The Inception of PACE Financing, its Support, and its Potential
Property Assessed Clean Energy (PACE) is a financing tool designed to reduce the hurdles that impede residential and commercial property owners from implementing energy efficiency and renewable energy upgrades to their property. Under PACE, municipalities1 as authorized by their states, may raise money which property owners can tap to finance energy upgrades. Property owners pay for the upgrade across a term of five to twenty years, usually via their property bill; meanwhile the municipality uses a lien on the property to secure its financial interest.2 The PACE mechanism can help overcome cost impediments and assure that property owners, municipalities, and bond owners all earn returns on their clean energy investments.
Once a state passes legislation to authorize local PACE programs, a municipality then passes some form of PACE-enabling legislation. This legislation allows the municipality to raise money for upcoming PACE programs, typically by selling municipal bonds to private investors—though other funding sources may be used to capitalize a PACE fund. An interested property owner would next obtain a contractor’s quote for an energy retrofit and apply for a portion of the PACE funding to finance the upgrade. Because municipalities can usually borrow money with a lower interest rate than can households and small businesses, a property owner utilizing PACE can usually finance their project at a favorable interest rate. With the municipality’s approval, the contractor installs the retrofit and the property owner pays the contractor from PACE funds. In consideration for the up-front cash, the property owner incurs the obligation to pay for the retrofit via an additional charge on the owner’s property taxes or through another billing, such as water and sewage charges.3 With the tax assessment set on the property, and not the individual, the municipality is insured: even in the event of default, the property serves as collateral. Thus, a PACE installation provides financiers with a relatively safe investment, local contractors with more work, homeowners with utility bill savings and property value enhancements, the municipality with an improved property on the tax roll, and the community and nation with energy and environmental benefits.
PACE, Benefits & Disadvantages
Other appealing aspects of PACE, besides spreading out payments at a low interest rate, are that PACE does not draw on taxpayers’ wallets to any significant extent and owners only pay for the benefits they receive. To spare taxpayer money, in theory, the municipality issues a bond that an investor purchases for cash with the promise of a low-interest return. The municipality hands the cash over to the owner in exchange for a lien. The owner pays the contractor for the work, and then begins repaying the lien, at an interest rate that is low, but higher than the investor’s aforementioned interest rate. The principal of the owner’s repayment will go through the municipality and straight back to the creditor, while the owner’s interest repayment should pay back both the investor’s promised interest and the municipality’s administrative costs. Thus, the rest of the municipalities taxpayers should have been left out of the equation. A further advantage is that unlike a home equity loan, a second mortgage, or other financing mechanisms, the PACE tax assessments ‘run with the land’ and not ‘with the owner.’ This is important because property owners may be unsure of how long they will own the property. Therefore an owner may be reluctant to invest in an energy retrofit if there is some possibility she will sell the property before the payback period is reached, as the sale price may not fully reflect the energy upgrade. However, a PACE payment obligation transfers with the deed of the energy-improved property to the new owner, as he or she is the new beneficiary of reduced energy utility bills.
PACE has a number of other benefits. By facilitating energy retrofits and upgrades, it fuels jobs for installation contractors and equipment manufacturers. In addition to utility bill savings for property owners, PACE-financed retrofits can improve building comfort (such as through window, insulation, or heating and cooling system upgrades) and increase property values. Enhanced property values augment neighborhoods and municipalities. Resulting energy savings can reduce stress to electric grids, thus improving energy reliability and lessening the need to build new generating plants and transmission lines. Finally, but not least important, the energy savings reduce pollution and other negative environmental impacts.
However, PACE is not without its perceived negatives. Split incentives between landlords and tenants or the transaction costs of participating in PACE may impede some property owners from implementing PACE. For instance, a tenant may want to cut her utility bills, but the landlord may not want added taxes. For transaction costs, in Sonoma County it costs $125 for a preliminary title search, and certain ‘clouds on the title’ could make an owner ineligible for PACE financing, thus forfeiting the $125.4 There is also a concern that potential buyers may be deterred from buying properties on which a PACE ‘liability’ is attached—either through added taxes, or a retrofit that has become technologically outdated.
Of utmost importance though, is the issue of “lien seniority.” Mortgagees’ (the banks and creditors) interest in a mortgaged property is secured by a lien on the property. Conventionally, if a property owner defaults, first outstanding real property taxes are satisfied, then mortgagees are second in line for repayment. From a mortgage lender’s perspective, a new tax raises the risk of default by being an additional liability and expense that the lender could not consider in underwriting the loan. Further, because the PACE financial obligation would have priority over the mortgage debt, the lender may collect less money in the event of default. As a result, many in the mortgage lending profession view a PACE lien as a cloud on the title. Though PACE homeowners’ default rates have been very low and are estimated at .1%5 (as compared to a national average of 3.2%), a backlash from the federal secondary mortgage market has virtually halted residential PACE programs around the country.
