The Wall Street Journal recently warned that a new subprime
lending boom could be emerging with the fast-growing popularity of Property
Assessed Clean Energy loans, known as PACE loans.
largest mortgage trade group, the Mortgage Bankers Association, also has warned
consumers to be wary of these specialized loans used to make energy improvements.
a new report, however, Morningstar Credit Ratings said PACE loans present little risk of driving a borrower into a
foreclosure, and could bolster property values and save the homeowner
money in efficiency improvements.The
securities backed by the PACE revenue streams also are highly rated, Morningstar
“We are looking at it through the lens of how much credit risk
are these assessments going to have, and do we have enough protection for
investors in the notes that are backed by these assessments,” said Brian Grow,
managing director at Morningstar Credit Ratings, who specializes in residential
“From that perspective, there is very little credit
risk in our opinion,” Grow told Scotsman Guide News.
PACE loans are a relatively new financing mechanism. What is especially
different about them is that the loan attaches to the property, and becomes a
tax lien on the property.
Borrowers will typically pay down a PACE loan semi-annually
for a period of up to 30 years. That assessment shows up as part of the tax bill. Another unique feature
is that the lien typically doesn’t get paid off when the borrower sells the house.
The new owner will assume the lien, in essence take over the payments until the balance pays off and rolls off the tax bill.
PACE financing is more common in commercial properties. Only
a few states have PACE programs for home improvements, with much of the industry
concentrated in California. PACE home originations have grown exponentially
over the last three years, and
the industry could move into the mainstream within the next decade.
Three of the largest PACE originators — Renovate
America, Ygrene Energy Fund and Renew Financial — sponsored more than $1.57
billion in PACE securities in 2016, according to Morningstar. The notes are collateralized by the income stream generated by the PACE assessments.
“In talking to originators, it seems that they see a lot of
demand for the product,” Grow said. “As soon as they start bringing new
regions onto the platform, I think it is going to grow a lot faster. We
estimate $2 billion this year, and I think it is going to grow from there.”
Morningstar offered several reasons why the PACE loans are
safe for the noteholders.
a borrower gets into
financial trouble and defaults on their mortgage, for example, Morningstar
said the mortgage servicer would likely pay the PACE lien while working out the
mortgage. If the property were to foreclose and be sold, the new owner would
eventually assume the PACE lien.
Morningstar also said most PACE liens to date are
relatively small and have been originated on homes
with low-leverage levels. Borrowers who do improvements with PACE loans also will realize savings for the borrowers, which should help offset some of the
costs of the loan.
Another misconception, according to Morningstar, is that
PACE loans are being originated in a freewheeling environment without
regulations. California, for example, recently adopted new regulations on PACE
originations, and the industry has developed national standards aimed at
“There is a lot more oversight on this than on the
originators back in the boom,” Grow said. “I do see a difference between what
we are originating now with the PACE loans versus back then.”
A PACE industry spokesman welcomed Morningstar’s
“This is a positive verdict on PACE financing that debunks
criticisms leveled by opponents of this innovative home-improvement financing
option,” said Greg Frost, a spokesman for the San Diego-based Renovate America.