Providers of property assessed clean energy financing have tended to shoot for relatively modest credit ratings when they initially tap the securitization market, seeking a single-A or double-A credit rating on their first deals.
But CleanFund, a San Francisco-based firm that provides PACE financing for commercial property, went a different route, achieving an AAA from DBRS on its inaugural securitization on the $115 million of PACE assessments. The firm did it in part because of a key benefit: Bragging rights.
“We were looking for a little distinction to set ourselves a bit apart,” CleanFund CEO Greg Saunders said in an interview.
The deal is not the first commercial PACE securitization ever — that distinction belongs to Greenworks Lending, which completed a private placement late in 2017. Still, “we like that it’s the first AAA, and not just the first 144a,” Saunders said, referring to the securities law rule that allows for the sale of unregistered offerings to certain types of institutional investors.
Bonds backed by PACE loans are one of the few types of asset-backeds with long tenors — the underlying assessments, which finance energy efficiency upgrades, can last 20 years or longer. So these investments are particularly attractive to insurance companies, which generally try to put their money to work in assets with terms as long as their policies.
Since insurance regulators assign the same risk weighting to securities with a credit rating of single-A-minus or higher, there’s less of an economic incentive for PACE providers to provide the additional investor protections necessary to achieve the top credit rating of AAA.
Insurance companies may not be as inclined to accept the lower yields on these super-safe securities as would other kinds of investors, such as banks or money managers.
Unlike Greenworks' $75 million deal, which was rated AA by Morningstar Credit Ratings and was placed with a single investor, TIAA Investments, CleanFund’s transaction was placed with a total of four investors, three insurers and a money manager.
CleanFund did have to make a concession to its investors, some of whom were not quite as comfortable with the collateral as DBRS; the sponsor increased the amount of excess collateral available to protect noteholders in the event of losses or late payments, to 10% of the balance of the notes from 5% originally. (DBRS was willing to assign an AAA based on 5% overcollateralization.) Doing so meant reducing the amount of notes issued to $103 million from $109 million originally.
“Five percent overcollateralization seemed light to some investors on calls; now that it’s at 10%. It was received well for sure,” Saunders said.
CleanFund also opted not to squeeze the last dollar of borrowing in the deal, which closed Tuesday; the sponsor did not issue any subordinated tranches with lower ratings and fewer investors protections.
The deal, CleanFund Commercial PACE 2018-1 refinances $115 million of PACE assessments on 82 properties in six states in the West Coast, Midwest and East Coast, or roughly two thirds of the financing that the CleanFund, which was founded in 2009, has arranged to date.
Commercial PACE providers have been slower to tap the securitization market than residential PACE providers; in part because it takes longer to underwrite the financing and assemble a diverse pool of assets. Now that CleanFund has completed the process, it has important feedback that can help it to price future funding more efficiently, knowing how potential investors view the various kinds of collateral.
“We did get good feedback the importance of the valuation process and leverage on a transaction,” Saunders said. “Eventually this will help us [as we] feed it into more precise pricing and structuring of individual deals to credit factors that seem to matter to investors.”
Another takeaway: While “it’s OK to have a golf course or a community center and factory as part of the collateral pool … we can’t get carried away with alternative asset classes,” he said. Instead, they need to be balanced with more traditional types of commercial property.
Commercial PACE securitizations are somewhat analogous to commercial mortgage securitizations, where investors are used to seeing a broad diversity of assets. So CleanFund also fielded questions from investors about the heavy exposure to California and Texas and to the five largest assessments. However they seemed to feel more comfortable once they understood that the lien created by an assessment is senior to that of a mortgage, and moreover cannot be extinguished upon default, since it does not “travel” with the borrower. Or as Saunders puts it, “it’s like an alien that keeps coming back.”
And for now, geographic concentration is unavoidable, since commercial PACE is only available in 34 states, and only about 21 of those have active programs.
There are other benefits to securitization as well. Now that CleanFund has demonstrated its ability to refinance PACE assessments, it will be that much easier to partner with banks and law firms to underwrite future deals.
Saunders also expects to be able to improve the terms of its warehouse financing from banks, over time. The reception for these assets "in the secondary market is pretty compelling,” he said. Potential partners “can see the liquidity.”
Continuing the analogy between PACE and commercial mortgages, Saunders said it could make sense in the future to securitize a few very large PACE assessments in a single deal, similar to the single-asset, single-borrower deals that have become popular in the CMBS market, in addition to deals structured more like CMBS conduits. “I would not be surprised to see the same bifurcation" as you see in the CMBS market," he said , "with conduits that achieve amazing leverage and pricing, thanks to their granularity, but make take longer to aggregate,” and deals backed by a few large assets.