Authors
Structured Finance ABS/RMBS
Sandra Fronteau
Paris
sandra.fronteau@spglobal.com
F
lorent Stiel
Paris
florent.stiel@spglobal.com
Sustainability Research
Terry Ellis
London
terry.ellis@spglobal.com
Contributors
Structured Finance ABS/RMBS
Matthew Mitchell
Paris
matthew.mit[email protected]
Sustainability Insights | Research
Building Energy Regulations
And The Potential Impact On
European RMBS
Sept. 6, 2023
Climate transition risks related to changes in building energy efficiency regulations are not
currently a material driver of European RMBS' credit quality.
This research report does not comment on current or future credit ratings or credit rating methodologies. It is part of the Toward
Net Zero report series and reflects research conducted by and contributions from S&P Global Ratings’ structured finance and
sustainability research teams.
This report does not constitute a rating action.
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2
Several countries in Europe have committed to cutting their greenhouse gas emissions by 2050,
and energy efficiency of homes is a primary focus of policymakers. This research aims to explore
the potential effects of the resulting initiatives in S&P Global Ratings' analysis of loan pools
backing residential mortgage-backed securities (RMBS) in the region.
To do so, we conducted a scenario analysis of properties in the U.K. (focusing on England and
Wales), Ireland, France, and the Netherlands, where energy performance certificates (EPCs)
indicate low energy efficiency (for example classes F and G). Our scenario analysis assumes
energy efficiency regulations would lower property values if owners do not carry out any
renovations to improve energy efficiency. This research entailed a review of energy efficiency
regulations for residential buildings and a comparison of EPC data reporting by country.
Our scenario analysis shows a valuation discount has a low impact on RMBS loss severity
pp(s)--Percentage point(s). Source: S&P Global Ratings.
Key Takeaways
• Climate transition risks linked to changes in energy-efficiency performance regulations
currently have a limited impact on European RMBS. This is due to uncertainties on the
timing and extent of sale or rental restrictions, financing available for renovations, supply
and demand in housing markets, and structural protections in RMBS transactions.
• Nevertheless, EPCs may influence property values. Studies show there is a valuation
discount for properties with low EPC classes. If this discount increases as EPC classes
gain importance or is not fully reflected in property valuations, it may eventually affect
how we calculate the foreclosure frequency and loss severity of RMBS loan pools.
• Our scenario analysis shows a low potential impact on our modelled loss severity
assumptions. This is even though energy-intensive properties could face higher losses.
Our weighted-average loss severity increases 2.5% at the 'AAA' rating level and 2.8% at
the 'B' rating level, albeit we acknowledge that our assumptions are very conservative.
• Foreclosure frequencies may increase over time due to higher leverage. Property
owners may incur higher debt to carry out renovations if countries start requiring
improvement in energy efficiency, especially if subsidies are insufficient to cover the cost.
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Regulation And Its Impact On The Housing Market
Targets and regulations differ by country in the EU and U.K.
The European Climate Law, which took effect in July 2021, wrote into law the European Green
Deal's goal of achieving climate neutrality (net zero greenhouse gas emissions) by 2050. As part
of this, EU member states are obliged to cut their greenhouse gas emissions by 55% by 2030,
compared to 1990. Fit for 55, a set of legislative proposals, describes concrete actions for the EU
to achieve this target.
Improving the energy performance of housing will likely be key to reaching this target, since the
residential building sector was responsible for 27.4% of the EU's energy consumption in 2020,
according to Eurostat, and 12% of its emissions in 2021, according to the European Environment
Agency.
As part of Fit for 55, the European Commission has proposed changes to the Energy
Performance of Buildings Directive (EPBD) to improve the energy efficiency of residential
buildings. EPCs are a keystone of the EU taxonomy to determine whether a building is energy
efficient (see box). In the U.K., the Climate Change Act requires the reduction of greenhouse
gases by 100% by 2050. The U.K. has also committed to cutting emissions by 68% by 2030 under
the Paris Agreement.
EU Taxonomy: Definition of energy-efficient property
Many RMBS issuers want collateral in the mortgage loan pool to show greater energy efficiency and, for some,
alignment with the EU taxonomy. The EU taxonomy is primarily a classification system that clarifies which
economic activities are considered environmentally sustainable, based on four overarching conditions. The
activity must:
• Make a substantial contribution to at least one of the six environmental objectives (see footnote);
• Do no significant harm to any of the other five environmental objectives;
• Comply with minimum safeguards; and
• Comply with the technical screening criteria (see below) set out in the Taxonomy's Delegated Acts.
