Staying Ahead of the PACE

Helping homeowners and businesses finance energy improvements to their properties sounds noble in theory. However, flawed theories can create dire ramifications.

That’s what Missouri bankers are discovering with the Property Assessed Clean Energy program, also known as PACE.

The MBA Regulatory Affairs Committee recently discussed PACE and how it affects the banking industry. 

What is PACE? 

Under PACE programs, residential and commercial property owners can finance energy efficiency and renewable energy improvements on private property. Local governments or other inter-jurisdictional authorities, when authorized by the state, fund the up-front cost of energy improvements on the property. These costs are then paid back by the property owners over a specified time frame — anywhere from five to 20 years. The improvement costs are paid via annual assessments levied with property taxes, and these assessments include administrative and interest costs.

The PACE programs have been promoted by the U.S. Department of Energy and state counterparts. Missouri enacted a PACE law (Sections 67.2800 to 67.2835, RSMo.) in 2010. Under state law, any county or municipality can charter an energy improvement district, and other counties and municipalities can join the district. The boundaries do not have to be contiguous. The Missouri Department of Economic Development provides some coordination for the program but little oversight. Renovate America is a PACE provider active in Missouri.

A handful of private equity companies have raised large sums of capital to fund PACE programs and offer local governments “turnkey” programs. The programs attract various contractors — solar panel, HVAC, window and insulation companies. Improvements often qualify for state and federal tax credits. National advocacy groups have formed to promote the program and protect the various tax subsidies enacted to support the programs.

How does PACE financing work?

In the PACE program, lending to property owners is entirely collateral-based because the assessment levied against the property has the same super priority as property taxes. As such, some PACE contractors may “strip” an owner’s equity by promoting over improvements. This assessment financing presents a very complex structure for homeowners to understand. The financing, tax structure and bid for improvements are combined in a proposal that makes shopping or owner due diligence a complex undertaking. Owners often do not comprehend the
impact on their annual tax bills — delinquent taxes that result in steep penalties or losing their homes. Instances like these, particularly in California, have recently gained congressional attention.

What is Washington’s response to PACE?

Federal lawmakers are considering legislation that would subject PACE lenders to TILA and other consumer protection laws. To blunt the push for federal law, the private equity companies backing PACE programs are “requesting” new state consumer protection laws. The industry views federal laws as more burdensome because it would likely result in new liabilities and penalties for PACE providers. 

The Federal Housing Finance Agency has long opposed the PACE lien priority. When a homeowner enters a PACE assessment contract, the “lien” in most cases presents a technical breach of the covenants in a deed of trust. The housing GSEs, such as Fannie Mae and Freddie Mac, will not approve a purchase or refinancing loan if an existing PACE lien and loan is not paid and cleared. Recently, the U.S. Department of Housing and Urban Development has revised Federal Housing Authority standards to allow PACE liens so long as the assessments are current and state law allows for the lien and assessment to transfer to a new owner.

Why should bankers be concerned about PACE?

The initial reaction to PACE from MBA’s Regulatory Affairs Committee was like that of most bankers — the “super lien” priority presents a bad policy! The lien promotes predatory, equity stripping behavior. It undermines conventional home lending and home equity lending programs because the liens can attach ahead of a prior bank loan. PACE contractors lack the training, standards and regulatory oversight that banks must accept for their residential lending programs. PACE liens and loans present an unfair competitive threat because these programs operate with fewer consumer protections, and the manner in which the loans are offered and marketed does not allow for a fair comparison to conventional home loans, home improvement loans or home equity loans.

Some Missouri bankers are beginning to see PACE programs in their local markets. Other bankers first heard of the program when their county commissioners or county collectors sought bankers’ opinions. County collectors have raised concerns because they see the potential for homeowners to be overwhelmed when they fail to comprehend how much their property taxes can increase with the addition of the special assessment. If there is a conventional home loan with an escrow account, the first-year PACE assessment can result in a negative balance. This can cause a second-year escrow adjustment that effectively presents more than two years’ worth of a PACE assessment to re-establish the escrow balance.

The MBA Regulatory Affairs Committee concurred that the PACE program requires better consumer disclosures, improved underwriting standards, regulation of PACE contractors and mechanisms to provide advance notice to existing lien holders. More important, banks and conventional lenders should have an opportunity to compete with PACE programs and provide homeowners potentially better rates and more appropriate loan structures to meet their financial needs for property improvements.

Since this article's publication in the November 2017 issue of The Missouri Banker, the banking regulatory relief bill introduced recently by U.S. senators includes a provision affecting Property Assessed Clean Energy financing. Section 108 of the bill would subject PACE loans to the ability-to-pay standards under the Truth in Lending Act. Currently, PACE loans do not have to meet those standards. The Consumer Finance Protection Bureau would be responsible for enforcing this provision.