receive on our leveraged assets may adversely affect our profitability and our cash available for distribution to our stockholders. Our borrowings may have a shorter duration than our assets.

Borrowing rates are currently at historically low levels that may not be sustained in the long run. As any short term borrowing agreements we enter into mature, we will be required either to enter into new borrowings or to sell certain of our assets. An increase in short-term interest rates at the time that we seek to enter into new borrowings would reduce the spread between the returns on our assets and the cost of our borrowings. This would adversely affect the returns on our assets, which might reduce our earnings and, in turn, cash available for distribution to our stockholders. In addition, because short-term borrowings including repurchase agreements and warehouse facilities 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 facilities 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 facilities, we may have to curtail our financing of sustainable infrastructure projects and/or dispose of assets. We will face particular risk in this regard given that we expect many of our borrowings will have a shorter duration than the assets they finance.

We do not have a formal policy limiting the amount of debt we may incur. Our board of directors may change our leverage policy without stockholder approval.

Although we are not required to maintain any particular debt-to-equity leverage ratio, the amount of leverage we may employ 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 and financing counterparties. Historically, we have financed our transactions with U.S. federal government obligors with more than 95% debt. We anticipate reducing the overall leverage on both individual assets classes and the entire portfolio for which we have the primary economic exposure. We expect that we will generally target up to two times leverage on our overall portfolio, with individual allocations of leverage based on the mix of asset types and obligors. For example, we may deploy higher leverage on debt financings made to U.S. federal and other high quality government obligors and lower leverage on other types of assets and obligors. However, our charter and bylaws do not limit the amount of indebtedness we can incur, and our board of directors has discretion to deviate from or change our leverage policy at any time, which could result in an investment portfolio with a different risk profile than contemplated in this prospectus. Moreover, we have more limited experience dealing with debt financings with obligors other than U.S. federal government agencies as well as with equity financings and we may apply too much leverage to our assets or use the wrong kinds of financings to leverage our assets.

The use of securitizations and special purpose entities would expose us to additional risks.

We presently hold, and to the extent that we securitize loans in the future, we anticipate that we will often hold the most junior certificates or the residual value associated with a securitization. As a holder of the most junior certificates or residual value, we are more exposed to losses on the underlying collateral because the equity interest we retain in the securitization vehicle would be subordinate to the more senior notes issued to investors and we would, therefore, absorb all of the losses up to the value of our junior certificates of residual value sustained with respect to the underlying assets before the owners of the notes experience any losses. In addition, the inability to securitize our portfolio or assets within our portfolio could hurt our performance and our ability to grow our business.

We also use various special purpose entities to own and finance our sustainable infrastructure projects. These subsidiaries incur various types of debt, which can be used to finance one or more projects. This debt is

 

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typically structured as nonrecourse debt, which means it is repayable solely from the revenue from the projects financed by the debt and is secured by such projects’ physical assets, major contracts and cash accounts and in some cases, a pledge of our equity interests in the subsidiaries involved in the projects. Although our subsidiary debt is typically nonrecourse to us, we make certain representations and warranties to the nonrecourse debt holder, the breach of which may require us to make payments to the lender. We may also from time to time determine to provide financial support to the subsidiary in order to maintain rights to the project or otherwise avoid the adverse consequences of a default. In the event a subsidiary defaults on its indebtedness, its creditors may foreclose on the collateral securing the indebtedness, which may result in our losing our ownership interest in some or all of the subsidiary’s assets. The loss of our ownership interest in a subsidiary or some or all of a subsidiary’s assets could have a material adverse effect on our business, financial condition and operating results.

We expect that certain of our financing facilities may contain covenants that restrict our operations and may inhibit our ability to grow our business and increase revenues.

We expect that certain of our financing facilities may contain restrictions, covenants, and representations and warranties that, among other things, may require us to satisfy specified financial, asset quality, loan eligibility and loan performance tests. If we fail to meet or satisfy any of these covenants or representations and warranties, we would be in default under these agreements and our lenders could elect to declare all amounts outstanding under the agreements to be immediately due and payable, enforce their respective interests against collateral pledged under such agreements and restrict our ability to make additional borrowings. We also expect our financing agreements will contain cross-default provisions, so that if a default occurs under any one agreement, the lenders under our other agreements could also declare a default.

The covenants and restrictions we expect in our financing facilities may restrict our ability to, among other things:

 

   

incur or guarantee additional debt;

 

   

make certain investments, originations or acquisitions;

 

   

make distributions on or repurchase or redeem capital stock;

 

   

engage in mergers or consolidations;

 

   

reduce liquidity below certain levels;

 

   

grant liens;

 

   

incur operating losses for more than a specified period; and

 

   

enter into transactions with affiliates.

These restrictions may interfere with our ability to obtain financing, or to engage in other business activities, which may significantly limit or harm our business, financial condition, liquidity and results of operations. A default and resulting repayment acceleration could significantly reduce our liquidity, which could require us to sell our assets to repay amounts due and outstanding. This could also significantly harm our business, financial condition, results of operations, and our ability to make distributions, which could cause the value of our common stock to decline and adversely affect our ability to qualify, or remain qualified, as a REIT. A default will also significantly limit our financing alternatives such that we will be unable to pursue our leverage strategy, which could curtail the returns on our assets.

 

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If a counterparty to our repurchase transactions defaults on its obligation to resell the underlying security back to us at the end of the transaction term, or if the value of the underlying security has declined as of the end of that term, or if we default on our obligations under the repurchase agreement, we will lose money on our repurchase transactions.

If we engage in repurchase transactions, we will generally sell loans or other financings to lenders (i.e., repurchase agreement counterparties) and receive cash from the lenders. The lenders will be obligated to resell the same financings back to us at the end of the term of the transaction. Because the cash we will receive from the lender when we initially sell the financing to the lender is less than its value (this difference is the haircut), if the lender defaults on its obligation to resell the same loans back to us we would incur a loss on the transaction equal to the amount of the haircut (assuming there was no other change in value). We would also lose money on a repurchase transaction if the value of the underlying loans has declined as of the end of the transaction term, as we would have to repurchase the loans for their initial value but would receive loans worth less than that amount. We may also be forced to sell assets at significantly depressed prices to meet margin calls, post additional collateral and maintain adequate liquidity, which could cause us to incur losses. Moreover, to the extent we are forced to sell assets at such time, given market conditions, we may be selling at the same time as others facing similar pressures, which could exacerbate a difficult market environment and which could result in our incurring significantly greater losses on our sale of such assets. In an extreme case of market duress, a market may not even be present for certain of our assets at any price. Such a situation would likely result in a rapid deterioration of our financial condition and possibly necessitate a filing for protection under the U.S. Bankruptcy Code. Further, if we default on one of our obligations under a repurchase transaction, the lender will be able to terminate the transaction and cease entering into any other repurchase transactions with us. We expect that our repurchase agreements will contain cross-default provisions, so that if a default occurs under any one agreement, the lenders under our other agreements could also declare a default. If a default occurs under any of our repurchase agreements and the lenders terminate one or more of our repurchase agreements, we may need to enter into replacement repurchase agreements with different lenders. There can be no assurance that we will be successful in entering into such replacement repurchase agreements on the same terms as the repurchase agreements that were terminated or at all. Any losses we incur on our repurchase transactions could adversely affect our earnings and thus our cash available for distribution to our stockholders. In the event of our insolvency or bankruptcy, certain repurchase agreements may qualify for special treatment under the U.S. Bankruptcy Code, the effect of which, among other things, would be to allow the lender under the applicable repurchase agreement to avoid the automatic stay provisions of the U.S. Bankruptcy Code and to foreclose on the collateral agreement without delay, which could ultimately reduce the amounts we could otherwise recover.

Risks Related to Hedging

We have entered and may in the future enter into hedging transactions that could expose us to contingent liabilities in the future and adversely impact our financial condition.

Subject to maintaining our qualification as a REIT, part of our strategy may involve entering into hedging transactions that could require us to fund cash payments in certain circumstances (e.g., the early termination of the hedging instrument caused by an event of default or other early termination event, or the decision by a counterparty to request margin securities it is contractually owed under the terms of the hedging instrument). The amount due would be equal to the unrealized loss of the open swap positions with the respective counterparty and could also include other fees and charges. These economic losses will be reflected in our results of operations, and our ability to fund these obligations will depend on the liquidity of our assets and access to capital at the time, and the need to fund these obligations could adversely impact our financial condition.

We have limited experience hedging the interest rate risk of our assets and such hedging may adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.

We have limited experience hedging the interest rate risk of our assets, as the holders of the notes issued by trusts or vehicles and collateralized by our projects historically managed this risk. However, as part of our

 

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strategy of retaining a larger portion of the economics in the financings we originate and subject to maintaining our qualification as a REIT, we may pursue various hedging strategies to seek to reduce our exposure to adverse changes in interest rates. Our hedging activity will vary in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions. Interest rate hedging may fail to protect or could adversely affect us because, among other things:

 

   

our hedging strategies may be poorly designed or improperly executed resulting from our limited experience hedging the interest rate risk of our assets;

 

   

interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;

 

   

available interest rate hedges may not correspond directly with the interest rate risk for which protection is sought;

 

   

the duration of the hedge may not match the duration of the related liability;

 

   

the amount of income that a REIT may earn from certain hedging transactions (other than through taxable REIT subsidiaries, or TRSs), to offset interest rate losses is limited by U.S. federal tax provisions governing REITs;

 

   

the credit quality of the hedging counterparty owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction;

 

   

the hedging counterparty owing money in the hedging transaction may default on its obligation to pay; and

 

   

our hedging transactions, which are intended to limit losses, may actually adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.

In addition, hedging instruments involve risk since they often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities. Consequently, there are no requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions. Furthermore, the enforceability of agreements underlying hedging transactions may depend on compliance with applicable statutory and commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in its default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our commitments, if any, at the then current market price. Although generally we will seek to reserve the right to terminate our hedging positions, it may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty and we may not be able to enter into an offsetting contract in order to cover our risk. We cannot assure you that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.

If we choose not to pursue, or fail to qualify for, hedge accounting treatment, our operating results may suffer because losses on the derivatives that we enter into may not be offset by a change in the fair value of the related hedged transaction.

We may choose not to pursue, or fail to qualify for, hedge accounting treatment relating to derivative and hedging transactions. We may fail to qualify for hedge accounting treatment for a number of reasons, including if we use instruments that do not meet the Accounting Standards Codification, or ASC, Topic 815 definition of a derivative (such as short sales), we fail to satisfy ASC Topic 815 hedge documentation and hedge effectiveness assessment requirements or our instruments are not highly effective. If we fail to qualify for, or choose not to pursue, hedge accounting treatment, our operating results may suffer because losses on the derivatives that we enter into may not be offset by a change in the fair value of the related hedged transaction.

 

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Risks Related to Our Common Stock

If you purchase shares of common stock in this offering, you will experience immediate and significant dilution in the net tangible book value per share.

We expect the initial public offering price of our common stock to be substantially higher than the book value per share of our outstanding common stock immediately after this offering. If you purchase our common stock in this offering, you will incur immediate dilution of approximately $         in the book value per share of common stock from the price you pay for our common stock in this offering. This means that investors who purchase shares in this offering:

 

   

will pay a price per share that substantially exceeds the per share value of our assets after subtracting our liabilities; and

 

   

will have contributed     % of the total amount of our equity funding since inception but will only own     % of the shares outstanding.

From time to time we also may issue shares of our common stock in connection with property, portfolio or business acquisitions. We may grant registration rights in connection with these issuances. Sales of substantial amounts of our common stock, or the perception that these sales could occur, may adversely affect the prevailing market price for our common stock or may adversely affect the terms upon which we may be able to obtain additional capital through the sale of equity securities.

There is no public market for our common stock and a market may never develop, which could cause our common stock to trade at a discount and make it difficult for holders of our common stock to sell their shares.

Shares of our common stock are newly-issued securities for which there is no established trading market. We expect that our common stock will be approved for listing on the New York Stock Exchange, or the NYSE. However, there can be no assurance that an active trading market for our common stock will develop, or if one develops, be maintained. Accordingly, no assurance can be given as to the ability of our stockholders to sell their common stock or the price that our stockholders may obtain for their common stock.

Some of the factors that could negatively affect the market price of our common stock include:

 

   

our actual or projected operating results, financial condition, cash flows and liquidity or changes in business strategy or prospects;

 

   

changes in the mix of our financing products and services, including the level of securitizations or fee income in any quarter;

 

   

actual or perceived conflicts of interest with individuals, including our executives;

 

   

our ability to arrange financing for projects;

 

   

equity issuances by us, or share resales by our stockholders, or the perception that such issuances or resales may occur;

 

   

seasonality in construction and in demand for our financial solutions;

 

   

actual or anticipated accounting problems;

 

   

publication of research reports about us or the sustainable infrastructure industry;

 

   

changes in market valuations of similar companies;

 

   

adverse market reaction to any increased indebtedness we may incur in the future;

 

   

commodity price changes;

 

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interest rate changes;

 

   

additions to or departures of our key personnel;

 

   

speculation in the press or investment community;

 

   

our failure to meet, or the lowering of, our earnings estimates or those of any securities analysts;

 

   

increases in market interest rates, which may lead investors to demand a higher distribution yield for our common stock, if we have begun to make distributions to our stockholders, and would result in increased interest expenses on our debt;

 

   

changes in governmental policies, regulations or laws;

 

   

failure to qualify, or maintain our qualification, as a REIT or failure to maintain our exemption from the 1940 Act;

 

   

price and volume fluctuations in the stock market generally; and

 

   

general market and economic conditions, including the current state of the credit and capital markets.

Market factors unrelated to our performance could also negatively impact the market price of our common stock. One of the factors that investors may consider in deciding whether to buy or sell our common stock is our distribution rate as a percentage of our stock price relative to market interest rates. If market interest rates increase, prospective investors may demand a higher distribution rate or seek alternative investments paying higher dividends or interest. As a result, interest rate fluctuations and conditions in capital markets can affect the market value of our common stock.

Common stock and preferred stock eligible for future sale may have adverse effects on our share price.

Subject to applicable law, our board of directors, without stockholder approval, may authorize us to issue additional authorized and unissued shares of common stock and preferred stock on the terms and for the consideration it deems appropriate. In addition, in connection with the formation transactions, we will issue              shares of our common stock and our operating partnership will issue             OP units to holders of membership interests in Hannon Armstrong. We will grant registration rights to these persons who will receive common stock (including common stock issuable upon exchange of OP units) in our formation transactions. These registration rights will require us to seek to register the resale of all such shares of our common stock approximately                      after we complete this offering. Our directors and executive officers, certain of our affiliates and certain of our significant stockholders have entered into lock-up agreements with the underwriters prior to the commencement of this offering pursuant to which each of these persons or entities, with limited exceptions, for a period of 180 days, after the date of this prospectus, may not, without the prior written consent of the representatives of the underwriters, sell or transfer any shares of our common stock or any securities convertible into or exercisable or exchangeable for our common stock.

We cannot predict the effect, if any, of future sales of our common stock or the availability of shares for future sales, on the market price of our common stock. The market price of our common stock may decline significantly when the restrictions on resale by certain of our stockholders lapse. Sales of substantial amounts of common stock or the perception that such sales could occur may adversely affect the prevailing market price for our common stock.

We cannot assure you of our ability to make distributions in the future. Although we currently do not intend to do so, until our portfolio of assets generates sufficient income and cash flow, we could be required to sell assets, borrow funds or make a portion of our distributions in the form of a taxable stock distribution or distribution of debt securities.

We are generally required to distribute to our stockholders at least 90% of our REIT taxable income (without regard to the deduction for dividends paid and excluding net capital gains) each year for us to qualify,

 

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and maintain our qualification, as a REIT under the Internal Revenue Code. Our current policy is to pay quarterly distributions, which on an annual basis will equal all or substantially all of our taxable income. Although not currently anticipated, in the event that our board of directors authorizes 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.

Our ability to make distributions may be adversely affected by a number of factors, including the risk factors described in this prospectus. We currently do not expect to use the proceeds from this offering to make distributions to our stockholders. Therefore, although we anticipate initially making quarterly distributions to our stockholders, our board of directors has the sole discretion to determine the timing, form and amount of any distributions to our stockholders. Although we currently do not intend to do so, until our portfolio of assets generates sufficient income and cash flow, we could be required to sell assets, borrow funds or make a portion of our distributions in the form of a taxable stock distribution or distribution of debt securities. To the extent that we are required to sell assets in adverse market conditions or borrow funds at unfavorable rates, our results of operations could be materially and adversely affected. Our board of directors will make determinations regarding distributions based upon various factors, including our earnings, our financial condition, our liquidity, our debt and preferred stock covenants, maintenance of our REIT qualification, applicable provisions of the Maryland General Corporation Law, or MGCL, and other factors as our board of directors may deem relevant from time to time. We believe that a change in any one of the following factors could adversely affect our results of operations and impair our ability to make distributions to our stockholders:

 

   

our ability to make profitable investments and loans;

 

   

margin calls or other expenses that reduce our cash flow;

 

   

defaults in our asset portfolio or decreases in the value of our portfolio; and

 

   

the fact that anticipated operating expense levels may not prove accurate, as actual results may vary from estimates.

