Earlier this month, federal housing officials erected a new hurdle for residential property-assessed clean energy (PACE) financing.

Pioneered in Berkeley, California a decade ago, PACE financing removes the upfront cost of energy- or water-saving improvements by enabling homeowners to pay off the cost of the upgrades over time via an assessment tied their property taxes.

In a December 7 letter, the U.S. Department of Housing and Urban Development said the Federal Housing Administration would no longer insure mortgages for homes with PACE liens. The move reverses guidance adopted by the Obama administration in July 2016. The new guidance takes effect next month.

According to HUD, the move reflects FHA’s concern “about the potential for increased losses to the Mutual Mortgage Insurance Fund due to the priority lien status given to such assessments in the case of default” and “the lack of consumer protections associated with the origination of the PACE assessment, which are far less comprehensive than that of traditional mortgage financing products.”

In a statement, industry trade group PACENation said it is “disappointing that HUD has made a determination that will eliminate one of the principal benefits of PACE, which is transferability of the PACE assessment upon resale, for homes that have used FHA financing.”

PACENation, and two industry players contacted by GTM, Renovate America and Renew Financial, noted that FHA-backed mortgages account for a small portion of the overall market. FHA’s reversal aligns its PACE position with the one held by Federal Housing Finance Agency (FHFA), which oversees mortgage backers Fannie Mae and Freddie Mac.

“Since 2010, the controlling federal housing finance guidance on property-assessed clean energy has been from the FHFA, which prohibits Fannie Mae and Freddie Mac from insuring mortgages with existing PACE assessments,” said Renovate America Chief Strategy Officer Ari Matusiak in an email. “That’s why PACE providers have disclosed to homeowners that they may need to pay off their PACE assessment when they sell or refinance, as they would with any property-secured financing.”

He added, “The impact of this policy change is to remove a transferability option for buyers, sellers, and those refinancing that has been used by just under 3,000 homeowners with Renovate America PACE assessments, or less than 2.7 percent of our pool.”

PACE providers push back on risk claims

PACE financing providers also reject the claim that PACE liens present a risk to federal mortgage backers. They point to both loan-performance data showing low default rates for PACE customers as well as industry-supported efforts, particularly in California, the largest residential PACE market, to enact a robust consumer protection regime.

In an interview, Cisco DeVries, who is credited with creating PACE financing in 2007, said HUD’s reversal “is disappointing because there is no credible evidence that PACE financing is creating risks for the mortgage market or to FHA mortgages.”

DeVries, now the CEO of PACE financing provider Renew Financial, cited the status of a $10 million PACE loss-reserve fund established by the state of California in 2013. The fund, created in part to allay concerns then expressed by federal housing officials, is intended to ensure that if a mortgage holder takes a loss on a property in foreclosure with a PACE assessment attached, the state would reimburse the mortgage holder for the PACE portion of the loss.

In the intervening four years, with more than 150,000 projects completed in California, said DeVries, “not a single time has any claim ever been filed against that reserve.” The California State Treasurer’s Office confirmed that to date the program “has not received any claims on the loss reserve.”

Renovate America’s Matusiak cited a study by housing economist Laurie Goodman on the value of PACE homes, which found that energy-saving improvements financed through PACE recover at least 100 percent of the costs of the project and financing. He added that the “rates of PACE homes’ tax and mortgage delinquencies and defaults do not exceed that of other homes in PACE markets.”

California leads on PACE consumer protections

PACE financing providers emphasize the importance of legislation signed into law in each of the last two years in California, written to address concerns that the industry was under-regulated. A story published last week by Vice documents some of the potential abuses, including customers not being informed that PACE payments would be added to their property taxes.

In September 2016, Gov. Jerry Brown signed AB 2693, which established state standards for written disclosures a property owner must receive before signing a PACE financing contract and mandated a three-day right to cancel.

In October 2017, Brown signed two bills, SB 242 and AB 1284, which added additional consumer protections for PACE transactions.

SB 242 requires a recorded confirmation of terms call before an assessment contract is signed; bans kickbacks for contractors; and requires contractors to quote property owners the same price as cash for projects.

AB 1284 strengthens and standardizes underwriting standards to include income verification and ability to pay; establishes licensing standards for PACE providers; requires PACE providers to train and monitor contractors and their sales reps; and designates the California Department of Business Oversight (DOB) as the state’s PACE regulator.

The new rules on contractors take effect on January 1, 2018. The income verification and ability-to-pay rules come into effect in April. And the California DOB assumes oversight of the PACE industry on January 1, 2019.

“In the history of American capitalism, you see a lot of examples of competitors within the same industry zealously cutting corners to defend market share and profits. What you don’t see a lot of is companies standing up, cleaning up their own business, and then asking for government regulation to prevent an industry-wide race to the bottom. And yet that’s what we’ve done,” Renovate America spokesperson Greg Frost said in an email.

Last month, Sen. Mike Crapo (R-ID), chairman of the Senate Banking Committee, introduced bipartisan banking reform legislation that included a section on federal PACE financing underwriting requirements. In a statement, Cisco DeVries said, “If passed, this bill will enable the Consumer Financial Protection Bureau to establish national ability-to-repay standards for all PACE communities.”

PACE authorizing legislation has been passed in 33 states and Washington, D.C., but, thus far, there are just three active residential PACE markets: California, Florida and Missouri. DeVries is confident that outstanding regulatory issues will be resolved, including those with federal mortgage backers, and that more states will enter the market in the coming years.

“Many states are saying, ‘This is a great tool, but we want to see these pioneer states learn, make adjustments, and we can replicate that,” he said.