EU taxonomy technical screening criteria
Category of building Technical screening criteria
7.7 Acquisition and
ownership of existing
buildings (built before
2021)
The building has an EPC of at least class A. Alternatively, the building is within the
top 15% of the national or regional building stock.
7.2 Renovation of existing
buildings
The renovation complies with the applicable national or regional requirements for
renovations. Alternatively, it leads to a reduction of primary energy demand (PED)
of at least 30%.
7.1 Construction of new
buildings (built in 2021 or
later)
PED, which defines the energy performance of the building resulting from the
construction, is at least 10% lower than the threshold set for the nearly zero-
energy building requirements for that country.
The Taxonomy's six environmental objectives are
climate change mitigation, climate change adaptation, sustainable use and protection of water
and marine resources, transition to a circular economy, pollution prevention and control, and protection and resto
ration of biodiversity and
ecosystems
. Nearly zero-energy building (NZEB).
According to the European Commission, an NZEB is a building with very high energy performance,
while the nearly zero or very low amount of energy required is covered to a very significant extent by energy from renewable
sources, including
energy from renewable sources produced on
-site or nearby. Source: EU Taxonomy.
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EPC assessments vary by country but provide a measure of the energy performance of a home
and recommendations to improve efficiency. An EPC is compulsory when selling or renting a
property in all EU countries and in the U.K. The EPBD sets general guidelines, and each EU
member state implements them in its own way. The U.K. (England and Wales) also has its own
definition of the EPC. As a result, there is a variety of EPC definitions and, historically, it has been
difficult to compare EPCs across European jurisdictions. EPC labels typically include a class,
based on a ranking system (see graphic 1), from class A (most energy efficient) to class G (least
energy efficient). The classes indicate the expected level of energy use and carbon dioxide the
property emits in the number of kilowatt hours per meters squared per year (m
2
/year).
Graphic 1
EPC class definitions vary widely among France, Ireland, and the Netherlands
kWh/m2/yr--Kilowatt hours per square meter per year. We did not add the U.K. to the table because the EPC definition in England and
Wales is based on a composite indicator, which is not directly comparable with EPC definitions in Ireland, France, or the Netherlands.
This composite indicator is derived from a property’s Standard Assessment Procedure score of 1-100 that is determined by an
accredited assessor based on the home's characteristics in terms of heating system, insulation, lighting, ventilation, carbon dioxide
emissions, and energy consumption, etc. Sources: France: Ministère de la Transition écologique et de la Cohésion des territoires,
Ministère de la Transition énergétique; Ireland: Sustainable Energy Authority of Ireland, Netherlands: Netherlands: Rijksdienst voor
Ondernemend Nederland – RVO (Netherlands Enterprise Agency); and S&P Global Ratings.
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Countries have differing approaches to defining minimum EPC classes for residential property
rentals. France and the U.K. have already put in place regulations that set a minimum EPC class
for rental properties (see table 1). In the case of the U.K., these prevent properties from being
rented unless they meet the minimum EPC class. In France, rents are frozen until the minimum
EPC class is met and, in the future, landlords will be prevented from renting properties with low
EPC labels; the Netherlands has also put in place policy that will apply in the future. So far,
Ireland has not announced any rent restrictions related to energy efficiency (see graphic 2).
Table 1
Sample of building energy efficiency regulations for property rentals by country
Jurisdiction Energy efficiency regulation
France The French government has implemented bans on renting properties with low EPC classes. Since August 2022, rents of
properties labelled as class G and class F have been frozen. Since January 2023, properties with energy consumption
exceeding 450 kWh/m2/year cannot be rented. Starting in 2025, all properties labelled class G will be banned from the
rental market, followed by class F in 2028, and class E in 2034.
Ireland In Ireland, EPCs are called Building Energy Rating (BER) certificates. The government has not implemented any
restrictions on the rental market with respect to BERs at this time.
Netherlands In the Netherlands, properties labelled class E, F, and G will be banned from public and private rental markets starting
January 2030. From 2026, when a heating installation needs to be replaced, the switch must be to a "greener" system,
notably hybrid heat pumps.
U.K. (England and
Wales)
Since April 2018, all rented properties must have a minimum EPC label of class E. More recently, the U.K. government has
proposed to ban all properties with EPC labels lower than class C from being rented from 2028. This policy is still in
development and has not been legally implemented yet. In our view, the main risk is a property value decline for low
energy-efficient homes if landlords decide not to renovate and, instead, sell their properties. If a landlord does not
renovate and continues to rent out the property, they can be fined.