As a result, no assurance can be given that we will be able to make distributions to our stockholders at any time in the future or that the level of any distributions we do make to our stockholders will achieve a market yield or increase or even be maintained over time, any of which could materially and adversely affect us.

In addition, distributions that we make to our stockholders will generally be taxable to our stockholders as ordinary income. However, a portion of our distributions may be designated by us as long-term capital gains to the extent that they are attributable to capital gain income recognized by us or may constitute a return of capital to the extent that they exceed our earnings and profits as determined for tax purposes. A return of capital is not taxable, but has the effect of reducing the basis of a stockholder’s investment in shares of our common stock.

Future offerings of debt or equity securities, which may rank senior to our common stock, may adversely affect the market price of our common stock.

If we decide to issue debt securities in the future, which would rank senior to our common stock, it is likely that they will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Additionally, any equity securities or convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock and may result in dilution to owners of our common stock. We and, indirectly, our stockholders will bear the cost of issuing and servicing such securities. Because our decision to issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock will bear the risk of our future offerings reducing the market price of our common stock and diluting the value of their stock holdings in us.

 

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Risks Related to Our Organization and Structure

Our management has no prior experience operating a REIT or a public company and therefore may have difficulty in successfully and profitably operating our business, or complying with regulatory requirements.

Prior to the closing of this offering and the formation transactions, our management had no experience operating a REIT or a public company. As a result, we cannot assure you that we will be able to successfully operate as a REIT, execute our business strategies as a public company, or comply with regulatory requirements applicable to public companies.

Our business could be harmed if key personnel terminate their employment with us.

Our success depends, to a significant extent, on the continued services of Jeffrey Eckel, Brendan Herron, Steve Chuslo, Rhem Wooten,                  and the other members of our senior management team. Upon completion of this offering and the formation transactions, several of our officers, including Jeffrey Eckel, our chief executive officer, Brendan Herron, our executive vice president and chief financial officer, Steve Chuslo, our executive vice president and general counsel, Rhem Wooten, our executive vice president and                  will enter into new employment agreements with us. These employment agreements will replace the employment arrangements that have been in place between these executives and Hannon Armstrong. These employment agreements provide for an initial four year term of employment for these executives. Notwithstanding these agreements, there can be no assurance that any of them will remain employed by us. Other than a policy of $5 million which we maintain for Jeffrey Eckel, we do not maintain key person life insurance on any of our officers. The loss of services of one or more members of our senior management team, particularly, could harm our business and our prospects.

Conflicts of interest could arise as a result of our structure.

Conflicts of interest could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our operating partnership or any partner thereof, on the other. Our directors and officers have duties to our company under applicable Maryland law in connection with our management. At the same time, we have fiduciary duties, as a general partner, to our operating partnership and to its limited partners under Delaware law in connection with the management of our operating partnership. Our duties, as the general partner, to our operating partnership and its partners may come into conflict with the duties of our directors and officers to us.

Unless otherwise provided for in the relevant partnership agreement, Delaware law generally requires a general partner of a Delaware limited partnership to adhere to fiduciary duty standards under which it owes its limited partners the highest duties of good faith, fairness and loyalty and which generally prohibit such general partner from taking any action or engaging in any transaction as to which it has a conflict of interest.

Additionally, the partnership agreement of our operating partnership, or our operating partnership agreement, expressly limits our liability by providing that neither we, as the general partner of the operating partnership, nor any of our directors or officers, will be liable or accountable in damages to our operating partnership, its limited partners or their assignees for errors in judgment, mistakes of fact or law or for any act or omission if the general partner, director or officer, acted in good faith. In addition, our operating partnership is required to indemnify us, our affiliates and each of our and their respective officers, directors, employees and agents to the fullest extent permitted by applicable law against any and all losses, claims, damages, liabilities (whether joint or several), expenses (including, without limitation, attorneys’ fees and other legal fees and expenses), judgments, fines, settlements and other amounts arising from any and all claims, demands, actions, suits or proceedings, civil, criminal, administrative or investigative, that relate to the operations of the operating partnership, provided that our operating partnership will not indemnify any such person for (1) willful misconduct or a knowing violation of the law, (2) any transaction for which such person received an improper personal benefit in violation or breach of any provision of our operating partnership agreement, or (3) in the case of a criminal proceeding, the person had reasonable cause to believe the act or omission was unlawful.

 

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The provisions of Delaware law that allow the common law fiduciary duties of a general partner to be modified by a partnership agreement have not been resolved in a court of law, and we have not obtained an opinion of counsel covering the provisions set forth in our operating partnership agreement that purport to waive or restrict our fiduciary duties that would be in effect under common law were it not for our operating partnership agreement.

Certain provisions of Maryland law could inhibit changes in control.

Certain provisions of the MGCL may have the effect of deterring a third party from making a proposal to acquire us or of impeding a change in control under circumstances that otherwise could provide the holders of our common stock with the opportunity to realize a premium over the then-prevailing market price of our common stock. We are subject to the “business combination” provisions of the MGCL that, subject to limitations, prohibit certain business combinations (including a merger, consolidation, statutory share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities) between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of our then outstanding voting stock or an affiliate or associate of ours who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of our then outstanding voting stock) or an affiliate thereof for five years after the most recent date on which the stockholder becomes an interested stockholder. After the five-year prohibition, any business combination between us and an interested stockholder generally must be recommended by our board of directors and approved by the affirmative vote of at least (1) 80% of the votes entitled to be cast by holders of outstanding shares of our voting stock and (2) two-thirds of the votes entitled to be cast by holders of our voting stock other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder. These super-majority vote requirements do not apply if, among other conditions, our common stockholders receive a minimum price, as defined under the MGCL, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. These provisions of the MGCL do not apply, however, to business combinations that are approved or exempted by a board of directors prior to the time that the interested stockholder becomes an interested stockholder. Our board of directors has by resolution exempted business combinations between us and (1) any other person, provided, that such business combination is first approved by our board of directors (including a majority of our directors who are not affiliates or associates of such person), (2) our predecessor and its affiliates and associates as part of the formation transactions and (3) persons acting in concert with any of the foregoing. As a result, any person described in the preceding sentence may be able to enter into business combinations with us that may not be in the best interests of our stockholders, without compliance by our company with the supermajority vote requirements and other provisions of the statute. There can be no assurance that our board of directors will not amend or revoke the exemption at any time.

The “control share” provisions of the MGCL provide that, subject to certain exceptions, a holder of “control shares” of a Maryland corporation (defined as shares which, when aggregated with all other shares controlled by the stockholder (except solely by virtue of a revocable proxy), entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of issued and outstanding “control shares”) has no voting rights with respect to such shares except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding votes entitled to be cast by the acquiror of control shares, our officers and our personnel who are also our directors. Our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of shares of our stock. There can be no assurance that this provision will not be amended or eliminated at any time in the future.

The “unsolicited takeover” provisions of Title 3, Subtitle 8 of the MGCL permit our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement certain takeover defenses, some of which (for example, a classified board) we do not yet have. Our charter contains a provision whereby we have elected to be subject to the provisions of Title 3, Subtitle 8 of the MGCL, pursuant to which our board of directors has the exclusive power to fill vacancies on our board of directors.

 

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These provisions may have the effect of inhibiting a third party from making an acquisition proposal for us or of delaying, deferring or preventing a change in control of us under the circumstances that otherwise could provide the holders of shares of common stock with the opportunity to realize a premium over the then current market price. See “Certain Provisions of the Maryland General Corporation Law and Our Charter and Bylaws—Business Combinations,” “Control Share Acquisitions” and “Subtitle 8.”

Our authorized but unissued shares of common and preferred stock may prevent a change in our control.

Our charter permits our board of directors to authorize us to issue additional shares of our authorized but unissued common or preferred stock. In addition, our board of directors may, without stockholder approval, amend our charter to increase the aggregate number of our shares of stock or the number of shares of stock of any class or series that we have the authority to issue and classify or reclassify any unissued shares of common or preferred stock and set the terms of the classified or reclassified shares. As a result, our board of directors may establish a series of shares of common or preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders.

Our rights and the rights of our stockholders to take action against our directors and officers are limited, which could limit your recourse in the event of actions not in your best interests.

Our charter limits the liability of our present and former directors and officers to us and our stockholders for money damages to the maximum extent permitted under Maryland law. Under Maryland law, our present and former directors and officers will not have any liability to us or our stockholders for money damages other than liability resulting from:

 

   

actual receipt of an improper benefit or profit in money, property or services; or

 

   

active and deliberate dishonesty by the director or officer that was established by a final judgment and was material to the cause of action adjudicated.

Our charter authorizes us to indemnify our directors and officers for actions taken by them in those and other capacities to the maximum extent permitted by Maryland law. Our bylaws require us to indemnify each present and former director or officer, to the maximum extent permitted by Maryland law, in connection with the defense of any proceeding to which he or she is made, or threatened to be made, a party or a witness by reason of his or her service to us. In addition, we may be obligated to pay or reimburse the expenses incurred by our present and former directors and officers in connection with any such proceedings without requiring a preliminary determination of their ultimate entitlement to indemnification. See “Certain Provisions of Maryland General Corporation Law and Our Charter and Bylaws—Indemnification and Limitation of Directors’ and Officers’ Liability.”

Our charter contains provisions that make removal of our directors difficult, which could make it difficult for our stockholders to effect changes to our management.

Our charter provides that, subject to the rights of holders of any series of preferred stock, a director may be removed with or without cause upon the affirmative vote of holders of at least two-thirds of the votes entitled to be cast generally in the election of directors. Upon completion of this offering, vacancies may be filled only by a majority of the remaining directors in office, even if less than a quorum. These requirements make it more difficult to change our management by removing and replacing directors and may prevent a change in control of our company that is in the best interests of our stockholders.

Ownership limitations may restrict change of control or business combination opportunities in which our stockholders might receive a premium for their shares.

In order for us to qualify as a REIT for each taxable year after 2013, no more than 50% in value of our outstanding capital stock may be owned, directly or constructively, by five or fewer individuals during the last

 

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half of any calendar year, and at least 100 persons must beneficially own our stock during at least 335 days of a taxable year of 12 months, or during a proportionate portion of a shorter taxable year. “Individuals” for this purpose include natural persons, private foundations, some employee benefit plans and trusts, and some charitable trusts. To assist us in preserving our REIT qualification, among other purposes, our charter generally prohibits any person from directly or indirectly owning more than 9.8% in value or in number of shares, whichever is more restrictive, of the aggregate outstanding shares of our capital stock, the outstanding shares of any class or series of our preferred stock or the outstanding shares of our common stock. These ownership limits could have the effect of discouraging a takeover or other transaction in which holders of our common stock might receive a premium for their shares over the then prevailing market price or which holders might believe to be otherwise in their best interests. We expect that, before the completion of this offering, our board of directors will establish an exemption from this ownership limit which permits MissionPoint and certain of its affiliates to collectively hold up to     shares of our outstanding common stock.

We expect to become subject to financial reporting and other requirements for which our accounting, internal audit and other management systems and resources may not be adequately prepared.

Following this offering, we will become subject to reporting and other obligations under the Exchange Act, including the requirements of Section 404 of the Sarbanes-Oxley Act. Section 404 requires annual management assessments of the effectiveness of our internal controls over financial reporting and, after we are no longer an “Emerging Growth Company” for purposes of the JOBS Act, our independent registered public accounting firm to express an opinion on the effectiveness of our internal controls over financial reporting. To the extent applicable, these reporting and other obligations place or will place significant demands on our management, administrative, operational, internal audit and accounting resources and will cause us to incur significant expenses. We may need to upgrade our systems or create new systems; implement additional financial and management controls, reporting systems and procedures; expand or outsource our internal audit function; and hire additional accounting, internal audit and finance staff. If we are unable to accomplish these objectives in a timely and effective fashion, our ability to comply with the financial reporting requirements and other rules that apply to reporting companies could be impaired. We expect to have in place accounting, internal audit and other management systems and resources that will allow us to maintain compliance with the requirements of the Sarbanes-Oxley Act either at the time of the completion of this offering or at the end of any phase-in periods following the completion of this offering permitted by the NYSE, the SEC and the JOBS Act. Any failure to maintain effective internal controls could have a material adverse effect on our business, operating results and stock price.

Pursuant to the recently enacted JOBS Act, we are eligible to take advantage of certain specified reduced disclosure and other requirements that are otherwise generally applicable to public companies for so long as we are an “emerging growth company.”

We are an “emerging growth company” as defined in the JOBS Act and we are eligible to take advantage of certain specified reduced disclosure and other requirements that are otherwise generally applicable to public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We may take advantage of these exemptions for up to five years or such earlier time that we are no longer an “emerging growth company.” We would cease to be an “emerging growth company” if we have more than $1 billion in annual gross revenues, we have more than $700 million in market value of our stock held by non-affiliates, or we issue more than $1 billion of non-convertible debt over a three-year period. If we do take advantage of any or all of these exceptions, we cannot predict if some investors will find our common stock less attractive because we will rely on these exemptions. If we do take advantage of any or all of these exemptions, we do not know if some investors will find our common stock less attractive as a result. The result may be a less active trading market for our common stock and our stock price may be more volatile.

 

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Risks Related to Our Taxation as a REIT

Qualifying as a REIT involves highly technical and complex provisions of the Internal Revenue Code, and our failure to qualify or remain qualified as a REIT would subject us to U.S. federal income tax and applicable state and local tax, which would negatively impact the results of our operations and reduce the amount of cash available for distribution to our stockholders.

We have been organized and we intend to operate in a manner that will enable us to qualify as a REIT for U.S. federal income tax purposes commencing with our taxable year ending December 31, 2013. The U.S. federal income tax laws governing REITs are complex, and judicial and administrative interpretations of the U.S. federal income tax laws governing REIT qualification are limited. To qualify as a REIT and remain so qualified, we must meet, on an ongoing basis, various tests regarding the nature and diversification of our assets and our income, the ownership of our outstanding shares, and the amount of our distributions. Even a technical or inadvertent violation could jeopardize our REIT qualification. Our ability to satisfy the asset tests depends upon our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals.

We intend to treat a substantial portion of our existing assets and any similar assets that we may in the future have an interest in as qualifying real estate assets for purposes of the REIT asset tests, and intend to treat the income derived from such assets as interest income qualifying under the 75% gross income test. We received a private letter ruling from the Internal Revenue Service, or the IRS, relating to our ability to treat certain of our assets as qualifying REIT assets to the extent they fall within the scope of such private letter ruling. We are entitled to rely upon this ruling for those assets which fit within the scope of the ruling only to the extent that we have the legal and contractual rights described therein and did not misstate or omit in the ruling request a relevant fact and that we continue to operate in the future in accordance with the relevant facts described in such request, and no assurance can be given that we will always be able to do so.

If we were not able to treat the interest income that we receive as qualifying income for purposes of the REIT gross income tests, we would be required to restructure the manner in which we receive such income and we may realize significant income that does not qualify for the REIT 75% gross income test, which could cause us to fail to qualify as a REIT. In addition, our compliance with the REIT income and quarterly asset requirements also depends upon our ability to successfully manage the composition of our income and assets on an ongoing basis in accordance with existing REIT regulations and rules and interpretations thereof. Moreover, the IRS, new legislation, court decisions or other administrative guidance, in each case possibly with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT. In addition, our ability to satisfy the requirements to qualify as a REIT depends in part on the actions of third parties over which we have no control or only limited influence, including in cases where we own an equity interest in an entity that is classified as a partnership for U.S. federal income tax purposes. Thus, while we intend to operate so that we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, and the possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year.

If we fail to qualify as a REIT in any taxable year, and we do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax on our taxable income, and distributions to our stockholders would not be deductible by us in determining our taxable income. In such a case, we might need to borrow money or sell assets in order to pay our taxes. Our payment of income tax would negatively impact the results of our operations and decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to maintain our qualification as a REIT, we no longer would be required to distribute substantially all of our taxable income to our stockholders. In addition, unless we were eligible for certain statutory relief provisions, we could not re-elect to qualify as a REIT for the subsequent four taxable years following the year in which we failed to qualify.

 

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Complying with REIT requirements may force us to liquidate or forego otherwise attractive investments.