PACE, in Practice
In California and in other states, a locality within a county wanting street lights or other community infrastructure improvements can set up a “special tax district.” Rather than the entire county financing improvements for a single locale, those residents primarily benefitting from the improvement pay for it with a special tax assessment on their properties. Cisco DeVries and other innovative thinkers decided to apply that theory to individuals desiring energy retrofits, and thus the PACE system was born through Berkeley, California's “Berkeley First” program. The program was extremely popular in Berkeley, California and similarly-modeled pilot programs soon sprung up across the state. The swelling support led the California legislature to pass AB811, which allows any jurisdiction in California to start a PACE program. Also, with the advent of the recession and of federal stimulus funds that required rapid dispersion, numerous states and localities sought to use stimulus funding to capitalize PACE-type revolving loan programs. With the Obama Administration’s endorsement, PACE took hold across the nation. As of Summer 2011, 24 states and the District of Columbia, despite divergent political backgrounds, have adopted PACE-enabling legislation.6 However, a few months after the excitement grew, the PACE discussion altered, dramatically.
In May 2010, two of the “government-sponsored enterprises” (GSEs) the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), which, together, are the largest source of housing financing in the U.S. secondary residential mortgage market, intervened in PACE. These two GSEs have an immense influence on the mortgage market because, though homebuyers typically finance their mortgages with a local bank, credit union or other lender, those loans are frequently sold to Fannie Mae or Freddie Mac in the secondary market. Since 2009 Fannie Mae and Freddie Mac have financed or insured—through guaranteeing and securitizing mortgages and through purchasing and holding mortgages and mortgage-backed securities in their portfolios—“more than 70 percent of the single-family residential mortgages originated in the United States.”7
After the 2008 housing market crashed, Fannie Mae and Freddie Mac together amassed $5.4 trillion of delinquent guaranteed mortgage-backed securities and debt, roughly equal to the publicly held debt of the United States at the time.8 This largely, led to Congress passing the Housing and Economic Recovery Act of 2008 (HERA), which addresses the subprime mortgage crisis. HERA authorized the creation of the Federal Housing Financing Agency (FHFA), appointing it the regulator and the conservator9 of the two GSEs until 2012; HERA further protects FHFA from legal action when it is acting as a “conservator.” In May 2010, Fannie Mae and Freddie Mac issued letters suggesting that PACE programs which bypass the mortgagee’s senior liens and create their own first-priority lien are loans that violate standard mortgage terms.10 On July 6, 2010, FHFA bolstered those letters, stating PACE assessments present “significant safety and soundness concerns” to lenders and taxpayers.11 Operating under HERA authority, FHFA instructed Fannie Mae and Freddie Mac, still fragile from the 2008 mortgage crisis, to use more restrictive mortgage underwriting standards for homes in which first-priority PACE liens are an option.
The U.S. Treasury Department Office of the Comptroller of the Currency (OCC), which regulates national banks, corroborated FHFA’s concern with its own, similar bulletin on July 6, 2010. The OCC bulletin called on banks to consider steps to mitigate their exposure to PACE’s priority-assessed liens.12 The bulletin, mentioning both residential and commercial PACE programs, was issued to encourage lenders to use certain “prudential actions” when evaluating potential mortgagors (the property buyers or owners in need of financing) who reside in a PACE-participating district.13 Altogether, the statements effectively halted both residential and commercial PACE programs in the United States. After a bit of time though, because commercial owners are not reliant on Fannie Mae and Freddie Mac for mortgage financing and the OCC statements did not specifically state that the programs had to shut down, several commercial programs were able to recommence.14 Subsequently, Fannie Mae and Freddie Mac announced in August that they would no longer “purchase [m]ortgages secured by properties subject to PACE obligations” that assert first-priority liens.15 They also set specific conditions for refinancing which would alter or extinguish the first-priority status of such obligations. In February 2011, FHFA reaffirmed the lenders’ positions in a letter to their counsel, and instructed the GSEs to continue their new policies.16
Congressionally-led PACE discussions began