Sources: France: Loi Climate et Résilience (Law of Climate and Resilience; 2021); Netherlands: Beleidsprogramma versnelling
verduurzaming gebouwde omgeving (Policy program to accelerate the sustainability of the built environment; 2022); U.K.
(England and Wales) - UK Minimum Energy Efficiency Standards (MEES) regulations (2018); and S&P Global Ratings.
Graphic 2
Share of housing stock subject to potential rental bans over time, based on the EPC class
EPC--Energy performance certificate. Sources: U.K. (England and Wales): U.K. government; France: fidéli, SDES data; The
Netherlands: CFP Green Buildings; and S&P Global Ratings.
The proposed EPBD aims to introduce a unified definition of the EPC across EU member states
and set a binding timeline for renovations and EPC upgrades. The draft EPBD would require all
existing residential buildings to have a minimum EPC label of class F by 2030 and class E by 2033,
and all new buildings to generate net zero emissions by 2030. The U.K. implemented the 2018
EPBD (the most recent revision) after the referendum in which the U.K. voted to leave the EU, and
it has been in effect since 2020. However, the U.K. does not participate in the new EPBD
discussions.
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Old houses may require more renovation to improve energy efficiency
Research from the European Commission and the EU Building Stock Observatory finds that the
U.K. has one of the oldest housing stocks in Europe, with half of its dwellings built before 1970
(see graphic 3). Although 44% of residences in the Netherlands were built before 1970, the
country has one of the highest shares of energy-efficient properties in Europe, based on the
reported distribution of EPC classes. However, EPC definitions are not directly comparable
across countries at present. In each of the four countries, about 40% of residential homes are
rented (see graphic 4) and could be affected by potential regulations banning the rental of
properties with low EPC classes.
Graphic 3
The age profile of residential housing varies across Europe
Sources: European Commission, EU Building Stock Observatory, 2017 data; and S&P Global Ratings.
Graphic 4
Distribution of homes by residential ownership type
Sources: France: INSEE, 2022 (share of residential primary homes), Ireland: Central Statistics Office, 2016 (share of
households), Netherlands: CBS 2021, Kadaster 2021 (share of residential housing units), U.K. (England and Wales): U.K.
Government, 2021 (share of households); and S&P Global Ratings.
0%
5%
10%
15%
20%
25%
30%
35%
France Ireland Netherlands U.K.
Percentage of housing stock
<1945
1945-1969
1970-1979
1980-1989
1990-1999
2000-2010
>2010
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
France Ireland Netherlands U.K.
Public renters or housing
associations
Private renters
Owner occupied
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EPC data reporting is inconsistent among jurisdictions
The distribution of residential buildings by EPC varies greatly across countries, due to the specific
features of housing, processes for assigning EPC classes, and the variety of EPC class definitions
(see graphic 5). National databases are publicly available in France, the Netherlands, the U.K.,
and Ireland. By looking at the distribution of EPCs across countries, we cannot conclude that a
certain country has more energy efficient buildings than another because the EPC definitions are
not directly comparable. For instance, a property with 155 kilowatt hours per m2/year of primary
fossil energy use could have an EPC label with class D in France and class A in the Netherlands.
Graphic 5
EPC classes vary widely across countries
Note: The EPC distributions across countries are not directly comparable given the differences in EPC class definitions
presented in graphic 1. Sources: England and Wales: U.K. government; France: fidéli, SDES data; Ireland: Central Statistics
Office; the Netherlands: CFP Green Buildings. Ireland data combines EPC classes F and G. Data as of 2019 (Ireland), 2020,
Netherlands, 2022 (England and Wales, France), and S&P Global Ratings.
As part of a new European Banking Authority regulation, banks will be required to disclose
information on the climate exposure of their real estate portfolios from December 2023. As a
result, many banks have started to capture EPCs during the loan origination process, and some
of them map existing properties to the national database when available. However, most banks
are at an early stage of development in this area, and it will take time to collect enough data to
create a meaningful sample. As more EPC data is provided over time by securitization issuers, it
should help to enhance the understanding and monitoring of the potential relevance of EPC-
related valuation and collateral risks.
Lower EPC classes could affect property values
Many of the studies we consulted (see the External Research list at the end of this report) that
were conducted across Europe show that a discount exists for properties with the lowest EPC
classes (F and G), both in the owner-occupied and buy-to-let (or BTL) markets. The magnitude of
the discount varies, depending on the type of property, price segment, location, market
tightness, and market sentiment. A number of studies argue that energy performance of a home
is highly correlated with its date of construction.
