As the energy efficiency finance market grows and matures, are robust secondary markets inevitable, necessary, or even appropriate?
This is the question that State and Local Energy Efficiency Action Network’s (SEE Action) Financing Solutions Working Group has attempted to answer in its new white paper, “Accessing Secondary Markets as a Capital Source for Energy Efficiency Finance Programs: Program Design Considerations for Policymakers and Administrators.” Clean Energy Finance Forum will host a two-part webinar series on March 10 and March 31 to explore this issue.
In secondary markets, investors purchase securities or assets from other investors rather than from the companies that issue them. Secondary markets are available for many financial products, from stocks and bonds to mortgages and student loans.
SEE Action’s report highlights the potential for secondary markets to rapidly expand the amount of capital flowing into energy efficiency financing. The ability of banks or public entities to bundle and resell energy efficiency finance creates a conduit for investors with large amounts of capital, such as pension funds and insurance companies. Increased standardization and liquidity can help to drive down the cost of capital.
The report highlights nine examples of completed and ongoing secondary market transactions for energy efficiency loans. These examples span the United States, include both public and private entities, and cover residential, commercial and institutional sectors.
One major challenge is that, unlike car loans, there is a huge amount of variation from one energy efficiency loan to the next. As a result, a great deal of care must go into developing accurate and low-cost processes for assessing risk, bundling loans together, and communicating clearly about risks to investors.
“Energy efficiency is very fragmented in a number of different dimensions,” said Bruce Schlein, director of alternative energy finance at Citigroup, Inc. and co-chair of the SEE Action Financial Solutions Working Group. “Some pieces of the market will be ready for secondary markets sooner than others. Those that are not yet ready could benefit from those that are.”
A second challenge is achieving the scale necessary to attract large institutional investors. This creates a chicken-and-egg situation: bond sales on the secondary market have the potential to increase the size of the energy efficiency market, but are most appropriate once the market has already reached a certain size.
Emily Martin Fadrhonc, program manager at Lawrence Berkeley National Laboratory and a contributor to the report, points to a second category of secondary market transactions known as loan portfolio sales, which involve the direct sale of loans from one investor to another. These tend to be smaller and faster to turn around than revenue bonds or asset-backed securities, but don’t offer the advantage of bonds in achieving liquidity and lowering the cost of capital to increase volume, Fadrhonc said.
The report shows successful examples of loan portfolio sales, revenue bonds, and asset-backed security transactions. These examples demonstrate that all three approaches have parts to play in the growth of the secondary market for energy efficiency loans.
Note: Clean Energy Finance Forum is planning to co-host a webinar series about this report.