After the decisive halt, PACE stakeholders began negotiating with FHFA in search of a resolution. When FHFA would not budge, PACE stakeholders and advocates engaged with Congress in a bipartisan manner. With many members of Congress unfamiliar with PACE, the movement began slowly, but eventually a number of Congressmen, alongside the Department of Energy (DOE) and the White House, led an effort to compromise with FHFA. Representative Steve Israel (D-N.Y.) proposed to FHFA a 300,000 house, 30 month pilot program to test whether PACE works. FHFA countered with a 10,000 house project, and left Israel and his supporters unimpressed. Unmoved, FHFA and OCC continued to reject the financing tool, still defining PACE as a loan, and not as a tax assessment. As a result, the talks did not produce positive results and no clear path forward emerged. Residential PACE programs remained largely shut down, but some locales, including Sonoma County (Calif.) and Town of Babylon (N.Y.), refused to close.17
PACE in Previous Legislation
The 111th Congress (2009-10) introduced a number of bills in support of PACE financing, yet none passed. First, before release of the FHFA directives, Sens. Jeff Merkley (D-Ore.) and Dick Lugar (R-Ind.) introduced S. 1574: the Clean Energy for Homes and Buildings Act of 2009. The bill was referred to the Committee on Energy and Natural Resources in August 2009, but it never received hearings or a markup. Subsequently, Israel introduced H.R. 3836: “To authorize the Secretary of Energy to provide credit support to enhance the availability of private financing for clean energy technology.” The bill was referred to the House Committee on Energy and Commerce and, in turn, was referred to the Subcommittee on Energy and Environment, where no action was taken.
FHFA’s directives did, however, spur more members of Congress to introduce legislation. Sen. Barbara Boxer (D-Calif.)responded with S. 3642: the PACE Assessment Protection Act of 2010, but it saw much the same fate as its predecessors. Rep. Mike Thompson (D-Calif.) introduced counterpart legislation, H.R. 5766, that directed the two GSEs to adopt PACE underwriting standards and recognize PACE obligations as compliant with standards, and placed further prohibitions on the GSEs. Rep. John Sarbanes (D-Md.) offered a separate measure in H.R.4155: the Property Assessed Clean Energy Tax Benefits Act, which would permit the issuance of tax-exempt bonds for energy improvement financing. Both bills fell by the wayside. When the 111th Congress adjourned, all un-passed legislation, including these unsettled PACE bills, was cleared from the books.
As resolution through negotiation or Congressional action looked unpromising, one state, three counties, two cities, and two environmental organizations18 filed lawsuits against FHFA, Fannie Mae, Freddie Mac and OCC—in different combinations—for their ‘unfounded’ warnings against PACE. There are similarities and differences in the lawsuits: claims include that the July 6 directives were based on inaccurate and unsupported assertions and that the agencies overstepped their federal authority; there are also procedural (rule-making) allegations, that FHFA and OCC did not conduct an analysis of potential environmental impacts, in violation of the National Environmental Protection Act, and that neither organization provided the public with a precursory opportunity to comment on the directives, as is required by law. FHFA moved to dismiss those complaints, contending that the courts cannot review its actions under HERA. The plaintiffs all contested this and filed oppositions. The parties argued the motion and the plaintiffs requested preliminary injunctions against FHFA in December.
A verdict was returned only for the Town of Babylon, where FHFA’s and OCC’s motion to dismiss was granted in June 2011. A federal judge held that FHFA, as conservator of Fannie Mae and Freddie Mac since September 2008, is protected under HERA and cannot be sued by the town.19 Babylon requested that the court parse out when FHFA acts as a “conservator” and when it acts as an (unprotected) “regulator,” but the court was unwilling, and could not imagine how it would do so. Due to the conservator-conservatee relationship, Fannie Mae and Freddie Mac seem to have been protected under FHFA’s auspices (but the holding does not specifically state why Fannie Mae and Freddie Mac are themselves protected).20 The court further held that Babylon did not have standing to sue OCC because it must be likely (and not merely speculative) that the injury will be redressed by a favorable decision.21 The court reasoned that OCC’s July 6 Bulletin is one of many that sets forth supervisory guidance instructions. Even revoking the guidance would not require banks to authorize mortgages subject to first-priority PACE programs; banks would still be obligated to consider all financial factors when securing mortgages. The verdict came as a defeat to Babylon, which has not announced plans to appeal.
In California, the cases, though separate, are being heard by the same judge. There, the court was not inclined to grant the preliminary injunction, but was inclined to preserve the procedural claims, and consequently a chance at a trial on the merits. The judge requested additional pleadings, which the parties complied with, but there still is no ruling on whether the defendants are subject to the court’s jurisdiction. FHFA, Fannie Mae and Freddie Mac are unwilling to engage in settlement negotiations until such a ruling is returned. A settling conference has been postponed, for the second time, until August 29, 2011 and possibly the judge will have issued a ruling by then on whether to hear the merits of the case.
