Recent U.S. legislation isn't enough to achieve the Paris Agreement's goal of net zero carbon emissions by 2050 (https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement), but it will spark innovative financing, including securitizations, that will go a long way toward reducing emissions, according to recent research from Moody's Investors Service.
U.S. emissions could be reduced by 40% relative to 2005 levels, closing two-thirds of the emissions gap, due to the Biden Administration's Inflation Reduction Act (IRA), according to findings from the report, "Governments have made policy progress toward net zero, but energy crisis will complicate implementation."
The IRA includes building decarbonization tax credits and rebates to promote electrification and energy efficiency in residential and commercial buildings.
Subsidies set the pace for real estate efficiency
With such incentives in place, U.S. government funding will be a major driver for asset-backed loans for electric vehicle purchases and building energy improvement programs such as commercial and residential Property Assessed Clean Energy (PACE) financing.
The ABS market has already embraced these asset classes, with substantial production in 2022 and expectations for more in 2023.
Sustainable home upgrades represent an estimated $450 billion annual U.S. market opportunity, according to GoodLeap, a loan platform for residential home energy enhancement. During 2022, GoodLeap raised $1.7 billion through four ABS issues that were backed by its loans. In July 2022, Fannie Mae said it had issued over $1 billion in Single-Family Green Mortgage-Backed Securities (MBS) in the two years since the program was launched. Although neither the GoodLeap nor the Fannie Mae issues are PACE-related, they indicate the opportunity in the sustainable home upgrade market.
Residential PACE loans for energy efficiency, retrofit and upgrade projects on properties are well suited for securitization, said Juan Martinez, residential PACE managing director at non-profit PACE advocacy organization PACENation. "They are low risk, since they are repaid through property taxes, and this makes them attractive to investors," he said. "Also, PACE loans help investors with ESG obligations meet their compliance requirements."
Commercial PACE loans also provide opportunities for securitization, even if the potential for new securitization business hasn't materialized as much as market participants had hoped, according to Colin Bishopp, CEO of Allectrify, which helps financial institutions issue C-PACE loans.
"Federal government incentives through the Bipartisan Infrastructure Law and the IRA provide an accelerant for the C-PACE market," he said. "The Department of Energy's loan program has hundreds of billions of dollars in financing capacity and will be deployed across multiple sectors including residential and commercial lending."
About $12 billion has been invested in 300,000 commercial and residential PACE projects across the U.S. to date, according to Martinez.
According to Bishopp, investors usually want to hold C-PACE assets until maturity, because of the high-quality of the supporting loans. "We haven't seen as much C-PACE securitization as we had hoped," he said. "But eventually there will be so much C-PACE lending that there will be significant opportunities for securitization. C-PACE assets are one of the few assets that provide low credit risk and good returns along with an ESG classification."
Bishopp estimates that over the next decade there could be $500 billion in C-PACE ABS originations.
Despite the lower than expected C-PACE production, a few substantial deals have priced throughout the year. In March 2022, for instance, Ygrene, a property improvement loan provider which has since paused its PACE financing, managed to raise $344 million in an issue of residential and commercial PACE investment-grade debt securities.
Urgency for ABS in EVs, severe storms
More stringent fuel economy standards for new U.S. passenger vehicles and light trucks, starting in 2023, along with large-scale federal investments to meet a 2030 target of 50% electric vehicle sales, make ABS for electric vehicle loans another growth area. Alternative vehicle sales will account for 33% of total U.S. vehicle sales in 2030, while battery-powered electric vehicles will account for 24%, the Moody's report predicts.
The report warns about the rising cost of reinsurance. "Increased frequency of extreme climate events and slow progress in transition toward a low-carbon economy will likely increase the focus on physical risks such as heat stress, water stress and flooding," according to the report. "Reinsurers are able to increase prices in response to rising risk, although their ability to do so isn't unlimited."
"As climate risks increase, investors will demand higher prices for cat bonds, requiring a new risk/reward equilibrium and collaboration between reinsurers, primary insurers, governments, companies and individuals to better understand climate risk, and to develop more effective adaptation and mitigation strategies," Brandan Holmes, Moody's vice president, financial institutions group and a report contributor, told Asset Securitization Report.
Cat bonds could be used to reduce the risk of exposure for local governments and municipalities in climate-sensitive regions such as the Florida coast, said Paul Schultz, Aon Securities' CEO.
Market participants shouldn't view cat bonds as a panacea for climate-related risks or substitute for collective effort, said Jeffrey Mohrenweiser, Fitch Ratings' senior director, insurance ratings.
"It's up to local governments and communities to counter climate risk at the local level and protect properties – this will bring down the economic losses and reduce the insurance protection gap."
PACE financing to make buildings resilient against risks such as wildfires or hurricanes will help make properties affected by climate change insurable, said PACENation's Martinez. "PACE enables property-owners to affordably finance expensive projects like storm-proofing, as they stretch the loan over a long period of time and are repaid from property taxes," he said.
