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.

Task force to Mayor Newsom: “Your 7 keys to existing building efficiency in San Francisco.”

How can green finance help increase existing commercial building efficiency?

As a member of the Mayor’s Task Force on Existing Building Efficiency, I had the pleasure of attending Mayor Gavin Newsom’s Friday announcement of his introducing new legislation, aimed at improving the energy efficiency of existing buildings in San Francisco.

The contemplated legislation is the product of a task force of 19 key stakeholders convened by the Mayor.  I was happy and proud to contribute to the financing aspects of this work and you can download the entire report here:  Report of Mayor's Task Force on Existing Buildings (389)

Goal: Cut energy use by 50% from existing buildings by 2030

The back story on San Francisco’s sustainability challenges reveals high stakes:

The operation, construction, and demolition of buildings accounts for almost half of San Francisco’s greenhouse gas emissions. Commercial, industrial, and municipal buildings account for 63% of building-sector emissions.

The City has established high standards of environmental performance for new construction. However, at the historic rate of 0.8% new buildings per year, it could take more than sixty years to ‘green’ even half of San Francisco.

As a result, the task force recommended that San Francisco move to help cut energy use by 50 percent, or 2.5% p.a. by 2030, from existing commercial buildings.

7 big ways San Francisco can achieve energy reduction goals via existing commercial buildings

The Task Force distilled its research down to seven big ideas that would help the City achieve the above GHG reduction targets by 2030.

1. Identify cost-effective savings in every commercial building: Require buildings to conduct an energy audit every 5 years.
2. Disclose energy performance information: Require building owners and managers to share energy data with the City.
3. Resolve split incentives: Provide a green lease toolkit and make submetering a policy priority.
4. Make incentives easy: Develop a web-based tool that finds all incentives and financing options for building owners in one place.
5. Educate, train, mentor and market existing building efficiency: Promote programs, facilitate mentorship and partner with institutions.
6. Lead by example in public facilities: Benchmark and disclose energy performance in public facilities.
7. Provide financing: Launch the San Francisco Sustainable Financing program and require that funding from that program prioritize efficiency before renewables.

Green finance focus - comprehensive incentives and smarter EE financing terms

Green finance mechanisms, the area I collaborated within, focused on recommendations #4 and #7.

Task force members reported seeing incentives either being ignored or misunderstood by property owners,  depressing the acceptance and prevalence of retrofits. Those problems were exacerbated by the fact that appraisers, contractors, lenders and others were equally unaware of the positive impacts that incentives could have on improving the economics of any commercial building retrofit program.

Based upon our own experience with assisting property owners in comprehensively sourcing incentives, I felt strongly that San Francisco should integrate a sourcing tool that would make it easier for property owners to quickly obtain comprehensive information on retrofit incentive options that were available to them.

We also made underwriting recommendations to the planned San Francisco Sustainable Financing program, to help it avoid problems that we’ve noticed in the loan programs of some of the other energy efficiency financing districts that are up and running.

Essentially, solar installers have a larger marketing force on the ground than energy efficiency retrofitters. As PACE loan programs are being rolled out across the country, we are getting reports of the unfortunate situation where the loans are going primarily for renewable energy, with energy efficiency funding running a distant second.  This results in the problem of solar panels supplying energy to “dirty” buildings. The regions in question are faced with achieving less of an impact from existing buildings to their climate action goals.

The financing recommendation to the City was that their own program include a provision to prioritize the funding of energy efficiency measures first, then renewable energy second. In our opinion, this requirement will would go a long way in making sure that the loans actually achieve the kind of impact expected by this financing mechanism.

I believe that even greater assurance of positive impacts from energy efficiency financing could be achieved by any program by further prioritizing energy efficiency measures according to the ‘loading order’ suggested by McKinsey in their recent studies. That level of detail was beyond the scope of our financing group’s work within this particular task force, but you’ll hear about it in upcoming posts.

At this point, it is gratifying to see that Mayor Newsom is moving forward with legislative action based upon a collaboration with key real estate industry stakeholders.

The task force has given him a lot to work with, assuring that San Francisco stands out as a leader in achieving real transformation through increasing the energy efficiency of existing buildings.