Even a casual reader of the business pages has noticed that banks and mortgage lenders are suffering because of the so-called sub-prime meltdown. During the recent housing boom years, lenders offered many innovative mortgage products that allowed buyers who didn’t meet strict lending ratios to buy houses that would have been out of their reach.

Now, problems in that sector are dragging down lenders large and small. Citigroup, the largest U.S. bank, warned in early October 2007 that its third quarter earnings are expected to decline 60 percent, while Switzerland’s second-largest bank, UBS reported anticipated third quarter losses of up to $690 million.

In late October, Merrill Lynch (NYSE: MER) said it would take a loss totaling $8 billion, $3.4 billion of which it attributed to mortgage losses. The mounting industry write downs totaled more than $20 billion as of late October. As the dust begins to settle, nwcurrent investigated new offerings in the green mortgage industry.

Today, green mortgages barely even register as a niche in the $10 trillion U.S. mortgage industry. The national Mortgage Bankers Association has conducted no research on the topic; mortgage industry analysts aren’t paying attention; and the big lenders’ offerings aren’t even promoted on Web sites.

In part, experts say, that’s because green or energy-efficient mortgage benefits need to be better understood by financial institutions and by consumers; there needs to be a widely accepted, clear set of standards for defining green housing; secondary markets for bundled green mortgages need to emerge; lending limits on federal energy-efficient mortgage programs need to be increased; and the mortgage insurance industry needs to play a role.

And particularly in the wake of the sub-prime meltdown, green mortgages need a track record that shows bankers the bottom-line benefits of lending to high-performance construction projects. The energy-efficient mortgage is the most popular and best understood of the green mortgage products. That’s because the benefits are clear and it’s easy for a lender to understand the payoffs, says Donald Simon, a partner with the Oakland, Calif., law firm Wendel Rosen Black & Dean.

In a typical scenario, the borrower is looking to buy a property with a sale price that bumps up against the maximum amount the lender is willing to finance. But the purchase price includes lots of energy-efficient measures that could reduce the borrower’s cost to operate the house. In such cases, the lender might be willing to let the borrower take out a larger mortgage than usual because the borrower can use the energy savings to make a larger mortgage payment. Or there’s the case of a borrower who is comfortably within the lender’s comfort zone but is able to negotiate a better interest rate because the energy savings make the loan a safer bet.

Over the past few years, Bank of America, Wells Fargo, Ctigroup, Chase Manhattan, Countrywide and other large financial institutions have taken their first tentative steps into the green mortgage arena by offering borrowers who meet environmental standards modest rebates or interest-rate reductions, typically in the range of $500 to $1,000 or a one-eighth to one-quarter reduction in the interest rate.

So far, despite the industry wide fallout, none of the big banks have announced plans to reduce or eliminate green mortgage offerings. And no one expects banks to stop making energy-efficient mortgages. But sources do expect that, in the short term at least, lenders will be focused more on their core businesses than innovative new loan products such as energy-efficient mortgages.

In the long run, however, green mortgage backers say they believe banks will see buyers of energy-efficient, sustainable houses as a better credit risk because they have more invested in their houses, and will consider green houses easier to sell because of a relative scarcity. As Simon puts it, truly green houses are a rare commodity buyers will be loath to surrender. “It is a product in the marketplace that is more desirable than the standard house,” Simon says. “People want to have a product that is actually consistent with their values.”

The primary challenge is demonstrating to the conventional mortgage industry that green or energy-efficient mortgages have an inherent financial value proposition, Simon says. “A green building is a better economic decision because, above all other considerations, it costs less to operate,” he says.

Making such a case, however, requires a track record. As more adventuresome, or values motivated, borrowers take the plunge that record will be established, sources agreed. Commercial builders, lenders and borrowers have the U.S. Green Building Council’s Leadership in Energy and Environmental Design (LEED) certification process, which is well established in the commercial marketplace and provides a growing track record that reassures most lenders.

Similarly, most LEED-certified buildings are owner-occupied, Simon says, which makes them less of a credit risk for lenders. After all, an owner has more invested—financially and emotionally—than a tenant who is paying a lease. Also, when the project involves a corporate headquarters building, the lender knows there’s a lot of collateral behind the loan.

But loans for LEED-certified buildings still lag far behind commercial loans for standard buildings. Wells Fargo announced in mid-July 2007 it had made $1 billion in loans for LEED-certified commercial buildings since 2004. At the end of 2007’s second quarter, the bank was carrying $16.4 billion in commercial real estate loans on its books.

There are, however, plenty of green mortgage skeptics. Whether a financial industry reeling from its recent debacle with providing innovative lending products is ready to embrace an unproven concept remains to be seen.

Tomek Rondio, CEO of San Francisco–based MortgageGreen, a provider of green mortgage products and services, says he believes an industry shift is likely in the next five years driven by the combination of measurable, consistent standards and an overriding need to increase energy efficiency in the United States.

Then, he says, green mortgage providers will compete on their ability to provide the most innovation for the dollar.

Oakland lawyer Donald Simon agrees. “The market is going to change really fast,” he says.