Self-destructing market

An energetic financial innovation worth nurturing

Financial innovation became a four-letter word in the global financial crisis. New York's Green Bank, led by a former Goldman Sachs partner, is out to prove otherwise. By teaming up with the private sector to fund clean - and profitable - energy projects, Richard Kauffman is hoping to create a genuine marketplace for green securities. The full mark of success would be his new bank's gradual disappearance.

Efficiency projects should be low-hanging fruit for investors. A recent initiative that carried out energy-saving retrofits in the South yielded a 387 per cent return on investment, according to the Southeast Energy Efficiency Alliance. Yet upgrades like extra insulation and new boilers are prohibitively expensive for most individuals, and loans to single residences are far too small for banks to bother with.

The Warehouse for Energy Efficiency Loans (WHEEL), a programme supported by Green Bank, has figured out how to address this economy-of-scale challenge by tapping capital markets. The programme is aggregating publicly supported loans and storing them in a virtual warehouse. Once it has critical mass, it plans to pool the loans and sell them to institutions, freeing up cash to purchase more of them.

If all goes to plan, borrowers will eventually save enough money on their utility bills to cover costs, and lenders face little risk. A study by the American Council for Energy-Efficient Economy showed default rates range from zero to three per cent. The default rate on student loans is four times higher.

But success isn't guaranteed. It's virtually impossible to put a dollar amount on future energy savings, which may make the loans a hard sell. It can also take years to see savings from some improvements, during which time homeowners may have sold and moved on.

The goal is to create a self-sustaining secondary market for clean energy securities. It's happened before. In 2012, Connecticut's Green Bank partnered with Sungage Financial to create a solar-loan investment product. In October, Sungage graduated from the bank after being approached by a private-sector partner. If the New York Green Bank is as lucky, it too can eventually put its energy elsewhere.