A new funding alternative for energy efficiency lending could help the U.S. meet the $200 billion shortfall in financing to make homes more energy efficient. It could also serve as another form of collateral for green’ securitizations.
The Warehouse for Energy Efficiency Loans (WHEEL), a public-private partnership, provides unsecured loans for energy efficient home improvements, loans that can eventually be securitized.
The program is sponsored by Citigroup, the Pennsylvania Treasury Department, Renewable Funding, the Energy Programs Consortium, the National Association of State Energy Officials and the U.S. Department of Energy.
In the past, there were two primary options for homeowners looking to make energy efficient retrofits: unsecured, bank loans, which pay relatively high rates of interest, or, if the program was available in their states, Property Assessed Clean Energy (PACE) loans, a type of secured lending funded via the municipal debt market.
Francisco DeVries, CEO of Renewable Funding, who pioneered the PACE program and is also behind WHEEL, says that there are benefits and drawbacks to both programs.
Renewable Funding specializes in design, administration, technology, and financing solutions for clean energy upgrade programs. It has committed a large amount of capital to finance PACE loans and is currently launching the nation’s largest PACE funding program covering over half the state of California.
The upside to PACE financing, according to DeVries, is that it offers investors the security of a lien on the home that is being improved. This lien also benefits the borrowers, to the extent that it lowers their borrowing costs. However the Federal Housing Finance Agency objects to these liens, which are senior to those of mortgage finance companies Fannie Mae and Freddie Mac. This has discouraged the use of PACE funding in many places, even in states that already have the necessary legislation in place.
PACE loans also have longer repayment timeframes, different repayment mechanisms and different regulatory concerns than unsecured loans. Both commercial and residential PACE loans are funded via the municipal bond market or specialty finance companies. To date there has been a single securitization of PACE bonds, by the Western Riverside Council of Governments (WROCG). He $104 million deal is secured by 5,898 PACE lien assessments on 5,890 residential properties. It was completed in March.
“Consumer Lending At Its Best”:
While they are unsecured, loans originated under WHEEL have characteristics that set them apart from garden varieties of consumer loans such as credit cards and auto loans. “They are fixed-rate, typically 10-year loans, for efficiency projects done with specific contractors,” said DeVries. “When you add those things [up] the performance dramatically improves."
He describes the WHEEL program as “consumer lending at its best”.
With the caveat that the loans for energy efficiency projects have only about eight years of performance data, they have performed significantly better, from a delinquency and loss standpoint, than other types of unsecured consumer asset classes, according to Peter Krajsa, chairman and CEO of AFC Financial, a non-bank lender that underwrites such loans.
“Our overall delinquency and losses over the last eight years have been on average about 1% per year, which is about a third of where credit card delinquencies are,” Krajsa said.
"We believe it is an excellent, tailor-made opportunity for securitization,” he said.
Ultimately DeVries believes that both PACE and WHEEL are a good fit for securitization.
For example, Home Energy Renovation Opportunity (HERO), which offers financing for PACE loans in the U.S. — the company funded WROCG's PACE program —has said that it is looking for options to provide unsecured financing. DeVries said that HERO plans to eventually offer both PACE and WHEEL together, wherever it can do so.
“We look at it as some overlap [between PACE and WHEEL], but for the most part they don’t cannibalize each other," he said. "They serve different parts of the market and do so in different ways and absolutely for both asset classes the right place to go is securitization."
Next Stop: Securitization
The idea is for WHEEL to become the warehouse for states to place energy efficiency loans underwritten by AFC into a conduit managed by Renewable Funding.
Citibank, which provided the initial $100 million credit facility to purchase the loans from states, will, once the program has aggregated enough loans, take the conduit to the securitization market.
“What’s been needed is the integration of finance into efficiency projects in a way that solar leasing has opened up that market,” said DeVries. “What was also needed was real access to the low costs and deep scale of the capital markets.”
WHEEL is designed to serve the segment of the market that isn’t covered by state and utility programs, said DeVries.
The platform is based on the Keystone Home Energy Loan Program (HELP), which AFC created with the Pennsylvania Treasury in 2006. Initially under the program AFC originated unsecured loans for energy efficiency projects, which it then then sold to the Pennsylvania Treasury.
Over the last 10 years, AFC set up similar programs with other states, mainly through its flagship programs that include Connecticut’s Solar Leasing Program, Kentucky’s Home Performance, Efficiency Maine’s PACE and Power Saver programs, Energize CT Heating Loan Program and the Illinois On-Bill Energy Loan program.
The energy efficiency loans are offered to consumers via a national network of over 5,000 approved energy efficiency contractors, managed by AFC. The contractors work with states, utilities and equipment manufacturers to promote the financing programs and AFC provides the loans.
The problem was that AFC sold the loans back to state treasuries. States didn’t want to keep a large amount of loans on balance sheet, so they only allocated small amounts of their budgets toward the funding of these loans, explained Krajsa.
Now AFC will sell its loans to WHEEL, which warehouses the loans until they can be securitized.
WHEEL is the product of a years-long collaboration between national leaders in the worlds of finance and energy, including Citi; the Pennsylvania Treasury Department; Renewable Funding; the Energy Programs Consortium; National Association of State Energy Officials and the U.S. Department of Energy. The Commonwealth of Kentucky has also joined the WHEEL program as a charter member.
Plain vanilla underwriting and a solid history of performance make the loans a perfect fit for securitization. The fixed-rate loans, which in addition to 10 years can have terms of five or seven years, are available to borrowers with FICO scores of over 640. Krajsa said that loans are approved for about 70% of applicants. He added that the average loan size is $5,500 and are offered at an interest rate of 7.99% for a single project, or 2.99% for “whole house” improvement projects.
While these loans have been performing better than regular consumer loans, this has not been necessarily reflected in lower rates. Krajsa hopes that securitization funding can change that.
“What was happening is that the energy efficiency loans were being priced at the same yield than those other consumer loans would require," he said. "What this first WHEEL securitization is doing is saying these [energy efficiency loans] perform better, the yield can be lower, which allows us to lower the cost to consumer.”
DeVries added that the goal with the initial deal, which may come to market as early as this summer, is to get a better idea of where pricing will be for the asset class.
“Later as volumes increase and the market gets better and more comfortable with the asset class, there will be ways to improve the efficiency and reduce costs,” he said, adding that the securities will be rated and initial conversation with the ratings agencies have been positive.
“From our perspective and Citigroup’s perspective what we are doing is only helpful if we set up something that can be done many times in the future,” said DeVries.
Facilitating funding for energy efficiency is considered vital for a greener economy.
McKinsey & Co. reported in 2009 that the U.S. could reduce energy consumption in homes by 28% by 2020, with an upfront investment of $229 billion. States and utilities are expected to double spending on energy efficiency rebate and incentive programs by 2025 to approximately $15.6 billion but that still leaves a $200 billion unmet need for financing in the home energy efficiency market.