0%
5%
10%
15%
20%
25%
30%
35%
40%
France Ireland Netherlands U.K.
Percentage of housing stock
A
B
C
D
E
F
G
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Nevertheless, some studies have rejected the date of construction as an indicator and instead
demonstrated that lower EPC classes themselves constrain property valuations. Some of them
show that the discount has increased in the last few years and is likely to rise further in the
coming years as public awareness of climate risks for the housing sector increases. Some
academic studies also report a premium for energy-efficient properties, in several markets.
Lower EPC classes can be associated with higher energy and renovation costs. They can also
reflect lower comfort, both in winter and during summer heat waves, notably if the property is
badly insulated. In the buy-to-let market, low EPCs can cause higher vacancy rates, lower rents,
and eventually a lower valuation; however, this depends on the market's location and conditions.
Financing Will Likely Be Needed For Renovations
The cost of renovation varies widely
Generally, renovation costs depend on the type of property, the EPC class targeted, and the
types of work. Light renovation refers to conducting only one or two types of works that might
raise the EPC label by one class, such as replacing an oil boiler with an electric boiler. A deep
renovation encompasses several types of works, such as replacing a boiler, and the insulation in
walls and the roof, to raise the label to class A or B. The types of retrofit necessary to improve
energy performance generally include walls and attic insulation, as well as replacement of
heating systems, controls, or ventilation.
Although most countries included in our scenario analysis offer grants to retrofit homes (see
table 2), we find the amount, conditions, and processes for receiving such a grant vary greatly
across countries. In most cases, grants are conditional upon a household's income and the type
of work. Governments can also provide incentives to owners through subsidized loans, tax
credits, or reduced value-added tax.
When grants are not sufficient or available, owners may finance works out of their own pocket
or from further borrowing (secured or unsecured). Financing solutions vary across countries.
However, when purchasing a property, it is common to finance renovation through the mortgage
loan, with the cost of renovation reflected in the loan's current balance once the amount
dedicated to the works is released by the lender (most of the time upon presentation of invoices).
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Barriers to energy-performance improvements remain
Government grants do not generally provide a sufficient incentive for owners to renovate their
homes. This is because such grants typically do not cover the whole cost of renovation and the
amount and types of grants vary widely across countries. In addition, the costs of renovation
often exceed the benefits of increasing the property's valuation and reducing energy bills, unless,
for the latter, the owner intends to keep the property for a long time. There is also the possibility
that EPC regulations could evolve in the coming years. Therefore, owners are often uncertain
whether renovations will be sufficient to achieve the minimum EPC class for rental when
standards are constantly raised.
For homeowner associations, it might be difficult to pursue works that have to be approved by
all owners. This is particularly the case for landlords when owner occupiers make up the majority
of homeowners in the building. Also, deep renovations cannot be done if the property is not
vacant.
Sometimes, unwillingness to renovate stems from a lack of information, for example about the
costs, types of works needed to improve energy performance, and how to find a contractor. In
several countries, renovation grants are conditional upon the works being conducted by a
certified contractor. However, there may not be sufficient certified contractors to do all the
renovations required to meet the EPC target. In some cases, renovations are not doable because
of the property's features, such as lack of a cavity for insulation or the building's classification as
a historical monument. Raw material shortages and cost inflation can also hinder completion of
renovations.
How EPCs Might Influence Our Credit Analysis
Renovation costs could be credit negative, absent mitigating factors
A homeowner or landlord may seek additional financing upon buying a property with a low EPC
class to complete energy-efficiency upgrades. If that homeowner or landlord decides to finance
the renovation through a mortgage loan, the cost would be reflected in the mortgage loan
balance once the lender releases the amount dedicated to the works. This could impair several
ratios we consider in our loan foreclosure frequency analysis, including the loan to value (LTV),
loan to income (LTI), debt to income (DTI; relevant for French RMBS transactions) and debt
service coverage (DSC; relevant for buy-to-let transactions in the U.K. and Ireland).
However, in our view, several factors could mitigate the impact:
• Whether the loan is new or seasoned, the lender will consider the additional financing
subject to the maximum LTV, LTI, DTI, and interest coverage ratio limits, as per its
underwriting criteria, which cannot be exceeded. In a seasoned loan, the borrower can
benefit from the loan’s amortization since origination (unless it is an interest-only loan)
and from any increase in primary income. The borrower could also benefit from a
potential increase in house prices since origination.
