Whether or not you believe in global warming, the recent frequency of severe climate-related events – from mudslides to bomb cyclone snowstorms – suggests Thomas Friedman had it right years ago when he coined the phrase “global weirding.” One would think that in this environment, the outlook for Property Assessed Clean Energy (PACE) financing, which makes energy efficiency possible for the average homeowner, would be sunny and bright.
Consider further that Bitcoin, a mostly speculative pursuit for which the mining of a single unit uses as much electricity as an average American home for two years, and, again, it seems PACE financing should be taking the country by storm. But, political and industry issues are creating challenging headwinds.
New Administration Policies
One of the most recent challenges is the Trump Administration’s Department of Housing and Urban Development’s (HUD’s) reversal of a short-lived Obama-era policy that permitted properties encumbered by PACE obligations to be eligible for FHA-insured loans (as long as the PACE lien did not take priority over the mortgage). PACE programs cause concern for mortgage lenders due to the financing’s senior position that can prime existing liens. In fact, the Federal Housing Financing Agency (FHFA) continues to prohibit Fannie Mae and Freddie Mac from purchasing loans that are encumbered by PACE liens given the risk associated with junior lien priority. But, it seems this Administration’s reservations about the human impact on climate change could be a drag on PACE’s growth.
Self-Inflicted Issues in the Industry
To some extent, concerns regarding underwriting processes and consumer disclosures are putting a damper on PACE’s potential. To start, given that the financing is repaid through assessments on the subject property, PACE sales efforts and underwriting decisions have largely focused on property values, without consideration of the creditworthiness of homeowners. As reported, though, many homeowners may not have fully understood their obligation to pay the assessment in order to avoid the risk of foreclosure.
In addition, because the funding is repaid as a tax assessment, it is up to local tax collectors to track defaults. As a result, performance data is often not as robust as in other credit markets.
Data that is available suggests there may be room for improvement in underwriting. A Wall Street Journal analysis of tax data in California (where the programs are prevalent) shows defaults for PACE loans in 2016-2017 increased versus 2015-2016. Some lenders have started to take the positive step of reviewing homeowner income as part of the approval process.
But, at this point, some advocacy groups want even more protections. Some state legislators have acted to increase consumer protections around PACE funding, including giving the state oversight over PACE lenders and requiring the underwriting analysis to include an assessment of the borrower’s “ability-to-repay.” The American Bankers Association, Mortgage Bankers Association, and the Credit Union National Association are hoping to see federal legislation enacted which would impose Truth-In-Lending Act (TILA) standards and prevent the PACE lien from taking seniority ahead of the mortgage.
More Oversight Seems Inevitable
In any event, the door has been opened to more regulation – whether it will be the less restrictive Economic Growth, Regulatory Relief and Consumer Protection Act of 2017, proposed by Idaho Senator Mike Crapo, or the more burdensome Protecting Americans from Credit Entanglements Act of 2017, proposed by Arkansas Senator Tom Cotton, which would make PACE loans subject to TILA-style disclosures. Ultimately, under any regulatory scheme, if PACE is to thrive and fulfill its promise of positive environmental impact, participants should promote the adoption of best practices for traditional secured lending to ensure continued viability of such a worthy concept.
Seiji Newman is counsel in the Insolvency, Creditors’ Rights & Financial Products Practice Group of Davis & Gilbert. Seiji’s practice focuses on complex commercial litigation, including disputes relating to the financial services sector, class actions, bankruptcy, residential mortgage-backed securities (RMBS), and real estate.