This trend report is written by T-REX for members of the investment community focused on energy efficient asset classes. T-REX leverages its perspective as a financial data, technology, and services provider to outline growing trends across the investment lifecycle of complex assets. Conclusions are based on our observations, publicly available financial and economic data, and supporting commentary from relevant market experts. A special thanks to Chris Miller (Nuveen, a subsidiary of TIAA), Sandeep Srinath (ING), Jim Stanislaus (Petros PACE Finance), and Cliff Kellogg (C-PACE Alliance) for their contributions to the report.
We are approaching an inflection point in the capital markets for energy efficiency asset classes. As demand from consumers and businesses to deploy renewable energy projects intensifies, we are seeing increasingly innovative ways to finance those projects. Commercial banks are more willing to lend into these sectors, subsequently leading to increased focus and sophistication in the capital markets to facilitate structured credit transactions. Institutional buy-side appetite for green investments and enhanced yield continues to grow, supporting the supply of deals. The convergence of these factors points to a spike in capital markets activity for renewable energy asset classes – particularly for Commercial PACE and Solar ABS – in 2019 and 2020. How can investors be prepared to capitalize on this opportunity? Here, we explore each of the above trends, as well as provide guidance for accurately assessing, pricing, and monitoring the risk associated with these complex asset classes.
In the sustained, relatively low interest rate environment, the risk premium of renewables represents an attractive long-term investment opportunity. In parallel, buy-side green mandates continue to increase in importance across both public and private investment funds. With $266 billion in total global renewable energy project finance investments in 2017 and a CAGR of 15% from 2004-2017[1], sector experts are bullish on the sustained growth and opportunity presented in these complex markets.
Significant Opportunity in Commercial PACE
The C-PACE segment has quickly become a major topic of conversation across the institutional investment community. While the number of project assessments has grown steadily in recent years, the volume of capital markets activity has remained relatively light…until now. Based on T-REX observations, trends in C-PACE programs, and 2018 issuance to date, we are at an inflection point in Commercial PACE ABS, positioning the segment for rapid fire growth in the capital markets in 2019 and 2020.
There are a number of developments in the segment that point to this growth:
Greater buy-side demand for clean energy assets
Now, with a few years of history and market traction, C-PACE has evolved from a sector-to-watch to a meaningful answer to green mandates for the institutional buy side. Chris Miller, Director of Private Placements at Nuveen (a subsidiary of TIAA), comments how portfolio strategies have evolved in recent years as investors search for increased yield at reasonable risk premiums: “Over the past few years, portfolio makeup has shifted dramatically with regards to the green mandate. TIAA and its peers are pushing to expand their clean energy investments. We expect to see growing demand for renewables into the next few years, particularly for C-PACE and Solar ABS. These are long-term, stable assets with a solid credit rating. The relative-value-for-risk in both asset classes remains quite favorable.”
Long-held financing roadblocks are vanishing
While C-PACE has been proven to offer better stability, terms, and security over other investments, the segment has been up against a number of barriers since programs started appearing in 2009. As buy-side demand builds however, these barriers are slowly diminishing, making way for originators to securitize and market more deals.
Commercial PACE-enabling legislation is becoming more common. To date, 36 states and the District of Columbia have all passed legislation enabling C-PACE programs. Twenty plus D.C. have launched active programs, with the expectation that five additional states will join them in the foreseeable future[2].Lender consent is increasingly easier to secure. As deal volume expands and C-PACE builds its credibility through market traction, mortgage lender consent is becoming easier to obtain, accelerating the project approval and financing process.
Commercial lending is opening up. Sandeep Srinath, Director of ING’s Structured Solutions Group, provides the investment bank and loan warehouse perspective, confirming that lending has shot up in recent months: “There absolutely is increased activity in Commercial PACE, and we’re a big part of it. As a commercial lender, ING is more comfortable than ever with the C-PACE asset class. We continue to increase the number and size of facilities and anticipate a considerable increase in the number of ABS deals coming to market in the near future as a result.”
Co-Founder of Petros PACE Finance Jim Stanislaus notes a distinct about-face in the industry in 2017, saying, “The $40 million project for upgrades to Seton Medical Center in Daly City that we completed with CleanFund and Renew set an important precedent for C-PACE. As the largest financing of its kind at the time, the project couldn’t help but influence perception of the segment’s long-term potential.”
