Financing for green

The mortgage business discovers the benefits of green homes

Retrofitting residential homes to be more energy efficient makes sense, both from an environmental perspective and from a home-value perspective. However, capital markets financing for green building materials is wrought with hazards for both the investors, mortgage lenders and even the homeowners themselves.

Two recent breakthroughs allow states to access the secondary market for these loans. On March 15, the Western Riverside Council of Governments (WRCOG) securitized $104 million of bonds issued by the county for green residential retrofits.

The following month, Citigroup announced that it was providing a $100 million warehouse line of financing for a multistate program that would facilitate the aggregation of unsecured loans made for green retrofits.

PACE IN THE DEBT CAPITAL MARKETS

The Property Assessed Clean Energy, or PACE, loans securitized in the WRCOG securitization deal offers borrowers a low-interest, long-term, tax-deductible financing option that is repaid through the homeowner’s property taxes.

Governments and municipalities fund the up-front cost of energy efficiency improvements on commercial and residential properties, which are paid back over time by the property owners.

This allows a property owner to implement improvements without a large up-front cash payment. Improvements are repaid over 10 to 20 years through property assessments, which are secured by the property itself and paid as an addition to the owners’ property tax bills.

In total, 31 states and the District of Columbia have adopted PACE enabling legislation.

But in July 2010, the Federal Housing Finance Agency (FHFA) took precipitous regulatory action that halted virtually all PACE programs in the U.S. serving the residential market. Fannie Mae and Freddie Mac were ordered by their regulator, the FHFA, to stop buying mortgages on properties that are subject to assessments financing energy-efficient upgrades.

The problem: PACE liens are considered senior to primary mortgages and, in the event of a foreclosure, would be paid ahead of the mortgaging institution. As a result, in 2010 FHFA ordered the government-sponsored enterprises (Fannie and Freddie) not to underwrite mortgages for homes with PACE loans. This slowed the development of PACE programs.

On March 15, the Home Energy Renovation Opportunity (HERO) financing program completed the first securitization of PACE bonds. The $104 million deal is secured by 5,898 PACE assessments levied against 5,890 residential properties located in WRCOG.

A PACE assessment is a debt of property, meaning the debt is tied to the property as opposed to the property owner(s), so the repayment obligation may transfer with property ownership. This eliminates a key disincentive to investing in energy improvements, since many owners are hesitant to make property improvements if they think they may not stay in the property long enough for the resulting savings to cover the upfront costs.

WRCOG’s residential PACE loan program is administered and funded by Renovate America, a San Diego-based company founded in 2008 exclusively to work with local governments to enact the HERO program. 

Renovate America is directly responsible for developing and marketing the program and originating each assessment. The minimum project size is $5,000 and projects could be financed for up to 25 years. 

Under the program, WRCOG issues municipal bonds secured by the assessments that are bought by Renovate America Inc. 

The securitization transaction packaged these municipal bonds issued by WRCOG, and carried innovative structural features which protected investors against credit and extension risk of the underlying assessments as well as the bankruptcy risk of Riverside County, which collects the underlying PACE special assessments. 

Deutsche Bank was the lead underwriter for the deal, HERO Funding Class A Notes, Series 2014-1, which was sold via a private placement. Kroll Bond Rating Agency assigned preliminary ratings of ‘AA’ to the notes, which mature in 10 years and priced with a coupon of 4.75%. 

The FHFA’s opposition to PACE assessments creates the risk that the regulator could challenge the validity of a PACE lien against a mortgagee’s security interest in federal court. If the FHFA wants to read it as violating no prior encumbrances or no prior liens that could call the homeowner into default. 

In its presale report, KBRA had to ensure that the deal was structured such that it could withstand the stress of a challenge by the FHFA. KBRA applied a stress scenario that assumed that all of the PACE Assessments related to properties having a Fannie or Freddie mortgage (which is approximately 40% of the pool) defaulted and that there were zero recoveries from these defaults. This stress showed that the transaction could withstand a default rate of up to approximately 14%, a rate in excess of the 11.53% default rate recorded in the 2007-2008 recession. 

However the risk of a legal challenge is “relatively remote.” That is because WRCOG obtained a final, non-appealable judicial order from the Riverside County Superior Court affirming the validity, enforceability and seniority of the PACE liens. The PACE liens therefore rank more senior than mortgages, giving them a greater right to foreclosure. 

HERO’s WRCOG complex deal signals that PACE loans have matured enough to achieve the critical mass necessary to execute a securitization and that there is a market for this asset. Accessing the capital markets should lead to more warehouse lenders willingly making lines available to buyers who want to accumulate the asset. 

The bond is one of a growing number of ‘Green Bonds’. Already more than $4.5 billion of green bonds have been issued in 2014, compared to $11 billion in 2013 and $2 billion in 2012, according to Deutsche Bank figures. 

Deutsche Bank and 12 other banks recently published Green Bond Principles for designating, disclosing, managing and reporting on the use of proceeds from a Green Bond. 

The principles introduced guidelines for the use of proceeds of green bonds, process for project evaluation and selection, management of proceeds and reporting. 

Bank of America, Citigroup, Crédit Agricole, JPMorgan Chase — the four banks that drafted the new guidelines —are joined by BNP Paribas, Daiwa, Deutsche Bank, Goldman Sachs, HSBC, Mizuho, Morgan Stanley, Rabobank and SEB. 

Sean Kidney, CEO of the Climate Bonds Initiative, said the progress made on the Green Bond Principles, is “a big development. With even more banks expected to now sign up to the principles they are likely to have a major impact on development of the market,” he said. 

