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Investing responsibly: How the mortgage market can answer the demand for ESG lending

The demand for Environmental, Social and Governance (ESG) lending programs is growing exponentially. According to the 2021 ULI Sustainability Outlook, an “increased appetite for ESG lending” is near the top of the list for topics shaping sustainability in Real Estate in 2021. Refinitiv’s Q4 2020 Sustainability report noted, “Sustainable Finance bonds totaled $544.3 billion during full year 2020, more than double issuance levels during full year 2019, and an all-time annual record.”

There is no question that pressure from regulators, stakeholders and investors is helping drive this booming market forward. And as the momentum for ESG lending grows, so do the consequences for companies that fail to adapt.

The U.S. mortgage market is a multi-trillion-dollar industry and the world’s largest credit market, making it an ideal marketplace to deploy both socially responsible lending as well as deliver quality ESG-based assets to investors at scale. However, due to the archaic and inefficient way mortgage loans are traded between financial institutions, this has been difficult to achieve.

Traditionally, buyers and sellers are required to sort through hundreds if not thousands of different counterparty rules and risks. As a result of this complexity, few ESG lending programs have been brought to the market at scale. Even then, smaller lenders, like community banks and credit unions, can’t efficiently compete–giving the larger banks and originators a significant advantage. This disparity further widens the gap for small lenders and the homeowners they serve.

ESG lending programs have the potential to greatly expand access to credit for homeowners in communities served by minority, women and veteran-owned originators. Providing consistent liquidity for qualifying ESG lenders means preferred loan pricing which can be passed down to borrowers in underserved communities. For lenders who wish to serve homeowners looking to reduce their energy footprint, preferred loan pricing for ESG loans for homes with green energy improvements can also provide significant incentives to install energy efficient products like solar panels and geothermal units.

Right now, the markets have increasingly pent-up demand from borrowers, originators and investors looking for a robust supply of credit worthy ESG loan investments. And until now there were few ways to satisfy that demand.

SOLVING THE PROBLEM WITH TECH

New technologies are making it easier for companies to buy into the socially responsible home lending movement. One popular solution is selling and buying loans through a centralized exchange and clearinghouse. This solves the problem on a broader scale by replacing the thicket of conflicting rules with a single platform and one set of rules. Loan buyers and sellers are able to sign one standardized contract and transact with a single counterparty (the clearinghouse) instead of the traditional and inefficient way of developing bespoke contracts for each lending relationship. This exchange construct dramatically simplifies the loan sale process and makes it much easier for loan buyers and sellers alike to better manage their risks.

When buyers make a loan purchase through a centralized clearinghouse, they can aggregate mortgages from approved MWOB and veteran-owned lenders or originate loans on homes with energy efficient improvements. These ESG loans are then securitized into private label mortgage-backed securities (PLMBS). Institutional investors then have a way to invest in ESG-compliant, fixed-income investments by purchasing PLMBS bonds collateralized exclusively by ESG-compliant loans.

The demand for PLMBS collateralized by ESG-compliant home loans will translate into greater margins for MWOB lenders, reduced borrowing costs for the homeowners they serve and financing flexibility by providing pricing incentives. Enabling borrowers to finance green energy improvements into their mortgage loan balance through ESG lending programs is a great way to facilitate environmentally responsible lending.

In addition to benefiting buyers, this type of exchange structure significantly levels the playing field for small- and mid-sized lenders. By allowing them to sign a single contract, lenders face a single counterparty and gain turn-key access to the exact same liquidity providers to which many of the largest lenders have long had access. Small- to mid-sized lenders – and now MWOB and veteran-owned lenders – gain the ability to dramatically expand their liquidity without navigating complicated, costly relationship-based contracts.

“There is an enormous amount of investor interest in putting money to work to address a wide range of social issues, but few ways to do it effectively,” said Jim Parrott, a former housing advisor in the Obama White House and now advisor to MAXEX. “With their exchange, MAXEX may have finally found a way to unleash all of this demand, sending private capital into corners of the market that desperately need it.”

Selling and buying loans through a centralized exchange and clearinghouse now makes it possible to efficiently connect smaller lenders with limited market directly to the market’s largest loan buyers instead of them being forced to work through a maze of middlemen. This reduces costs for loan buyers and sellers alike while increasing efficiencies, liquidity and profitability for both sides. Additionally, MWOB and veteran-owned lenders would no longer have to buy and sell mortgages in a cumbersome, inefficient and unprofitable market. 

MAXEX debuted its first ESG lending program in December 2020. To date, our platform has traded approximately $750 million in loans made to homeowners in the underserved communities supported by these MWOB and veteran-owned lenders. In just three months of this program being available, it has already proved itself to be a necessity in the marketplace.

Our second ESG lending program supports environmental responsibility and was brought to market in March 2021. This unique program enables homeowners to finance green energy improvements as part of their home mortgage and has proven to be very popular with lenders across the United States.

ESG lending is not just an avenue for expanded investment possibilities, it is a vehicle for social and environmental change in the mortgage industry. Through ESG lending programs we can facilitate more responsible lending practices, increased transparency in the mortgage market and allow community lenders to better serve the homeowners in their respective communities.  

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