The emerging ESG market is a diamond in the rough

Private-label securities backed by green mortgages are in the pipeline

HW+ ESG market

When the terms “green” or “ESG” are broached in polite company, eyes have a tendency to roll. It’s natural for the mind to wander toward a parade of green branding campaigns that may be aspirational in messaging but rarely result in measurable climate-friendly or socially sustainable solutions in practice.

Still, hidden among all that greenwashed coal may be a framework or two for manufacturing diamonds, according to some experts working to develop those investment standards. ESG securities such as bonds are backed by collateral, like mortgages, that can be defined as meeting environmentally sustainable, socially responsible, or good governance criteria.

Digital mortgage platform MAXEX, backed by investment from financial-services giant JPMorgan, sees a bright future in the ESG market. The platform currently offers two ESG mortgage programs — one focused on green home loans, called MAXEX Sustainable; and the second, MAXEX Opportunity, serves minority, women and veteran-owned mortgage lenders and is focused on the socially responsible part of ESG.

“MAXEX has been at the forefront of creating standardized ESG-compliant loan programs with investors paying up as much as 50 basis points for these loans,” states a market-update report published by MAXEX this past December. “Originator interest in the Opportunity and Sustainable programs helped ESG loans make up 26% of loan volume traded through the exchange in November. 

“As the programs continue to gain traction and more ESG buyers are added to the platform, it is likely we will see the first true ESG-compliant RMBS issuance happen in 2022.”

Bloomberg Intelligence report published last year states that global ESG assets are expected to exceed $53 trillion by 2025, representing more than a third of all projected assets under management. On the agency front, Fannie Mae recently announced that its green multifamily mortgage-backed securities (MBS) issuance has topped $100 billion, and its single-family green MBS program, launched in April 2020, has already reached $600 million in issuance. 

Freddie Mac also recently announced that its single-family green bond program has issued some $600 million in mortgage-backed securities since it was launched in April of last year. In addition, issuance through the agency’s multifamily green bond program exceeds $4.5 billion.

Still, concerns that the agencies’ green bond programs suffer from doses of “greenwashing” have surfaced in news reports. 

The nonprofit publication Grist, which focuses on environmental coverage, in a report published this past summer found that in terms of energy use “about a fifth of the buildings enrolled [in Fannie’s multifamily green program] from 2016 through 2019 performed worse than the median U.S. building, even after fulfilling program requirements.” Part of that poor performance is due to the substandard energy-use conditions of many of the properties to begin with, the report explains, so even large gains in energy-use efficiencies won’t catch the properties up to the median scores.

The U.S. Securities and Exchange Commission also has its eye on the ESG market. Last year, it stood up a “Climate and ESG Task Force” in its enforcement division to better police the emerging ESG market.

“Proactively addressing emerging disclosure gaps that threaten investors and the market has always been core to the SEC’s mission,” said Acting Deputy Director of Enforcement Kelly Gibson, who heads the task force. “This task force brings together a broad array of experience and expertise, which will allow us to better police the market, pursue misconduct, and protect investors.” 

Roelof Slump, managing director of U.S. RMBS at New York-based Fitch Ratings, said investors are very interested in ESG bonds, adding if “they’re paying up for something,” that will create interest on the issuer and originator side.

“The general experience has been that if you’re able to successfully identify ESG tied to your loans, tied to your bonds, that does generate increased investor focus,” Slump explained. “Investors are very interested in ESG, so some are eagerly reaching out to rating agencies to better understand what are the various ways of thinking about ESG, and some investors are further along than others.”

The lack of standardization in what constitutes an ESG loan or bond, however, is still an issue in the U.S., Slump added. “That’s been an obstacle,” he said. “But it’s still very early on here. Europe is much further along on these things.”

Over time, tested frameworks, the market and credible regulation might lead us to more diamonds than coal in the ESG investing world. And some of that pilot work is already underway in the private-label residential mortgage-backed securities (RMBS) market.

Robert McDonough, director of ESG and regulatory initiatives at Angel Oak Capital Advisors, part of non-QM lender Angel Oak Cos., said that the company’s borrowers are largely self-employed individuals who can’t get access to housing-finance programs through mainstream channels, such as banks, credit unions or traditional mortgage companies.

“If you’re a self-employed individual, if you’re a sole proprietor, if you’re in the gig economy, if you’re an entrepreneur, it’s really hard to get a bank loan,” McDonough said. “And so that’s where non-QM lending comes into play.”

Angel Oak, he added, wants to hold itself out to the marketplace as having a sustainable business model that is helping underserved borrowers and having a positive social impact in the process. 

“But conveying that message is challenging [in the ESG space] because there are a lot of concerns about greenwashing in the capital market,” McDonough said. “So, we wanted to be able to align with some kind of standard that the marketplace has accepted in order for us to say we are issuing ESG bonds or issuing social bonds.

“Starting in early 2021, we developed our social-bond framework, and we calibrated that against the ICMA[International Capital Market Association] social bond principles and engaged ISS ESG [the International Shareholder Services group] to provide a second-party opinion against those principles. They validated our framework against those principles without exception.”

Angel Oak, through its affiliates, both originates and securitizes non-QM loans. Last year, the company brought eight non-QM private-label deals to market valued at nearly $3 billion, according to bond-rating reports.  Two of those private-label deals — the second and third securitizations valued in total at $534 million — were issued as social bonds under the company’s ESG framework.

“We’re going to be alternating social bonds with what we call traditional bonds from our mortgage platform going forward,” McDonough said, “[The frequency] has to do with how we originate and aggregate loans, and when we have enough appropriate loans to put into a social bond, versus a traditional loan framework, 

“But we will be alternating between social bonds and traditional bonds going forward, and part of that is informed by the marketplace. …We are the only private-label non-QM non-agency RMBS issuer of social bonds to this point that we are aware of.”

McDonough added that Angel Oak also is developing a new “green” loan product modeled on the energy efficient mortgage (EEM) already offered through the government-sponsored enterprises Fannie Mae and Freddie Mac. He explained that Angel Oak’s planned EEM loan will allow a borrower to finance energy-efficient improvements through a single mortgage.

“Over time, these energy efficiencies save the homeowner money, and it basically lowers the borrower’s debt-to-income ratio,” McDonough explained. “Basically, it allows them to qualify for more mortgage because their housing expenses in the long-term are reduced.”

McDonough said anyone originating EEM loans today is doing so for agency delivery. He added, however, that Angel Oak is developing a non-QM EEM program “because our aspiration is to supplement our social bonds with green bonds.”

“We want to originate these green mortgages, which help to create energy efficiencies in existing or new-home purchases [or linked to refinanced loans], and then securitize those under a green bond program,” McDonough said. “We want to create and hopefully be the market leader in devising an EEM program for non-QM.”

McDonough stresses that Angel Oak’s EEM loan program is still in the “aspirational” stage, but projects that the lender could begin originating loans through a new EEM program by the third quarter of next year, with the first ESG private-label deal backed by green EEM loans hitting the market by the end of 2022 or early 2023.

“The SEC is saying build a framework, tell us what it is and then stick to it,” McDonough said in explaining his take on the future direction of the ESG market in the U.S. “[The SEC is] not going to dictate what the green standard is, or the social standard is, but they do want us [as issuers or companies] to say what it is … then prove we’re adhering to that framework. 

“They don’t want to create an overarching rigid regulatory framework like they have in Europe, because that’s not the way the U.S. operates.”

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