• In addition, if the EPC class improves due to renovation, the property value will likely also
improve. The renovation cost's potential weight on the LTV--and therefore on our
foreclosure frequency assumption--would be at least partly mitigated by the increase in
property value. However, it is hard to assess the magnitude of the rise in value after
renovation because this depends on many factors, such as the types of renovation,
market location, and market sentiment.
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• For buy-to-let properties, another mitigant is that the rental income could increase after
the property is renovated, especially if the EPC class improves from a low-efficiency
class. A higher EPC class (the A classes are the highest) is typically associated with lower
energy costs and potentially higher rent.
Effect of property valuation haircut on the WAFF and WALS
To simulate the hypothetical impact on the weighted average foreclosure frequency (WAFF) and
weighted average loss severity (WALS), we applied an average 15% haircut to the valuation of low-
energy-efficient properties backing a mortgage loan pool. Climate transition risk may materialize
through potential property valuation discounts for such properties if the owners do not
undertake any renovations.
We use EPC class distributions to indicate this risk in our scenario analysis. We assume the main
effect would be lower property sale proceeds after a repossession in case of a borrower default,
and therefore a higher WALS. This risk could also affect our stressed WAFF assumptions by
reducing the current LTV ratio, therefore influencing the effective LTV ratio we use to determine
our LTV adjustment. This is because 80% of the effective LTV represents the original LTV and
20% the current LTV. However, this aspect is less significant to our scenario analysis than the
potential increase in WALS.
Components Of The Scenario Analysis
Assumptions
Valuation haircut of 15% for the average cost of renovation. A valuation haircut equals the
estimated cost of renovation. In other words, the property's market value fully discounts the
estimated costs to improve its energy efficiency. Research papers mention costs of renovation
ranging from approximately 8% of the property value, for a light renovation, to 25% for a deep
renovation. With the variety of renovations possibly required, we assumed an average cost of
renovation of 15% in all markets and for all properties.
A larger haircut (20%) for buy-to-let (BTL) properties than for owner-occupied properties
(15%). We distinguish between BTL and owner-occupied properties in our scenario because the
energy-efficiency requirements announced by some countries to date apply only to rental
properties. As a result, we believe there could be a relatively higher valuation discount on rental
properties with a low EPC class, since some landlords may choose to sell rather than carry out
improvements, and there could be less demand for those properties on the BTL market.
In France and the Netherlands, properties with EPC classes F or G are assumed the first affected
by the ban on renting properties with low energy efficiency. In the U.K., currently all properties to
be rented should have an EPC class of at least E. In addition, properties with low energy
efficiency on the rental market might be subject to higher vacancy rates and potentially lower
rental prices, since tenants avoid properties with high energy costs; this may then be reflected
through a lower property value.
However, the magnitude of discount would depend on a variety of factors, such as market
location, type of property, price range, and market sentiment. For instance, in markets where the
supply of BTL properties is low, the discount is generally lower. The discount for BTL properties
would also be mitigated by demand for owner-occupied property to a certain extent. When a
landlord sells a low-energy-efficient BTL property, a first-time or low-income buyer that can
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afford the property, because of the discount, may purchase it without being obligated to
renovate, since they plan to occupy the property rather than rent it out.
30% of the mortgage loan pool comprises low-energy-efficient properties. EPC data is not
required when submitting individual mortgage loans to securitization repositories, and we
typically do not receive the EPCs of properties backing rated RMBS transactions. Many
originators now request EPCs during the loan underwriting process, so data availability may
improve over time. But for seasoned loans, EPC data is not widely reported; therefore, we use a
proxy.
To determine the percentage of a collateral pool comprising low-energy-efficient properties, we
considered the new definition of the G class under the proposed EPBD. The G class will reflect
the bottom 15% of all residential properties in the EU in terms of energy efficiency. This means
some properties currently labelled class F will be considered class G, and some labelled class E
will be considered class F. For our scenario analysis, we assumed that both class F and class G
properties will account for a maximum 30% of residential property in the future.
For simplicity, we applied the same assumption for the U.K., although the current distribution of
classes F and G in the housing stock is currently very low, and we are uncertain how the EPC
framework might evolve compared to that in the EU. However, with a potential new U.K. law
targeting rental properties with EPC classes lower than C, a higher share of loan pools might be
affected than the 30% we assume for our scenario analysis.
