PACE inside baseball: Private-label securities to the rescue?

GSE’s bench PACE

If you follow the PACE saga — which we covered in February’s Pacesetter as well as in numerous posts before, you know that it’s attracted enough interest to keep us all hopeful about the prospects for a liquid secondary market for energy efficiency loans.

But, like any saga, there are always curveballs and intrigue to keep us wondering.

GSE’s (government-sponsored entities) Fannie Mae and Freddie Mac supplied the  action in this latest edition of PACEwatch.

They recently sent PACE financing back to the dugout, by declining the purchase of tax-lien secured energy efficiency loans on residential properties, citing concerns with repayment risk associated with the priority of the tax-lien over the senior mortgages.

No, folks,  the tax-lien-priority issue will not just get up and walk away on it’s own.  Market watchers quoted in the article point out that pricing in the theoretical risk and/or clearer underwriting to clarify the value improvements to the retrofitted properties could help the GSE’s and others buy into PACE-related debt.

IMHO, it’s going to take a solid mix of both approaches to get the secondary market comfortable with fund PACE paper.  Altering a senior mortgage’s status makes it tougher for the lender to price and re-sell their loans, even if retrofits improve property valuation. They’ll want compensation for what could be an important change to their contractual structure. It’s always been that way with modifications and I don’t think there’s anything wrong with a lender expecting to be paid a market return for agreeing to re-do a deal.

Additionally, requests to see, touch and feel (and standardize) the control of the retrofit value-creation process, beyond the theoretical math of energy savings is reasonable. Programs that dole out tax payer dollars without robust underwriting and performance measurement are setting themselves up for failure.  No matter how smart we become every economic cycle, a certain percentage of loans typically fail for the same old reasons.  “Failure to properly monitor” loans is one of the oldest, and most typical paths to default.

So, while I greatly wish to see lots more capital flowing towards PACE financing, I still think it’s prudent for any lender to request clarity on the loans they buy and to be paid the right price for the risk and underwriting.

Inside baseball: private-label securitizations to the rescue?

That being said, I suggest we keep our collective eyes on the private-label securities market as an alternative funding source.  Yeah, I know it’s been dead since the economic downturn, but that would be the alternative for PACE to build up a liquid secondary market as long as the GSE’s aren’t stepping up to buy energy loans.

And the idea’s not so far-fetched since the private-label market is now starting to show signs of life.  While the GSE’s are definitely big players in the residential mortgage secondary market, which reached $2 trillion at it’s height in 2006, private-label securities were responsible for as much as 56% of home mortgage securitizations during the same time frame.

Today’s WSJ details how Redwood Trust is taking a shot at offering ~$200 million in jumbo residential mortgages in a private-label sale. This will be the first sale of private-label mortgages in two years. Market watchers say that the timing seems good for private-label securitizations to make a comeback, now that the homeowner default surge that killed the market a couple of years ago has receded. Add to that, the currently tight underwriting guidelines in effect, which strengthens the credit quality of these loans, making them attractive to secondary market investors.

Note that this particular transaction is not a done deal yet, and Redwood may have to postpone the transaction if they can’t generate sufficient interest in the offering.

For us PACE fans, however, this is bit of side action is worth tracking. The private-label securitization market is another potential source of secondary market liquidity, if the GSE’s continue to reject energy efficiency finance.

I’m willing to bet, however, that private-label market will be just as tough on conforming documentation and tight underwriting guidelines. If investors are now able to buy into residential mortgage paper structured  with tight underwriting and and high credit quality, what will compel them to give that up for PACE-paper?

Nothing, I think.

Nonetheless, the game is not over and we’ve still got several more innings to go.

$1 billion in retrofit financing from Community Preservation Corporation

People always ask ‘where’s the beef’? when it comes to green finance.

Of course, they’re asking who’s making money available to develop or retrofit buildings to sustainable standards.

You should pay attention to the recent announcement from the Community Preservation Corporation (CPC), to bring $1 billion in energy efficiency retrofit financing to multifamily property owners in New York. This should provide a great energy efficiency financing model for others to duplicate.

The newly formed CPC Green Initiative aims to be an industry pacesetter by proving that seemingly disparate public and private entities can foster new and creative green finance solutions. According to Michael Lappin, CPC President:

“We anticipate financing retrofits for up to 15,000 apartments over the next few years. But to change the urban landscape we will also need to adjust the financing landscape.”

This program is notable because it includes participation by the great range of potential sustainable finance partners — an affordable housing lender, a GSE, pension funds, private lenders and utility companies.

Key financing components:

• $150MM in construction funds will be provided by the New York Building Revolving Fund for properties needing extensive renovation. That fund is backed by proceeds from Deutsche Bank, HSBC and other lenders.
• $300MM will come from New York pension funds.
• Freddie Mac will fund permanent loans for buildings not requiring the above construction loans.
• Freddie Mac has also committed to buy $500 million of loans from this program.

By directly incorporating efficiency retrofits into the loan process as well as requiring ongoing monitoring regimes through the loan life-cycle, we feel the CPC and its funding partners are taking the long-term holistic perspective that we believe is essential.

With a sizable partners including Freddie Mac, Deutsche Bank and the NY State Pension Fund, the CPC will need to fill a role that we find essential – being a strategic hub were investors and key stakeholders can find expertise and guidance.

This kind of pooled investment and lending commitment that relies on multiple layers of funding solutions is one that we are seeing on current projects. We think these kinds of well-designed and sufficiently capitalized partnerships will compliment local government funding.

We’re sure that we’ll see more structures like the CPC Green Initiative emerging on the market. Let us know if you are aware of any similar programs for commercial properties in your area.

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