Securitization: Green opportunities appear as PACE accelerates
Europe lags behind the US in green securitizations, but efforts buoyed by pro-ABS regulations — and an initiative to kick-start the Property Assessed Clean Energy (PACE) market in Spain — could soon change that. Meanwhile in the US, ABS participants are hyping the emergence of a robust secondary market for residential PACE bonds, in addition to increasing momentum in commercial PACE ABS, after a maiden transaction hit last September. Sasha Padbidri and Sam Kerr report.
Sean Kidney, the CEO of the Climate Bond Initiative, says that 2018 could potentially be the perfect time to grow the green ABS market hand-in-hand with the rest of European securitization to meet global climate goals.
“On the back of these challenges, we don’t just have to grow securitization, which is Mario Draghi and Mark Carney’s focus, but we also have to make it green,” says Kidney. “I can’t see any way out of this hole otherwise, so we have to think how we can do this. The regulatory scene in Europe is not too bad, thanks to the STS changes and so on. The major problem in Europe is not regulatory but is in fact the identification and quality of green assets.”
Opportunities for ‘green’ EU mortgages, CMBS
Although European green securitization is at a nascent stage, one issuer has stepped forward and begun to identify green assets and to securitize them. Mortgages are one of the more obvious areas for green finance in Europe, as homes can be retrofitted and solar panels can be added to houses and commercial buildings.
Obvion Mortgages, the mortgage lending arm of Dutch financier Rabobank, has issued two deals — one in 2016 and one last year — under its Green Storm shelf, backed by mortgages on energy-efficient homes. This is helped by the energy performance certificates, which are a result of the European Union Directive 2002/91/EC relating to the energy performance of buildings.
“With the Green Storm transactions, we refinanced existing mortgage portfolios backed by energy-efficient residential houses. The selection of these houses is based on the Dutch system of residential energy performance certificates,” says Max Bronzwaer, executive director and treasurer at Obvion.
“The pool represents a selection within the top 15% in terms of energy performance in the Netherlands. There are also houses selected with lower EPCs that have realised an energy efficiency improvement of at least 30%.”
But mortgages are not the only asset class that could be juxtaposed with green finance, Kidney tells GlobalCapital. Electric vehicles are also likely to become more important for auto manufacturers as governments around the world move away from cars that run on fossil fuels.
“The biggest ABS market is the housing market, so that is an area for green ABS opportunities, and the second will be electric vehicles,” said Kidney. “The fleets are expanding very fast but are not big enough for the German and French companies to do ABS against them yet, but probably will be by the end of next year.”
Already, the UK and France have introduced plans to ban polluting vehicles from the roads by 2040, and China, once the globe’s most demonised polluter, has introduced rules that mean auto manufacturers must obtain a new energy score, through the production of low or zero-emission vehicles, before they can produce any more polluting cars.
By 2019 10% of Chinese auto production must be electric and by 2020 at least 12%. Much of this production can be financed through ABS. With a push towards electric vehicles becoming more the norm and green mortgages becoming easier to identify, green securitizations should naturally follow. However, according to Bronzwaer, there are still some issues with investor identification.
“One of the challenges is to get the right people to talk to on the investor side,” he says. “During the planning of the non-deal related roadshow that we did before Green Storm 2017, we experienced that it was sometimes difficult to get the right people to the table to talk about this type of transaction. We obviously know the investors that have an RMBS mandate and we know most investors that have a green mandate. This time we needed the specialists of both sides.” However, he is optimistic about the future as the success of Green Storm had led more green investors to start considering RMBS, and vice versa.
EU PACE on the horizon
Property Assessed Clean Energy (PACE), originally a Californian product that allows home owners to retrofit their houses to make them more energy efficient using a loan that is repayed through property taxes, is also expected to take off in Europe this year. Olot, a Catalonian municipality, could become the first incubator of European PACE if a pilot project from Global New Energy Finance funded by the European Union (EU) takes off.
Spain is ideal for PACE because the tradition of differentiated local taxes already exists there.
“There’s tremendous interest across Europe and we already know a couple of countries that are particularly suited for PACE, such as Spain, Italy and Holland,” says Kristina Klimovich, PACE financing adviser at GNE, in a November 2017 announcement.
Secondary market emerges in the US
Meanwhile in the US, the reach for yield in a low rate environment has led to growing buyer interest in residential PACE bonds, which is one of the few US ABS asset classes with green certification. Spurred by a busy primary pipeline, the past two years have also seen the emergence of a robust secondary trading market.
“We saw a significant increase in PACE secondary trading activity in 2017,” says Nicole Montecalvo, head of investor relations at residential PACE issuer Renovate America. “Volumes are up by six times from an average of $5m a month in 2016 to $30m a month in 2017. Some dealers are even sending out dedicated PACE ABS daily runs, which is new to the industry.”
“With more investors trading paper in the secondary market, we have been able to add new investors through this avenue — something that would have been far more difficult in 2016.”
Montecalvo also notes there has been interest from foreign buyers in PACE ABS, and a number of European buyers participated in Renovate America’s 2017 deals. However, European investment is expected to be limited in the future as the offerings are not structured to be European risk retention compliant.
In the primary markets in 2017, the sector also saw the evolution of PACE deal structures.
“We have been changing things a little bit structure-wise since 2016, such as the premium bond structure,” says Craig Braun, managing director at Renovate America. “We also introduced the ‘A2’ notes, based on either our collective input or investor interest. It is possible that we might look at different deal structures in 2018.”
Additionally, with the signing of two consumer protection bills for residential PACE in California by Governor Jerry Brown in 2017, industry participants hope to see the asset class gain momentum in 2018, with the development of a regulatory framework that can serve as a model for other states.
“Beginning in January 1, 2018, a host of consumer protections — including enhanced disclosures — will take effect, while as of April 1, 2018, all PACE providers will be required to verify income and conduct an ability-to-repay analysis as part of their underwriting process,” says Greg Frost, national communications director at Renovate America.
“By the time the state regulator begins giving out licences to PACE providers on January 1, 2019, PACE in many ways will be a fundamentally new and improved product in California.”
Commercial PACE reaches critical mass
The commercial segment of the PACE sector has seen explosive growth over the past two years, with origination levels more than doubling since December 2015 to reach $493m as of the third quarter of 2017, according to data from industry group, PaceNation.
On the back of this growth, the market saw the first commercial PACE securitization last September. Connecticut-based Greenworks Lending closed a debut $75m single-tranche offering led by Guggenheim. TIAA Investments was the sole buyer of the single tranche.
“The securitization that we completed in September was an important milestone for our company and the industry,” says Greenworks CEO Jessica Bailey. “It suggests that there is significant investor appetite for the small to medium-sized commercial PACE assets, which is what we specialise in.”
CIO Alexandra Cooley adds that the company is already hearing interest from international investors, including Asian buyers, about future deals.
“Our model is to access the capital markets to bring the most efficient cost of capital to our end-users,” Cooley says. “So, that naturally leads us to another securitization as our volumes continue to grow. I think you’ll see some activity on the capital markets side from us in 2018.”