Calculating the total haircut applied at pool level
To do this, we take the sum of:
• 15% of the assumed property value discount for owner-occupied properties, multiplied
by the share of owner-occupied properties in the pool, multiplied by 30%, which is the
assumed share of properties with EPC classes F and G; and
• 20% of the assumed property value discount for BTL (buy-to-let) properties, multiplied
by the share of BTL properties in the pool, multiplied by 30%, which is the assumed
share of properties with EPC classes F and G.
For example, if a pool contains 40% owner-occupied properties and 60% BTL properties, we
would apply a haircut of 5.4% at pool level.
We applied the valuation haircut to the current indexed valuation and on top of any valuation
haircut already applied under our rating criteria
Sample RMBS transactions
We used a representative sample of eight transactions, including prime, nonconforming, and BTL
assets in the U.K., Ireland, France, and the Netherlands to assess how our scenarios affect the
WAFF and WALS. The ratings on these transactions range from 'AAA (sf)' to 'B (sf)'.
Some limitations and caveats to our scenario analysis
• The stresses we selected are hypothetical, are not meant to be predictive, and may not be a
precise representation of reality.
• We apply declines in house prices immediately, which we believe is a conservative
assumption because the timing and final form of any energy efficiency regulations that could
influence property valuations remains highly uncertain. In our view, any future decline in
property values for low-energy-efficient properties is likely to occur gradually and--in the
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meantime--borrowers with amortizing loans would continue to reduce their outstanding
balances, which may mitigate any deterioration in the LTVs at that time.
• In addition, an appreciation of overall property market prices in the long term would
contribute to lower LTVs and reduce the impact of declines versus that in our scenario
analysis.
Results of the scenario analysis
Table 2
Haircuts and the impact on the WAFF and WALS
Country
Type of
transaction
Share of
owner
-
occupied
properties (%)
Share of buy-
to-
let
properties (%)
Valuation
haircut applied
for sensitivity*
(%)
Increase o
f
WAFF at 'AAA
'
rating level
§
Increase o
f
WALS at 'AAA
'
rating level
§
Increase of
credit
coverage at
'AAA'
rating
level§
Increase of
WAFF at 'B'
rating level§
Increase o
f
WALS at 'B
'
rating level
§
Increase o
f
credit
coverage at 'B
'
rating level
§
France
Prime
65.1
34.9
5.00
0.14
2.37
0.41
0.02
0.79
0.02
Ireland
Prime
100.0
0.0
4.50
0.79
2.26
0.74
0.10
2.10
0.08
Ireland
BTL
0.0
100.0
6.00
2.14
2.84
2.26
0.30
3.70
0.37
Netherlands
Prime
100.0
0.0
4.5
0.14
1.64
0.16
0.02
0.96
0.01
Netherlands
BTL
0.0
100.0
6.00
0.28
2.59
0.62
0.04
4.25
0.12
U.K.
Prime
100.0
0.0
4.50
0.78
2.72
0.96
0.12
2.66
0.11
U.K.
BTL
0.0
100.0
6.00
1.17
2.96
1.40
0.17
4.70
0.21
U.K.
Nonconforming
65.4
34.6
5.00
0.94
2.62
1.19
0.15
3.06
0.19
*On top of existing valuation haircut applied under our RMBS methodology, if any. §In percentage points. BTL--Buy to let.
Source: S&P Global Ratings.
Graphic 6
Effect on WALS: Additional percentage points at the 'AAA' rating level
WALS--Weighted average loss severity. Source: S&P Global Ratings.
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
France
prime
Ireland
prime
Netherlands
prime
U.K.
prime
U.K.
nonconforming
Ireland
buy to let
Netherlands
buy to let
U.K.
buy to let
Percentage point increase in WALS
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13
Graphic 7
Effect on WALS: Additional percentage points at the 'B' rating level
WALS --Weighted average loss severit y. Source: S&P Global Ratings.
Main findings: Overall influence on loss severity is relatively low
After applying the value discount in our scenario, we saw an increase of only 2.5% in the WALS
for RMBS at the 'AAA' rating level and 2.8% in the WALS for RMBS at the 'B' rating level, on
average. This is before considering any mitigating factors such as a gradual rather than an
instant decline in property values for low EPC classes, continued deleveraging, or price
appreciation of properties over time. This does not reflect any offsetting benefit from higher
valuations of properties with high EPC classes in mortgage collateral pools, which may benefit
from climate transition policies.
