State and Local Energy Report: PACE Makers

August 28, 2012

Property Assessed Clean Energy (PACE) financing was the most exciting thing in energy efficiency until June 2010. The idea was simple: homeowners could take out a loan to finance efficiency work as a property tax assessment. Because it became the senior lien on the property, the interest rates were lower.

The Federal Housing Finance Agency (FHFA) saw it differently. In its view, a senior lien devalued its mortgages by placing others in front of mortgage lenders in a bankruptcy. In July 2010, the FHFA advised member banks not to purchase mortgages with a PACE assessment attached to the property and to calculate the full amount of a potential PACE loan into any mortgage given in an area allowing PACE. The FHFA ruling effectively derailed the burgeoning residential PACE efforts around the country.

Since then, several states have moved forward with PACE in ways that stay clear of the FHFA ruling. They are altering the model to address the FHFA’s concerns. In the process, these states are determined to get PACE back on track.

A series of legislative and judicial initiatives seeking to overturn the FHFA’s directive are under way. In this article, however, we focus on the untold story of how state and local governments from coast to coast are forging ahead with new PACE programs, separate from the battle over the FHFA ruling.

CALIFORNIA

An early decision for any PACE program is how to source the capital for the energy upgrades. Around the nation, at least three different approaches to sourcing capital to finance PACE programs have emerged in the process: warehoused, pooled bond, or owner-arranged funds. Under warehousing, funds are temporarily taken from a warehouse until sufficient volume is aggregated for the capital markets. Under a pooled bond, the agency—often a local government—will collect individual financing amounts into a pool adequate for bonding. Under owner-arranged financing, lenders that participate offer capital directly to owners, essentially competing for the financing business.

Some programs are using more than one of these approaches, with California leading the way for the newest model of owner-arranged funds.

The FHFA decision only affected residential properties. Commercial properties have a different loan structure, not associated with Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) funds, and therefore are able to move forward. In California, counties with existing residential PACE programs are adapting those policies to commercial PACE programs.

“Residential PACE looks very different from commercial PACE,” noted Cliff Staton, executive vice president for Renewable Funding, a program partner for PACE initiatives in several states.

“In residential PACE, most upgrades are very similar to one another, with some variation for age and size of home. But in commercial PACE, upgrades to an office building, a food processing facility, and a cement plant will all be very different from one another. Because of those differences, it is even more important that local governments have uniform program standards and paperwork to make the process simple for commercial property owners and their lenders and contractors.”

Fourteen California counties representing 127 cities reached agreement with the California Statewide Communities Development Authority (California Communities) for a residential PACE program modeled on the programs established in Los Angeles and San Francisco. When the FHFA advisory of 2010 effectively froze progress on residential PACE, these local governments began to examine PACE financing for commercially owned properties. The resulting program, CaliforniaFIRST, replicates the standards and process used in the counties of Los Angeles and San Francisco.

After a competitive process, California Communities selected Renewable Funding and Royal Bank of Canada Capital Markets as project partners to offer a complete AB 811 program to cities and counties throughout the state, including administration, legal, and finance. The founders of Renewable Funding, the CaliforniaFIRST Program administrator, helped create the PACE program model and is assisting cities, counties, and states nationwide to launch these financing programs.

“Our hope and goal is to create a unified market in California with uniform standards for property owners, lenders, and contractors,” says Staton. “Between Los Angeles, San Francisco, and CaliforniaFIRST, about two-thirds of the state’s population lives in a commercial PACE community.”

In early June 2012, a coalition of these same counties and cities launched the Commercial Clean Energy Financing Alliance, bringing together leaders and experts at the forefront of PACE financing programs to share knowledge, skills, and tools with interested communities throughout California.

The existing programs that form the basis of the commercial PACE Alliance are the programs in San Francisco and Los Angeles. Under the Alliance, the three programs in California–CaliforniaFIRST, Los Angeles, and San Francisco–will not only have similar rules and process, but even similar forms for owners and lenders to use. This standardization will make comparing finance offerings from multiple lenders easier, and lenders active in multiple counties will only have to learn one set of underwriting standards.

“This is one of those great situations where local governments are collaborating on common guidelines for the benefit of all the stakeholders,” explained Staton.

CaliforniaFIRST expects to launch its commercial PACE program by late summer 2012. As with Los Angeles and San Francisco, CaliforniaFIRST is taking an owner-arranged approach to sourcing capital, also known as “open market” financing.

“What distinguishes these programs from others,” explained Richard Chien, program manager of GreenFinanceSF, “is the use of the ‘open market’ model, which means a property owner is able to secure and negotiate the specific terms of the PACE financing with a third-party capital provider of their choice.”

Specifically, two aspects of California’s programs make them an open market approach. First, under owner-arranged financing, an owner has access to multiple sources of capital from the many different participating lenders, creating some competition among lenders that benefits property owners. Second, the mortgage lenders must provide acknowledgement of the PACE senior lien, which is not the same as “consent” but serves the same purpose under California statutes of avoiding the “due upon encumbrances” clause in many commercial mortgages.

“For example, in California, Wells Fargo has expressed interest in participating as a PACE lender for those commercial properties on which it holds a mortgage,” noted Staton, “and for whom the energy upgrade financed by PACE would improve cash flow for a property owner.”

When asked whether capital sources for CaliforniaFIRST will be warehoused funds, pooled bonds, or owner-arranged, DeVries clarified, “The program is launching as ‘open market,’ which allows for all three options. But it will be primarily owner-arranged as we get started.”

“We have the capacity under the program authorization to finance up to $14 billion, but obviously it will start small and work up from there,” continued DeVries. “A number of capital providers are working to finance projects in the program.”

The CaliforniaFIRST commercial PACE program should clear its last regulatory hurdle in August 2012, when it expects to receive validation from the courts for the benefit assessments. This validation will prevent a new property owner in any of the 14 counties from contesting the special benefit assessment at some future time.

Read the full article here.