PACE program is good for banks & property owners
On March 25th, the Wall Street Journal published an article titled “Fannie and Freddie Resist Loans for Energy Efficiency” that looks at an innovative financing vehicle for clean energy retrofits called PACE (Property Assessed Clean Energy). While we were glad to see coverage of this exciting new mechanism, we were disappointed that the article focused narrowly on concerns about PACE that the mortgage banking industry raised a year ago. These concerns were valid, but they are old news and have been fully addressed. Perhaps more importantly, the WSJ article doesn’t mention the significant business opportunities that PACE presents for the mortgage banking community: the banks themselves can participate in various stages of the PACE financing system.
The article correctly asserts that PACE makes clean energy retrofits easier for property owners, by allowing them to undertake retrofits at no upfront cost, and repay PACE financing through incremental assessments on their property taxes over terms as long as 20 years. And it correctly asserts that PACE has faced resistance from the government’s mortgage finance agencies - Fannie Mae, Freddie Mac and their regulator, the Federal Housing Finance Agency (FHFA) - which are concerned about PACE lien priority over existing mortgage holders in the event of foreclosure. But here the article omits an essential point: if a property with a PACE lien goes into foreclosure, the entire PACE-financed amount does not become due. Instead, only the past-due portion of the PACE financing is paid out before the existing lender’s mortgage. Thus, the risk to existing lenders of PACE lien seniority in foreclosure is actually extremely small.
In response to the very same mortgage industry concerns that are rehashed by this WSJ article, the White House created an inter-agency task force last summer, including senior representatives from FHFA, the National Economic Council, and the Departments of Energy, Treasury, and Housing and Urban Development. Following an in-depth analysis of the issues, the task force published the federal PACE Policy Framework last October, which establishes a set of best practices for PACE programs, specifically designed to resolve the mortgage bankers’ issues.
Large and small communities alike (e.g., San Francisco, CA and Montgomery County, MD) are adopting the task force’s best practice guidelines as they launch their PACE programs this spring. Planned programs in Los Angeles, San Diego, New Mexico and Louisiana are also expected to adhere to the task force guidelines. When properly designed to include these best practices, PACE programs will benefit virtually all stakeholders, including homeowners and existing lenders, while creating large job growth and all with no credit risk to municipalities.
In particular, the position of existing lenders is actually improved by PACE-financed clean energy retrofits because:
- PACE lowers the risk that mortgage holders will default on their mortgages. PACE financing is designed so that the annual energy savings resulting from clean energy retrofits will be greater than the corresponding annual PACE assessments, so property owners have more cash to make their mortgage payments. This increased cash on hand, combined with property owners’ lower vulnerability to energy price spikes, reduces mortgage default risk, consistent with prudent underwriting practices (contrary to critics’ claims otherwise).
- PACE projects increase property value, benefitting both owners and lenders. As noted by the article, PACE financing can only be used to make qualified energy saving improvements to the owners’ property. According to this recent article in the Appraisal Journal, every utility-bill dollar saved annually by energy improvements yields an increase of approximately $20 in property value, so reducing a property owner’s annual utility bill by $1,000 would return about $20,000 in property value. In other words, PACE projects substantially increase the value of the existing mortgage lenders’ collateral.
- In the case of foreclosure, the incremental risk PACE causes for lenders is very low. As noted above, in the event that a property with a PACE lien goes into foreclosure, the good news for mortgage lenders is that only the past-due PACE assessments are paid prior to the lender’s claim.
Contrary to the inference raised by the article, PACE best practices include various underwriting criteria to further protect existing lenders and property owners, including: (a) the sum of existing mortgage debt plus proposed PACE financing should not exceed the fair value of the property; (b) the PACE financing should be limited to a certain percentage of property value (generally 10%); and (c) property owners must be current on property taxes and have no unsatisfied liens, notices of default or other material property-based delinquencies.
Finally, the WSJ article alluded to the “legal challenges” that critics of PACE say cities will face, but in reality, PACE financing presents very little that is out of the ordinary. PACE is simply a variation on municipal financing districts which have a 100+ year history in the U.S. to pay for improvements in the public interest, such as sewer systems, parks and street lights. PACE programs support important public purposes, including job creation, advancement of a clean energy economy, improved energy independence, and global climate change mitigation. In fact, PACE programs should be even less of a concern to mortgage lenders than traditional municipal financing districts because PACE is 100% voluntary – no property owner pays additional tax assessments or fees unless they opt to have clean energy improvements made to their property as part of the program.
Certainly, we agree that now is not a time to take any lending concerns lightly – but these issues have all been addressed. It’s also not the time to turn our back on creative, responsible and financially sound ideas like PACE. PACE gets to the core of energy efficiency, while increasing property value and creating jobs. We hope mortgage bankers will begin to see the financial opportunity that PACE presents, and will help scale up this innovative program.