First energy-efficiency bonds sold to investors

Fri Mar 7, 2014 2:14pm EST

NEW YORK, March 7 (IFR) - The first-ever ABS backed by property-tax assessments funding residential renewable-energy and energy-efficient projects - known as Property Assessed Clean Energy loans - priced yesterday.

The new innovation offered a relatively juicy yield to ABS investors who enjoyed the 4.75% coupon and the 11-year duration.

PACE loans can finance a variety of renewable energy projects and efficiency improvements, such as installing new windows and upgrading heating and air conditioning systems.

In the PACE program, the local county or municipality offers a tax assessment increase in exchange for paying up-front costs to fund these various "green" energy-saving improvements.

In the US$104m deal, titled HERO Funding 2014-1, the average assessment was about US$18,000, according to Kroll, which sole-rated the deal at the AA level. The PACE program is a green alternative to borrowers either paying out of pocket for such improvements or taking on unsecured consumer loans that pay down over time.

The county increases the property-tax assessment by approximately US$2000 per year.

Excess interest, overcollateralization, and a liquidity reserve provided protection on the deal: For instance, the single-tranche transaction paid a coupon of 4.75%, compared with an underlying coupon of 8% on the underlying PACE limited obligation bond.

Additionally, the deal doesn't advance par - it advances approximately 97 cents on the dollar, according to sources familiar with the transaction.

Overcollateralization will be 3.00% of the initial aggregate PACE bond principal amount, and the liquidity reserve amount will initially be 3.00% of the aggregate PACE bond principal amount, which equals approximately seven months of interest.

The liquidity reserve will gradually build up to 7.00% of the outstanding collateral principal, which equals approximately 17 months of interest, Kroll said. There are also a number of eligibility requirements on top of all this, covering the property owner and property.

There is also a requirement that the lien that gets assessed against the property could not be more than 15% of the property value.

ONGOING BATTLE

The trade however seemed to exacerbate an ongoing battle that the municipal-loan product has had with the government sponsored enterprises in recent years.

This is because the property tax liens associated with the homes underlying the security, which are meant to fund energy-savings measures, are senior to all other liens - including mortgages on the properties financed by Fannie Mae and Freddie Mac (which currently finance close to 90% of US mortgages).

In other words, payment priority is an issue: if a foreclosed property is liquidated, the PACE loans get paid back before the GSEs do.

The GSEs have not been happy about this, and in 2010 their regulator, the Federal Housing Finance Agency, ordered Fannie and Freddie to avoid financing mortgages on homes with PACE liens already on them.

In March 2013 the GSEs even defeated an effort in court by various California counties - and the Sierra Club - to force the FHFA to adopt new rules that would prevent Fannie and Freddie from avoiding homes that have PACE assessments on them. The FHFA succeeded, and Fannie confirmed and stood by its policy in a note to clients last November.

That factor gave some investors pause in this week's ABS, although sources said the GSEs only financed less than 40% of the mortgages linked to the residential properties with PACE loans in the deal's underlying portfolio.

There is also a specific "final, non-appealable judicial order" that affirmed in Riverside County the seniority of the PACE lien versus any other liens, according to a presale report from Kroll Ratings. Kroll noted that there was a risk the validity of a PACE lien against a mortgagee's security interest could be challenged in the federal court.

The investor orders for the small transaction were described as "big and chunky", as it was not a particularly broadly distributed transaction.

"It was a complicated story, and was more or less privately placed," said one ABS market participant.

About 90 individual so-called PACE limited obligation bonds secured the transaction, which was lead-managed and structured by Deutsche Bank.

These bonds have coupons that will be paid by money collected by the California county of Riverside in the form of nearly 6,000 tax assessments levied against a similar number of residential properties in the area.

A government entity, the Western Riverside Council of Governments, worked with two different third parties to get the deal done: Renovate America, a municipal consulting firm, and 400 Capital, the portfolio administrator.

Renovate America dealt with the administration of all the tax assessments.

FURTHER EXPANSION

The new trade signals the further expansion of products in the US ABS market after last November's first-ever USD54.425m solar ABS from SolarCity.

That deal was backed by a portfolio of SolarCity's photovoltaic (PV) solar systems as well as related contractual host customer payments and performance-based incentive payments.

Securitization specialists said PACE loans were much better from a credit quality perspective compared to solar ABS; the senior liens on the underlying properties in the PACE deals are superior to payment priorities structured into the solar ABS template.

"Interest in this deal shows that investors are looking for a different thing," the banker said. "And the 4.75% coupon gets peoples' attention - especially when spreads on asset classes such as timeshare and container leases are getting tighter and tighter."