To qualify as a REIT, we must ensure that we meet the REIT gross income tests annually and that, at the end of each calendar quarter, at least 75% of the value of our total assets consists of cash, cash items, government securities, shares in REITs and other qualifying real estate assets. The remainder of our investment in securities (other than government securities and REIT qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our total assets (other than government securities, securities of a TRS and securities that are qualifying real estate assets) can consist of the securities of any one issuer, and no more than 25% of the value of our total assets can be represented by securities of one or more TRSs. See “U.S. Federal Income Tax Considerations—Asset Tests” If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate from our portfolio, or contribute to a TRS, otherwise attractive investments, and may be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source of income or asset diversification requirements for qualifying as a REIT. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.

REIT distribution requirements could adversely affect our ability to execute our business plan and may require us to incur debt or sell assets to make such distributions.

In order to qualify as a REIT, we must distribute to our stockholders, each calendar year, at least 90% of our REIT taxable income (including certain items of non-cash income), determined without regard to the deduction for dividends paid and excluding net capital gain. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to U.S. federal corporate income tax on our undistributed income. In addition, we will incur a 4% non-deductible excise tax on the amount, if any, by which our distributions in any calendar year are less than a minimum amount specified under U.S. federal income tax laws. We intend to distribute our taxable income to our stockholders in a manner intended to satisfy the REIT 90% distribution requirement and to avoid the 4% non-deductible excise tax.

In addition, differences in timing between the recognition of taxable income, our U.S. GAAP income and the actual receipt of cash may occur. For example, we may be required to accrue interest and discount income on debt securities or interests in debt securities before we receive any payments of interest or principal on such assets, and there may be timing differences in the accrual of such interest and discount income for tax purposes and for U.S. GAAP purposes.

As a result of the foregoing, we may generate less cash flow than taxable income in a particular year and find it difficult or impossible to meet the REIT distribution requirements in certain circumstances. In such circumstances, we may be required to: (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms, (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt, (iv) make a taxable distribution of our shares as part of a distribution in which stockholders may elect to receive shares or (subject to a limit measured as a percentage of the total distribution) cash or (v) use cash reserves, in order to comply with the REIT distribution requirements and to avoid U.S. federal corporate income tax and the 4% non-deductible excise tax. Thus, compliance with the REIT distribution requirements may hinder our ability to grow, which could adversely affect the value of our common stock.

Even if we qualify as a REIT, we may face tax liabilities that reduce our cash flow.

Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, franchise, property and transfer taxes, including

 

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mortgage recording taxes. See “U.S. Federal Income Tax Considerations—Taxation of REITs in General.” In addition, any TRSs we own will be subject to U.S. federal, state and local corporate income or franchise taxes. In order to meet the REIT qualification requirements, or to avoid the imposition of a 100% tax that applies to certain gains derived by a REIT from sales of inventory or property held primarily for sale to customers in the ordinary course of business, we may hold some of our assets through TRSs. Any taxes paid by such TRSs would decrease the cash available for distribution to our stockholders.

The failure of assets subject to a repurchase agreement to be considered owned by us or a mezzanine loan to qualify as a real estate asset may adversely affect our ability to qualify as a REIT.

We may enter into repurchase agreements under which we will nominally sell certain of our assets to a counterparty and simultaneously enter into an agreement to repurchase the sold assets. We believe that we will be treated for U.S. federal income tax purposes as the owner of the assets that are the subject of any such agreements and that the repurchase agreements will be treated as secured lending transactions notwithstanding that such agreements may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could assert that we did not own the assets during the term of the repurchase agreement, in which case we could fail to qualify as a REIT.

In addition, we may acquire mezzanine loans, which are loans secured by equity interests in a partnership or limited liability company that directly or indirectly owns real property. In Revenue Procedure 2003-65, the IRS provided a safe harbor pursuant to which a mezzanine loan, if it meets each of the requirements contained in the Revenue Procedure, will be treated by the IRS as a real estate asset for purposes of the REIT asset tests, and interest derived from the mezzanine loan will be treated as qualifying mortgage interest for purposes of the REIT 75% gross income test. Although the Revenue Procedure provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law. We may acquire mezzanine loans that may not meet all of the requirements for reliance on this safe harbor. In the event we own a mezzanine loan that does not meet the safe harbor, the IRS could challenge such loan’s treatment as a real estate asset for purposes of the REIT asset and income tests, and if such a challenge were sustained, we could fail to qualify as a REIT.

We may be required to report taxable income for certain investments in excess of the economic income we ultimately realize from them.

We may, in the future, acquire debt instruments in the secondary market for less than their face amount. The amount of such discount will generally be treated as “market discount” for U.S. federal income tax purposes. We expect to accrue market discount on the basis of a constant yield to maturity of a debt instrument. Accrued market discount is reported as income when, and to the extent that, any payment of principal of the debt instrument is made, unless we elect to include accrued market discount in income as it accrues. Principal payments on certain loans are made monthly, and consequently accrued market discount may have to be included in income each month as if the debt instrument were assured of ultimately being collected in full. If we collect less on the debt instrument than our purchase price plus the market discount we had previously reported as income, we may not be able to benefit from any offsetting loss deductions.

Similarly, some of the debt instruments that we acquire may have been issued with original issue discount. We will be required to report such original issue discount based on a constant yield method and will be taxed based on the assumption that all future projected payments due on such debt instruments will be made. If such debt instruments turn out not to be fully collectible, an offsetting loss deduction will become available only in the later year that uncollectability is provable. In addition, in the event that any debt instruments acquired by us are delinquent as to mandatory principal and interest payments, or in the event payments with respect to a particular debt instrument are not made when due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income as it accrues, despite doubt as to its ultimate collectability. While we would in general ultimately have an offsetting loss deduction available to us when such interest was determined to be uncollectible, the utility of that deduction could depend on our having taxable income in that later year or thereafter. Although we do not

 

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presently intend to, we may, in the future, acquire debt investments that are subsequently modified by agreement with the borrower. If such amendments are “significant modifications” under the applicable Treasury Regulations, we may be required to recognize taxable income as a result of such amendments. Finally, we may be required under the terms of indebtedness that we incur with private lenders to use cash received from interest payments to make principal payments on that indebtedness, with the effect of recognizing income but not having a corresponding amount of cash available for distribution to our stockholders.

The interest apportionment rules under Treasury Regulation Section 1.856-5(c) provide that, if a loan is secured by both real property and other property, a REIT is required to apportion its annual interest income to the real property securing the loan based on a fraction, the numerator of which is the value of such real property, determined when the REIT commits to acquire the loan, and the denominator of which is the highest “principal amount” of the loan during the year. IRS Revenue Procedure 2011-16, interprets the “principal amount” of the loan to be the face amount of the loan, despite the Internal Revenue Code requiring taxpayers to treat any market discount, that is the difference between the purchase price of the loan and its face amount, for all purposes (other than certain withholding and information reporting purposes) as interest rather than principal. The interest apportionment regulations apply only if the loan in question is secured by both real property and other property.

If the IRS were to assert successfully that our loans were secured by property other than real estate, the interest apportionment rules applied for purposes of our REIT testing, and that the position taken in IRS Revenue Procedure 2011-16 should be applied to certain loans in our portfolio, then depending upon the value of the real property securing our loans and their face amount, and the sources of our gross income generally, we may fail to meet the 75% REIT gross income test discussed under “Material U.S. Federal Income Tax Considerations—Gross Income Tests.” If we do not meet this test, we could potentially lose our REIT qualification or be required to pay a penalty to the IRS.

The “taxable mortgage pool” rules may increase the taxes that we or our stockholders may incur, and may limit the manner in which we effect future securitizations.

Securitizations by us or our subsidiaries could result in the creation of taxable mortgage pools for U.S. federal income tax purposes. As a result, we could have “excess inclusion income.” Certain categories of stockholders, such as non-U.S. stockholders eligible for treaty or other benefits, U.S. stockholders with net operating losses, and certain U.S. tax-exempt stockholders that are subject to unrelated business income tax, could be subject to increased taxes on a portion of their dividend income from us that is attributable to any such excess inclusion income. In the case of a stockholder that is a REIT, a regulated investment company, or RIC, common trust fund or other pass-through entity, our allocable share of our excess inclusion income could be considered excess inclusion income of such entity. In addition, to the extent that our common stock is owned by U.S. tax-exempt “disqualified organizations,” such as certain government-related entities and charitable remainder trusts that are not subject to tax on unrelated business income, we may incur a corporate level tax on a portion of any excess inclusion income. Because this tax generally would be imposed on us, all of our stockholders, including stockholders that are not disqualified organizations, generally will bear a portion of the tax cost associated with the classification of us or a portion of our assets as a taxable mortgage pool. A RIC, or other pass-through entity owning our common stock in record name will be subject to tax at the highest U.S. federal corporate tax rate on any excess inclusion income allocated to their owners that are disqualified organizations. Moreover, we could face limitations in selling equity interests in these securitizations to outside investors, or selling any debt securities issued in connection with these securitizations that might be considered to be equity interests for tax purposes. Finally, if we were to fail to qualify as a REIT, any taxable mortgage pool securitizations would be treated as separate taxable corporations for U.S. federal income tax purposes that could not be included in any consolidated U.S. federal corporate income tax return. These limitations may prevent us from using certain techniques to maximize our returns from securitization transactions.

 

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Although our use of TRSs may be able to partially mitigate the impact of meeting the requirements necessary to maintain our qualification as a REIT, our ownership of and relationship with our TRSs is limited and a failure to comply with the limits would jeopardize our REIT qualification and may result in the application of a 100% excise tax.

A REIT may own up to 100% of the stock of one or more TRSs. Subject to certain exceptions, a TRS may hold assets and earn income that would not be qualifying assets or income if held or earned directly by a REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 25% of the value of a REIT’s total assets may consist of stock or securities of one or more TRSs. In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis. Our TRSs will pay U.S. federal, state and local income or franchise tax on their taxable income, and their after-tax net income will be available for distribution to us but will not be required to be distributed to us, unless necessary to maintain our REIT qualification. While we will be monitoring the aggregate value of the securities of our TRSs and intend to conduct our affairs so that such securities will represent less than 25% of the value of our total assets, there can be no assurance that we will be able to comply with the TRS limitation in all market conditions.

Dividends payable by REITs generally do not qualify for the reduced tax rates on dividend income from regular corporations, which could adversely affect the value of our shares.

The maximum U.S. federal income tax rate for certain qualified dividends payable to U.S. stockholders that are individuals, trusts and estates is 20%. Dividends payable by REITs are generally not eligible for the reduced rates and therefore may be subject to a 39.6% maximum U.S. federal income tax rate on ordinary income. Although the reduced U.S. federal income tax rate applicable to dividend income from regular corporate dividends does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including shares of our common stock.

The tax on prohibited transactions will limit our ability to engage in transactions, including certain methods of securitizing loans, that would be treated as sales for U.S. federal income tax purposes.

A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, but including loans, held as inventory or primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were to sell or securitize loans in a manner that was treated as a sale of the loans as inventory for U.S. federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans, other than through a TRS, and we may be required to limit the structures we use for our securitization transactions, even though such sales or structures might otherwise be beneficial for us.

Complying with REIT requirements may limit our ability to hedge effectively.

The REIT provisions of the Internal Revenue Code may limit our ability to hedge our assets and operations. Under these provisions, any income that we generate from transactions intended to hedge our interest rate exposure will be excluded from gross income for purposes of the REIT 75% and 95% gross income tests if the instrument hedges interest rate risk on liabilities used to carry or acquire real estate assets, or certain other specified types of risk, and such instrument is properly identified under applicable Treasury Regulations. Income from hedging transactions that do not meet these requirements will generally constitute nonqualifying income for

 

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purposes of both the REIT 75% and 95% gross income tests. See “U.S. Federal Income Tax Considerations—Gross Income Tests—Hedging Transactions.” As a result of these rules, we may have to limit our use of hedging techniques that might otherwise be advantageous or implement those hedges through a TRS. This could increase the cost of our hedging activities because our TRS would be subject to tax on gains or the limits on our use of hedging techniques could expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in our TRS will generally not provide any tax benefit to us, although such losses may be carried forward to offset future taxable income of the TRS.

We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of shares of our common stock.

At any time, the U.S. federal income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be changed, possibly with retroactive effect. We cannot predict if or when any new U.S. federal income tax law, regulation or administrative interpretation, or any amendment to any existing U.S. federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective or whether any such law, regulation or interpretation may take effect retroactively. We and our stockholders could be adversely affected by any such change in, or any new, U.S. federal income tax law, regulation or administrative interpretation.

Liquidation of our assets may jeopardize our REIT qualification.

To qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our assets to repay obligations to our lenders, we may be unable to comply with these requirements, thereby jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as inventory or property held primarily for sale to customers in the ordinary course of business.

Your investment has various U.S. federal income tax risks.

Although the provisions of the Internal Revenue Code generally relevant to an investment in shares of our common stock are described in “U.S. Federal Income Tax Considerations,” we urge you to consult your tax advisor concerning the effects of U.S. federal, state, local and foreign tax laws to you with regard to an investment in shares of our common stock.

 

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FORWARD-LOOKING STATEMENTS

We make forward-looking statements in this prospectus that are subject to risks and uncertainties. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may” or similar expressions, we intend to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking:

 

   

use of the proceeds of this offering;

 

   

the state of government legislation, regulation and policies that support energy efficiency, renewable energy and sustainable infrastructure projects and that enhance the economic feasibility of energy efficiency, renewable energy and sustainable infrastructure projects and the general market demands for such projects;

 

   

market trends in our industry, energy markets, commodity prices, interest rates, the debt and lending markets or the general economy;

 

   

our business and investment strategy;

 

   

our relationships with originators, investors, market intermediaries and professional advisers;

 

   

competition from other providers of financing;

 

   

our or any other companies’ projected operating results;

 

   

actions and initiatives of the U.S. federal, state and local government and changes to U.S. federal, state and local government policies and the execution and impact of these actions, initiatives and policies;

 

   

the state of the U.S. economy generally or in specific geographic regions, states or municipalities;

 

   

economic trends and economic recoveries;

 

   

our ability to obtain and maintain financing arrangements on favorable terms, including securitizations;

 

   

general volatility of the securities markets in which we participate;

 

   

changes in the value of our assets;

 

   

our portfolio of assets;

 

   

our investment and underwriting process;

 

   

interest rate and maturity mismatches between our assets and any borrowings used to fund such assets;

 

   

changes in interest rates and the market value of our target assets;

 

   

changes in commodity prices;

 

   

effects of hedging instruments on our target assets;

 

   

rates of default or decreased recovery rates on our target assets;

 

   

the degree to which our hedging strategies may or may not protect us from interest rate volatility;

 

   

impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters;

 

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our ability to qualify, and maintain our qualification, as a REIT for U.S. federal income tax purposes;

 

   

our ability to maintain our exemption from registration under the 1940 Act;

 

   

availability of opportunities to originate energy efficiency, renewable energy and sustainable infrastructure projects;

 

   

availability of qualified personnel;

 

   

estimates relating to our ability to make distributions to our stockholders in the future; and

 

   

our understanding of our competition.

The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. Forward-looking statements are not predictions of future events. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. Some of these factors are described in this prospectus under the headings “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. New risks and uncertainties arise over time, and it is not possible for us to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately $         million, or approximately $         million if the underwriters’ option to purchase additional shares is exercised in full, after deducting the underwriting discounts and commissions, and estimated expenses of this offering. We will contribute the net proceeds of this offering to our operating partnership, which will subsequently use the net proceeds as follows:

 

   

$         million to retire the notes collateralized by              of our projects in order to enable us to retain a larger share of their future cash flows; and

 

   

$         million to repay our existing credit facility and related interest rate cap and swap with Bank of America, N.A., an affiliate of one of the underwriters in this offering. The existing credit facility bears interest at a floating rate equal to one-month LIBOR plus 2.75%. We have fixed the interest rate at 4.90% through the purchase of an amortizing interest rate swap from Bank of America, N.A. Both the credit facility and the swap have a maturity date of September 30, 2015.

The net proceeds remaining after the uses described above, which are estimated to be $         million, or approximately $         million if the underwriters’ option to purchase additional shares is exercised in full, will be used to acquire additional assets and for general corporate and working capital purposes.

Pending application of cash proceeds, we will invest such portion of the net proceeds in interest-bearing accounts and short-term, interest-bearing securities which are consistent with our intention to qualify for taxation as a REIT.

 

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DISTRIBUTION POLICY

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 pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its taxable income. Although not currently anticipated, 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, we could be required to sell assets or borrow funds 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. For more information, see “U.S. Federal Income Tax Considerations—Taxation of Our Company—General.”

If we pay a taxable stock distribution, our stockholders would be sent a form that would allow each stockholder to elect to receive its proportionate share of such distribution in all cash or in all stock, and the distribution will be made in accordance with such elections, provided that if our stockholders’ elections, in the aggregate, would result in the payment of cash in excess of the maximum amount of cash to be distributed, then cash payments to stockholders who elected to receive cash will be prorated, and the excess of each such stockholder’s entitlement in the distribution, less such prorated cash payment, would be paid to such stockholder in shares of our common stock.

