Bonhoeffer Capital Management recently released its Q3 2020 Investor Letter, a copy of which you can download here. The fund posted a return of 5.1% for the third quarter (net of fees), compared to up 5.0% for the MSCI World ex-US, a broad-based index. You should check out Bonhoeffer Capital Management’s top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.
In the said letter, Bonhoeffer Capital Management highlighted a few stocks and MMA Capital Holdings Inc. (NASDAQ:MMAC) is one of them. MMA Capital Holdings Inc. (NASDAQ:MMAC) is a portfolio management company. Year-to-date, MMA Capital Holdings Inc. (NASDAQ:MMAC) stock lost 21.5% and on November 19th it had a closing price of $24.98. Here is what Bonhoeffer Capital Management said:
“MMA Capital (MMAC) is an alternative asset fund. Historically, MMAC was an asset manager so the transition to an alternative asset fund has created an interesting investment opportunity. MMAC is managed by Hunt Investment Management, LLC (HIM), an experienced originator and asset manager in the renewable energy lending sector. Since 2015, HIM has originated over 190 loans for 760 renewable projects in 24 US states and territories. MMAC has investments in renewable energy (primarily solar projects) bridge financing and legacy investments in affordable housing debt and real estate debt and equity. MMAC is selling the legacy portfolio investments to fund new renewable energy bridge financing investments. The renewable energy bridge financing is provided to renewable power developers between the pre-construction and operations phases of renewable power projects. About 67% of the portfolio is for construction financing while 33% is for pre-construction financing for design and land purchases. In the operations phase of a renewable power project, lower long-term financing can be obtained due to the long-term power purchase agreements with creditworthy electric utilities. These loans facilitate the current disruption taking place in the energy generation business with solar displacing coal for power generation.
Currently 78% of the portfolio is in solar ventures while 22% is legacy (affordable housing debt and real estate debt and equity). The solar investments are via joint ventures with Fundamental Investors (an investment fund). MMAC has an approximately 50% interest in the renewable power loan pools. The solar loans have principal balances of $5 to $20 million, have coupon rates of 7% to 14%, and an average remaining maturity of seven months. The current portfolio has 60 loans with an average loan to value of 50%, an average interest rate of 9.5%, and the fund generates 1% to 3% origination fees. The loans are primarily first-lien loans on the projects. As of June 30, 2020, the funded balance is $758.8 million ($364.4 million MMAC share) with an unfunded balance of $427.5 million ($214.9 million MMAC share). The solar investments have $110 million of debt at the MMAC level and $364 million of equity. MMAC has an 81% recurring revenue rate from existing customers. The current pipeline is about $800 million out of $2 billion opportunities reviewed annually. Historically, solar ventures have originated $540 million of loans over the past year and $2.8 billion since inception. MMAC directly sources loans with no reliance on brokers. Loans have been underwritten to 10% to 15% annual returns. Actual returns have been 16.7% for all loans originated to date. The current trailing 12-month returns on the portfolio have been 11.8%. The current net interest margin in the solar portfolio is 4.9% (6.9% if fully invested in solar ventures) with an average financing rate for MMAC of 3.9%. This margin combination with an efficiency ratio of 41.6% results in a return on equity of 8.3% (11.1% if fully invested in solar ventures).
The solar asset management firm (formerly owned by MMAC) was sold to Hunt in 2018 for $57 million. Hunt had a $365 million asset value in 2018, so the price paid was 15.7% of assets under management (AUM). The proceeds were used by MMAC to invest in more solar loans. Hunt is paid a management fee (2.0% of equity and 20% above 7% increase in equity book value) and reimbursements of about 3.5% of equity or 1.9% of assets as of Q2 2020. Current operating expenses as a percentage of net interest income (efficiency ratio) is about 41.6%. If you include the pro-rata operating expenses of solar ventures of $2.4 million per year, then the adjusted efficiency ratio is 45.7%. The efficiency ratio will decline as the portfolio grows and the fixed non-management fee operating expenses stay constant. As a result of the asset management sale, some investors sold MMAC, as they wanted to invest in an asset management firm, not an alternative asset fund.
MMAC is the largest competitor in the market of banks and specialty finance funds. Many solar lenders will not provide lending before commercial operations, so MMAC is one of the few financing sources preoperations. The market growth is based upon the increased amount of installed solar capacity over time. According to the Solar Energy Industries Association (SEIA) and Wood Mackenzie, over the next five years, the amount of installed solar capacity is expected to double (15% annual growth) which will create many more lending opportunities for MMAC as the solar energy infrastructure is built out across the US.
Historically, MMAC has not had enough capital to meet the 50% loan share agreement it has with Fundamental Investors.
The legacy assets include: debt and equity in a mixed-use town center development in Spanish Fort, Alabama; a land development project in Winchester, Virginia; a tax-exempt affordable housing bond for a property in Atlanta, Georgia; and interests in South African housing (a REIT and a housing fund).