Unsurprisingly, a high share of BTL properties in a mortgage pool correlates with a higher
influence on the WALS in our scenario analysis. The impact on the WAFF is limited, with an
increase of only 0.8 percentage points overall at the 'AAA' rating level, and 0.12 percentage points
at the 'B' rating level.
The effect on credit coverage is low, with an average increase of 0.97 percentage points only
at 'AAA' and 0.14 percentage points at 'B'. This shows that the higher loss severity as a result of
a property value discount for low energy efficiency would have only a limited effect on our cash
flow analysis, especially when the WAFF is low.
Structural features in RMBS transactions could mitigate the risk of reduced property
valuations for low-energy-efficient homes. First, at an individual loan level, borrowers generally
repay principal over time, which reduces the potential loss severity if they default. Additionally,
although we do not give credit for future house price appreciation in our RMBS analysis, house
price increases can reduce LTVs over time. RMBS structures differ from transaction to
transaction. Generally, however, RMBS structures often have generic structural features that
provide stability to our RMBS ratings. Structural mitigants often include some or all or the
following:
• Sequential amortization of rated notes, meaning that higher-rated notes are repaid before
lower-rated notes and credit enhancement often increases over time for all notes.
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
France
prime
Ireland
prime
Netherlands
prime
U.K.
prime
U.K.
nonconforming
Ireland
buy to let
Netherlands
buy to let
U.K.
buy to let
Percentage point increase in WALS
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14
• Hard credit enhancement. This refers to tangible forms of credit enhancement, such as
reserve funds, overcollateralization, or unrated subordinated notes. Generally, hard credit
enhancement would cover any losses on the sale of underlying mortgage collateral before it
is allocated to the rated RMBS.
• Soft credit enhancement. This generally takes the form of excess spread and, if available,
can be used to cover any losses on the sale of property underlying the RMBS.
Looking Ahead
Our scenario analysis enables a better understanding of the range of possible exposures that
issuers of RMBS face and may enhance our dialogue with issuers and market participants
regarding future climate transition risks and any related mitigants.
The scenarios in this research illustrate how EPC-related variables could in the future influence
RMBS credit-rating analytics. However, they are not considered in our current assumptions for
securitized mortgage loans because of uncertainty regarding the timing and extent of any legal
obligation to renovate properties to reach some mandated minimum level of energy efficiency.
Furthermore, there is limited visibility on the required amount of financing for renovations and
any resulting effect on property valuations.
The valuation discount of homes with the lowest energy efficiency could be significant if owners
do not do the renovations. Moreover, in countries that already have or may implement rental
market bans based on EPCs, BTL properties with low energy efficiency might be subject to higher
vacancy rates and lower rents, and therefore even lower valuations. Therefore, in our view,
mortgage loan pools with a high share of BTL properties may present a higher credit risk in the
future. In RMBS transactions backed by nonperforming loans, the main risk would be lower sale
proceeds if property is repossessed, due to the discounted value of low-energy-efficient
properties.
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Appendix
Table 3
Sample of government and private lender support for building renovations by country
Jurisdiction Government and regulatory support for renovation Banks/lenders energy-efficiency financing solutions
France --The French government offers grants for homeowners and
landlords to finance energy performance improvements. The
amount is up to €11,000 and depends on household income
and energy improvement. A specific scheme for low-income
borrowers offers grants up to €17,500.
--The government has introduced subsidized interest-free
loans (Eco-PTZ) up to €50,000, available for all owners, for
energy performance renovation, in partnership with main
banks. The maximum term is 20 years. Low-income
households can benefit from a specific renovation mortgage
loan and the state guarantees up to 75% of the amount.
--There are many local grants available, and the value-added
tax for energy performance works is reduced to 5.5% instead
of 20%.
--In France, light renovations are often financed through a
consumer loan and deep renovations through a residential loan.
--All main banks offer interest-free loans (Eco-PTZ) in
partnership with the government.
--Some banks have set tighter underwriting criteria to purchase
BTL properties with an EPC class of G or F, requiring borrowers
to commit to renovate the property (evidence via quotations or
invoices is required). If the borrower does not commit to
renovate, then the rental income is excluded from the debt-to-
income ratio calculation.
Ireland --Government grants are available for all homeowners and
private landlords and managed by the Sustainable Energy
Authority of Ireland. The grants, of up to €6,000, are for a
variety of works including attic and wall insulation, heating
upgrades, solar panels, and heat pumps. A specific, fully-
funded grant scheme is also available for qualifying
homeowners that already get welfare benefits.
