Residential EPCs versus Credit Relevance

This commentary explores how Energy Performance Certificates (EPCs) could affect DBRS Morningstar’s rating evaluation, if at all. EPC elements that would have a material financial impact on issuers would be those that affect credit risk, in the securitisation context typically via the expected or stressed default rates and/or the loss-given-defaults.

We investigate the quantitative relationship between energy efficiency improvements and lower probability of default of associated loans by conducting an analysis on loan-level data of European residential mortgage portfolios.

Summary highlights include

-- Slight evidence exists that EPC levels may have an impact on the default rate for securitised assets. Loans related to properties classified in the high energy performance classes and medium energy performance classes exhibit fewer defaults compared with those related to properties in lower energy performance classes.

-- In light of the observable influence of various credit factors on the default rate, the low default rate might not be primarily linked to an energy efficiency characteristic but is more likely associated with the complex interplay of other credit-related factors such as lower loan-to-value (LTV) and higher affordability.

-- The limited reporting makes it difficult to draw any firm conclusions, particularly when unable to control for other characteristics that might affect demand for a particular building and/or default rates.

While we do acknowledge the presence of some initial evidence of credit implications related to EPC factors, their current significance falls short of justifying their inclusion as pertinent for quantitative credit analysis. Nevertheless, as the timeline of energy transition approaches, their potential impact might amplify, potentially rendering them more relevant in the context of credit assessment. As of now, we think EPC considerations in the credit analysis would need to be made via qualitative adjustments to the analysis, if at all.