Renewable Lending Business
The renewable lending business competitors include financers of solar projects from development to operations. MMAC focuses on the pre-construction and construction phases of solar projects. The competitors include large banks and bonds for operational solar projects, and smaller banks and funds for development and construction loans.
Other comparable firms include private debt providers (BDCs) and real estate loan providers (construction bridge loans). See Appendix A.
The downside protection is the asset value of MMAC. The value of MMAC is driven by the cash flow of MMAC’s assets (solar ventures and legacy assets) less interest payments for its debt. MMAC has debt of $245 million or 51% of equity book value. None of the 132 solar loans that have been repaid since inception (2015) have incurred a principal loss.
Financial leverage can be measured by the debt/enterprise ratio. MMAC debt/enterprise ratio is higher than the low cost comparable firms (see Appendix A), but MMAC’s portfolio has better credit metrics than the low cost comparable firms (see Benchmarking in Appendix A) and the stock, in my opinion, is undervalued.
COVID has been a test of the resilience of MMAC. The impact thus far has been (1) an impairment on the Spanish Fort, Alabama development, (2) no incremental losses in the solar loan portfolio, (3) the origination levels for the solar loan portfolio have been flat year-on-year, and (4) lower interest rates have increased the fair value of the solar portfolio.
Management and Incentives
MMAC is managed by HIM. The asset management agreement pays HIM 2% of equity per year (1.5% on assets) and an incentive fee of 20% above a 7% increase in book value per year. The current efficiency ratio is 41% of net interest income, typical for an alternative asset management fund. Once MMAC is fully invested in solar loans, the efficiency ratio will decline to 39.2%. HIM and MMAC management hold about 15% of MMAC’s equity.
MMAC is valued based upon the income its assets can generate capitalized by a normalized capitalization rate. MMAC is comprised of solar assets that are currently generating 10.8% and legacy assets that are generating a 2% return. The cost of the debt has to be subtracted from the income generated by the assets resulting in net interest income. Finally, the operating costs of management fees, salaries, and professional fees are subtracted from net interest income resulting in net investment income (NII). The efficiency ratio is 41.6% which is at the high end of the low-cost alternative asset funds. The current return on equity is 8.3%. One way to value MMAC is to estimate a normalized return on equity from comparable funds (see Appendix A). Given MMAC’s low loss ratio, the normalized return on equity should be on the low end of the comparable firm range of 6.8% to 11.9%. The resulting normalized return on equity is 8.0%. Therefore, using the normalized return on equity results in a price-to-book value of 1.03 (8.3%/8.0%). Applying this to MMAC’s equity of $224 million results in a low-end value of $231.8 million or $39.89 per share. If you add the deferred tax assets associated with the net operating loss carryforward of $57 million, then the resulting high-end value is $288.8 million or $49.70 per share.
Currently, MMAC’s plan is to further replace legacy assets with more solar loans. If the remaining legacy assets are replaced by solar loans, then the income from investments will increase from $41.4 million currently to $50.7 million (see table below).
The cost of the debt has to be subtracted from the income generated by the assets resulting in net interest income of $41.0 million. Finally, the operating costs of management fees, salaries, and professional fees are subtracted from net interest income resulting in NII of $24.9 million. The efficiency ratio is 39.2% (assuming no salary savings) which is on the high end of the range compared to other alternative asset funds at the high end of the low-cost alternative asset funds. The expected return on equity is 11.1%. Using the normalized return on equity of 8% (derived above) results in a price-to-book value of 1.39 (11.1%/8.0%). Applying this to MMAC’s equity of $224 million results in a low-end value of $311.62 million or $53.63 per share. If you add the deferred tax assets associated with the net operating loss carryforward of $57 million. then the resulting high-end value is $368.62 million or $63.45 per share.
In the table in Appendix A are the low-cost BDC and real estate loan funds firms engaged in the assetbacked lending. MMAC has a lower NII multiple of 5.9 (w full solar investment) than the comparables’ range of 8.4 to 15.1x and average of 10.7x.
MMAC has one of the lowest total loss/year ratios versus the comparables and 100% of the loans are first lien secured loans. While the expense ratio of 41.6%/39.2% is above average for the low-cost comparable firms, it has some downside as overhead is reduced.
The primary risks are:
• lower than expected return on solar investments;
• a dependence on functional renewable energy financing market; and
• a lack of new investment opportunities (including solar if subsidies are reduced).
The primary potential catalysts are:
• higher return on solar investments as lending standards reduce competition; and
• other high-return renewable investment opportunities.
The short-term target is $45.00 per share, which is almost 80% above today’s stock price. If the replacement of legacy assets with solar assets thesis plays out over the next five years, then a value of $58.00 could be realized. This is an 18% IRR over the next five years.”
Earlier this month, we published an article revealing that Arquitos Capital is bullish on MMA Capital Holdings Inc. (NASDAQ:MMAC) stock. The investment firm is not concerned about the change in leadership.
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