--The cost of renovation can generally be financed through a
mortgage loan.
--Some originators have launched green mortgage loans, with
lower rates, for borrowers purchasing a property with a high
energy performance assessment or conducting home
improvement works to increase the energy performance
assessment.
Netherlands --The government offers subsidies to homeowners and
renters for home energy efficiency renovation. Installation
must be completed to apply for the subsidy, based on
quotations, invoices, and photos. The amount of subsidy
depends on the number and types of works, and equipment
used.
--Local subsidies are also available.
--The National Heat Fund, funded by the Dutch government
and banks, provides homeowners and landlords with cheap
consumer loans for home renovation. Interest-free mortgage
loans exist for low-income households.
--Renovation is typically decided when a property is purchased,
and often financed through a construction deposit released to
the borrower after the renovation has been completed.
--Home energy performance has become a marketing strategy
for Dutch lenders to distinguish themselves. Some propose
discounted interest rates for loans backed by properties with
strong EPCs, or when the borrower commits to renovate the
property and improve the EPC class. Lenders also offer tools to
help borrowers get information on energy performance
renovation.
U.K.
(England
and Wales)
--The Energy Company Obligation (ECO4) and ECO+ schemes
are funded by the main energy suppliers. ECO4 targets low-
income homeowners or tenants in energy inefficient
properties and can finance insulation, boiler replacements,
electric heating, draught proofing, heat pumps, and solar
panels. ECO+ targets both low-income and middle-income
households with grants of up to £15,000 to finance mostly
insulation. About 80% of the scheme is dedicated to homes
with an EPC class of D or lower.
--The Home Upgrade Grant is funded by the government’s
Local Authority Delivery scheme. It targets both homeowners
and private renters to finance various measures, including
insulation and low-carbon technologies.
--The Boiler Upgrade Scheme, funded by the government,
offers grants of up to £6,000 to finance heat pumps and
biomass boilers.
--The cost of renovation can generally be financed through a
mortgage loan. Some homeowners and landlords benefit from
increased property values and amortization since their initial
loan, which can help finance the costs through their existing
mortgage loan.
--There are some initiatives from lenders to create specific
offers related to energy efficiency. Some originators have
decreased the interest rate on their green additional borrowing
product to 0%. However, only a limited number of mortgage
holders could benefit from this green product.
Sources: France: Ministère de l'Économie des Finances et de la Souveraineté Industrielle et Numérique (Ministry of the
Economy, Finance and Industrial and Digital Sovereignty; Ireland - Sustainable Energy Authority of Ireland: Netherlands:
Rijksdienst voor Ondernemend Nederland – RVO (Netherlands Enterprise Agency); UK (England and Wales) - Ofgem,
Department for Energy Security and Net Zero; and S&P Global Ratings.
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Related Research
• Carbon Pricing, In Various Forms, Is Likely To Spread In The Move To Net Zero, Aug. 9, 2022
External Research
• La valeur verte des logements en 2021 (The green value of housing in 2021), Nov. 14, 2022
(Etudes statistiques immobilières, Notaires de France)
• De waarde van het energielabel - investeren in duurzaamheid loont steeds meer (The value
of the energy label - investing in sustainability increasingly pays off), July 12, 2022 (Brainbay)
• Rood energielabel doet steeds meer pijn bij woningverkoop (Red energy label increasingly
hurts home sales), Nov. 14, 2021 (Tilburg and Maastricht Universities)
• Energy performance certificates and house prices: A quantile regression approach, Aug. 31,
2020 (M. McCord, M. Haran, PT. Davis, J. McCord, Journal of European Real Estate Research)
• What will you pay for an ‘A’? – a review of the impact of building energy efficiency labelling on
building value, June 3, 2017 (F. Brocklehurst, Ballarat Consulting, European Council For An
Energy Efficient Economy)
• The Impact of Energy Performance Certificates on property values and nearly zero-energy
buildings - Report for policy makers, July 2016 (J. Santos, A. Rajkiewicz, I. De Graaf, R.
Bointner, Zebra 2020 project)
• The Price Effect of Building Energy Ratings in the Dublin Residential Market, Oct. 2, 2015 (R.
Lyons, S. Lyons, S. Stanley, Energy Efficiency)
• An investigation of the effect of EPC ratings on house prices, June 17, 2013 (U.K. Department
Of Energy & Climate Change)
• Energy performance certificates in buildings and their impact on transaction prices and
rents in selected EU countries, April 19, 2013 (Directorate-General for Energy, European
Union Commission)
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