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Morningstar rates PACE loans high

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.

The nation’s largest mortgage trade group, the Mortgage Bankers Association, also has warned consumers to be wary of these specialized loans used to make energy improvements.

PACEloaIn 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 said.

“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 asset-backed securities.

“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.

When 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 protecting consumers.

“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 report.

“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. 


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