To satisfy the requirements to qualify as a REIT and generally not be subject to U.S. federal income and excise tax, we intend to make regular quarterly distributions of all or substantially all of our taxable income to holders of our common stock out of assets legally available therefor. Any distributions we make will be at the discretion of our board of directors and will depend upon our earnings and financial condition, any debt covenants, funding or margin requirements under credit facilities, repurchase agreements or other secured and unsecured borrowing agreements, maintenance of our REIT qualification, applicable provisions of the MGCL and such other factors as our board of directors deems relevant. Our earnings and financial condition will be affected by various factors, including the net interest and other income from our portfolio, our operating expenses and any other expenditures. For more information regarding risk factors that could materially and adversely affect our earnings and financial condition, see “Risk Factors.”

We anticipate that our distributions generally will be taxable as ordinary income to our stockholders, although a portion of the distributions may be designated by us as qualified dividend income or capital gain or may 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. For more information, see “U.S. Federal Income Tax Considerations—Taxation of Taxable U.S. Stockholders.”

 

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CAPITALIZATION

The following table presents the capitalization as of December 31, 2012 on a combined historical basis for Hannon Armstrong, on a pro forma basis for our company taking into account the formation transactions, but before this offering, and on a pro forma as adjusted basis for our company taking into account both this offering (assuming an offering price at the mid-point of the initial public offering price range on the cover page of this prospectus) and the formation transactions. The pro forma adjustments give effect to this offering and the formation transactions and the application of the net proceeds as described in “Use of Proceeds,” as if they had occurred on December 31, 2012. You should read this table in conjunction with “Use of Proceeds,” “Summary Financial Data,” “Selected Pro Forma and Historical Financial and Operating Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the more detailed information contained in the consolidated financial statements and notes thereto included elsewhere in this prospectus.

 

     As of December 31, 2012  
     Historical      Pro Forma      Pro Forma
As Adjusted
 
     (In thousands, except share and per
share data)
 

Cash and cash equivalents

   $ 8,024       $         $     
  

 

 

    

 

 

    

 

 

 

Liabilities:

        

Credit facility

   $ 4,170         

Nonrecourse debt

     195,952         

Other Liabilities

     6,813         
  

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ 206,935       $         $     
  

 

 

    

 

 

    

 

 

 

Member/Stockholders’ equity:

        

Series A Participating Preferred Units, 15,601,077 units authorized and outstanding on a historical basis

     —           

Common stock Units, par value $0.01 per unit, 1,733,453 units authorized, 1,200,000 units issued on a historical basis

     68         

Preferred stock, par value $0.01 per share,              shares authorized, no shares issued and outstanding on a historical basis;              shares authorized,              shares issued and outstanding on a pro forma basis;              shares authorized,              shares issued and outstanding on a pro forma as adjusted basis

        

Common stock, par value $0.01 per share,              shares authorized, no shares issued and outstanding on a historical basis;              shares authorized,              shares issued and outstanding on a pro forma basis;              shares authorized,              shares issued and outstanding on a pro forma as adjusted basis(1)

        

Additional paid in capital

        

Retained earnings

     5,511         

Accumulated other comprehensive income

     272         

Non-controlling interests

        
  

 

 

    

 

 

    

 

 

 

Total member/stockholders’ equity

     5,851         
  

 

 

    

 

 

    

 

 

 

Total capitalization

   $ 212,786       $                    $                
  

 

 

    

 

 

    

 

 

 

 

(1) The common stock outstanding as shown includes shares of common stock to be issued in this offering and our formation transactions and shares of restricted common stock to be issued to our independent directors, officers and employees upon completion of this offering and excludes (1) up to              shares issuable upon exercise in full of the underwriters’ option to purchase additional shares, (2)              shares issuable upon exchange of outstanding OP units and (3)             shares issuable upon exchange of              LTIP units and (4) any shares of our restricted common stock that may be granted in the future to our independent directors, officers or other personnel under our equity incentive plan. See “Our Management—Equity Incentive Plan.”

 

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DILUTION

Purchasers of shares of our common stock in this offering will experience an immediate and significant dilution of the net tangible book value of our common stock from the initial public offering price. As of December 31, 2012, the historical book value of Hannon Armstrong was $         million or $         per share of common stock (calculated by dividing the historical book value of Hannon Armstrong as of December 31, 2012 by the number of shares of common stock and OP units we expect to issue in the formation transactions). After giving effect to the sale of shares of common stock in this offering, the receipt by us of the net proceeds from this offering (assuming an offering price at the mid-point of the initial public offering price range shown on the cover page of this prospectus), the deduction of underwriting discounts and commissions, and estimated offering expenses payable by us, our pro forma net tangible book value at December 31, 2012 would have been $         million or $         per share of common stock or an                      in pro forma net tangible book value attributable to the sale of shares of common stock to new investors of $         million or $         per share. This amount represents an immediate dilution in pro forma net tangible book value of $         per share from the initial public offering price of $         per share (assuming an offering price at the mid-point of the initial public offering price range shown on the cover page of this prospectus). The following table illustrates this per share dilution:

 

Assumed initial public offering price per share of common stock

   $                

Historical net tangible book value per share(1)

   $     

Increase in net tangible book value per share attributable to this offering(2)

   $     

Pro forma net tangible book value per share after the offering(3)

   $     
  

 

 

 

Dilution in net tangible book value per share to new investors(4)

   $     
  

 

 

 

 

(1) Historical net tangible book value per share is based on the historical book value of Hannon Armstrong as of December 31, 2012 divided by the number of shares of common stock and OP units expected to issued in the formation transactions. Such number of shares do not include the LTIP units/shares of our restricted common stock to be issued to our independent directors, our officers and other personnel upon consummation of this offering.
(2) This amount is calculated after deducting underwriting discounts and commissions and estimated offering and formation transaction expenses.
(3) Based on pro forma net tangible book value of approximately $         divided by the sum of              shares of our common stock to be outstanding upon completion of this offering on a fully diluted basis, but excluding the LTIP units/ restricted shares of our common stock to be issued to our independent directors, our officers and our other personnel upon consummation of this offering. There is no further impact on book value dilution attributable to the exchange of OP units to be issued to the continuing investors in the formation transactions.
(4) Dilution is determined by subtracting pro forma net tangible book value per share of our common stock after this offering and the formation transactions from the initial public offering price paid by a new investor for a share of our common stock.

The table below summarizes, as of December 31, 2012, the differences between the number of shares of common stock and OP units issued by us and our operating partnership in the formation transactions, the total consideration paid and the average price per share/unit paid by former owners of Hannon Armstrong (based on the historical net tangible book value attributable to the ownership interests exchanged by such owners in the formation transactions) and by the new investors purchasing shares of common stock in this offering (assuming an offering price at the mid-point of the initial public offering price range shown on the cover page of this prospectus).

 

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     Shares/Units Issued     Cash/Net Tangible/Book
Value of Contribution
    Average Price
Per Share/Unit
      Number    Percentage     Amount     Percentage    
          (dollars in thousands)      

Common stock to be issued in connection with the formation transactions

                     $          (1)                  

OP units to be issued in connection with the formation transactions

           

Subtotal

               (1)     

Limited partner profits interests and restricted shares of common stock to be issued to independent directors, our officers and our other personnel upon consummation of this offering

           

New investors

               (2)     
  

 

  

 

 

   

 

 

   

 

 

   

 

Total

        100   $          100  
  

 

  

 

 

   

 

 

   

 

 

   

 

 

(1) Represents historical net tangible book value as of December 31, 2012 of Hannon Armstrong, giving effect to the issuance of shares of common stock or OP units (as applicable) in the formation transactions.
(2) Assuming an initial public offering price at the mid-point of the initial public offering price range shown on the cover page of this prospectus. Estimated underwriting discounts and commissions and estimated offering expenses have not been deducted.

This table excludes shares of common stock that may be issued by us upon exercise of the underwriters’ option to purchase additional shares of common stock, and              shares of common stock issuable upon exchange of LTIP units and                  shares of our restricted common stock to be issued to our independent directors, officers and employees upon consummation of this offering under our equity incentive plan, as described under “Our Management—Equity Incentive Plan.” Further dilution to our new investors will result if these excluded shares of common stock are issued by us in the future.

 

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SELECTED PRO FORMA AND HISTORICAL FINANCIAL AND OPERATING DATA

The following table sets forth selected financial and operating data on a historical basis for Hannon Armstrong and on a pro forma basis for us giving effect to the formation transaction (including the distribution of our equity interest in HA EnergySource) and the application of the net proceeds of this offering. We have not presented historical information for our company because we have not had any corporate activity since our formation other than the issuance of shares of common stock in connection with the initial capitalization of our company and because we believe that a discussion of the results of our company would not be meaningful.

The following historical and pro forma financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical financial statements and related notes thereto and our unaudited pro forma combined consolidated financial statements included elsewhere in this prospectus. Hannon Armstrong’s fiscal year ends on September 30 of each year. Our fiscal year is expected to end on December 31 of each year, beginning with the year ended December 31, 2013. The historical combined consolidated balance sheet information as of September 30, 2012 and 2011 of Hannon Armstrong and the consolidated statements of operations information for the years ended September 30, 2012, 2011 and 2010 of Hannon Armstrong have been derived from the historical audited consolidated financial statements and related notes appearing elsewhere in this prospectus. The historical combined consolidated balance sheet information as of September 30, 2010, 2009 and 2008 of Hannon Armstrong and the consolidated statements of operations information for the years ended September 30, 2009 and 2008 of Hannon Armstrong have been derived from our audited historical consolidated financial statements not included in this prospectus. The historical condensed consolidated balance sheet information as of December 31, 2012, and condensed consolidated statements of operations information for the three-month periods ended December 31, 2012, and December 31, 2011 have been derived from the unaudited historical condensed consolidated financial statements of Hannon Armstrong, which we believe include all adjustments (consisting of normal recurring adjustments) necessary to present the information set forth therein under accounting principles generally accepted in the United States. The results of operations for the interim periods ended December 31, 2012 and December 31, 2011 are not necessarily indicative of the results to be obtained for the full fiscal year.

The selected unaudited condensed pro forma combined consolidated balance sheet data as of December 31, 2012 is presented as if this offering and our formation transactions all had occurred on December 31, 2012, and the unaudited pro forma condensed combined statement of operations and other data for the three month period ended December 31, 2012, and the unaudited pro forma condensed combined statement of operations and other data for the year ended September 30, 2012, are presented as if this offering and our formation transactions all had occurred on October 1, 2011. The pro forma information is not necessarily indicative of what our actual financial position or results of operations would have been as of or for the period indicated, nor does it purport to represent our future financial position or results of operations.

 

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    Three Months Ended December 31,     Year Ended September 30,  
    Pro Forma     Historical     Pro Forma     Historical  
    2012     2012     2011     2012     2012     2011     2010     2009     2008  
    (unaudited )      (unaudited )      (unaudited )      (unaudited )           
    (In Thousands, except share and per share data)  

Net Investment Revenue:

                 

Income from financing receivables

  $                   $ 2,834      $ 3,350      $        $ 11,848      $ 11,739      $ 10,904      $ 11,435      $ 8,902   

Investment interest expense

      (2,347     (2,821       (9,852     (9,442     (9,606     (10,593     (8,595
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Investment Revenue

      487        529          1,996        2,297        1,298        842        307   

Other Investment Revenue:

                 

Gain on securitization of receivables

      2,534        1,940          3,912        4,025        6,322        9,990        4,108   

Fee income

      254        288          11,380        877        7,716        933        1,215   

(Loss) income from equity method investment in affiliate

      (448     (799       (1,284     (5,047     8,663        (405     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Investment Revenue

      2,340        1,429          14,008        (145     22,701        10,518        5,323   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenue, net of investment interest expense

      2,827        1,958          16,004        2,152        23,999        11,360        5,630   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
                 

Compensation and benefits

      (1,157     (1,065       (7,697     (4,028     (7,191     (4,391     (3,302

General and administrative

      (584     (626       (3,901     (2,506     (1,856     (1,875     (1,293

Depreciation and amortization of intangibles

      (105     (113       (440     (431     (685     (816     (761

Other interest expense

      (56     (83       (287     (295     (369     (489     (599

Other income

      1        14          52        61        70        67        48   

Unrealized gain (loss) on derivative Instruments

      23        29          73        35        113        (94     (91
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Expenses, net

      (1,878     (1,844       (12,200     (7,164     (9,918     (7,598     (5,998
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

  $        $ 949      $ 114      $        $ 3,804      $ (5,012   $ 14,081      $ 3,762      $ (368
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance Sheet Data (at Period End):

                 

Investments in financing receivables

    $ 191,399          $ 195,582      $ 143,776      $ 159,210      $ 159,000      $ 184,742   

Cash and marketable securities

      8,024            20,948        2,139        5,784        10,272        6,112   

Total assets

      212,786            232,463        174,594        192,226        188,037        210,707   

Nonrecourse debt

      195,952            200,283        148,177        163,889        163,766        188,045   

Credit facility

      4,170            4,599        6,895        4,336        5,524        7,009   

Total liabilities

      206,935            213,301        158,309        169,797        173,166        197,677   

Total equity

      5,851            19,162        16,285        22,429        14,871        13,030   

Total liabilities and equity

      212,786            232,463        174,594        192,226        188,037        210,707   

Per Share Data:

                 

Pro forma basic and diluted earnings per share

                 

Pro forma weighted average shares outstanding—basic and diluted

                 

Other Data (unaudited):

                 

Net investment revenue

    $ 487      $ 529        $ 1,996      $ 2,297      $ 1,298      $ 842      $ 307   

Gain on securitization of receivable

      2,534        1,940          3,912        4,025        6,322        9,990        4,108   

Fee income

      254        288          11,380        877        7,716        933        1,215   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Investment Revenue from Ongoing Business Operations

    $ 3,275      $ 2,757        $ 17,288      $ 7,199      $ 15,336      $ 11,765      $ 5,630   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Investments in financing receivables

    $ 191,399          $ 195,582      $ 143,776      $ 159,210      $ 159,000      $ 184,742   

Plus Assets held in securitization trusts

      1,431,635            1,412,693        1,394,750        1,422,919        1,290,243        1,130,501   
   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Managed Assets

    $ 1,623,034          $ 1,608,275      $ 1,538,526      $ 1,582,129      $ 1,449,243      $ 1,315,243   
   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from financing receivables

    $ 2,834          $ 11,848      $ 11,739      $ 10,904      $ 11,435      $ 8,902   

Income from assets held in securitization trust

      20,670            84,582        82,176        72,126        60,534        60,755   
   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Investment Income from Managed Assets

    $ 23,504          $ 96,430      $ 93,915      $ 83,030      $ 71,969      $ 69,657   
   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Credit losses as a percentage of assets under management

      0.0         0.0     0.0     0.0     0.0     0.0

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion in conjunction with the “Selected Pro Forma and Historical Financial and Operating Data,” the historical consolidated financial statements and related notes of Hannon Armstrong, “Risk Factors,” and “Business” included elsewhere in this prospectus. Where appropriate, the following discussion includes the effects of this offering and our formation transactions on a pro forma basis. These effects are reflected in our pro forma consolidated financial statements located elsewhere in this prospectus. Unless specifically stated otherwise, all references to the years 2012, 2011 and 2010 in this Management’s Discussion and Analysis of Financial Condition and Results of Operations refer to our fiscal years ended September 30, 2012, 2011 and 2010, or the last day of such fiscal years, as the context requires. In connection with our determination to continue our business as a REIT, our fiscal year will coincide with the calendar year upon completion of this offering and the formation transactions, beginning with our year ending December 31, 2013.

Our Business

We are a specialty finance company that provides debt and equity financing for sustainable infrastructure projects. We focus on profitable sustainable infrastructure projects that increase energy efficiency, provide cleaner energy sources, positively impact the environment or make more efficient use of natural resources. We began our business more than 30 years ago, and since 2000, using our direct origination platform, we have provided or arranged over $3.9 billion of financing in more than 450 sustainable infrastructure transactions. Over this period, we have become the leading provider of financing for energy efficiency projects for the U.S. federal government, the largest property owner and energy user in the United States.

We provide and arrange debt and equity financing primarily for three types of projects, which we refer to together as sustainable infrastructure projects:

 

   

Energy Efficiency Projects: projects, typically undertaken by ESCOs, which reduce a building’s or facility’s energy usage or cost through the design and installation of improvements to various building components, including HVAC systems, lighting, energy controls, roofs, windows and/or building shells;

 

   

Clean Energy Projects: projects that deploy cleaner energy sources, such as solar, wind, geothermal and biomass as well as natural gas; and

 

   

Other Sustainable Infrastructure Projects: projects, such as water or communications infrastructure that reduce energy consumption, positively impact the environment or make more efficient use of natural resources.

