Early this month, the Federal Housing Finance Agency took PACE to task for a lack of performance and underwriting standards.
The fear was that PACE financing is too unproven to be given priority over mortgage loans.
Because the agency regulates government mortgage giants Fannie Mae and Freddie Mac, its words carry big clout. As a result, many of the PACE programs taking root in 23 states came to a halt.
Not those in Sonoma County or Babylon, New York. Government officials in both communities pressed ahead -- and with good reason. Track records so far are good.
Repayment levels are high, defaults non-existent and the programs have stimulated at least some local business activity. In both communities, basic lending standards are in place. And so far, energy savings appear to justify the lending -- though the lack of standards to evaluate retrofits seems to be the weak link in the chain.
In short, the programs are anything but high risk.
For those who don't know, PACE is a program designed to encourage home and commercial energy efficiency and solar energy. Homeowners borrow government money for energy improvements and typically repay the loans through special assessments on property tax bills. Some municipalities bill monthly and do not tie repayments to taxes. The loans stay with a home when it is sold, so are collateral-based rather than linked to the borrower's ability to pay. Local officials frequently draw from government accounts to get the programs going and hope to float bonds to expand them.
Fannie Mae, Freddie Mac and the FHFA took exception to PACE because the program is often granted the right to place first liens on homes. These liens take priority over mortgages, putting lenders second in line in the cases of default. PACE supporters have tried to minimize this concern by arguing that only the unpaid portion of a PACE loan is at issue in a foreclosure. When the home is sold, the new owner takes over the responsibility for the remainder of the debt.
In any event, first-lien conflicts have not occurred in Sonoma County or Babylon. Both programs seem to be on sound financial footing and are in no danger of a sharp deterioration. Because the two programs are likely the only ones that remain active in the country, they also may be the best source of PACE data for years to come.
Here is an accounting of both:
The two-year-old Babylon program has financed work on 370 homes, with another 180 homes under contract. The average project size is $9,000 and the average payback period is 8.7 years.
The community raised money from its solid waste reserves to kick off a $2 million pilot program in 2008. That sum has since risen to almost $3 million.
The interest rate in the program is a surprisingly low three percent (the historic rate of return for the conservative investments in the fund) and homeowners are billed monthly.
So far no one has defaulted, though from time to time, several people have fallen behind on PACE payments, says Sammy Chu, director of the Long Island green homes program. If homeowners go into default, Babylon has the right to place first liens on properties.
Babylon has put into place a number of performance standards for the program. The first involves contractors. They have to be certified and subject to Building Performance Institute quality-assurance inspections. The town also conducts audits on 15 percent of retrofits to monitor quality standards.
Other basic rules govern lending. The town never finances improvements worth more than 10 percent of a property's value and homeowners with histories of non-payment are not accepted.
Babylon has seen at least a modest pick-up in construction activity as a result of the program. During its first year, the program created 20 construction jobs, as well as additional positions behind sales counters and in municipal government. The total should grow to 80 positions either created or protected from layoffs this year.
Chu calculates the savings from the retrofit work will be twice the size of a homeowner's investment over the lifetime of the equipment installed. He also says the town is willing to adjust payback periods to lower monthly payments if energy-savings projections don't pan out. (He acknowledges doing this once.) The aim is to make projects at least slightly cash-flow positive.
"The lesson we've learned is you have to continue doing this to get better at it," says Chu. "We're not going to find the best way to run this program by shutting it down."
The town has vowed to file suit against the FHFA. But another step it is taking could have an even greater impact on the PACE debate. Babylon is conducting its first extensive study of program performance, looking closely at whether projections of energy savings are matching reality. The analysis will determine for the first time from field data whether PACE really works.
The analysis should be completed by the end of the summer and is likely to be required reading in the PACE community.
Babylon says program activity is picking up, and its targets for the future are ambitious. "We're hitting our stride," says Chu. The town's goal is to retrofit 1,000 homes a year, or 20 percent of the community's 60,000 homes in the decade. That means outside capital will probably be needed. Before the FHFA statement was issued on July 6, private investors were looking seriously at providing cash. Since the letter, the interest has disappeared. The town is now examining alternatives. "It will take a little while to determine what the options will be for the future," says Chu.
Sonoma County by some measures has the largest program in the country and certainly one of the most solidly established. The program began in March 2009 and hopes to make as much as $100 million available for home-energy improvements and solar panels. The county draws money from an investment pool managed by its treasurer and from the Sonoma County Water Agency.
So far, work has been completed on 967 homes and buildings, and more than 300 additional projects are approved for construction. With an average project size of $30,000, the county has spent $30.4 million.
Payback periods vary from 5 to 20 years -- most residential work has a 20-year payback -- and the interest rate is 7 percent.
Fifty percent of residential projects include solar. Sometimes solar is installed along with energy remodeling; sometimes it is not. The county does not insist upon loading order requirements, such as mandating that a home's energy consumption be reduced 10 percent or 20 percent with an energy retrofit before solar is installed.
The region doesn't have a high heating or air conditioning load, so the payback from retrofits such as adding insulation or installing a slightly more efficient furnace is modest. Solar can have a big impact on electricity use, though, replacing grid electricity for appliances and televisions.
So far, key metrics are respectable. No defaults have occurred and less than two percent of repayments are late. The county also has seen a boost in its construction industry. Employment rose 8.4 percent in the program's first nine months, though a drop in new construction starts this year wiped out the gain. Without the program, layoffs would be deeper. "We are sort of a lifeline to the construction industry," says John Haig, energy and sustainability manager for Sonoma County.
Some lending standards are in place. Borrowers need to have equity in their homes, no involuntary liens and must be current on tax and mortgage bills. They also can't have declared bankruptcy in the past year.
Administrators don't pull credit reports. That's because the money is secured by the property, not the individual.
Sonoma targets 20-percent energy efficiency improvements and Energy Star standards for buildings. It also works with contractors to make sure projects have value.
But better yardsticks are needed to measure retrofit success. For instance, the county isn't yet sure whether energy savings fully cover loan repayments.
Haig says he plans to use the Home Energy Rating System, or HERS, Phase II for evaluating projects, conducting audits and calculating paybacks. The California Energy Commission is expected to adopt HERS Phase II and approve instructors this week (July 28).
The county also is just now beginning to collect data on cash flow, convinced after one year it finally has enough information to make a meaningful analysis. The study should be available by October or November.
Sonoma County's goal is to expand the program thirty-fold. It has ambitious goals to lower greenhouse gas emissions 25 percent below 1990 levels by 2015. A reduction of energy use in buildings is part of the strategy.
Clearly, better-established standards for retrofit work would help local officials convince mortgage regulators to side with PACE. It is no surprise these standards are still evolving with such a young program. The drawback is that the main source of data on this key point will likely be just two programs. Fortunately, both have track records to play the role.