There’s a new trend taking shape that could affect cash flows of property assessed clean energy (PACE) notes, most notably in the residential space, according to a Morningstar Credit Ratings [1], analysis. Morningstar based its findings [2] on nearly two years’ worth of historical data on patterns and trends in the nascent sector.
The data revealed a consistent upturn in prepay rates spanning all R-PACE originators in Morningstar-rated securitizations. It said that investors should keep their eye on prepayment rates because they can have different effects on the notes, depending on their position in the capital structure. “In general, higher prepayments help to support the senior notes, while they can have a negative effect on the residual certificates, which rely on an excess spread,” it said. “Morningstar was the first credit rating agency to assign a AAA rating to an R-PACE securitization, and increasing prepayments bolster our view on the strength of this sector, particularly at the senior note level.”
Although Morningstar did pinpoint volatility in prepayment rates over the roughly 20-month period since the first R-PACE securitization it rated was finalized in 2016, it has seen an overall rising trend in constant prepayment rates, with monthly annualized conditional prepayment rate (CPR) averages growing from single digits to high teens, it says. As a matter of fact, the annualized CPRs register even higher in certain months, it notes.
Whether or not CPR rates will continue gaining steam remains to be seen, Morningstar says.
“Thanks to the long-term tenor of PACE assessments and the fact that they have yet to experience a full amortization cycle, there are challenges in discerning whether prepayment rates have peaked and are near stabilizing or if they are going to continue their march upward,” the company said.
What might be spurring this accelerating rate? Morningstar offers a couple of possible explanations. Reforms reducing the amount of state and local property taxes that homeowners can deduct on their returns could be one. Originators buying back select assessments because of eligibility requirements as mandated by transaction documents might be another.