We are highly selective in the projects we target. Our goal is to select projects that generate recurring and predictable cash flows or cost savings that will be more than adequate to repay the debt financing we provide or will deliver attractive returns on our equity investments. Our projects are typically characterized by revenues from contractually committed obligations of government entities or private high credit quality obligors and are often supported by additional forms of credit enhancement, including security interests and supplier guaranties. Our projects also generally employ proven technologies which minimize performance uncertainty, enabling us to more accurately predict project revenue and profitability over the term of the financing or investment. As a result of our highly selective approach to project targeting, the credit performance of our originated assets has been excellent. Since 2000, there has been only one incidence of realized loss, amounting to approximately $7.0 million (net of recoveries) on the more than $3.9 billion of transactions we originated during that time. This transaction in an asset class in which we no longer participate, represents an aggregate loss of less than 0.2% on cumulative transactions originated over this time period.

 

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We have traditionally financed our business primarily through the use of securitizations, including Hannie Mae. In these transactions, we transfer the loans or other assets we originate to securitization trusts or other bankruptcy remote special purpose funding vehicles. Large institutional investors, primarily insurance companies and commercial banks, have historically provided the financing needed for a project by purchasing the notes issued by the trust or vehicle. The securitization market for the assets we finance has remained active throughout the financial crisis due to investor demand for high credit quality, long-term investments. Historically, we have arranged such securitizations of loans or other assets 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. Additionally, we have typically avoided funding risks for these loans or other assets given that our securitization partners contractually agree to fund such assets before the origination transaction is completed. For additional information regarding our origination process, see “Business—Our Investment Process.”

In most cases, the transfer of loans or other assets to non-consolidated securitization trusts qualify as sales for accounting purposes. In these transactions, we receive economics in the form of gain on sale income, which arises from the difference between the financing rate quoted to our customers and the interest rate required by our syndication partners. This income is reflected in our statement of operations as gain on securitization of receivables. We also typically manage and service these assets in exchange for fees and other payments, which we record as fee income on our statement of operations.

In some cases, our transactions are accounted for as financings and the assets together with the corresponding nonrecourse debt are carried on our balance sheet. In these transactions, we generate income from financing receivables and incur interest expense. We may periodically provide services, including arranging financing that is held on the balance sheet of other investors and advising various companies with respect to structuring investments.

As of December 31, 2012, of the approximately $1.6 billion of the outstanding financings we own or manage (which we collectively refer to as our managed assets), approximately $1.4 billion were not carried on our balance sheet and were held in non-consolidated securitization trusts and approximately $200 million were held on our balance sheet. Approximately 58% of this portfolio was financings for energy efficiency projects, approximately 33% was financings for clean energy projects such as solar, biomass or other renewable resources as well as combined heat and power, while the remaining 9% of this portfolio was financings for other sustainable infrastructure projects such as water or communication projects. Our managed assets have an average remaining balance of approximately $7.2 million, a weighted average remaining life of approximately 12.9 years and are typically secured by the installed improvements that are the subject of the financing. As of December 31, 2012, our managed portfolio consisted of fixed rate amortizing loans or direct financing leases with approximately 99% of the portfolio consisting of U.S. federal government obligations. Information relating to our managed assets is included in the Other Data section of our “Selected Historical Financial and Operating Data.”

Our strategy in undertaking this offering is to expand our proven ability to serve the rapidly growing sustainable infrastructure market by increasing our capital resources, enhancing our financial structuring flexibility, expanding the types of projects and end-customers we pursue, and selectively retaining a larger portion of the economics in the financings we originate, while delivering attractive risk-adjusted returns to our stockholders.

As part of our strategy, we expect to hold a significantly larger portion of the loans or other assets we originate on our balance sheet and to finance these loans and other assets using our capital as well as on balance sheet financings. As a consequence, we expect over time to see significant increases in both income from financing receivables and investment interest expense. We also believe that our net investment revenue, which represents the margin, or the difference between income from financing receivables and investment interest expense, will increase due to a higher average margin on a per asset basis as well as growth in the overall amount of our investments. We expect our average margin will increase as a result of increased use of equity in place of

 

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debt as well as lower anticipated interest rates on our borrowings. We expect to pay lower interest rates due to an expected reduction in our per transaction leverage percentage, which historically was in excess of 95% on a typical transaction, increased access to new capital sources and shortening the term of our borrowings. We expect to see, in comparison to historical periods, a much larger portion of our total revenue derived from net investment revenue and other recurring and predictable revenue sources.

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 portion of our portfolio which we hold on our balance sheet, the income we receive from securitizations, syndications and other services, our portfolio’s credit risk profile, changes in market interest rates, commodity prices, U.S. 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 the 1940 Act.

Portfolio Size

The size of our portfolio, including the portion of our portfolio that we hold on our balance sheet, will be a key revenue driver. Generally, as the size of our portfolio on our balance sheet grows, the amount of our net investment revenue will increase. Our portfolio may grow at an uneven pace as opportunities to provide financing to support sustainable infrastructure projects may be irregularly timed, and the timing and extent of our success in such projects cannot be predicted. The level of new portfolio activity will fluctuate from period to period based upon the market demand for the financings we provide, our view of economic fundamentals, our ability to identify new opportunities that meet our investment criteria, the volume of projects that have advanced to stages where we believe financing is appropriate, seasonality in our financing activities and our ability to consummate the identified opportunities, including as a result of our capital resources. In addition, we may decide for any particular project that we should securitize or syndicate a portion of, or all of, the project which would result in other investment income as described below. The level of our new origination activity, the percentage of the originations that we choose to hold on our balance sheet and the related income, will directly impact future investment revenue.

Income from Securitization, Syndication and Other Services

We will also earn other investment income by securitizing or syndicating a portion of the sustainable infrastructure projects we finance and by servicing the securitization financings we arrange. For transactions that we securitize to one of our non-consolidated trusts, we receive economics from the securitization and recognize a gain on securitization of receivables based on the difference between the financing rate quoted to our customers and the interest rate required by our securitization partners. In financing the transaction, we include, and receive, a majority of the gain in cash and record the present value of the remaining portion as a retained interest in our securitization assets. We may also recognize additional income from these securitization assets over the life of the project.

Historically, we have arranged 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. Additionally, we have typically avoided funding risks for these loans 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 directly on the balance sheet of 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. A large portion of these fees is earned upon the closing of a financing transaction, the timing of which will vary from quarter to quarter.

 

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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 newly originated assets we decide to finance through securitizations or syndications. We view this other investment revenue from such activities as a valuable component of our earnings and an important source of franchise value. The total amount of fee income 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 mix of our assets that we hold on our balance sheet versus those that we syndicate or securitize and our need to tailor our mix of assets in order to allow us to qualify as a REIT for U.S. federal income tax purposes and remain exempt from registration under the 1940 Act.

Credit Risks

We source and identify high quality financing opportunities within our broad areas of expertise and apply our rigorous underwriting processes to our assets, which, we believe, will generally enable us to keep our credit losses and financing costs low. While we do not anticipate facing significant credit risk in our financings related to U.S. federal 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 will also be exposed to credit risk in projects we finance that do not depend on funding from the U.S. federal government. We expect to increasingly target such projects as part of our strategy. In the case of various other sustainable infrastructure projects, we will also be exposed to the credit risk of the obligor of the project’s power purchase agreement or other long-term contractual revenue commitments. We may encounter enhanced credit risk as we expect that over time our strategy will increasingly include equity investments. 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. 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.

Historically, our portfolio has consisted primarily of assets with the U.S. federal government as the primary credit obligor, which did not, in our view, require a risk rating system that used specific metrics, such as watch lists, credit ratings or loan-to-value. However, as we pursue our expansion strategy, which includes financing projects undertaken by state and local governments, universities, schools and hospitals, as well as privately owned commercial projects, we plan to use an approach to portfolio management that will include a risk rating system for investments not involving the U.S. federal government based on a uniform set of criteria. We will also review the performance of each investment through activities, as appropriate, such as a review of project performance, monthly payment activity and active compliance monitoring, regular communications with project management and, as applicable, its obligors and sponsors, monitoring the financial performance of the collateral, periodic property visits, monitoring cash management and reserve accounts and meetings with the owner.

Changes in Market Interest Rates

Interest rates and prepayment speeds vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. With respect to our business operations, increases in interest rates, in general, may over time cause: (1) project owners to be less interested in borrowing or raising equity and thus reduce the demand for our investments and services; (2) the interest expense associated with our borrowings to increase; (3) the market value of our fixed rate or fixed return investments to decline; and (4) the market value of interest rate swap agreements to increase, to the extent we enter into such agreements as part of our hedging strategy. Conversely, decreases in interest rates, in general, may over time cause: (1) project owners to be more interested in borrowing or raising equity and thus increase the demand for our investments; (2) prepayments on our investments, to the extent allowed, to increase; (3) the interest expense associated with our borrowings to decrease; (4) the market value of our fixed rate or fixed return

 

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investments to increase; and (5) the market value of interest rate swap agreements to decrease, to the extent we enter into such agreements as part of our hedging strategy. We, in the future, will be subject to changes in market interest rate for any new floating or inverse floating rate assets and credit facilities. 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 facilities 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 facilities, we may have to curtail our financing of sustainable infrastructure projects 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. In addition, our ability to receive protection against prepayments which occur in a declining interest rate environment, including through the use of make-whole payments, will vary according to type of investment and obligor. Subject to maintaining our qualification as a REIT for U.S. federal income tax purposes, we may, from time to time, utilize derivative financial instruments to hedge interest rate risk. 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, which allows us to maintain a minimum threshold of recurring principal repayments and capital to redeploy into changing rate environments.

Commodity Prices

When we provide financing for sustainable infrastructure projects that act as a substitute for an underlying commodity we are exposed to volatility in prices for that commodity. For example, the performance of clean energy projects that produce electricity is impacted by volatility in the market prices of various forms of energy, including electricity, coal and natural gas. Although we generally expect that the clean energy projects we finance will have their operating cash flow supported by long-term power purchase agreements, ranging from 10 to 30 years, to the extent that our projects have shorter term contracts (which may have the potential of producing higher current returns), such shorter term contracts may subject us to risk if energy prices change. 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 which may be a substitute for natural gas. We seek to structure our energy efficiency financings 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 where repayment is based upon a fixed monetary value for energy savings that would not decline if the price of energy declines.

Government Policies

The projects we finance typically depend in part on various U.S. federal, state or local governmental policies that support or enhance project economic feasibility. Such policies may include governmental initiatives, laws and regulations designed to reduce energy usage, encourage the use of clean energy or encourage the investment in and the use of sustainable infrastructure. Incentives provided by the U.S. federal government may include tax credits (some of which that are related to clean energy have recently expired), tax deductions, bonus depreciation and federal grants and loan guarantees. Incentives provided by state governments may include renewable portfolio standards, which specify the portion of the power utilized by local utilities that must be derived from clean energy sources such as renewable energy. Additionally, certain states have implemented feed-in tariffs, pursuant to which electricity generated from clean 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. In addition, U.S. federal, state and local governments may provide regulatory, tax and other incentives to encourage the development and growth of sustainable infrastructure. Governmental agencies and other owners of real estate frequently depend on these policies 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. A number of U.S. federal government incentives focused on reducing the cost of such projects, have recently expired or are scheduled to expire in the near term. Further changes in government policies, including retroactive changes, could negatively impact our operating results.

 

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Market Conditions

We believe the market for the financings we provide is in the midst of a prolonged expansion, driven by several macro-economic and geopolitical trends, including:

 

   

global population growth and concerns about its impact on natural resources;

 

   

higher commodity prices arising from increasing global per capita consumption and the ongoing depletion of conventional natural resources;

 

   

national security risks associated with energy procurement that threaten energy supply and increase the potential for price volatility;

 

   

governmental policies that seek to protect the environment and support job creation;

 

   

fiscal challenges and budgetary constraints facing U.S. federal, state and local governments; and

 

   

changes in global banking regulations which increase banks’ capital requirements for financing long-lived projects thus reducing the amount of available bank financing for such projects.

Notwithstanding this growing demand, we believe that a significant shortage of capital currently exists in the market to satisfy the demands of the sustainable infrastructure sector in the United States and around the world. Over the last several years, certain of the funding sources that have traditionally financed this market have exited the market as many European banks that were active in sustainable infrastructure and especially clean energy finance have reduced their level of activity in the aftermath of the global financial crisis and due, in part, to new capital requirements for banks that hold long term projects on their balance sheet. In addition, direct government funding subsidies have declined or expired along with sources of capital historically dedicated to tax equity investments. In addition, much of the capital that is available to the sector comes with conditions attached, including substantial minimum project size requirements, requirements that all project cash flows be fully contracted prior to any provision of financing, and the inability of lenders to take any “merchant” or investment risk with respect to various government incentives. We believe these conditions make it difficult for many project developers to access capital. In addition, for those developers who can gain access to capital, these conditions may lead to increased cost or delays in the commencement of project construction and operation. As a result, we believe a significant opportunity exists for us to assemble new forms of capital to meet these growing demands.

Our Qualification as a REIT

We have determined to continue our business as a REIT beginning with our taxable year ending December 31, 2013. By electing REIT status, we generally will not be required to pay U.S. federal income taxes on our taxable income to the extent we distribute to our stockholders annually all of our REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and maintain our qualification as a REIT. In order to maintain our qualification as a REIT, we also need to comply with certain operational limitations which govern the types of assets we can own and the sources of income we can receive. See “U.S. Federal Income Tax Considerations.”

Critical Accounting Policies and Use of Estimates

Our financial statements are prepared in accordance with U.S. 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 are used by Hannon Armstrong and that we will apply based on our expectation of our operations following the formation transactions. Our most

 

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critical accounting policies will 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 will be based will be reasonable at the time made and based upon information available to us at that time. Our critical accounting policies and accounting estimates will be expanded over time as we fully implement our strategy. 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.

Investment in Financing Receivables

Investment in financing receivables includes financing sustainable infrastructure project receivables and direct finance leases that are held on our balance sheet, whether we retain economic exposure to them or finance them on a nonrecourse basis. We account for leases as direct finance leases or operating leases in accordance with the Financial Accounting Standards Board, or FASB, ASC 840, Leases. The investment in financing receivables represents the present value of the minimum note or lease payments, net of any unearned fee income, which is recognized as income over the term of the note or lease using the interest method.

Securitization Transactions

We have established, and may establish in the future, various special purpose entities or securitization trusts for the purpose of securitizing certain financing receivables or other debt investments. We have determined that the trusts used in our securitizations are variable interest entities, as defined in ASC, 810, Consolidation. We typically serve as primary or master servicer of these trusts; however, as the servicer, we do not have the power to make significant decisions impacting the performance of the trusts. Based on our analysis of the structure of the trusts, under U.S. GAAP, we are not the primary beneficiary of the trusts as we do not have a controlling financial interest in the trusts because we do not have power over the trust’s significant activities. Therefore, we do not consolidate these trusts in our consolidated financial statements.

We account for transfers of financing receivables to these securitization trusts as sales pursuant to ASC, 860, Transfers and Servicing, as the transferred receivables have been isolated from the transferor (i.e., put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership) and we have surrendered control over the transferred receivables. When we sell receivables in securitizations, we generally retain interests in the form of servicing rights, cash reserve accounts and deferred fees, all of which are carried on our consolidated balance sheet as retained interests in securitized receivables.

Gain or loss on sale of receivables is calculated based on the excess of the proceeds received from the securitization (less any transaction costs) plus any retained interests obtained over the cost basis of the receivables sold. We generally transfer the receivables to securitization trusts immediately upon the initial funding from the third party purchasing a note collateralized by the receivables. For our retained interests, we generally estimate fair value based on the present value of future expected cash flows using our best estimates of the key assumptions of anticipated losses, prepayment rates, and discount rates commensurate with the risks involved.

We initially account, as described above, for all separately recognized servicing assets and servicing liabilities at fair value as required under ASC 860. Under ASC 860-50, Transfers and Servicing—Servicing Assets and Liabilities, entities may either subsequently measure servicing assets and liabilities using the amortization method or fair value measurement method and we have selected the amortization method to subsequently measure our servicing assets. We assess our servicing assets for impairment at each reporting date. If the amortized cost of our servicing assets is greater than the estimated fair value, we recognize an impairment in net income.

Our other retained interest in securitized assets (other residual assets) are classified as available-for-sale securities and carried at fair value on the consolidated balance sheets. We generally do not sell our retained interests. If we make an assessment that (i) we do not intend to sell the security or (ii) it is not likely we will be

 

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required to sell the security before its anticipated recovery, changes in fair value, such as those resulting from changes in market interest yield requirements, are reported as a component of accumulated other comprehensive income. However, in the case where we do intend to sell our retained interest or if the fair value of other retained assets is below the current carrying amount and we determine that the decline is OTTI, any impairment charge would be recorded through the statement of operations. An OTTI is considered to have occurred when, based on current information and events, there has been an adverse change in the timing or amount of cash flows expected to be collected. The impairment is equal to the difference between the residual asset’s amortized cost basis and its fair value at the balance sheet date. In the case where there is any expected decline in the forecasted cash flows, such decline would be unlikely to reverse during the holding period of the retained interests and thus would be considered an OTTI.