The White House has been a long-time supporter of PACE—both as an opportunity to increase America’s energy efficiency and as a way to stimulate local economies with job-creating revolving loans.22 Still, understanding the steadfast opposition from the secondary mortgage market, the administration is also looking at other methods for financing energy retrofits, like the Clean Energy Deployment Administration (CEDA), the U.S. Department of Housing and Urban Development’s Power Savers, the Rural Star program, or On-Bill Financing. Though an article was erroneously released to the contrary, Nancy Sutley, the Chair of the White House Council on Environmental Quality stated at a June 2011 event hosted by the U.S. Chamber of Commerce and the Alliance to Save Energy that the President’s office is persistently working to make PACE a workable and available option.23 While the Office of the President is engaged in the efforts to re-establish PACE, cooperation and determined effort from others outside of the Executive office may be required to overcome FHFA’s resistance.
Granted $30 million from DOE, in April 2011 Maine launched a new statewide PACE program in which the PACE tax assessment’s lien position is subordinate to the mortgage’s lien position. FHFA sent Maine’s program a letter of praise—showing some potential for similar, legislation in other states. Vermont also instituted a program with underwriting standards and in which PACE liens are subordinate to existing liens (including the mortgage), but superior to any liens that accrue afterwards. With a depreciated lien priority, a municipality is subject to most of the same risks as the mortgagee in a traditional PACE program. Therefore, municipalities have been ironically reluctant to adopt PACE legislation with a deferred lien priority. Additionally, Maine’s and Vermont’s programs likely cannot be transcribed into federal legislation because divergent state laws prevent a uniform method to alter the lien authorities in each state. Of course, states remain free to individually pass similar PACE legislation.
In the House of Representatives, Reps. Dan Lungren (R-Calif.), Nan Hayworth (R-N.Y.) and Thompson introduced a new federal PACE bill, H.R. 2599, on July 20, 2011.24 The PACE Assessment Protection Act of 2011 utilizes Thompson’s 2010 PACE bill as a framework to restore PACE programs in the United States. The new bill aims to revive PACE by defining it as an assessment rather than as a loan, and by alleviating FHFA concerns about placing taxpayer money at risk. H.R. 2599 is expected to be referred to the House Committee on Financial Services, which Hayworth chairs. Thompson’s office reported that a host of Members are very supportive and that the sponsors expect bipartisan support; it included nine Republican and six Democratic original co-sponsors. While Members will support PACE for reasons already mentioned, others may see PACE as an issue about local government rights or as an opportunity to limit the ‘overpowered’ GSEs, whose power, some feel, has gotten out of control.
The Representatives’ offices even met with Fannie Mae’s and Freddie Mac’s counsel prior to introducing the bill in an attempt to quell their concerns. In order to answer FHFA’s arguments and questions, the planned House bill will incorporate underwriting standards and will establish rights of rescission, consumer protections, and limitations on delinquent payment collection. The underwriting standards, adopted from DOE’s PACE guidelines, would qualify PACE applicant eligibility based on project costs relative to the value of the house, lifespan of the installed measures, projected savings, owner’s financial history and other parameters. As a result, underwriting standards would help eliminate the fear of ‘wild PACE assessments’ issued to those who cannot afford additional expenses, are under foreclosure, or who otherwise present a high risk of default. The bill also touts a study by ECONorthwest, which concluded that $4 million in total PACE project spending can on average generate $10 million in gross economic output, $1 million in combined Federal, State and Local tax revenue, and 60 jobs.26 While the PACE Assessment Protection Act’s lead sponsors hope to show that PACE is a logical course of action, the bill could provide an opportunity for Members of Congress to take bipartisan action, both because of the positive economic and environmental effects of PACE and concerns about Fannie Mae’s and Freddie Mac’s influence over the economy.
Practically, PACE seemed an effective method to retrofit buildings, reduce energy costs, provide jobs, and save money. Even though the actual rate of default on PACE-financed homes is extremely low and some feel that FHFA and OCC acted rashly and should have followed established rule-making procedures, the priority lien that a PACE tax assessment holds over the mortgage is cause for concern in the housing market. Yet, while commercial PACE programs are spreading, neither lawsuits nor legislation in the 111th Congress produced results that restored PACE as a possible residential retrofit financing method. Residential PACE supporters should now look to the PACE Assessment Protection Act of 2011 and to the courts in California and Florida to learn whether PACE may be revitalized. Yet, with such steady opposition from the secondary mortgage market, there currently are no assurances that PACE will return as a ‘green’ option for American residences.
