A Behind-the-Scenes Look at Secondary Markets for Energy Efficiency

Some investors are looking with anticipation toward the development of secondary markets for energy efficiency in the United States. To provide an inside perspective on why these markets are crucial today, authors of the report “Accessing Secondary Markets as a Capital Source for Energy Efficiency Finance Programs: Program Design Considerations for Policymakers and Administrators” spoke with Clean Energy Finance Forum.

Attention-getting transactions prompted the team to write this report, said Chris Kramer, senior consultant at Energy Futures Group. The report was produced by State and Local Energy Efficiency Action Network (SEE Action).

Within the energy efficiency industry, comprehension of the phrase ‘secondary markets’ still seems low, Kramer said. The report defines energy efficiency secondary markets as “financial markets where energy efficiency loans can be sold to investors – either as single loans or as packages of loans divided into tradable instruments.”

“Financing, to begin with, is an area where there’s less comfort for some folks,” Kramer said.

The report’s goal was to lay out “a typology of secondary market transactions,” Kramer said. The authors laid out a framework showing where these transactions can be helpful, what their impacts are on program design decisions, and what their costs and benefits are for programs.

Why Secondary Markets Can Catalyze Large-Scale Investment

“There were some early transactions in the secondary market that generated a lot of buzz,” said Emily Martin Fadrhonc, program manager at Lawrence Berkeley National Laboratory. These transactions were conducted by Delaware Sustainable Energy Utility, Connecticut Green Bank, California’s HERO Program, and New York State Energy Research and Development Authority (NYSERDA), she said.

The authors often emphasize the promise of secondary markets. “Secondary markets can offer you a larger source of capital,” Fadrhonc said. “This can translate to lower interest rates for program participants and a potentially lower-cost source of capital. Some of the programs we interviewed actually ran out of money to make loans.”

Kramer said secondary market transactions may play a key role in helping energy efficiency in the United States reach climate goals. The goal of SEE Action is to drive energy efficiency higher through state and local policies and programs so that all cost-effective efficiency is obtained.

“There’s a long road ahead,” Kramer said. “It’s equally important to recognize that secondary markets on their own don’t drive us there. They are only one piece of the puzzle. The market’s continuing to mature.”

How Secondary Market Programs Work

Kramer said decision makers should refer to the flow chart below, from page 9 of the report, when making program design choices. [[{"type":"media","view_mode":"media_large","fid":"2070","attributes":{"alt":"Decision Framework for Secondary Market Transactions","height":"825","width":"975","class":"media-image alignnone size-full wp-image-17367 media-element file-media-large"}}]] There are many cost and design tradeoffs to consider, Kramer said. Design tradeoffs may involve interest rates, loan terms, and underwriting criteria. Cost tradeoffs may involve credit enhancements and transaction costs.

How Strategic Choices Can Drive Programs Forward

The report outlines choices that program administrators can consider. Some of the central features of the report are detailed diagrams that outline these specifics.

One of these choices involves evaluating the comparative advantages of portfolio sales and bond sales. Portfolio sales are typically ideal for small volumes of loans under $50 million, while bond sales are often used for volumes of loans over $50 million.

Portfolio sales provide a relatively straightforward route to capital. These sales do not require packaging loans into tradable instruments. They also do not usually require a credit rating. In portfolio sales, third parties such as lawyers and bankers play lesser roles than they do in bond sales.

Despite these many advantages, it can be challenging to connect with portfolio sale buyers that are interested in holding a large pool of these loans for a long time.

There are two types of bond sales available for energy efficiency secondary market transactions: municipal revenue bonds and asset-backed securities.

Municipal revenue bonds, which are issued by municipalities or public agencies, are guaranteed by designated revenue. Debt is offered by a specialized financial entity backed by loans. Revenue bonds tend to be easier and less expensive to administer than asset-backed securitizations. They also have simpler rating requirements than asset-backed securitizations do.

Asset-backed securitizations can open the door to larger pools of capital. They have the potential to grow the industry dramatically. These securitizations may be carried out by public or private bond issuers of any type.

There are two basic approaches to securitization, Fadrhonc said. “One is supply-focused and one is demand-focused.”

A supply-focused approach may be appropriate if you can meet levels of demand easily, Fadrhonc said. You can structure your financial project so it will be very attractive to investors. In contrast, with the demand-focused approach, program growth is the main goal.

Fadrhonc said limiting the amount of unique or unusual features that programs offer can help to increase their appeal to investors.

“Go into each of these options with open eyes,” Kramer said. “We’re trying to demystify secondary markets. They’re one tool in the toolkit. There doesn’t have to be anything mysterious about them.”

Note: Clean Energy Finance Forum co-hosted a webinar series about this report. A member of our advisory board is affiliated with SEE Action.

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