Valuation of Financial Instruments

ASC 820, Fair Value Measurements, establishes a framework for measuring fair value in accordance with U.S. GAAP and expands financial statement disclosure requirements for fair value measurements. ASC 820 further specifies a hierarchy of valuation techniques, which is based on whether the inputs into the valuation technique are observable or unobservable. Where inputs for a financial asset or liability fall in more than one level in the fair value hierarchy, the financial asset or liability is classified in its entirety based on the lowest level input that is significant to the fair value measurement of that financial asset or liability. At December 30, 2012, and at September 30, 2012 and 2011, we carried only retained interests in securitized receivables and derivatives at fair value on our balance sheets. We use our judgment and consider factors specific to the financial assets and liabilities measured at fair value in determining the significance of an input to the fair value measurements. The hierarchy is as follows:

 

   

Level 1—Valuation techniques in which all significant inputs are quoted prices from active markets that are accessible at the measurement date for assets or liabilities that are identical to the assets or liabilities being measured.

 

   

Level 2—Valuation techniques in which significant inputs include quoted prices from active markets for assets or liabilities that are similar to the assets or liabilities being measured and/or quoted prices from markets that are not active for assets or liabilities that are identical or similar to the assets or liabilities being measured. Also, model-derived valuations in which all significant inputs and significant value drivers are observable in active markets are Level II valuation techniques.

 

   

Level 3—Valuation techniques in which one or more significant inputs or significant value drivers are unobservable. Unobservable inputs are valuation technique inputs that reflect our assumptions about the assumptions that market participants would use in pricing an asset or liability.

For financial assets and liabilities carried at fair value, we use quoted market prices, when available, to determine the fair value of an asset or liability. If quoted market prices are not available, we consult independent pricing services or third party broker quotes, provided that there is no ongoing material event that affects the issuer of the securities being valued or the market therefor. If there is such an ongoing event, or if quoted market prices are not available, we will determine the fair value of the securities using valuation techniques that use, when possible, current market-based or independently-sourced market parameters, such as interest rates.

Fair value under U.S. GAAP represents an exit price in the normal course of business, not a forced liquidation price. If we were forced to sell assets in a short period to meet liquidity needs, the prices we receive could be substantially less than their recorded fair values. Furthermore, the analysis of whether it is more likely than not that we will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold is also subject to significant judgment, particularly in times of market illiquidity.

 

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Any changes to the valuation methodology will be reviewed by our investment committee to ensure the changes are appropriate. As markets and products develop and the pricing for certain products becomes more transparent, we will continue to refine our valuation methodologies. The methods used by us may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods will be appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. We will use inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced.

Revenue Recognition

In accordance with our valuation policy, we evaluate accrued income from financing receivables periodically for collectability. When a financing receivable becomes 90 days or more past due, and if we otherwise do not expect the debtor to be able to service all of its debt or other obligations, we will generally place the financing receivable on non-accrual status and cease recognizing income from that financing receivable until the borrower has demonstrated the ability and intent to pay contractual amounts due. If a financing receivable’s status significantly improves regarding the debtor’s ability to service the debt or other obligations, or if a financing receivable is fully impaired, sold or written off, we will remove it from non-accrual status. The revenue recognition for the major components of revenue is accounted for as described below (see “—Critical Accounting Policies and Use of Estimates—Securitization Transactions” for discussion of gains and losses recognized from the securitization of receivables):

 

   

Income from Financing Receivables. We record income from financing receivables held on our balance sheet on the accrual basis to the extent amounts are expected to be collected. We expect that income on our financing receivables investments will be accrued based on the actual coupon rate and the outstanding principal balance of such securities, or if no actual coupon rate exists, using the effective yield method. Premiums and discounts will be amortized or accreted into income over the lives of the financing receivables using the effective yield method, as adjusted for actual prepayments in accordance with ASC 310-40, Receivables—Nonrefundable Fees and Other Costs. For financing receivables that are direct finance leases under ASC 840, Leases, we amortize the unearned income to income over the lease term to produce a constant periodic rate of return on the net investment in the lease.

 

   

Servicing and other residual interests in securitized assets. Servicing income is recognized as received. Servicing assets are amortized in proportion to, and over the period of, estimated net servicing income, and are periodically assessed for impairment. Interest income related to the cash reserve account and deferred fees (collectively referred to as residual assets) is recognized using the effective interest rate method. If there is a change in expected cash flows related to the residual assets, we calculate a new yield based on the current amortized cost of the residual assets and the revised expected cash flows. This yield is used prospectively to recognize interest income. Actual economic conditions may produce cash flows that could differ significantly from projected cash flows, and differences could result in an increase or decrease in the yield used to record interest income or could result in impairment losses.

 

   

Other Fee Income. We may periodically provide services, including arranging financing that is held on the balance sheet of other investors and advising various companies with respect to structuring investments. For services that are separately identifiable and evidence exists to substantiate fair value, income is recognized as earned, which is generally when the investment or other applicable transaction closes. Retainer fees are amortized over the performance period.

 

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Equity Method Investment in Affiliates

Under the equity method of accounting, the carrying value of the investment in a non-consolidated affiliate is determined based on amounts invested by our company, adjusted for the equity in earnings or losses of investee allocated based on the partnership agreement, less distributions received. Because the partnership agreements contain preferences with regard to cash flows from operations, capital events and/or liquidation, we reflect our share of profits and losses by determining the difference between our “claim on the investee’s book value” at the end and the beginning of the period. This claim is calculated as the amount we would receive (or be obligated to pay) if the investee were to liquidate all of its assets at recorded amounts determined in accordance with U.S. GAAP and distribute the resulting cash to creditors and investors in accordance with their respective priorities. This method is commonly referred to as the hypothetical liquidation at book value method. We evaluate the realization of our investment accounted for using the equity method if circumstances indicate that its investment is OTTI. Intra-company gains and losses are eliminated for an amount equal to the interest of our company and are reflected in the share in income (loss) from non-consolidated affiliate in our consolidated statements of operations.

Hedging Instruments and Hedging Activities

We account for derivative financial instruments in accordance with ASC 815, Derivatives and Hedging, which requires us to recognize all derivatives as either assets or liabilities on the balance sheet and to measure those instruments at fair value. Additionally, the fair value adjustments will affect either other comprehensive income or net income depending on whether the derivative instrument qualifies as a hedge for accounting purposes (and the type of hedge) and if we elect to apply hedge accounting for that instrument. We use derivatives for hedging purposes rather than speculation. We value derivative financial instruments in accordance with ASC 820. See “—Critical Accounting Policies and Use of Estimates—Valuation of Financial Instruments.” At December 31, 2012 and 2011 and September 30, 2012, 2011 and 2010, no derivatives were designated in hedge accounting relationships.

In the normal course of our business, subject to maintaining our qualification as a REIT, we may use a variety of derivative financial instruments to manage or hedge interest rate risk on our borrowings. These derivative financial instruments must be effective in reducing our interest rate risk exposure in order to qualify for hedge accounting. When the terms of an underlying transaction are modified, or when the underlying hedged item ceases to exist, all changes in the fair value of the derivative instrument are marked-to-market with changes in value included in net income for each period until the derivative instrument matures or is settled. Any derivative instrument used for risk management that does not meet the effective hedge criteria or for which we do not elect hedge accounting is marked-to-market with the changes in fair value included in net income.

Income Taxes

Our financial results are generally not expected to reflect provisions for current or deferred income taxes. We believe that we have been organized in conformity with the requirements for qualification and taxation as a REIT, and we intend to operate in a manner that will allow us to qualify for taxation as a REIT. As a result of our expected REIT qualification, we do not generally expect to pay U.S. federal income tax, although our TRSs will be required to pay U.S. federal income taxes at regular corporate rates. Many of the REIT requirements, however, are highly technical and complex. If we were to fail to meet the REIT requirements, we would be subject to U.S. federal, state and local income taxes.

Share-Based Compensation

Prior to the completion of this offering, we intend to adopt an equity incentive plan that provides for grants of stock options, shares of restricted common stock, phantom shares, dividend equivalent rights, and LTIP units and other restricted limited partnership units issued by our operating partnership and other equity-based awards. Equity-based compensation will be recognized as an expense in the financial statements over the vesting

 

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period and measured at the fair value of the award on the date of grant. The amount of the expense may be subject to adjustment in future periods depending on the specific characteristics of the equity-based award and the application of ASC 718, Compensation—Stock Compensation.

Results of Operations

We have traditionally financed our business primarily through the use of securitizations, in which we transfer the loans or other assets we originate to securitization trusts or other bankruptcy remote special purpose funding vehicles. As of December 31, 2012, the outstanding principal balance of our managed assets financed through the use of securitizations was $1.4 billion and the outstanding principal balance of the Investment in Financing Receivables held on our balance sheet and financed by nonrecourse debt was approximately $200 million for total managed assets of $1.6 billion.

Investment in Financing Receivables

At December 31, 2012, we hold $191.4 million of managed assets on our balance sheet as Investment in Financing Receivables, which consist of:

 

     Balance
in Millions
     Maturity  

Fixed-rate Investment in Financing Receivables, interest rates from 2.40% to 5.00% per annum

   $ 70.5         2014 to 2032   

Fixed-rate Investment in Financing Receivables, interest rates from 5.01% to 6.50% per annum

     52.4         2013 to 2031   

Fixed-rate Investment in Financing Receivables, interest rates from 6.51% to 9.62% per annum

     68.5         2013 to 2031   
  

 

 

    

Total Investment in Financing Receivables

   $ 191.4      
  

 

 

    

 

     Three Months ended
December 31,
    Year Ended September 30,  
     2012     2011     2012     2011     2010  
     (In thousands except for interest rate data)  

Income from Financing Receivables

   $ 2,833.7      $ 3,349.5      $ 11,848.0      $ 11,739.3      $ 10,904.2   

Average Monthly Balance of Investment in Financing Receivables

   $ 191,729.2      $ 145,026.9      $ 186,845.8      $ 151,818.9      $ 159,117.5   

Average Interest Rate from Investment in Financing Receivables

     5.91     9.24     6.34     7.73     6.85

Investment Interest Expense

   $ 2,346.5      $ 2,820.6      $ 9,851.8      $ 9,441.6      $ 9,606.0   

Average Monthly Balance of Nonrecourse Debt

   $ 196,331.9      $ 149,448.0      $ 191,343.1      $ 156,316.5      $ 163,755.6   

Average Interest Rate from Nonrecourse Debt

     4.78     7.55     5.15     6.04     5.87

Net Interest Margin

   $ 487.2      $ 528.9      $ 1,996.2      $ 2,297.7      $ 1,298.2   

Average Interest Spread

     1.13     1.69     1.19     1.69     0.98

These financing receivables are collateralized, contractually committed obligations of government entities or private high credit quality obligors and are often supported by additional forms of credit enhancement, including security interests and supplier guaranties. There were no credit losses during the three months ended December 31, 2012 and 2011 or the years ended September 30, 2012, 2011 and 2010, and no financing receivables were past due, on nonaccrual status, or impaired at December 31, 2012 and 2011 or September 30, 2012, 2011 and 2010. Accordingly, management has concluded that no allowance for credit losses was necessary at December 31, 2012 and 2011 or September 30, 2012, 2011 and 2010.

 

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The following table provides a summary of our anticipated principal repayments to our investment in financing receivables as of September 30, 2012:

 

Payment due by Period (in thousands)  
Total     Less than
1 year
    1-5 years     More than
5 years
 
$ 195,582      $ 22,012      $ 109,722      $ 63,848   

As an outgrowth of the strategy we are pursuing in undertaking this offering, we expect to hold a significantly larger portion of the loans or other assets we originate on our balance sheet and finance these loans and other assets using our capital as well as on balance sheet financings. For example, as part of our expansion strategy, we plan to deploy approximately $         of the net proceeds from this offering to retire notes collateralized by certain of our projects in order to allow us to retain a larger portion of the economics of these projects. The purchase of these notes will bring these assets onto our balance sheet or retire the existing nonrecourse debt for transactions already on our balance sheet. As a consequence of the note purchases and other transactions, we expect over time to see significant increases in both income from finance receivables and investment interest expense. We also expect in comparison to the financial statement periods discussed below to see a much larger portion of our total revenue, net of investment interest expense derived from net investment revenue and other recurring and predictable revenue sources.

As a result of these and other factors and our decision to continue our business as a REIT beginning with our taxable year ending December 31, 2013, we do not believe that our results of operations for the periods set forth below are comparable to our anticipated operating results following completion of this offering and the formation transactions.

Other Investments

Hannon Armstrong co-developed and financed the construction of the Hudson Ranch renewable energy geothermal project in Imperial Valley, California, a 50 MW geothermal power plant, which commenced operations in 2012. Through December 2012, Hannon Armstrong owned an equity interest in Hudson Ranch through its investment in HA EnergySource, which holds an approximately 40% equity interest in EnergySource, the project development company which indirectly owns Hudson Ranch.

We have determined that Hannon Armstrong’s interest in HA EnergySource would not be suitable for inclusion as part of our plan to continue our business as a REIT. In December 2012, we undertook the distribution of this business to our current owners. We will not receive an ownership interest in HA EnergySource.

The book value of our investment was $0 as of December 31, 2012 and $0.8 million and $13.0 million as of September 30, 2012 and 2011, respectively. We made investments in HA EnergySource of $0.6 million and received distributions of $0.4 million for the quarter ended December 31, 2012 and made investments of $3.3 million and $5.1 million for the years ended September 30, 2012 and 2011, respectively, and received distributions of $14.3 million and $0 for the years ended September 30, 2012 and 2011, respectively.

Comparison of the Three Months Ended December 31, 2012 to the Three Months Ended December 31, 2011

Net income increased by $0.8 million to $0.9 million for the three months ended December 31, 2012, compared to $0.1 million for the same period in 2011. This increase was the result of an increase in other investment revenue of $0.9 million offset by increased compensation cost of $0.1 million.

 

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             Three Months Ended December 31,                       
     2012      2011      $ Change     % Change  
     (In thousands)  

Net Investment Revenue:

        

Income from financing receivables

   $ 2,834      $ 3,350      $ (516     (15.4 )% 

Investment interest expense

     (2,347     (2,821     474        16.8
  

 

 

   

 

 

   

 

 

   

Net Investment Revenue

     487        529        (42     (7.9 )% 
  

 

 

   

 

 

   

 

 

   

Other Investment Revenue:

        

Gain on securitization of receivables

     2,534        1,940        594        30.6

Fee income

     254        288        (34     (11.8 )% 

Loss from equity method investment in affiliate

     (448     (799     351        43.9
  

 

 

   

 

 

   

 

 

   

Other Investment Revenue

     2,340        1,429        911        63.8
  

 

 

   

 

 

   

 

 

   

Total Revenue, net of investment interest expense

     2,827        1,958        869        44.4
  

 

 

   

 

 

   

 

 

   
        

Compensation and benefits

     (1,157     (1,065     (92     (8.6 )% 

General and administrative

     (584     (626     42        6.7

Depreciation and amortization of intangibles

     (105     (113     8        7.1

Other interest expense

     (56     (83     27        32.5

Other Income

     1        14        (13     (92.9

Unrealized gain on derivative instruments

     23        29        (6     (20.7 )% 
  

 

 

   

 

 

   

 

 

   

Other Expenses, net

     (1,878     (1,844     (34     (1.8 )% 
  

 

 

   

 

 

   

 

 

   

Net Income

   $ 949      $ 114        835        732.5
  

 

 

   

 

 

   

 

 

   

Net Investment Revenue

Net investment revenue was unchanged at $0.5 million in the three months ended December 31, 2012, compared to the comparable period in 2011. While the monthly average balance of investments in financing receivables increased to $191.7 million in the three months ended December 31, 2012 from $145.0 million in the comparable period in 2011, the average interest rate earned on these assets decreased to 5.91% from 9.24% in three months ended December 31, 2011. The decline in the interest rate earned resulted from the timing of principal repayments and the yield differences on the financing receivables held during the periods. A large project began in late 2010, resulting in higher investment income in 2011 and there was a one time pass through of interest income and expense of approximately $0.6 million relating to a partial prepayment of a fixed rate loan in the three months ended December 31, 2011. In addition, due to generally lower interest rates in 2012 as compared to 2011, the interest rates earned on new projects fell as did the cost of new nonrecourse debt. As a result, income from financing receivables declined by $0.5 million to $2.8 million in 2012 as compared to $3.3 million in 2011.