And that is only California; there are another 30 states that have PACE legislation in place, with many operating and originating. Florida’s statewide PACE program, for example, has the ability to finance up to $2 billion in loans. 

CALIFORNIA FUND FOR RESI PACE

Investors may also take comfort from the fact that the state of California created its residential PACE mortgage loss reserve program to address concerns raised by the FHFA.

California’s residential PACE reserve is designed to protect mortgage holders, including Fannie Mae and Freddie Mac, from losses associated with PACE liens.

This program was recently approved and will be administered by the California Alternative Energy and Advanced Transportation Financing Authority and be used to refund mortgage holders from losses associated with a PACE lien on the property.

The breakthrough legislation has led to the approval of residential PACE loans in San Diego. In April, the San Diego County Board of Supervisors approved the residential PACE program. Loans will be financed through HERO, California First, and Figtree PACE programs.

Carlsbad, Escondido, Lemon Grove, San Diego, San Marcos, Solana Beach, Oceanside and Vista and are among the San Diego County cities that have adopted the program and expanded service availability to residents in all unincorporated parts of the county.

“It’s great to see the county of San Diego taking an open market approach by offering multiple PACE programs,” said Dustin Reilich, HERO Director of Municipal Development. “Property owners will more quickly learn about the advantages of PACE and get to choose the program that best fits their needs, and the community will see greater results.”

WRCOG launched its statewide California HERO Program in participating cities in Orange County and San Diego County in February.

Approximately 6,000 property owners were able to make energy-efficient upgrades to their homes thanks to California’s PACE program. This will reduce their annual energy consumption by over 67 gigawatts and reduce annual CO2 emissions by 17,000 tons.

Since the WRCOG HERO Program was launched in early 2012, 20,167 applications have been received, with 13,560 approved for energy improvements totaling $460.4 million as of February 2. Approximately $132.8 million in bonds have been sold to date under the WRCOG HERO Program.

San Bernardino, another California county, launched its HERO Program in October 2013, and 5,434 applications have been received, with 3,377 approved for energy improvements totaling $134.5 million, as of February 2. Approximately $15.8 million in bonds have been sold to date under the program.

UNSECURED LOAN OPTION

A number of investment funds have been buying up PACE bonds to hold pending securitization, and some have used bank lines of credit to defray some of their acquisition costs.

In April, Renewable Funding announced a new funding platform to provide low-cost, large-scale capital for state and local government and utility-sponsored residential energy efficiency loan programs.

Renewable Funding worked with the Energy Programs Consortium, Citigroup and the Pennsylvania Treasury to help create the Warehouse for Energy Efficiency Loans (WHEEL) program.

WHEEL’s goal is to create a secondary market for residential clean-energy loans, and to deliver the resulting benefit — a virtually unlimited amount of lower-cost capital — to state and local energy loan programs.

The WHEEL loans fund residential energy efficient retrofits similar to residential PACE loans The loans are offered over three-, five- or 10-year fixed rates up to $15,000, to borrowers with 640+ FICO scores.

They are structured as unsecured loans at an interest rate of 7.99% for a single project, or 2.99% for “whole house” improvement projects.

WHEEL builds on the Pennsylvania’s Keystone HELP Loan program. The loans are originated and underwritten by AFC First. 

AFC provides loans in all 50 states with “flagship” programs including Pennsylvania’s Keystone Home Energy Loan Program, Connecticut’s Solar Leasing Program, Kentucky Home Performance, Efficiency Maine’s PACE and Power Saver programs, Energize CT Heating Loan Program and the Illinois On?Bill Energy Loan program.

WHEEL facilitates secondary market sales by purchasing unsecured residential energy-efficiency loans originated in participating programs.

WHEEL purchases unsecured residential energy efficiency loans originated in participating programs. The loans are aggregated into diversified pools and used to support the issuance of rated asset-backed notes sold to capital markets investors. Proceeds from these note sales will be used to recapitalize WHEEL, allowing it to continue purchasing eligible loans from state and local programs for future rounds of bond issuance.

Renewable Funding is using a $100 million warehouse facility provided by Citi and the State of Pennsylvania Treasury purchases the loans. 

These loans will be aggregated into diversified pools, securitized, and sold to institutional bond investors. “WHEEL essentially becomes the warehouse for states to sell their unsecured energy-efficiency loans into, based on standardized credit underwriting matrix and Renewable funding manages the conduit,” said Peter Krajsa, chairman and CEO of AFC First Financial Corp. “Citibank provides the capital and ultimately when they get enough in the warehouse they will be able to take it to securitization.”

“WHEEL is designed to serve a $200 billion unmet need for financing in the home energy efficiency market,” said Cisco DeVries, CEO of Renewable Funding. 

“Now, we are making it easier for consumers and contractors to utilize affordable loans, supported by their state or utility, to make energy efficiency improvements. We are also making it easier for investors to find a path into this important and urgently needed market.”

A key difference between WHEEL and PACE is that no lien is filed on the home. That means the loans work around the FHFA objections to the senior lien that PACE financing creates.

Krajsa said that the unsecured loan for energy efficiency might also be more appealing to homeowners who don’t necessarily want to add a five-year tax lien to their bill.

Reactive homeowners (homeowners that are driven to action only when a problem arises) dominate 80% of the housing market, according to Krajsa. These borrowers make energy improvements to address an immediate need, such as faulty or inefficient heating and cooling, defective windows or air sealing.

The low interest-rate, long-term financing for upgrading to energy efficient fittings is what is appealing to these reactive homeowners.

For states, the platform opens up a place to sell their unsecured loans, once they’ve filled their own buckets. “Much like the growth in the mortgage market, it’s all about opening up a secondary market for this stuff and this is the first step,” said Krajsa. 

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