By Kat Friedrich, Clean Energy Finance Center
Guest Blogger, Energy Efficiency Markets
March 13, 2013
Although connecting energy efficiency programs and private capital may seem like an ideal partnership, program managers from New York and Pennsylvania have found it is challenging to achieve competitive investment ratings for energy efficiency loan portfolios. Jeff Pitkin and Keith Welks discussed their experiences with accessing the secondary market in these two states during a webinar on energy efficiency loan pool securitization on Feb. 27. The U.S. Green Building Council (USGBC), the Los Angeles Chapter of the USGBC, and the Clean Energy Finance Center co-sponsored the event.
Welks, who is deputy treasurer for fiscal operations and senior advisor for policy at the Pennsylvania Treasury Department, was surprised by the obstacles he faced initially when the Treasury decided to seek private investment for the Keystone HELP residential energy efficiency program. But the Treasury was able to pursue an alternative track and eventually achieved promising results. It is now working on a national program which will aggregate energy efficiency loans and sell them to secondary market investors.
The Treasury had to seek to recapitalize the Keystone HELP program because the unsecured loan program was so successful. In six to seven years, Welks said, AFC First Financial has issued about 11,000 residential loans with a volume of almost $80 million.
As the program’s success became clear, the Treasury realized it would need to convert part of its loan portfolio back into cash to continue making loans and still be able to comply with the department’s investment requirements. These requirements call for diversification and set limits on portfolio concentration.
At this point, the effort to recapitalize Keystone HELP loans ran into an obstacle – the recession. The Treasury engaged Bostonia Partners to assist it in selling a portion of the loan portfolio into the secondary market. At first, many investors expressed interest in the product even though no agency had rated it. But after the worst part of the recession, financial institutions and other investors tightened their investment criteria and began requiring that all of the assets in which they invested be rated.
“That lack of a rating turned out to be an insurmountable obstacle,” Welks said. “We were just coming out of the worst of the economic crisis. The unrated nature of the assets – not the basic economics of the transaction we offered – came to represent the real problem.”
Facing market constraints, the Treasury tried a different tactic. Bostonia Partners, working with Drinker Biddle & Reath and Stradley Ronon, restructured the deal by creating a special purpose vehicle which took out a commercial loan from a consortium of banks. The Treasury then sold Keystone HELP loans to the special purpose vehicle. The special purpose vehicle paid for them with the proceeds of the loan it had just received. These loans provided the revenue to repay the commercial loan and the collateral to secure it. For the banks, this structure allowed the transaction to be evaluated according to traditional loan underwriting criteria. For this purpose, the lack of a rating was not as critical as it would be otherwise.
Through this recapitalization, the Treasury has reduced $28 million of financial exposure to $5 million. It also has additional reserves.
Welks said that this transaction may be a one-time solution. However, this experience does suggest ways to exchange well-performing energy efficiency loan portfolios for cash. The Treasury is now interested in identifying additional sources of senior capital and developing long-term strategies to open secondary markets for energy efficiency lending.
“Our goal wasn’t to develop a one-off deal; our goal was to find out what we could learn for secondary market transactions,” Welks said.
The Treasury is exploring partnering with other organizations to create the Warehouse for Energy Efficiency Loans (WHEEL). WHEEL intends to spur the growth of a secondary market for energy efficiency loans nationally by aggregating loan portfolios from existing programs. Citigroup and Renewable Funding will sell the loans as investment-grade rated securities to the secondary market.
In the webinar, Welks also discussed the State and Local Energy Efficiency Action Network (SEE Action Network), a nationwide initiative to help achieve all cost-effective energy efficiency in the United States by 2020. The network is facilitated by the U.S. Department of Energy and the U.S. Environmental Protection Agency. The program has a number of working groups, one of which is a financing group which Welks co-chairs.
The financing group’s goal, according to Welks, is to “try to address any financing barriers that are impeding the wholesale application of technologies to buildings in the United States.” Initially, the financing working group is focused on the residential market. The group plans to develop toolkits for state and local stakeholders and to develop a conceptual structure for energy efficiency loan data. This structure will connect energy efficiency savings data and loan performance data.