As the projects were match funded, the monthly average nonrecourse debt balance increased in the three months ended December 31, 2012 to $196.3 million compared to $149.4 million in the comparable period in 2011. As a result of the one time interest expense of $0.6 million in the three months ended December 31, 2011, interest expense decreased to $2.3 million in the three months ended December 31, 2012, compared to $2.8 million in 2011 and the average debt interest rate fell to 4.78% in 2012 from 7.55% in 2011. As a result of the lower interest rate earned on the investments offset partially by the lower interest rate on the nonrecourse debt, the net investment revenue spread fell to 1.13% in the three months ended December 31, 2012 from 1.69% in the comparable period in 2011 and net investment revenue remained unchanged at $0.5 million in the three months ended December 31, 2012, compared to the comparable period in 2011.

Other Investment Revenue

Gain on securitization of receivables increased by $0.6 million to $2.5 million for the three months ended December 31, 2012 compared to $1.9 million in the comparable period in 2011. The increase was the result of an increase of $9.8 million of receivables securitized during the three months ended December 31, 2012 compared to the comparable period in 2011. Fee income was unchanged at $0.3 million.

 

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The loss from equity method investment in affiliate decreased by approximately $0.4 million to $0.4 million in the three months ended December 31, 2012, compared to $0.8 million in the comparable period in 2011. This decrease in this loss was the result of lower losses resulting from the Hudson Ranch plant being placed in operation in 2012 and our lower share of the earnings in the plant as a result of the sale of equity in Hudson Ranch in September 2012. As of December 31, 2012, we have distributed this investment to Hannon Armstrong’s existing owners.

Total Revenue, Net of Investment Interest Expense

Total revenue, net of investment interest expense increased by $0.9 million to $2.8 million in the three months ended December 31, 2012, compared to $1.9 million in the comparable period in 2011, as a result of an increase in other investment revenue of $0.9 million.

Other Expenses, Net

Other expenses, net was unchanged at $1.9 million for the three months ended December 31, 2012 and 2011.

Net Income

Net income increased by approximately $0.8 million to $0.9 million in the three months ended December 31, 2012, compared to $0.1 million in the comparable period in 2011 due primarily to the increase in other investment revenue.

Comparison of 2012 to 2011

Net income increased by $8.8 million to $3.8 million for the year ended September 30, 2012, compared to a loss of $5.0 million for the same period in 2011. This increase was the result of an increase in total revenue, net of investment interest expense of $13.8 million offset by increased compensation and benefits and general and administrative cost of $5.0 million due to higher performance based compensation expense as a result of the higher fee income as well as higher costs for additional personnel and professional fees to expand our origination capability and prepare for this offering.

 

     Year Ended September 30,              
         2012             2011         $ Change     % Change  

Net Investment Revenue:

        

Income from financing receivables

   $ 11,848      $ 11,739      $ 109        0.9

Investment interest expense

     (9,852     (9,442     (410     (4.3 )% 
  

 

 

   

 

 

   

 

 

   

Net Investment Revenue

     1,996        2,297        (301 )      (13.1 )% 
  

 

 

   

 

 

   

 

 

   

Other Investment Revenue:

        

Gain on securitization of receivables

     3,912        4,025        (113     (2.8 )% 

Fee income

     11,380        877        10,503        1,197.6

Loss from equity method investment in affiliate

     (1,284     (5,047     3,763        74.6
  

 

 

   

 

 

   

 

 

   

Other Investment Revenue

     14,008        (145     14,153        9,760.7
  

 

 

   

 

 

   

 

 

   

Total Revenue, net of investment interest expense

     16,004        2,152        13,852        643.7
  

 

 

   

 

 

   

 

 

   

Compensation and benefits

     (7,697     (4,028     (3,669     (91.1 )% 

General and administrative

     (3,901     (2,506     (1,395     (55.7 )% 

Depreciation and amortization of intangibles

     (440     (431     (9     (2.1 )% 

Other interest expense

     (287     (295     8        2.7

Other Income

     52        61        (9     (14.8 )% 

Unrealized gain on derivative instruments

     73        35        38        108.6
  

 

 

   

 

 

   

 

 

   

Other Expenses, net

     (12,200     (7,164     (5,036     (70.3 )% 
  

 

 

   

 

 

   

 

 

   

Net Income (Loss)

   $ 3,804      $ (5,012   $ 8,816        175.9
  

 

 

   

 

 

   

 

 

   

 

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Net Investment Revenue

Net investment revenue decreased by $0.3 million to $2.0 million in 2012, compared to $2.3 million in 2011. While the monthly average balance of investments in financing receivables increased to $186.8 million from $151.8 million in 2011, the average interest rate earned on these assets decreased to 6.34% from 7.73% in 2011. The decline in the interest rate earned resulted from the timing of principal repayments and the yield differences on the financing receivables held during the periods. A large project began in late 2010, resulting in higher investment income in 2011. In addition, due to generally lower interest rates in 2012 as compared to 2011, the interest rates earned on new projects fell as did the cost of new nonrecourse debt. As a result, income from financing receivables only rose by $0.1 million to $11.8 million in 2012 as compared to $11.7 million in 2011.

As the projects were match funded, the monthly average nonrecourse debt balance increased in 2012 to $191.3 million compared to $156.3 million in 2011. This change resulted in an increase in investment interest expense of $0.4 million to $9.8 million in 2012, compared to $9.4 million in 2011 despite the average debt interest rate falling to 5.15% in 2012 from 6.04% in 2011. As a result of the lower interest rate earned on the investments offset partially by the lower interest rate on the nonrecourse debt, the net investment revenue spread fell to 1.19% in 2012 from 1.69% in 2011 and net investment revenue decreased by $0.3 million to $2.0 million in 2012 as compared to $2.3 million in 2011.

Other Investment Revenue

Gain on securitization of receivables was $3.9 million for 2012, a decrease of $0.1 million from $4.0 million in 2011. Fee income increased by $10.5 million to $11.4 million in 2012, compared to $0.9 million in 2011, primarily the result of higher advisory service fees from the closing of several sustainable infrastructure financing transactions in 2012.

The loss from equity method investment in affiliate decreased by approximately $3.8 million to $1.2 million in 2012, compared to $5.0 million in 2011. EnergySource completed a number of transactions in the year including placing its primary holding, a geothermal plant, into production as well as refinancing its existing debt and selling equity to a third party investor. The decrease in this loss was also the result of decreased losses on an interest rate swap which was held by EnergySource. In December 2012, we distributed our investment in EnergySource to Hannon Armstrong’s existing owners.

Total Revenue, Net of Investment Interest Expense

Total revenue, net of investment interest expense increased by $13.8 million to $16.0 million in 2012 compared to $2.2 million in 2011, as a result of an increase in other investment revenue of $14.1 million offset by a decrease in net investment revenue of $0.3 million.

Other Expenses, Net

Other expenses, net increased by approximately $5.0 million to $12.2 million in 2012, compared to $7.2 million in the comparable period in 2011. The increase in compensation and benefits of $3.7 million from $4.0 million in 2011 to $7.7 million in 2012 was the result of higher performance based compensation expense associated with the higher fee income as well as higher costs for additional personnel and professional fees to expand our origination capability and prepare for this offering. General and administrative expenses increased by $1.4 million to $3.9 million in 2012, compared to $2.5 million in 2011, as a result of higher professional fees on certain of the transactions that closed during the year as well as expenses to prepare for this offering.

 

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Net Income (Loss)

Net income increased by approximately $8.8 million to $3.8 million in 2012, compared to a loss of $5.0 million in 2011 due primarily to the increase in fee income and a lower loss from the equity method investment in affiliate offset by the higher compensation and benefits and general and administrative expenses.

Comparison of 2011 to 2010

Net income decreased by $19.1 million to a loss of $5.0 million in 2011, compared to income of $14.1 million in 2010. This decrease was the result of a decrease in other investment revenue of $22.8 million offset by an increase in net investment revenue of $1.0 million due to the higher amortization of the financing receivables during this period as a result of new investments, and a decrease in other expenses of $2.7 million as a result of lower compensation expense.

 

     Year Ended September 30,              
         2011             2010         $ Change     % Change  

Net Investment Revenue:

        

Income from financing receivables

   $ 11,739      $ 10,904      $ 835        7.7

Investment interest expense

     (9,442     (9,606     164        1.7
  

 

 

   

 

 

   

 

 

   

Net Investment Revenue

     2,297        1,298        999        77.0
  

 

 

   

 

 

   

 

 

   

Other Investment Revenue:

        

Gain on securitization of receivables

     4,025        6,322        (2,297     (36.3 )% 

Fee income

     877        7,716        (6,839     (88.6 )% 

(Loss) gain from equity method investment in affiliate

     (5,047     8,663        (13,710     (158.3 )% 
  

 

 

   

 

 

   

 

 

   

Other Investment Revenue

     (145     22,701        (22,846     (100.6 )% 
  

 

 

   

 

 

   

 

 

   

Total Revenue, net of investment interest expense

     2,152        23,999        (21,847     (91.0 )% 
  

 

 

   

 

 

   

 

 

   

Compensation and benefits

     (4,028     (7,191     3,163        44.0

General and administrative

     (2,506     (1,856     (650     (35.0 )% 

Depreciation and amortization of intangibles

     (431     (685     254        37.1

Other interest expense

     (295     (369     74        20.1

Other Income

     61        70        (9     (12.9 )% 

Unrealized gain on derivative instruments

     35        113        (78     (69.0 )% 
  

 

 

   

 

 

   

 

 

   

Other Expenses, net

     (7,164     (9,918     2,754        27.8
  

 

 

   

 

 

   

 

 

   

Net Income (Loss)

   $ (5,012   $ 14,081      $ (19,093     (135.6 )% 
  

 

 

   

 

 

   

 

 

   

Net Investment Revenue

Net investment revenue increased by $1.0 million to $2.3 million in 2011, compared to $1.3 million in 2010. While the monthly average balance of investments in financing receivables declined to $151.8 million from $159.1 million in 2010, the average interest rate earned on these assets increased to 7.73% in 2011 from 6.85% in 2010. The increase in the average interest rate earned resulted from the timing of principal repayments and the yield differences on the financing receivables held during the periods. A large project began in late 2010, resulting in higher investment income in 2011. As a result, income from financing receivables rose by $0.8 million to $11.7 million in 2011 as compared to $10.9 million in 2010.

As the projects were match funded, the monthly average nonrecourse debt balance decreased in 2011 to $156.3 million compared to $163.8 million in 2010. This resulted in a decrease in investment interest expense of $0.2 million to $9.4 million in 2011, compared to $9.6 million in 2010 despite the average debt interest rate increasing to 6.04% in 2011 from 5.87% in 2010. As a result of the higher interest rate earned on the

 

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investments, the net investment revenue spread increased to 1.69% in 2011 from 0.98% in 2010 and net investment revenue increased by $1.0 million to $2.3 million in 2011 as compared to $1.3 million in 2010.

Other Investment Revenue

Gains on securitization of receivables declined by $2.3 million to $4.0 million in 2011, compared to $6.3 million in 2010 as we securitized $120.5 million of finance receivables in 2011 compared to $226.6 million in 2010. The decline in gains on securitization of receivables was the result of fewer financings of U.S. federal government energy efficiency projects, as U.S. federal government agencies were focused on completing the large amounts of directly appropriated projects that resulted from passage of the American Recovery and Reinvestment Act of 2009 (also referred to as the Stimulus Act) in place of developing new multi-year financings of energy savings performance contracts. Fee income declined by $6.8 million to $0.9 million in 2011, compared to $7.7 million in 2010, primarily as a result of fees from two large sustainable infrastructure syndication engagements in 2010 which were not repeated in 2011.

The earnings from the equity method investment in affiliate decreased by $13.7 million to a loss of $5.0 million in 2011, compared to income of $8.7 million in 2010. This change was the result of an increase in the unrealized loss on an interest rate swap, which is held by an equity method investee of HA EnergySource, due to declining interest rates.

Total Revenue, Net of Investment Interest Expense

Total revenue, net of investment interest expense declined by $21.8 million to $2.2 million in 2011, compared to $24.0 million in 2010, as a result of a decrease in other investment revenue of $22.8 million offset by an increase in net investment revenue of $1.0 million.

Other Expenses, Net

Other expenses, net decreased by approximately $2.8 million to approximately $7.1 million in 2011, compared to $9.9 million in 2010. The decrease in total operating expenses was attributable principally to lower compensation and benefits of $3.2 million resulting from lower incentive compensation on lower other investment revenue. General and administrative expenses increased by $0.7 million principally due to consulting and legal costs for a transaction that did not close and consulting fees relating to new financing opportunities. This increase was offset by a $0.3 million decrease in amortization of intangible assets as certain intangible assets were fully amortized before the end of 2011.

Net Income (Loss)

The net loss for 2011 was $5.0 million compared to net income of $14.1 million in 2010 or a change of $19.1 million due primarily to the decrease in earnings from the equity method investment in affiliate of $13.7 million and lower income before equity method investment in affiliate of $5.4 million.

Non-GAAP Financial Measures

We consider the following non-GAAP financial measures useful to investors as key supplemental measures of our performance: (1) managed assets, (2) investment income from managed assets and (3) investment revenues from ongoing business operations. These non-GAAP financial measures should be considered along with, but not as alternatives to, net income or loss as a measure 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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Managed Assets and Investment Income from Managed Assets

As we both consolidate assets on our balance sheet and securitize investments, certain of our financing receivables and other assets are not reflected on our balance sheet where we may have a residual interest in the performance of the investment. Thus we also calculate both our investments and our income on our investments on a non-GAAP “managed” basis, which assumes that securitized loans are not sold, with the effect that the income from securitized loans is included in our income in the same manner as the income from loans that we consolidated on our balance sheet. We believe that our managed basis information is useful to investors because it portrays the results of both on- and off-balance sheet loans that we manage, which enables investors to understand and evaluate the credit performance associated with the portfolio of loans reported on our consolidated balance sheet and our retained interests in securitized loans. Our non-GAAP managed basis measures may not be comparable to similarly titled measures used by other companies.

The following is a reconciliation of our GAAP investments in financing receivables to our managed assets and our GAAP income from financing receivables to our investment income from managed assets as of December 31 and September 30, 2012 (in thousands):

 

     December 31,      September 30,  
     2012      2012  
    

(In thousands)

 

Investments in financing receivable

   $ 191,399       $ 195,582   

Assets held in securitization trusts

     1,431,635         1,412,693   
  

 

 

    

 

 

 

Managed Assets

   $ 1,623,034       $ 1,608,275   
  

 

 

    

 

 

 

Income from financing receivables

   $ 2,834       $ 11,848   

Income from assets held in securitization trusts

     20,670         84,582   
  

 

 

    

 

 

 

Investment Income from Managed Assets

   $ 23,504       $ 96,430   
  

 

 

    

 

 

 

Investment Revenue from Ongoing Business Operations

As we distributed our investment in equity method affiliate on December 31, 2012 and it will not be a part of our future business, we have provided the following measure of revenue, which we believe provides investors with the investment revenue that is more aligned with our ongoing business operations.

 

     Quarter Ended
December 31,
2012
     Year Ended
September  30,
2012
 
    

(In thousands)

 

Total revenue, net of investment interest expense

   $ 2,827       $ 16,004   

Add back loss from equity method investment in affiliate

     448         1,284   
  

 

 

    

 

 

 

Investment Revenue from Ongoing Business Operations

   $ 3,275       $ 17,288   
  

 

 

    

 

 

 

Other Financial Measures

The following are certain financial measures as of the years ended September 30, 2012, 2011 and 2010.

 

     Year Ended September 30,  
     Historical  
     2012     2011     2010  
                    

Return on assets

     1.9     (2.7 )%      7.4

Return on equity

     21.5     (25.9 )%      75.5

Equity to total assets ratio

     8.7     10.6     9.8

 

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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 sustainable infrastructure projects, make distributions to our stockholders and other general business needs. We will use significant cash to finance our sustainable infrastructure projects, repay principal and interest on our borrowings, make distributions to our stockholders and fund our operations.

We expect to use leverage to increase potential returns to our stockholders. We have traditionally financed our business primarily through the use of securitizations, such as Hannie Mae, or other special purpose funding vehicles. Large institutional investors, primarily insurance companies and commercial banks, have historically provided the financing needed for a project by purchasing the notes issued by the funding vehicle. As of December 31, 2012, the outstanding principal balance of our managed assets financed through the use of securitizations and held in non-consolidated trusts was approximately $1.4 billion and the outstanding principal balance of investments in financing receivables held on our balance sheet was approximately $200 million, as shown above in our discussion of non-GAAP measures.

We expect we will continue to use securitizations or other special purpose funding vehicles to finance our business and continue to maintain and potentially expand our relationships with various securitization investors. We also believe we will be able to customize securitized tranches to meet the investment preferences of our investors.

