Much ado about PACE and GSEs

Posted: July 8th, 2010 | Author: mfguide | Filed under: Finance, Legislation, News | 4 Comments »

If you check my Twitter stream, much has been Tweeted of late about PACE bonds (Property Assessed Clean Energy Bonds) and the current imbroglio with the GSEs.

PACE bonds are issued by local governments, with proceeds used to improve the energy profile of buildings. The most politically popular use of these bonds is to retrofit homes and add renewable energy capacity. The building owner repays the funds through an additional assessment on the property tax.

Because property taxes are superior in lien position to the mortgage, the GSEs are anxious that there is now another lender that will be repaid before them in the event of foreclosure.

PACE advocates describe PACE bonds as a simple extension of a state or municipality’s existing right to issue bonds. Typical descriptive language usually reads like this:

Land secured financing districts – which are creatures of state law and are variously referred to as assessment districts, public improvement districts and community facilities districts, among other terms – are a building block of municipal finance and have been utilized for more than a century. They are used to finance projects which serve a public purpose, including street paving, parks, open space, water and sewer systems and street lighting, among others.
All land secured financing districts operate by placing a senior tax/assessment lien on properties which will receive a benefit from the financed improvement. The lien secures a tax/assessment payment that is levied on properties through the property tax bill. Tens of thousands of these districts already exist in this country and are a standard part of the property appraisal, underwriting and disclosure processes.

PACE bonds are usually statutorily approved under the auspices of existing bond creation legislation. They have the following commonalities with a water treatment bond:
1. Issued by an entity with tax levying authority.

2. Repayment sources are individual properties within the affected district.

Here are some differences:
1. Tax levying authority does not design or complete the work directly.

1a. Contractors who actually design and complete the work may or may not be sufficiently licensed or inspected.

2. The improvements are speculative and the anticipated savings may or may not coincide with the period of repayment.

3. A property’s “share” of a water treatment plant is not due upon sale or foreclosure. In a PACE-related foreclosure, that cost can be accelerated and be payable upon foreclosure.

4. If a water treatment plant does not generate sufficient funds to repay the bond directly from user fees, the municipality is typically responsible for the shortfall. PACE bonds have no such mechanism.

Some quick math may illuminate the GSEs unease with the program:
$20,000 in efficiency improvements

6% rate of interest (the municipality may pay 5% to bondholders and keep 1% for overhead costs)

20 year term of repayment (supposed to be less than the lifespan of the improvements)

If you’re using Excel, it should look like this:

=PMT(6%, 20, 20000)

and the answer is = $1,744 (the amount paid for this improvement per year)

or $1,744/12 = $145 (the monthly amount your energy costs must fall to break even on your improvements).
From a lender’s perspective (because the improvements need to be either cost neutral or cost positive to the homeowner), that $145 in savings better be there each and every month or the borrower is not meeting the same income to debt ratio at the origination of the GSE-backed loan. From a lender’s perspective, there are a couple of ways to save money on utilities that don’t involve placing a $20,000 lien on the property. These include:
1. Reducing your energy use.

2. Reducing your energy use.

3. Reducing your energy use.

I’m not anti-PACE and I strongly believe that there is a method to integrate a program like this within a GSE framework. I don’t believe in headline hysteria like this, or this, or this, or this. When you write these types of articles and allow inflammatory link-bait headlines to summarize them, you come across as ill-informed, ill-tempered, and ill-suited to write something that actually advances the conversation toward the desired solution.

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