A Lighter Shade of Green

Earlier this month we saw Kensington Mortgages issue Finsbury Square 2021-1 GREEN, the first ever Green labelled UK RMBS transaction. While the £750m deal featured multiple tranches including AAA rated seniors, other rated mezzanine notes and excess spread notes, it was only the AAA bonds which were labelled Green. The transaction saw very strong demand, partly reflecting the ongoing favourable supply-demand technical in RMBS, but also Kensington’s reputation as the largest and most well-known issuer in the non-bank RMBS space with a long track record and very strong performance. 
 
Though Kensington does not have specific green mortgage products, it does have two green initiatives for its mortgage customers. In February 2020 the company announced the eKo Cashback Mortgage, which offers borrowers £1,000 cashback for improving the energy efficiency of their home (they must improve the EPC score of their property by at least 10 SAP points within 12 months of their mortgage completion date to receive the reward). Last month the lender launched the New Build eKo Reward Mortgage, this time offering owner-occupied borrowers double the cashback fee of a regular cashback product for purchasing an A or B EPC-rated new build property. 

Kensington’s decision to develop a market leading Green Bond Framework looks a natural progression in relation to these developments, as the financial sector overall continues to move towards more sustainable and social lending. Kensington of course also printed the first Social labelled UK RMBS in February, and preparing the framework for both these deals will have involved a considerable commitment in time and resources for building models and analysis for underlying applications – all of that is to be commended.
 
When scoring this latest transaction for ESG features, we looked closely at the Green label. As mentioned already, it is only the AAA bonds that are described as Green Bonds. This is because rather than the underlying loan pool already being green, the proceeds of the AAA notes (around £640m) will be used to finance Green mortgage origination in future. This is where it gets interesting, as this would appear to be a significant amount of lending via the two relatively new products Kensington has brought to market.
 
From conversations with the sponsor as part of our ESG due diligence, Kensington says its intention is to use these proceeds over the lifetime of the bond’s issuance (five years) to lend against properties with an A or B EPC rating. This means lending  around £128m per annum for mortgages with these high quality ESG scores. In the last full year unaffected by COVID-19 disruption Kensington lent £1.5bn in total, and roughly 10% of the pool in this deal is EPC-rated A or B. If current A or B rated lending is running at around 10%, and the ongoing requirement is to generate less than 10% of existing production rated A or B (just £128m out of £1.5bn), then we think it is reasonable to assume Kensington can hit this target fairly easily, especially given it is expected to roll out further green mortgage initiatives or products in 2021 or 2022 and with expectations of a growing lending book.
 
However, our one criticism of this transaction would be that it is not particularly ambitious. First, the format of this deal asks RMBS investors to pre-fund something that should easily be within reach of the issuer, especially since the two current initiatives are really only that – initiatives – not specific green mortgage products. Furthermore, there are no structural protections for bondholders if this target is not hit. Including such protections would have added to our ESG rating of the transaction and made it more sustainable overall. Second, our ESG scoring system puts a high value on the ‘momentum’ demonstrated by an issuer, and this deal does not really push Kensington to do much different to achieve its stated targets, only to keep running at current market average production.

We have a high opinion of Kensington as a mortgage lender and when we score it for ESG as part of our investment analysis it performs very well even without this latest Green initiative, but we do feel it can stretch further. As the issuer in the space with what is probably the strongest funding franchise, we think Kensington can have a more positive impact and lead the evolution of the market over the next few years. If it did so then we could be commenting on a trailblazing green deal, rather than just a good one.