Evidence on the credit quality of green mortgages is limited so far, but it seems to suggest that people who make green investments in their homes are likely to have a higher disposable income, live in a more valuable property, and be more likely to keep up their mortgage payments.
There’s little beyond speculation on which way the causation runs — do richer people live in greener homes, or do greener homes make people richer through lower energy bills? — but this has not stopped some in the green finance community arguing the loans should attract a lower capital charge than conventional mortgage lending.
This could then, in turn, help channel capital into environmentally sound projects, since a bank could then pass on the lower capital costs in the form of lower interest rates for green lending. This would help promote the product and create a virtuous circle.
But the theory will be difficult to prove. It needs lots of data, across long timelines — and could be so marginal as to make little difference. Prime mortgages may already have a risk weight as low as 15%, meaning that a bank with 10% CET1 would have just €1.50 of capital against each €100 of mortgage lending. Cutting this further might be difficult, or indeed dangerous.
Nevertheless, the European Commission is behind the green lending drive. The EU is striving to meet its commitment to reduce greenhouse gas emissions by 20% from 1990 levels in the year 2020, and by 30% by 2030. Since the housing market and the construction industry are major components of Europe’s economy and its emissions, these are areas with great potential for carbon savings.
In the absence of a lower capital charge for banks to make green loans, policymakers are likely to look for other ways to keep pushing the product. One way this could be enhanced is by streamlining the origination of green mortgages.
The biggest prospective gain in reducing carbon emissions is likely to be made in refurbishing older existing properties in established residential areas where historically people have always wanted to live.
One way to help streamline the process could be to make it easier to take out a green mortgage, covering energy efficiency improvements as well as the cost of the property, at the point of origination. For example, borrowers could be shown upfront costs compared to a conventional loan and the savings that could be generated.
All too often people already have a mortgage and are unwilling to add separate debt on top, despite the benefits associated with lower energy costs and higher property values.
The complexity of financing green improvements, and the lack of clear unbiased advice, possibly presents the biggest hurdle that needs to be overcome in the promotion of the product — not necessarily the capital charge.
Different investors
Issuers have an incentive to create green finance products because they can sell them to a differentiated pool of investors, or to different types of funds with their existing investors.
But from an issuer’s perspective, the green senior unsecured route offers more flexibility than pure mortgage products such as RMBS or covered bonds, because the proceeds can be used over a range of green lending projects.
Backing a green issue with mortgages only creates a higher hurdle for originating banks, in the shape of green documentation across a very high number of underlying assets.
The costs, however, are mostly upfront. Lenders like Berlin Hyp and Muenchener Hyp, which have both issued green Pfandbriefe, will attest to the fact that the main costs are in the initial period when systems are put in place to originate green loans through time. Once the origination process is set up and standardised, the process becomes more streamlined and efficient.
Another potential difficulty with covered bonds is that it is not legally possible to set up a green cover pool within the existing covered bond programme which is backed by conventional mortgages. The green loans are earmarked for the green investors but in the event of an issuer’s default all investors have access to the same pool.
This stands in contrast to an RMBS, such as Obvion’s Green Storm, where investors can be sure that the composition of their security is comprehensively secured on green mortgages. A dedicated RMBS pool is easier to keep track of but this needs to be weighed against the fact that that the universe of RMBS investors is smaller than in senior unsecured and covered bonds due to structural complexity.
Lowering the risk weight of green mortgages could be a small carrot to incentivize issuers to look at green RMBS and covered bonds, if the European Commission or the industry itself can indeed demonstrate that these are lower risk, but the mortgage industry should not hang its hopes on this happening anytime soon.
In the meantime, there is much more that lenders can do to promote their green credentials than hope for a capital subsidy.