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Feds Say Popular PACE Retrofit Program Is Still Too Risky

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A handful of states are picking up PACE, but the rest of the nation might have to wait.

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Bob Rueter of Thermal House in Brattleboro, Vermont, sets up a blower door as part of an energy audit. Vermont PACE regulations require an energy audit before work begins and make PACE liens junior to mortgages; it is the only state whose program has been accepted by FHFA so far.

By Paula Melton

In another blow to the retrofit loan program known as PACE, the U.S. Federal Housing Finance Administration (FHFA) has proposed a new rule (PDF) that could automatically disqualify a huge number of mortgagers from participating. If the proposed rule is finalized as currently written, restrictions will be placed on mortgage giants Fannie Mae and Freddie Mac—which together back the majority of mortgages in the U.S.—to prevent them from purchasing mortgages on most properties with PACE liens. States will be able to get around federal restrictions by writing their PACE regulations in a way that addresses FHFA’s concerns but could increase risk for local governments.

Who’s on first?

PACE programs (“PACE” stands for “property assessed clean energy”) are authorized by states and run by local governments, which finance major improvements such as deep energy retrofits or renewable energy systems. The funds are paid back to the local government through property taxes over a long period, perhaps 10 or 20 years, removing the major barrier for these types of retrofits: the high upfront cost.

At the heart of the proposed rule is a conflict about whether PACE liens should be considered property taxes (since they are associated with properties rather than individuals) or loans (since they pay back a fixed amount of funding); if they are taxes, this means that PACE liens, rather than mortgage loans, would be repaid first in the event of foreclosure—something FHFA finds unacceptable (see “Nationally Stalled PACE Program Moves Forward in Vermont,” EBN Aug. 2011), since it (or a private bank) could end up losing money it had never agreed to lend.

But according to Alfred Pollard, general counsel at FHFA, there are also other problems.

“What subprime lending was all about”

“There are no national underwriting standards that are uniform,” noted Pollard—and in many states, he suggested, the underwriting standards are not up to snuff. PACE laws around the country tend to tie acceptable financing amounts to the value of the property—this is where the “property assessed” part of the acronym comes in—so that homeowners, for example, could obligate themselves for 10% of the assessed value of their property regardless of their credit rating or income. “This is what subprime lending was all about; they looked at the value of collateral,” Pollard explained. “The Dodd-Frank Act from 2010 made it clear that the old-fashioned idea of the ‘ability to repay’ is the issue.” States wishing to implement PACE programs may need to change their underwriting standards if they want Fannie and Freddie to be able to buy loans on properties with PACE liens.

Finally, Pollard continued, most PACE laws do not define acceptable retrofit standards that would protect consumers and their property from weak performance or shoddy workmanship.

PACE proponents disappointed

 “The language in the June 15 statement suggests the strong possibility of an FHFA blanket refusal to participate in PACE, throwing the baby out with the bathwater,” says Leanne Tobias, managing principal at Bethesda, Maryland-based real estate consultancy Malachite LLC. Tobias believes FHFA needs to take more of a leadership role in the development of PACE, which she readily admits is in its infancy and needs national standards for both financing approvals and retrofit quality control. She disagrees with FHFA, though, that the burden of developing these standards should fall entirely on PACE proponents, and she also criticizes the agency for not accepting assistance from experts who are only too happy to help.

“It was very disappointing that FHFA summarily dismissed a variety of underwriting standards suggested by the Council of Environmental Quality, the White House, and the Department of Energy as well as a variety of private standards for energy audits and retrofits from ASTM, ASHRAE, and other building energy organizations,” Tobias told EBN. “A substantial and significant body of potential underwriting, energy audit, and retrofit standards was summarily dismissed as overly complex.”

Tobias says she understands where FHFA is coming from—the agency was created in 2008 in part to oversee Fannie and Freddie after the subprime mortgage crisis—but she believes it is missing an opportunity to boost the housing market. “What FHFA’s leadership has done is to interpret the agency’s mandate very narrowly,” she argues. “It is rejecting participation in a variety of measures that would help stabilize the housing sector and provide additional credit to the housing sector. I think it’s extraordinarily disappointing that, rather than helping to shape the market constructively, FHFA is suggesting that it prefers that Fannie Mae and Freddie Mac not participate at all.”

In the proposed rule, FHFA does not refuse to participate in pilots but makes it clear that PACE proponents—not the agency—need to provide the details and the data: “No document produced by PACE commenters or by any government agency has provided a fully specified plan for an actual pilot program,” states the proposed rule.

Some states moving forward

Despite the delays for most of the country, FHFA has given the green light to one state. “We have already indicated to the State of Vermont that there is no problem with their program as far as Fannie Mae and Freddie Mac are concerned,” said Pollard. Vermont’s law makes all PACE liens junior to a mortgage; three other states—Maine, New Hampshire, and Oklahoma—have also rewritten their laws to address FHFA’s concerns about loan primacy in case of foreclosure, and Connecticut is considering doing the same.

“Florida did kind of the opposite,” says Susan Churuti, shareholder at Tallahassee-based law firm Bryant Miller Olive. “We specifically adopted a state law in 2010 that said PACE assessments are loans of equal dignity.” Churuti, who notes that PACE in Florida includes retrofits for “hurricane hardening” in addition to energy, doesn’t believe FHFA’s rule, if finalized, will cause problems for property owners there. For one thing, there is a lot of interest in PACE among commercial property owners (FHFA deals almost exclusively with residential mortgages). “The issue is, do Fannie and Freddie want to disqualify themselves from that market in Florida, because it’s going to be a pretty big market, we think,” Churuti said.

The proposed rule gets FHFA one step closer to resolving a lawsuit, brought by the State of California, that aims to make Fannie and Freddie recognize PACE liens as “tax assessments” rather than loans. Public comments will be accepted through September 13, 2012.

For more information:

Federal Housing Finance Agencywww.fhfa.gov

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July 17, 2012