Photo Credit: David Biagini via Shutterstock.com
For proof of how securitization can grow a market really quickly, consider the single-family home rental market.
After the 2008 financial crisis (which was, in large part, caused by trading of very risky securities), mortgage underwriters were sitting on a lot of housing stock. Seeing an opportunity, institutional investors bought thousands of homes, rented them out, and then bundled the rental payments into securities for sale on the secondary market.
Last October, the private equity firm Blackstone Group sold the first securitized single-family housing bond, a $479 million package of rent payments from properties it now owns. That started a rush of activity, and investors purchased tens of thousands of homes with the intention of bundling the rental payments and selling slices of the bonds to banks, insurance companies and pension funds.
In 2014, the market will be worth about $5 billion. Next year, it could be worth $20 billion. And some are projecting a trillion-dollar market.
"It doesn't take much. It took just one [issuance] to break the levy," said Dan Sullivan, an expert on structured bonds at PricewaterhouseCoopers. "This ultimately could be the same sustainable source of financing for efficiency."
Sullivan joined three other experts at this week's ACEEE finance forum to discuss financial lessons learned from other industries. All agreed that securitization, which has taken hold in many other industries, is a necessary and inevitable step in bringing energy efficiency to scale.
The solar industry has started making moves in this arena. In late 2013, SolarCity offered a $54.4 million securitized portfolio of projects to investors -- the first for distributed generation. This year, it offered another $70.2 million portfolio to a small group of institutional investors. Analysts expect more similar products from Sunrun, SunPower and other companies with lots of solar systems under management.
The efficiency industry is a few steps behind solar, but attempting to catch up. In March, Deutsche Bank sold the first securitized portfolio of efficiency projects -- a $104 million bond made up of 5,900 residential property-assessed clean energy (PACE) loans from Riverside, California. Deutsche Bank and the program administrator worked for a year and a half with rating agencies. Ultimately, the bond was rated AA -- the second highest possible -- and priced at a 4.75 percent yield.
"Getting those discussions with the rating agencies early is critical to accessing this market," said Sullivan.
But the securitization levy is far from open in efficiency. The fractured industry is still in the early stages of creating lending standards and simple project origination tools that investors need in order to easily bundle projects.
Scott Harmon, CEO of Noesis Energy, valued the yearly U.S. commercial building efficiency market at $17 billion. Harmon said the industry features roughly 10,000 firms pitching projects to more than 5 million properties, with a closing rate of between 10 percent and 25 percent. Theoretically, there's sufficient volume to start bundling projects. But a lack of performance standards, investor distrust of audits, long and unpredictable sales cycles, and "woefully bad" marketing all make securitizing efficiency projects difficult.
"The result is that transaction costs are measured in the tens of thousands of dollars," said Harmon. "What we need on the demand side is a way to funnel projects and produce loans at a predictable rate."
That's the reason why Harmon started Noesis, an online matchmaking service for building owners, efficiency contractors and financiers. Online lending platforms are making it easy to originate car loans, small business loans and, in a very small way, loans for distributed energy systems like solar. Harmon figured someone had to do it for efficiency.
Noesis started out as a platform for modeling projects and connecting energy services companies to customers. But the startup eventually started offering financing when it became clear that efficiency providers lacked the tools to fund projects. Harmon claimed that Noesis can cut project origination times to four weeks or less and reduce underwriting costs by half. The goal is to create a tenfold increase in deal flow, thus attracting investors.
"We just have to get comfortable with software and technology," said Harmon. "You look at market after market, and online lending is taking loans from weeks to days to hours. Energy efficiency is not that different."
Jack Bernard, chief executive of the PACE administrator Renewable Funding, agreed with the need to make efficiency an easier sell. He displayed a screenshot of an eBay auction, which showed what he called a "simple infrastructure for transactions." Bernard then compared the site to an energy efficiency loan -- a piece of paper with convoluted text that usually gets processed by a small, local bank.
"The biggest lesson here is that you need to make what you want to sell look like what everybody else buys," said Bernard, who structured mortgage-backed securities deals for a decade at Merrill Lynch.
Better online tools are an important way to get stronger deal flow. But feeding investors with a steady stream of "plain vanilla" projects requires standards for monitoring and verification, data acquisition and technical systems. Without them, institutional investors would be required to analyze projects individually -- a virtually impossible task when bundling hundreds or thousands of projects together.
"We’re trying to take that complexity and package it in a way that investors know what they’re looking at. "We need to create 'investor ready' efficiency," said Matt Golden, senior energy finance consultant for the Environmental Defense Fund, which runs the Investor Confidence Project.
The Investor Confidence Project is attempting to bring together rating agencies, big institutional investors, energy services companies, utilities and efficiency program administrators to agree on protocols for evaluating projects. So far, a handful of projects, including one in Connecticut, have used the Investor Confidence Project's protocols. Golden said other green banks and state efficiency programs are closely engaged.
Although there are positive signs that institutional investors are interested in efficiency, getting the industry to the point where it's common to bundle hundreds of millions of dollars in projects may take a few more years. The enabler, agreed the group of experts, will be an industry-wide push to design project origination tools and standards with securitization already in mind.
"We have to get sophisticated and not be a bunch of cowboys so we can standardize things," said Harmon.