Efficiency First

The Environmental Energy Technologies Division of the Lawrence Berkeley National Laboratory in Berkeley, Calif., has issued a PACE Status Update that clearly analyzes the current regulatory impasse regarding property assessed clean energy (PACE) financing.

Most PACE programs halted abruptly this summer following a July 6 letter from the Federal Housing Finance Agency (FHFA) that essentially blocked access to home loans for properties with PACE liens that take priority over mortgage debt. “Whether PACE resumes its expansion as an innovative tool for financing energy efficiency and clean generation,” the brief states, “depends on outcomes in each of the three branches of government, discussions on a PACE pilot phase among federal agencies, litigation in federal court, and legislation in Congress – all highly uncertain.”

The brief goes on to describe possible next steps for PACE financing programs as follows:

Since its July 6th letter, the FHFA and all financial regulators, under pressure from some members of Congress, have reengaged in discussions about possible options for responsibly moving PACE forward. Several legal challenges to the FHFA’s actions have been filed nationwide, and legislation has been introduced in the both the House and Senate that would strip the FHFA of its ability to alter underwriting standards for mortgages in PACE communities or with PACE assessments attached.

While these developments may provide a long-term solution, cities, counties and states faced with close deadlines for obligating American Reinvestment and Recovery Act (ARRA) grants are already suspending or withdrawing PACE programs—including cancellation of San Francisco’s $150 million program and the California Energy Commission’s $30 million municipal PACE program intended to support 23 counties and 184 cities. More than a dozen communities that planned to implement PACE programs around the United States by the end of 2010 may be forced to abandon these efforts. Several early adopters of PACE – Sonoma County, CA and Babylon, NY – weighed ending their residential PACE programs but elected to continue, and some jurisdictions are proceeding with or considering commercial-only PACE programs or acceptance of a subordinated lien.

This last scenario, in which mortgage debt takes precedence over PACE liens in a foreclosure, would by-pass the FHFA’s concerns about PACE financing, but could make it difficult for PACE programs to scale:

Subordinate-lien PACE programs may face significant challenges in attracting secondary market financing. Without access to low-cost private capital, the ability of these programs to scale would be limited.  A 2009 Barclays Capital analysis concluded that “there would be little to no meaningful bond buyer interest in pari passu or subordinated PACE liens and therefore the PACE bond market would be highly unlikely to develop.”  The driver of this conclusion was that “it is highly likely that subordinated/pari passu PACE Special Assessment Bonds will be rated as non-investment grade.” There is potential that this ratings challenge may be overcome with appropriately-sized credit enhancements (e.g., loan loss reserve funds) that limit risk to the bondholder.

Based on experience to date, PACE program experience suggests that PACE assessment non-payment rates will be low. For example, communities with PACE pilot programs have non-payment rates below 1%. However, a subordinate-lien position may hinder the ability of local governments to recover PACE assessments in the event of non-payment. If a property owner fails to make subordinated PACE payments, but remains current on first mortgage payments, the local government would need to pay off the first mortgage and then proceed to foreclosure in order to recover both overdue PACE payments and the mortgage value – two extremely burdensome steps. More likely, the local government may choose to maintain the subordinated lien on the property and force it to be paid off upon property transfer. To the extent PACE assessments support municipal revenue bonds, the absence of an efficient recovery mechanism is likely to be a significant investor concern.

Download the full LBL brief at www.eetd.lbl.gov/EAP/EMP/reports/ee-policybrief081110.pdf.