PACE Goes Poof!
By: Nancy Anderson, Ph.D.
July 31, 2010
PACE bonds — now you see them, now you don't. Property Assessed Clean Energy bonds are new power tools to provide upfront financing for improving energy efficiency or installing clean energy technologies in homes and office buildings. They were born in Berkeley, California, late in 2007, blessed by the 2009 American Recovery and Reinvestment Act and Joe Biden's Middle Class Task Force, and have enabling legislation in twenty-two states. Now, it seems, this green dream crashed and burned in May 2010 when federal financial giants Fannie Mae & Freddie Mac, which hold more than half of the nation's home mortgages, publicly refused to grant new mortgages to homes that sought PACE bonds loans. In July, the Federal Housing Finance Agency went a step further and called the PACE program a safety risk.
Why are the federal mortgage agencies so put out? So far, PACE bond revenue has come either from local taxes, as is the case of Berkeley's special property tax assessment or Babylon, New York's solid waste management funding, with the loans, or "assessments" running with the property, not the current owner. They can be repaid over a period up to twenty years by whoever holds title to the property. Advocates assert that repayments ought to be easy since utility and fuel bills should go down with the PACE-financed building and equipment improvements. As well, since the loans do not have to be repaid at the time of sale, this should encourage investing in durable energy improvements. Typically, the PACE loan is deemed by local government to be a lien or a tax assessment and not the same thing as a home-improvement loan. Like any local property tax assessment, in cases of bankruptcy, their repayment has first lien status and stands in line ahead of the financial institution that hold the mortgage on the property. It's this first lien status of PACE bonds that have Fannie and Freddie on the warpath. As FHFA put it on July 6, 2010:
First liens established by PACE loans are unlike routine tax assessments and pose unusual and difficult risk management challenges for lenders, servicers and mortgage securities investors. The size and duration of PACE loans exceed typical local tax programs and do not have the traditional community benefits associated with taxing initiatives.
FHFA urged state and local governments to reconsider these programs and continues to call for a pause in such programs so concerns can be addressed. First liens for such loans represent a key alteration of traditional mortgage lending practice. They present significant risk to lenders and secondary market entities, may alter valuations for mortgage-backed securities and are not essential for successful programs to spur energy conservation.
In light of the near collapse and continued crisis of the home-mortgage industry as well as Fannie's and Freddie's own near melt-down, averted with $163 billion in help from the Treasury, it's hard to be surprised by this hostile reaction to anything that looks like a new debt opportunity, even one with a great green pedigree and no evidence of increased financial delinquency by PACE participants.
Nor is it surprising that PACE bond supporters and their climate action and high-performance building allies see the federal mortgage agencies as hidebound bureaucrats at best, and stealth climate-skeptics, at worst, and they have sprung into action. The California Attorney General has announced plans to sue Fannie and Freddie, based on a theory that since the PACE bond program is based on local property tax policy, the federal government cannot interfere. The town of Babylon, New York is seething and talks about the "redlining" of less well-off home owners who could afford to make their properties more energy efficient or solar power equipped only with PACE financing. In May, the Department of Energy issued PACE program guidelines to create a more rigorous loan assessment process and offered to gather and crunch the energy performance data on properties with PACE loans in hopes of forestalling a Fannie and Freddie home mortgage freeze out, but to no avail. A bill has been introduced into Congress to override federal mortgage agency opposition to PACE loans and a Long Island Congressmen met with Fannie and Freddie officials seeking to convince them to go forward with a pilot project, but as of this writing, there has been no official response. While it is also no surprise that New York City's Economic Development Corporation is mum on whether it will take advantage of the State law allowing localities to establish their own PACE bond programs and use federal ARRA money to start them up, still, it is shaping up to be a lost opportunity.
With enactment of the City's Greener, Greater Building Plan in late 2009, benchmarking, auditing, retro-commissioning and enhanced energy efficiency and lighting code requirements will soon create demand for building improvements in some 22,000 large commercial and residential properties. Although I cannot document it, it seems likely that many owners of these 22,000 properties or owners of units within these buildings do not qualify for direct or indirect mortgage financing through Freddie or Fannie under the auspices of programs like My Community Mortgages for low and moderate income people or Fannie Neighbors, which encourages home buying in central-city locations.
They would not qualify either because they own commercial buildings or they are residential condo or co-op owners who might elect to install energy upgrades without PACE financing as a consequence of market pressures and greater awareness generated by the 2009 legislation. Of course, some large apartment buildings will be put at a disadvantage without access to PACE bonds. Since the Greener, Greater Building Plan offers neither inducements nor incentives for early adapters and energy innovators, a vibrant PACE bond program would be a real boon and force for the market transformation that's the holy grail of many urban sustainability advocates. As a May 2010 National Renewable Lab report puts it:
In general, state, municipal and utility loan programs offer attributes that are considered more favorable than those offered by traditional lending institutions. These types of programs often provide long term, fixed rate loans and reduced consumer-transaction costs. They may also offer greater flexibility in addressing loan delinquencies, and they may be designed to provide additional incentives for clean energy technology by providing below-market interest rates. Furthermore, individual programs may rely on underwriting metrics that allow a wider array of individuals and business to qualify for financing. This does not necessarily mean lowering lending standards as public sector entities may be able to rely on alternative mechanisms for securing loans, such as property liens. With such features, loan programs are some of the most common state and local clean energy policy tools.
Could traditional lending institutions have whispered into the federal mortgage agencies' ears, asking them to pull the plug on a program that might become a competitive source of home improvement loans?
But, enough of this black box speculation! What else could a PACE bond program do? Its funding could free up other, scarce public dollars to invest in energy efficiency or weatherization upgrades for other New Yorkers. Of course, for such a program to be funded at a scale that matters, the City would need a revenue stream greater than the $40 million in Department of Energy funds made available through the federal stimulus program while not raising local taxes or the City's own debt level. Securitization of PACE debt could be a way to get to scale. Another route would be to have entities like the Industrial Development Agency issue tax-exempt PACE bonds to enable property owners able to raise their own funds to keep down interest payments since the IDA issues tax free bonds with lower yields than bonds which are taxed. Then again, maybe the train wreck between federal energy and housing finance policies will erase the specter of PACE haunting federal mortgage financiers and replace it with a DOA carved in stone.