Going forward, we plan to selectively retain a larger portion of the economics in the financings we originate on our balance sheet and broaden our financing sources to include other fixed and floating rate borrowings in the form of bank credit facilities (including term loans and revolving facilities), warehouse facilities, repurchase agreements and public and private equity and debt issuances, in addition to transaction or asset specific funding and match-funded arrangements. The decision on how we finance specific assets or groups of assets will largely be driven by capital allocations and portfolio management considerations, as well as prevailing credit spreads and the terms of available financing and market conditions. We have ongoing discussions with a number of financial institutions regarding warehouse or other bank credit facilities. Over time, as market conditions change, we may use other forms of leverage in addition to these financing arrangements.

Although we are not restricted by any regulatory requirements to maintain our leverage ratio at or below any particular level, the amount of leverage we may employ 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 and financing counterparties. Historically, we have financed our transactions with U.S. federal government obligors with more than 95% debt. We anticipate reducing our overall leverage on both individual assets classes and our entire portfolio for which we have the primary economic exposure. We expect that we will generally target up to two times leverage, with internal allocations of leverage based on the mix of asset types and obligors. For example, we may deploy higher leverage on debt financings made to U.S. federal and other high quality government obligors and lower leverage on other types of assets and obligors. We believe our target leverage ratios will be significantly lower than our historical leverage. 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 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 financings, if any, cannot be predicted with any certainty. Since we expect that our assets will generally be financed, we expect that 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 will be adequate for purposes of meeting our short-term and long-term liquidity needs, which include funding future sustainable infrastructure projects, operating costs

 

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and distributions to our stockholders. To qualify as a REIT, we must distribute annually at least 90% of our REIT taxable income without regard to the deduction for dividends paid and excluding net capital gains. These distribution requirements limit our ability to retain earnings and thereby replenish or increase capital for growth and our operations. For more information, see “Distribution Policy.”

Sources and Uses of Cash

We had $8.0 million and $20.9 million of cash and cash equivalents as of December 31 and September 30, 2012, respectively. In addition, we have restricted cash that has historically been required as part of borrowings and is not available for general operating purposes of $55,000 as of December 31, 2012 and $2.0 million as of September 30, 2012.

As a result of our expansion strategy and our intention to hold more direct economic interests in our assets in the future and our decision to continue our business as a REIT beginning with our taxable year ending December 31, 2013, we do not believe that our sources and uses of cash for the periods as set forth below are comparable to our anticipated sources and uses of cash following completion of this offering and the formation transactions.

Cash Generated from Operating Activities

Net cash used in operating activities was $1.4 million for the three months ended December 31, 2012. In addition to the net income of $0.9 million, there was the non-cash loss from our equity method investment of $0.4 million and depreciation and amortization of $0.1 million. This was offset by the changes in operating assets and liabilities of $2.9 million, primarily resulting from the payment of expenses accrued at September 30, 2012. Net cash provided by operating activities was $6.8 million for the three months ended December 31, 2011. In addition to net income of $0.1 million, there was the non-cash loss from our equity method investment of $0.8 million and an increase in accounts payable and accrued expenses of $6.0 million resulting from timing differences from amounts accrued but not yet paid relating to financing receivables at quarter end.

Net cash provided by operating activities was $9.7 million for 2012. In addition to net income of $3.8 million, there were significant non-cash expenses, including the loss from our equity method investment of $1.3 million and depreciation and amortization of intangibles of $0.4 million for 2012. In addition, changes in operating assets and liabilities, primarily resulting from accrued compensation expense at year end, provided cash of $3.8 million and the non-cash component of the securitizations increased operating cash by $0.4 million.

Net cash provided by operating activities was $1.5 million for 2011. The net loss in 2011 was due in significant part to non-cash expenses including the loss from our equity method investment in HA EnergySource of $5.0 million and depreciation and amortization of intangibles of $0.4 million. In addition in 2011, changes in other assets and liabilities provided cash of $0.8 million and the non-cash component of the securitizations increased operating cash by of $0.3 million.

Net cash provided by operating activities was $7.2 million for 2010. The net income in 2010 included non-cash income from our equity method investment in HA EnergySource of $8.6 million and an unrealized gain on derivatives of $0.1 million. This non-cash income was offset by non-cash depreciation and amortization of intangibles of $0.7 million and a recovery of $2.3 million on non-amortizable intangible assets. In addition in 2010, a reduction in accounts payable and accrued expenses used cash of $1.7 million due to the payment of some expenses accrued in 2009 that were paid in the beginning of 2010 and the non-cash component of the securitizations increased operating cash by $0.7 million.

Cash Flows Relating to Investing Activities

Net cash generated from investing activities was $6.0 million for the three months ended December 31, 2012. In the three months ended December 31, 2012, cash used for new investments in finance receivables held on our balance sheet was $2.1 million and principal collections on financing receivables held on our balance

 

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sheet were $6.3 million. In the three months ended December 31, 2012, the investment and advances in non-consolidated affiliates, other than the $3.4 million non-cash contribution as part of the spinout of HA EnergySource, was $0.6 million and the distributions from the non-consolidated affiliates were $0.4 million. In addition, the release of restricted cash generated $2.0 million.

Net cash used in investing activities was $2.7 million for the three months ended December 31, 2011. In the three months ended December 31, 2011, cash used for new investments in finance receivables held on our balance sheet was $8.8 million and principal collections on financing receivables held on our balance sheet were $6.3 million. In the three months ended December 31, 2011, the investment and advances in non-consolidated affiliates was $0.4 million.

Net cash used in investing activities was $40.2 million for 2012. In 2012, cash used for new investments in finance receivables held on our balance sheet was $103.3 million and principal collections on financing receivables held on our balance sheet were $51.5 million. For 2012, the investment and advances in non-consolidated affiliates was $3.4 million and the distributions from the non-consolidated affiliates were $14.3 million. In addition, $0.2 million was spent on property and equipment, primarily as the result of our office move described under “—Contractual Obligations and Commitments” and the net proceeds from the sale of marketable securities generated $0.5 million and the release of restricted cash generated $0.3 million.

Net cash provided by investing activities was $8.2 million for 2011. Cash used for new investments in finance receivables held on our balance sheet was $7.2 million and principal collections on financing receivables held on our balance sheet were $22.6 million in 2011. Additionally, our investment and advances in non-consolidated affiliates resulted in a cash outflow $5.1 million in 2011 and the establishment of the restricted cash reserve of $2.1 million was also a cash outflow in 2011.

Net cash used in investing activities was $3.9 million for 2010. Cash used for new investments in finance receivables held on our balance sheet was $30.0 million, which was offset by principal collections on financing receivables held on our balance sheet of $29.8 million in 2010. Additionally, our investment and advances in non-consolidated affiliates resulted in cash outflow $3.4 million in 2010 and $0.3 million was used to purchase marketable securities.

Cash Flows Relating to Financing Activities

Net cash used in financing activities was $17.5 million for the three months ended December 31, 2012. During the quarter, $12.7 million was used to fund accrued distributions on and to return capital in respect of the Series A participating preferred units. Total proceeds from nonrecourse debt to fund the origination of financing receivables were $2.2 million versus repayments on the nonrecourse debt of $6.5 million during the period. In addition, principal repayments on our existing credit facility were $0.4 million. Net cash provided by financing activities was $1.9 million for the three months ended December 31, 2011. Total proceeds from nonrecourse debt to fund the origination of financing receivables were $8.9 million versus repayments on the nonrecourse debt of $6.4 million during the period. In addition, principal repayments on our existing credit facility were $0.6 million.

Net cash from financing activities was $49.8 million for 2012. Total proceeds from nonrecourse debt to fund the origination of financing receivables were $104.2 million for 2012 versus repayments on the nonrecourse debt of $52.1 million during such period. In addition, principal repayments on our existing credit facility were $2.3 million.

Net cash used in financing activities was $13.4 million in 2011. In 2011, proceeds from nonrecourse debt were $7.4 million and repayments on nonrecourse debt were $23.1 million. In 2011, proceeds from borrowings on our credit facility were $4.0 million, offset by repayments on our existing credit facility of $1.4 million. The $4.0 million of borrowings were used for general corporate purposes, including investing in sustainable infrastructure projects and to establish a restricted cash reserve.

 

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Net cash used in financing activities was $8.1 million in 2010. In 2010, proceeds from nonrecourse borrowings to fund the origination of financing receivables were $30.6 million and repayments on nonrecourse debt were $30.5 million. In 2010, we made repayments of $1.2 million on our existing credit facility and there were payments to the Series A Participating Preferred Unit holders of $7.0 million for accrued dividends and return of capital.

Existing Credit Facility

In May 2007, we obtained a recourse term loan credit facility in the amount of $8.6 million from an affiliate of one of the underwriters. The proceeds of the credit facility were used to help repurchase the member interests of the former members of our company. In May 2011, we amended this credit facility by borrowing an additional $4.0 million and extending the term by thirteen months. In December 2012, the credit facility was amended to replace the restricted cash requirement with a minimum cash balance of $1.0 million. We owed $4.2 million and $4.6 million under the outstanding credit facility as of December 31 and September 30, 2012, respectively.

The amended credit facility bears interest at a floating rate equal to the one-month LIBOR plus 2.75%, and the interest has been fixed at a rate of 4.90% through the purchase of an amortizing interest rate swap. The swap had a notional amount of $4.2 million and $4.6 million as of December 31 and September 30, 2012, respectively, and a termination date of September 30, 2015. The interest rate swap is not accounted for as a hedge under FASB ASC Topic 815, Derivatives and Hedging. The agreement includes certain financial covenants requiring our company to maintain (i) a fixed charge coverage ratio, defined as the ratio of cash flow for the last four quarters to all contractually scheduled principal and interest payments on all indebtedness over the same period, of no less than 1.25 for any four consecutive fiscal quarters, (ii) a net present value ratio, defined as the credit facility balance divided by the net present value of the income stream, that is no greater than 75% through the four fiscal quarters ending May 31, 2013, no greater than 65% through the four fiscal quarters ending May 31, 2014, no greater than 50% through the four fiscal quarters ending May 31, 2015, and no greater than 25% for the fiscal quarters beginning June 1, 2015, and (iii) a minimum cash or cash equivalents balance of $1.0 million. As of December 31, 2012, our fixed charge coverage ratio was 2.73, our net present value ratio was 52%, and our cash balance was $8.1 million. Amounts due under the credit facility are secured by our general assets.

The stated minimum maturities of our credit facility at December 31, 2012 were as follows:

 

Due in less than one year

   $ 1.64 million   

Due in one to 3 years

     2.53 million   
  

 

 

 
   $ 4.17 million   
  

 

 

 

We intend to use a portion of the net proceeds of the offering to repay this facility.

General and Administrative Expenses

Upon completion of this offering, we will have general and administrative expenses, including salaries, rent, professional fees and other corporate level activity expenses associated with operating as a public company. As of January 1, 2013, we employed 20 people. We intend to hire several additional business professionals in the near term in connection with this offering and the implementation of our strategy. We also expect to incur additional professional fees to meet the reporting requirements of the Exchange Act and comply with the Sarbanes-Oxley Act. The timing and level of these costs and our ability to pay these costs with cash flow from our operations depends on our execution of our business plan, the number of financings we originate or acquire and our ability to attract qualified individuals to fill these new positions. We believe that our initial portfolio will generate cash flow in an amount that will exceed our first year general and administrative expenses.

 

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Contractual Obligations and Commitments

We lease office space under an operating lease entered into in July 2011. The lease provides for operating expense reimbursements and annual escalations that are amortized over the respective lease terms on a straight-line basis. Lease payments under the July 2011 lease commenced in March 2012. Our previous lease expired December 31, 2011. We also lease space at a satellite office under an operating lease entered into in November 2011. Lease payments under this lease commenced in February 2012.

In December 2012, we undertook the distribution of our equity interest in HA EnergySource, which we determined would not be suitable for inclusion as part of our plan to continue our business as a REIT, to the current owners of Hannon Armstrong. Prior to and as part of the transaction, the board of Hannon Armstrong approved a $3.4 million capital commitment to HA EnergySource to be used by HA EnergySource for general corporate purposes, future investments or dividends to HA EnergySource owners. The historical book value as of December 31, 2012 attributable to HA EnergySource, taking into account this capital commitment was approximately $3.9 million. We recorded an obligation representing our $3.4 million capital commitment to HA EnergySource as of December 31, 2012 in other accrued expenses. In addition, in respect of the distribution of our equity interest in HA EnergySource, we recorded a dividend as a reduction in equity totaling $3.9 million which represents the $3.4 million capital commitment plus the carrying value of HA EnergySource of $0.5 million. Following the distribution, the Company no longer has an equity ownership in HA EnergySource or EnergySource and will not have an obligation to provide additional funding.

The following table provides a summary of our contractual obligations as of December 31, 2012:

 

     Payment due by Period (in thousands)  
Contractual Obligations    Total      Less
than 1
year
     1 – 3
Years
     3 – 5
Years
     More
than 5
years
 

Long-Term Debt Obligations (1)

   $ 195,952       $ 24,124       $ 71,513       $ 37,162       $ 63,153   

Interest on Long-term Debt Obligations (1)

     53,752         8,497         13,383         8,702         23,170   

Credit facility, due on September 30, 2015 (2)

     4,170         1,640         2,530         —           —     

Interest on Credit Facility (2)

     265         164         101         —           —     

Operating Lease Obligations

     2,408         233         480         509         1,186   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 256,547       $ 34,658       $ 88,007       $ 46,373       $ 87,509   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) The Long-Term Debt Obligations are secured by the Investment in Financing Receivables that were financed with no recourse to our general assets. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Critical Accounting Policies and Use of Estimates—Investments in Financing Receivables.” Debt service, in the majority of the cases, is equal to or less than the investment in financing receivables. Interest paid on these obligations in the year ended September 30, 2012 was $8.9 million and $2.0 million for three months ended December 31, 2012.
(2) We intend to use a portion of the net proceeds of this offering to repay this credit facility. Interest paid on this facility in the year ended September 30, 2012 was $0.3 million and $0.1 million for the three months ended December 31, 2012.

Off-Balance Sheet Arrangements

As described under “—Critical Accounting Policies and Use of Estimates,” 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 of $6.2 million which may be at risk in the event of defaults in our securitization trusts, 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.

 

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Distributions

We intend to make regular quarterly distributions to holders of our common stock. 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 pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its taxable income.

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. For more information, see “Distribution Policy.”

We cannot assure you that we will make any distributions to our stockholders.

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.

Quantitative and Qualitative Disclosures About Market Risk

We anticipate that our primary market risks will be related to commodity prices, the credit quality of our counterparties and project companies, market interest rates and the liquidity of our assets. 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.

Credit Risks

While we do not anticipate facing significant credit risk in our financings related to U.S. federal 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 energy savings. We will also be exposed to credit risk in projects we finance that do not depend on funding from the U.S. federal government. We expect to increasingly target such projects as part of our strategy. In the case of various other sustainable infrastructure projects, we will also be exposed to the credit risk of the obligor of the project’s power purchase agreement or other long-term contractual revenue commitments. We may encounter enhanced credit risk as we expect that over time our strategy will increasingly include equity investments. 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.

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 in the future, will be subject to interest rate risk for any new floating or inverse floating rate assets and credit facilities. 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 facilities 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 facilities, we may have to curtail our financing of sustainable

 

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infrastructure projects 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 may be of limited duration and are periodically refinanced at then current market rates. We expect to attempt to reduce interest rate risks and to minimize exposure to interest rate fluctuations through the use of match funded financing structures, when appropriate, whereby we may seek (1) to match the maturities of our debt obligations with the maturities of our assets and (2) to 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 have to 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, which allows us to maintain a minimum threshold of recurring principal repayments and capital to redeploy into changing rate environments. We monitor the impact of interest rate changes on the market for new originations and often have the flexibility to increase the term of the project to offset interest rate increases.

All of our nonrecourse debt is at fixed rates and changes in market rates on our fixed debt impact the fair value of the debt but have no impact on our consolidated financial statements. If interest rates rise, and our fixed debt balance remains constant, we expect the fair value of our debt to decrease. As of December 31 and September 30, 2012, the estimated fair value of our fixed rate nonrecourse debt was $212.7 million and $218.2 million, respectively, 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 facility is a variable rate loan and we have an interest rate swap and an interest rate cap relating to our credit facility. As of December 31 and September 30, 2012, the aggregate fair value of our credit facility was $4.2 million and $4.6 million, respectively, equal to the book value of $4.2 million and $4.6 million, respectively. We record our interest rate swap and cap at fair value and the total fair value of the interest rate swap and interest rate cap was a liability of $0.1 million at December 31 and September 30, 2012. Significant increases in interest rates would result in a lower unrealized losses on our interest rate swap and cap while decreases in interest rates would result in higher unrealized losses on our interest