By Rona Cohen
Last July, the Federal Housing Finance Agency halted a popular energy efficiency financing mechanism that proponents said would catalyze home efficiency retrofits, but that regulators warned could raise homeowner debt burdens, and increase the risk of default.
A few New England states, however, are forging ahead with their own versions of the program, known as Property Assessed Clean Energy (PACE), following passage of measures crafted to allay concerns among the banking industry and earn the support of the marketplace.
PACE enables municipalities to issue bonds or use other sources of capital to fund home energy efficiency improvements or renewable energy systems. The financing is repaid by the homeowner through a special assessment on a property tax bill, typically over a period of up to 20 years, thereby amortizing the cost of the improvements over a lengthy period of time. In most of the 24 states that enacted PACE-enabling legislation beginning with the launch of the first pilots in 2008, the measures called for the assessment to be backed by a senior lien on the property that would provide security to investors in the case of default.
That provision raised red flags among federal regulators, and led to FHFA’s decision last July to call for a halt to most residential PACE programs out of concern that granting the loan’s senior lien status would present “significant risk” to lenders. The move followed warnings from officials at Fannie Mae and Freddie Mac, who suggested in letters to mortgage lenders that energy liens could not take precedence over any mortgages financed through them. Since property taxes are usually paid off first in the case of foreclosure, the concern was that a PACE lien would take precedence over a conventional mortgage.
The decision sparked lawsuits and was broadly dismissed by ardent PACE proponents, who argued that PACE-funded improvements would actually make homes more affordable by lowering energy costs. Further, experience with the programs already in operation showed limited instances of default, they said.
In Maine, officials expressed less concern following FHFA’s announcement, given that during passage of their PACE legislation last year, state lawmakers chose to grant PACE loans “junior” lien status. The original measure had contained a priority lien, but ran into stiff opposition from the local banking industry. The structuring of Maine’s program enabled it to go forward in the wake of FHFA’s decision.
The program launched in April, and is being administered by the Efficiency Maine Trust, an independent quasi-state agency created by the state Legislature last July with the goal of grouping the state’s efficiency programs under one structure. Homeowners can apply for PACE loans as high as $15,000 at a 4.99 percent interest rate for terms of up to 15 years. Eligible improvements range from adding insulation to the exterior walls and attic space to installing new energy-efficient appliances.
Officials have created a centralized fund to support PACE programs in municipalities across Maine, since many local governments are eager to establish PACE programs but reluctant to take on the risk of issuing bonds and adding administrative costs to their budgets.
Municipalities must opt into the program through passage of a PACE ordinance. So far, 83 municipalities, representing more than half of the state population, have done so. All have elected to have Efficiency Maine administer the program, said Dana Fischer, residential program manager at Efficiency Maine.
A $30 million grant awarded to Maine last year under the stimulus-funded Better Buildings program will provide up to 1,500 loans during the next two years.
PACE program administrators are betting that by enforcing stringent underwriting standards and lowering a home’s energy costs, which in turn increases its owner’s ability to make timely payments, they will provide proof to the secondary marketplace that the loans are good investments. Fischer said Maine’s underwriting standards comply with general best practices in the banking industry, and include two key requirements that determine eligibility: a debt-to-income ratio of not more than 45 percent, and a loan-to-value ratio of less than 100%, meaning that the homeowner must have as least as much equity in a home as they want to borrow. Borrowers must also be up-to-date on property tax and sewer payments, have no outstanding tax or sewer liens, and their residence cannot be subject to a reverse mortgage or to a mortgage or other lien that has a recorded notice of default, delinquency or foreclosure.
The program has received about 150 applications thus far, and a number of loans have closed, said Fischer. Loans have averaged $13,600, and in some cases, homeowners have been able to cut their energy bills by 50 percent or more, he said.
Some states eager to push on with PACE despite the constraints imposed by federal regulators have embraced the concept of a junior lien.
Connecticut recently enacted a wide-ranging energy bill, SB 1243, which enables the creation of PACE programs, provided that the loans are backed by liens that do not take priority over any mortgages on the property.
In May, Vermont’s legislature approved changes to its 2009 PACE law designed specifically to address regulators’ concerns. The new law, H.56, makes the loans subordinate to existing liens and first mortgages but superior to most other liens on the property. To reduce the risk to investors, all participating property owners will have to contribute a one-time payment to a reserve fund equal to two percent of their assessment. As further protection to cover losses due to defaults, the measure creates an escrow account equal to five percent of total assessments, not to exceed $1 million, supported by proceeds from the Regional Greenhouse Gas Initiative and Forward Capacity Market funds. The program will also establish underwriting criteria.
The changes easily drew the support of the banking industry, said Senator Ginny Lyons, who chairs the Vermont Senate Energy and Natural Resources Committee. “Once it went to a second lien the Vermont bankers became supportive; and once the fund was established to offset risk they were happy. We hope the added financial burden will not dampen enthusiasm for individual participation,” she said.
The law authorizes local governments to create PACE districts, with voter approval. A number of towns have already established the districts. Overall, there are “at least 40 towns chomping at the bit” to move forward, said Lyons.
PACE proponents elsewhere have expressed skepticism that loans backed by a junior lien will generate the kind of broad support needed in the secondary loan marketplace to scale up the program.
Last year, private investors were buzzing about the success of the PACE program in Babylon, New York, but that interest evaporated in the wake of FHFA’s announcement.
Babylon helped pioneer the PACE model when it launched its program in 2008. Officials tapped into their solid waste reserve fund as a revolving pool of funds to finance home retrofits, by expanding the definition of solid waste to include carbon dioxide—in other words, energy waste. The fund currently stands at $4 million. Homeowners repay the loans, which carry below-market rates, over a period of twenty years.
“Unlike the first year and half of operations, we don’t have investment bankers trooping in here suggesting they can finance this when it goes to the scale of $30 million to $50 million. That just disappeared, and it’s absolutely the result of FHFA,” said Dorian Dale, Babylon’s energy director.
Other supporters of the original PACE model have expressed skepticism that eliminating the security of the senior lien will attract enough investment clout to catalyze the home energy retrofit market.
Proponents in Maine are hoping to prove the merit of the “junior” path. Fischer said the goal is to make use of PACE and a variety of other programs to retrofit every house in the state by 2030, which works out to 25,000 a year. Maine has an old housing stock and its energy infrastructure is more dependent on heating oil than any other state in the nation, which makes its residents particularly vulnerable to energy price volatility.
Once Maine’s entire grant has been committed, the program anticipates having $150,000 coming in each month in loan payments, which will serve as a buffer for loan losses and enable the trust to secure public bonds. In essence, the funds would serve as a revolving loan pool.
Fischer was hopeful that Maine’s PACE product will build confidence among investors. He said that AFC First , which is providing financial services for the PACE program, offers energy efficiency loan products in a dozen states that do not carry senior liens and have a default rate of less than one percent, overall.
“The proof is going to be a year from now when we see what the loan performance is like,” said Fischer. “At the end of the day, when we have hundreds and hundreds of loans out there and only have a one percent default rate, that will become a marketable product,” he said.