Green mortgages and the future of sustainable funding

When Australia’s first green residential mortgage-backed securities (RMBS) tranche was issued by NAB in February 2018, it was an exciting development for the sustainable debt market in its own right. The transaction also marks another step in the process of unlocking the bank’s balance sheet for sustainable lending and borrowing.

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In late April, in association with the Australian Securitisation Forum’s publication, ASJ, NAB hosted a roundtable to discuss the green RMBS and what it means for debt funding. Participants concluded that the transaction hints at the untapped potential of green funding, as classification and labelling of assets on banks’ balance sheets is still in its relatively early stages.

The deal itself was a A$300 million tranche issued as part of the A$2 billion National RMBS 2018-1 securitisation. The green tranche is based on Climate Bonds Standard proxy criteria for Australian low-carbon residential buildings, which were introduced in 2017.

These criteria require dwellings to be in the top 15 per cent of residential buildings in a local market for emissions, representing a benchmark sufficient to meet the target of net zero emissions for the building sector by 2050.

In Australia, the Climate Bonds Standard proxy criteria leverage national building codes and energy rating schemes and certificates although so far only three states – New South Wales (NSW), Tasmania and Victoria – meet the proxy criteria.

As eligible green collateral in the RMBS pool, NAB was able to include mortgages written on:

  • NSW houses approved from June 2004 onwards – excluding the Sydney local-government area (LGA)
  • NSW including Sydney LGA houses approved from July 2005
  • Victorian houses approved from May 2011
  • Tasmanian houses approved from May 2013

The green mortgages aren’t segregated within the pool, but the aggregate volume of these loans is close to A$500 million. NAB believes this should be sufficient to ensure there are enough assets to cover the volume of green notes on issue and meet the use of proceeds test.

In other words, while holders of the green notes will receive payments on a pari passu basis from all the mortgages in the pool they should be confident that there will always be sufficient green mortgages available to collateralise their investment. The green RMBS is certified by the CBI and verified by DNV GL.

Criteria and assets

Having standardised criteria in place for classifying mortgages as green was a vital first step. “The process was actually relatively easy once we had the CBI proxy criteria for Australian low-carbon residential buildings,” Eva Zileli, Head of Funding at NAB, told the roundtable. “Without these, the challenge would’ve been establishing a means by which to classify a mortgage as green. The criteria solves this issue, giving us a scalable standard to apply to our portfolio.”

NAB has already issued green and social bonds, all of which had underlying assets from the bank’s institutional lending book. The green RMBS marks its first foray into green funding supported by household loans.

“We took a conservative approach to the pool for the RMBS transaction, starting with the inclusion of new-build only. This puts aside a lot of homes that have been upgraded,” explained David Jenkins, Director, Sustainable Capital Markets, NAB.

For instance, in NSW a home renovation costing A$50,000 or more and requiring development approval requires a building sustainability index (BASIX) certificate. But NAB excluded these from its green RMBS pool because it believed doing so gave certainty around the concept of best in class. According to Jenkins, the bank also excluded apartments in NSW entirely because its loan tagging didn’t incorporate the certainty of BASIX 40 certification it felt it needed.

“This illustrates the challenges involved in identifying appropriate assets subsequent to the loans being written,” Jenkins added. “If you don’t have your own information from the outset and it isn’t readily available publicly, you have to rely on build and approval dates.”

Future potential

There’s clear potential for NAB to significantly ramp up its green funding – if it can clear the hurdles of understanding, labelling and classifying appropriate assets in areas that are less bespoke than the institutional book.

Zileli explained: “With a balance sheet the size of NAB’s, our assumption is that we have a lot more assets that could theoretically be classified as green than is the case so far. We have gone through a process of trying to classify assets as green, but it’s easier to do with large dollar-value assets especially in the infrastructure space.”

She continued: “It’s much harder at SME level. The size and quantity of loans needed to support a green bond would mean quite intensive work. If the system doesn’t facilitate a simple way of identifying a loan as green – via adding an appropriate field at origination – it becomes operationally cumbersome.”

Jenkins explained that there’s an obvious reason why institutional loans formed the first collateral for green and social bond issuance, describing this part of the asset book as the “low-hanging fruit” when it comes to identifying and classifying green assets. NAB has a system called LoanIQ, which allows it to drill down into what are large, lumpier loans to develop comfort around eligibility, scale and use of funds.

“Consumer mortgages are at the other end of the scale, but the product is fairly generic and the accreditation system here is relatively robust – albeit with plenty of room to evolve,” Jenkins added. “It’s the space in between that’s hardest to define. There are still gaps, but we’re trying to fill them.”

The real challenge will come in SME loans, which don’t have the economies of scale that make institutional lending suitable for bespoke classification but also lack the homogeneity of mortgage product that lends itself to relatively easy tagging.

Zileli revealed: “It’s an area I have an eye on and NAB has a working group looking at other loans on the balance sheet. But it’s absolutely correct to say this is the biggest challenge yet for attribution and verification.”

Jenkins said there’s “no doubt” that NAB will look to unlock the green and social credentials across its balance sheet in due course. But he added: “It’s important to understand the nature of the challenges. We’d like to find assets that can be aggregated, perhaps along the lines of the SME lending facility we have developed with the Clean Energy Finance Corporation.”