Supply is going up, stemming from new sources
To date, we have seen a cumulative $712 million in C-PACE financings, with the average size of investments reaching $427,247 in the first six months of 2018.[3] With buy-side demand up and barriers to entry diminishing, Stanislaus predicts originations to climb both in terms of volume and assessment size based on a few factors. Aside from an uptick in assessments expected as a result of continued adoption of C-PACE-enabling legislation, the market expects a surge in activity stemming from commercial real estate companies. Echoing Miller’s comments on green mandates, Srinath sees the sell side as equally driven by internal sustainability objectives: “We can’t underestimate the underlying value in the green aspect of the financial product. That in and of itself will change who is considering C-PACE in a huge way.” Cliff Kellogg, Executive Director of the C-PACE Alliance, comments, “Until recently, originations had come from one asset owner at a time. Now, major property owners, such as hospitality companies and malls, are seeing the value of C-PACE, not only from a financial perspective but reputationally as well for being associated with energy efficient operations.”
Another expected driver of PACE financings per Morningstar: natural disaster retrofitting. Given the damage done by, e.g., recent hurricanes, the rating agency sees property owners expanding from energy efficient upgrades to structural enhancements for better storm and flood preparedness.[4]
Technology is improving capital markets workflow
Assessments across various state and county C-PACE programs carry nuanced and unique amortization profiles, accrual methods, and payment schedules. As originations become more geographically diverse, the process of securitizing these assessments will become more complex.
As appetite for green financing and investments expands, so will the reliance on analytical and data-driven solutions to achieve the scale and precision needed to maximize opportunities in the market. Stanislaus sees fintech innovation as an important piece of the puzzle: “C-PACE is a complex asset class that, like other esoterics, suffers from a lack of sufficient analytical and reporting tools. Technology is critical to making data accessible and relevant, ultimately lowering capital and operating costs, improving efficiency, and driving greater liquidity through the investment lifecycle.”
Miller, who agrees with Stanislaus’s comments on data transparency and analytics, suggests that efficient access to unique datasets combined with cloud-based analytical tools are paving the way for growing investment across C-PACE and other highly-nuanced asset classes. He says, “The greatest obstacle impacting early stage asset classes like C-PACE and Solar right now is their opacity. By introducing greater data transparency, we are unlocking tremendous opportunity. The better the view into a C-PACE deal, the more accurately I can price risk, make swifter, smarter investment decisions and monitor them.”
Conclusion and Key Takeaways
What are the implications of the trends we’re seeing and how can investors better prepare to capitalize on C-PACE?
T-REX spoke with a number of practitioners to understand the factors impacting issuance and investment in energy efficient sectors today. Regardless of their role in the investment lifecycle, experts touched on four distinct needs:
1. Greater transparency. Esoteric markets like C-PACE and Solar are still in their nascent stages. There is virtually no model standardization or efficient access to accurate performance data – both of which limit proper risk assessment and comparative analysis. Kellogg states, “It still takes months to get from project approval to securitization. The key to accelerating financing for complex asset classes is for asset originators to equip investors with steady access to standardized data and analytics. The better investors understand the price-to-risk ratio, the greater interest there will in the capital markets to facilitate structured credit.”
2. Automating workflow. Today, C-PACE, Solar, and other esoterics rely on manual data entry and reporting which leads to multiple issues:
- Cost- and time-intensive workflow, especially given monthly reconciliation at both the asset and portfolio levels
- Output is prone to human error
- Workflow and related communication are siloed while also being open to security issues
By leveraging technology to enhance repeatability, precision, and scalability in workflow, users can better understand the financial implications of asset-level performance. Furthermore, housing and managing data in the cloud significantly reduces security risk while improving accessibility, version control, and collaboration capabilities. Stanislaus, an early adopter of T-REX’s structuring platform, underlines the result of game-changer analytics and innovative data management, “Within T-REX’s system, I can not only structure more effectively at a speed and level of accuracy that just isn’t possible manually in Excel, I can also collaborate on and expose critical datasets to others involved in the investment process.”
3. Increased access to asset class expertise. There are a finite number of subject matter experts that can model and conduct risk assessments of complex assets. Solar ABS, e.g., requires a certain level of combined industry and finance knowledge to understand how to model a deal based on variable returns resulting from fluctuations in energy output. A structuring tool that properly assesses and prices related financing risk for the nuances of this asset class is invaluable to, e.g., a buy-side firm focused on maximizing efficiency as they look to handle greater volumes.
4. Improved compliance. Accounting errors and regulatory scrutiny are costly, both financially and reputationally. Audit-ready data and models will ease proof of compliance and operational integrity in a way that siloed, spreadsheet-based workflow cannot.
Conclusion: The outlook for C-PACE is extremely positive, but capital markets workflow must evolve in order for investors to fully take advantage of the opportunity.
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[1] Global Trends in Renewable Energy Investment and United Nations Environmental Program and Bloomberg New Energy Finance
[2] Pacenation.org data as of October 2018
[3] Pacenation.org data as of October 2018
[4] ABS Research: Natural Disaster Retrofitting is Likely to Drive PACE Growth – Morningstar Credit Ratings Perspective, September 21, 2018