Alliance to Save Energy Resources Relevant to PACE Financing
Property Assessed Clean Energy Financing, an Alliance factsheet
112th Congress (2011-2012)
The PACE Assessment Protection Act of 2011 (HR 2599)
- Bill Summary
- Bipartisan Bill Aims to Bring Residential PACE Back to Life, News Article, Jul. 28, 2011
PACE is Not Dead: New Financing Model Leads Future for Energy Efficiency Retrofits, an Alliance webinar
111th Congress (2009-2010)
Energy Efficiency Financing: The Current Landscape and Where We Need to Go, an Alliance webinar
News related to the Fannie Mae / Freddie Mac / FHFA guidance
- PACE: Legal Action Aims to Save Clean Energy Program, Oct. 14, 2010
- Legislation, Legal Action Aim to Safeguard PACE, Aug. 13, 2010
- Crunch Time for PACE Financing, Jul. 29, 2010
- Fannie and Freddie Drop the PACE, Jun. 29, 2010
2. In some cases, the assessment may be tacked to local water and sewer, refuse, or other billings.
3. The owner still owes the same amount, but the energy retrofit is continuously saving money in utilities. In some cases, the added savings are so great that the owner conserves more money on utilities each year than the tax assessment costs. In most cases though, the installation takes closer to ten years to net a positive return.
4. There is an additional $66 fee in Sonoma to record the lien on the property.
5. Numbers are calculated by PACENow from data supplied by PACE Program Administrators, but the sample size is limited. “PACE - Property Assessed Clean Energy.” PACENow.org. July 2011.
6. As of 2011, Calif., Colo., Conn., Fla., Ga., Ill., La., Mass., Me., Md., Mich., Minn., Mo., Nev., N.H., N.M., N.Y., N.C., Ohio, Okla., Ore., Texas, Vt., Va., Wis., Wyo. and D.C. have all enacted PACE-enabling legislation; Hawaii is understood to have existing authority.
7. “Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market.” Congressional Budget Office. Page 9. Dec. 2010.
8. "Statement of FHFA Director James B. Lockhart.” Federal Housing Finance Agency. Statement. 7 Sept. 2008.
9. A regulatory agency supervises and oversees the operation of a market, enforcing its rules and regulations, for the public benefit. A conservatory agency becomes the overseer of a gravely ailing organization and makes decisions on behalf of the organization.
11. FHFA: “Statement on Certain Energy Retrofit Loan Programs.” 6 July 2010.
12. OCC: “Property Assessed Clean energy (PACE) Programs: Supervisory Guidance.” 6 July 2010.
14. As of April 2011, there were four commercial PACE programs in operation, nine in design and four in the preliminary planning stage. “Property Assessed Clean Energy (PACE) Financing: Update on Commercial Programs.” Lawrence Berkeley National Laboratory. Policy Brief. (Page 12). 23 March 2011.
15. Freddie Mac: “Mortgages Secured by Properties with an Outstanding Property Assessed Clean Energy (PACE) Obligations.” and Fannie Mae: “Options for Borrowers with a PACE Loan.”31 Aug. 2011.
16. FHFA: “Notice of proposed rulemaking; request for comment.” Proposed Rules. 8 Feb. 2011.
17. Leddy, Jim. “Board Keeps the Lights On, Innovative Energy Program Will Stay Open for Business.” Energy Independence: a Sonoma County Program. (13 July 2010.)
18. The California Attorney General’s Office; Sonoma County, Calif.; Leon County, Fla.; Palm Desert, Calif.; Town of Babylon, N.Y.; the Sierra Club, and the Natural Resources Defense Council all filed lawsuits against either FHFA, Freddie Mac, Fannie Mae, and/or OCC. Placer County, Calif. initially filed suit, but then joined Sonoma’s suit.
19. Town of Babylon v. Fed. Housing Finance Admin. No. WL 2314989, F.Supp. 2d at 1 (E.D. N.Y. 2011) CV 10-4916
22. Policy Framework for PACE Financing Programs. Whitehouse.gov. (18 October 2009.)
23. Sutley, Nancy. Speaking Engagement. Washington, D.C. “Energy Efficiency: The Path Forward.” 21 June 2011.
24. No Senators appear to have immediate intention of introducing PACE legislation.
25. McNeill, Carla. Rep. Thompson’s Energy Legislative Assistant. Telephone Interview. 16 June 2011
26. “Economic Impact Analysis of PACE.” ECONorthwest. Study. April 2011.