Challenges for Energy Efficiency Finance Products from the Investors’ Perspective
From an investor’s perspective, two challenges for residential energy efficiency finance products include lack of historic activity and ratings.
Lack of Historic Activity
Clean energy lending has a short history, and unsecured energy efficiency/renewable energy residential loan products that are pooled together and then sold to investors (in the secondary market) are an entirely new kind of product. As a result, investors who might be interested in buying the loans may see them as risky investments and require a higher return right now than they would once the track record of the clean energy loans proves them to be of high credit quality. Another consequence of the newness of this loan product is that any investor that purchases the loans might require a credit enhancement that is more generous now (a larger loan loss reserve fund, for example) than it might need to be after the loans have demonstrated their high credit quality. Grantees and their partner financial institutions have to be prepared to deal with those demands from wary investors.
The capital markets (secondary markets) have suffered an enormous contraction in recent years from having purchased highly rated securities which, as it turned out, were not the low-risk, conservative products they were marketed to be. Investors are now more cautious and more demanding. Rating agencies are required to offer high category ratings on any investment that institutional investors (i.e., insurance funds, pension funds, etc.) with large amounts of capital to invest are considering. The short history of clean energy lending activity makes securing a high category rating from a rating agency very difficult and expensive. Rating agencies are paid to analyze and rate financial products, typically using a standard application and process. Being new, a clean energy lending product requires a new (meaning “nonstandard” from the rating agency’s perspective) type of application and rating analysis process. That, in turn, means the rating agencies will spend more time on each rating, thus driving up the cost of a rating.
Grantees and all who support them during the American Recovery and Reinvestment Act-funded energy efficiency/renewable energy loan program period need to understand that, at least initially, sales of energy efficiency investments on unrated securities will not be possible to some institutional investors. That limits the number, size, and type of potential investors in clean energy lending. However, there are forward-thinking private investors and others—state treasury offices, for example— that will step up and participate in these lending programs.