Could these 7 changes save PACE?

Greentechenterprise proposes 7 changes to PACE to ‘save the program’. I’ll have my own ideas shortly, but these are worth discussing:

1. Eliminate the Loading Order. The loading order requires that the owner show that energy efficiency retrofits reduce power consumption by 10 percent to 20 percent in many cases before PACE can be used to pay for solar.

2. Skip Residential PACE for Now.

3. Limit the Types of Repairs. If cutting out homeowners is too politically risky, how about this tack? Limit the size of PACE loans — to say, $15,000 for homes measuring 2,000 square feet or less — and circumscribe the types of repairs that can be undertaken.

4. Make PACE Debt Junior.

5. Threaten Even More Stringent Financial Controls.

6. Change the Investment Tax Credit.

7. Advertise. In the three weeks that San Francisco’s PACE program was up and running, the city received 33 applications and rejected 13 for financial issues. Twenty were completed and one got approved, according to Rich Chien, who runs it.

One in three weeks. Surely some word of mouth could help.

via Seven Ways to Save PACE : Greentech Media.

PACE: Battle of the Bondholders

It’s been a busy couple of Tweetdays as discussion about the problems and opportunities of PACE continue.

It’s well known that PACE is having trouble as the Federal Housing Finance Agency (FHFA) announces its concerns about properly underwriting properties (PDF link) with PACE. In the earlier entry, I wrote about the standard justification used by PACE advocates to liken a PACE bond to other property-based special assessments such as water or seismic improvements. The FHFA response merely takes the non-standard nature of PACE transactions as a given:

”First liens established by PACE loans are unlike routine tax assessments and pose unusual and difficult risk management challenges for lenders, servicers, and mortgage security investors.”

Note the use of “PACE loans” and mention of “mortgage security investors” among those affected. FHFA’s point of view could not be more clear: it does not consider PACE transactions to be any different from a traditional property-backed loan and feels that the popularity of PACE transactions threatens the attractiveness of GSE-backed securities to investors.

In my earlier post, I mentioned a couple of reasons why FHFA would not consider PACE transactions to be like traditional special assessments:

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.

One item that I failed to expand upon is the nature of collateral. When a loan is made, the first and usually only source of repayment is the property itself. When a special assessment is made to improve the seismic resistance or water quality, the presumption is that without these improvements, the collateral will no longer be inhabitable; the collateral is effectively worthless.

When a PACE transaction is made, it has no effect on the habitability. Therefore, the improvements are not essential to maintaining the value of the collateral, and FHFA sees them as optional.

Reasonable people can disagree about FHFA’s position and can effectively argue that climate change or even mere efficiency improvements are essential to maintaining or improving the value of collateral. Because efficiency is not currently evaluated by lenders or regulators in single family home transactions, FHFA will continue to consider it largely irrelevant to establishing value. Furthermore, although society accrues benefits from additional employment, improved air quality, and reduced energy use, society does not directly (or indirectly) provide a method of repayment. Unless and until municipalities incorporate energy efficiency into their tax, zoning, or other regulatory structure or until they make PACE bonds payable as a general obligation bond (see below), it will not be supporting the repayment of PACE obligations.

Indeed, FHFA might even see the presence of a PACE obligation as a factor in reducing the value of a property. Lawrence Berkeley National Lab cites the one (!) sale of a PACE-improved home in Boulder as a cautionary tale (PDF link):

In the PACE program of Boulder County, Colorado, one home with a PACE lien has sold to date. This assessment included a PV system. In this instance, the lien was paid off by the seller as a condition of the sale. The original homeowner received the full benefit of the residential investment tax credit for the PV system, which was apparently a factor in the negotiation process. While one example is not representative of what will occur across a broader collection of PACE programs, it does indicate that program administrators should be cognizant of this issue as they conduct their outreach efforts.

In this case, the seller received a 30% investment tax credit (or grant) for the installation of a solar array. It is suggested, but unclear, that the homeowner pocketed the 30% credit while the PACE funded 100% of the total installation cost. As a result, the buyer asked for the seller to essentially retroactively apply the 30% received plus the outstanding amount of the PACE obligation to pay off the total obligation early.

After much delay, here’s the question presented by FHFA: why does lien priority matter to PACE bondholders?


Lien priority matters because it provides a measurable certainty of recovery. The higher the priority the greater likelihood that in a sales action (foreclosure or short sale, e.g.), the senior lienholder will be repaid first and in toto. Because certainty of repayment reduces risk, bondholders will accept lower returns in exchange for certainty of receiving those payments.

PACE bondholders, because they are financing a new and yet-unproven model with uncertain repayment prospects, require lien priority to keep rate manageable for borrowers. They should, but rarely receive, a credit enhancement from the sponsoring PACE issuer. In this case, a municipality that sponsors a PACE issuance might provide a ‘moral obligation’ clause to their bond documents suggesting that they will likely repay or provide assurance or repayment to bondholders, but it is rarely enough to provide truly ‘affordable’ interest rates to borrowers/homeowners.

FHFA has obligations to the bondholders of the GSEs; they also provide money with lower expectations of interest paid in exchange for lien priority. Because loans from the GSEs (Fannie and Freddie) are senior to all but property taxes, there is great comfort in the ability of the GSEs to recover their principal investment.

Regarding PACE obligations, FHFA in effect announces that you cannot have a functioning low-interest rate mortgage market if you have a functioning low-interest PACE market. One must be senior to the other, and FHFA claims its product should predominate.

HUD, Money & Green Housing 2010

Irritated by my PACE post? Green Landlady has a welcome tonic in the form of HUD’s sustainability initiatives and it’s support for the Energy Efficiency in Housing Act of 2009.

Energy efficiency and green building play a crucial role in housing affordability. Some are concerned that green building adds to the cost of housing. I do not subscribe to that view. I believe that we can’t afford not to build green. Research increasingly shows that all types of affordable housing can be built or rehabilitated to rigorous green standards at a minor additional cost, and often without the need for capital investment. As we dispel the notion that green building will mean higher costs for low income families we must recognize while everyone is hurt by high energy costs, no one is more vulnerable to rising energy prices than low- and moderate-income families. Higher energy costs often result in cutting back on other critical needs, such as medicine and food.

HUD, Money & Green Housing 2010 – via Greenlandlady.com

Much ado about PACE and GSEs

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.

Resources: Novo’s Tax Credit Tuesday

For anyone working with tax credits, the Novogradac podcast “Tax Credit Tuesday” are a useful way to learn about Federal and state initiatives in the tax credit sphere. I’ve always subscribed via iTunes, so I had no idea there was a PDF transcript available.

In this week’s podcast, Novo reports on Rep. Frank’s “TARP for Main Street” proposal, which would direct $1B of dividends from banks that received TARP funding to the Affordable Housing Trust Fund, established last year in the Housing and Economic Recovery Act.

Also covered is a letter from the Affordable Housing Tax Credit Coalition expressing concern about the potential sale of tax credits held by Fannie and Freddie. The AHTCC, providing Congress with a short lesson in supply and demand, is concerned that the sale of tax credits on the secondary market will further depress prices that currently languish between $0.68-0.78 per $1 of tax credit. Instead of selling the credits, AHTCC advocates for the Treasury to accept GSE-held LIHTC as part of the dividend payments owed. Alternatively, AHTCC suggests that credits be sold to LIHTC investors who have been inactive for 10+ years and that the GSEs should immediately reinvest those proceeds back into LIHTC.