Craig Diamond, executive director of the Clean Energy Finance Center, moderated the discussion. In a separate interview, he said the Clean Energy Finance Center, in partnership with other organizations, is seeking to create the kind of data structure being recommended by the SEE Action Network finance working group and other stakeholders. Diamond said he has identified four states as initial candidates to provide high-quality data for a new national repository of energy efficiency loan performance and energy savings data.
Diamond said, “The experience to date of the PA Treasury, NYSERDA (New York State Energy Research and Development Authority) and other organizations who have sought to raise capital for pools of energy efficiency projects clearly demonstrates the need for a national repository of standardized loan performance and energy savings data that can be used by rating agencies, investors, and other stakeholders.”
Pitkin, treasurer and chief financial officer of NYSERDA, is building on insights from the Pennsylvania Treasury’s strategy to build a financial product that will appeal to investors in the secondary market. He said collecting energy efficiency loan data is a key part of reaching out to investors.
NYSERDA offers multiple options for financing energy efficiency improvements in multi-family buildings, houses, and nonprofit and small business facilities. The Green Jobs – Green New York program has an on-bill recovery financing option in which customers can pay for energy efficiency upgrades over time through their utility bills.
The program also offers unsecured consumer loans. The program approves loans through two tiers of loan underwriting standards.
One tier is for applicants who meet traditional Fannie Mae financing criteria – a debt-to-income ratio of less than or equal to 50 percent and a FICO credit score of at least 640. These loans will be securitized through a secondary market bond issuance.
The second tier is for customers who do not meet these criteria, but have strong utility bill and mortgage payment histories. These loans will be held until their demonstrated performance history allows them to be included in a future loan securitization. NYSERDA has issued close to $26 million in residential energy efficiency loans as of Jan. 31.
NYSERDA approached a national rating agency to provide a rating on a proposed bond issue supported by a pledge of repayment from its portfolio of residential energy efficiency loans. NYSERDA hoped to achieve an A rating for investors. Unfortunately, the road to this goal has turned out to be challenging.
“We were a bit of an unknown commodity in the eyes of the rating agency,” said Pitkin. He explained that while NYSERDA has experience with issuing more than $3 billion of bonds on behalf of the state’s investor-owned utilities, NYSERDA has never issued bonds for consumer loan securitizations.
Quality data turned out to be essential for the rating process. The rating agency was very interested in acquiring data about the financial loan performance of NYSERDA’s program and similar programs. The Keystone HELP program shared its data with NYSERDA to help move the process forward.
“The real holy grail, of course, sits with Fannie Mae, which has been offering an unsecured energy efficiency loan program for a decade,” said Pitkin. Fannie Mae shared a summary of its data with NYSERDA, but the level of detail was not sufficient to meet normal rating agency requirements.
However, although the ratings process is not final, it appears the combined data from all of these sources will not be robust enough to convince the rating agency that the program deserves a rating higher than BBB.
The rating agency also expressed concern about several other features of the program: the 15-year loan terms, the use of funds from federal qualified energy conservation bonds, and the on-bill recovery option. The on-bill recovery option is innovative and was just launched in Jan. 2012, so the agency was unable to assess how well it was working.
Pitkin said NYSERDA is revising the program using a municipal bond structure and hopes to reach an AA- rating with a bond issuance in June. NYSERDA is exploring offering a credit enhancement and guarantee arrangement with the New York State Environmental Facilities Corporation and is seeking the necessary approvals. NYSERDA hopes to complete its bond issuance by June.
“It’s always a challenge to try to break through new processes,” Pitkin said.
As rating agencies become more familiar with energy efficiency organizations, it may become easier for energy efficiency loans to achieve the ratings they seek.
A lack of data is holding back the progress of energy efficiency loan securitization. Developing reliable, standardized databases for rating agencies will make it easier for energy efficiency investments to break into the secondary market.