Looking at alternatives after the PACE setback

Aaron Berg

The Federal Housing Administration (FHA) recently derailed one of the most popular and important tools for financing energy efficiency and clean-energy job creation. The tool, called Property Assessed Clean Energy (PACE), had attracted interest from communities across the country and millions of dollars in federal funding. Now, PACE programs for residential homes are all on hold, or canceled, while states and municipalities consider different strategies. 

FHA, however, had legitimate reasons for stopping PACE, as PACE would have created tax liens on private property senior to the existing mortgage instruments that it insures. This would have subordinated the FHA’s senior position behind that of new investors thus increasing the perceived risk of the transaction through a diminished collateral position for the primary mortgage holder. The benefit of PACE is the proposition of a repayment mechanism for clean-energy financing focused on the foreclosure rights and liquidated value of the entire underlying real-estate asset perfected by the tax-lien (super-lien) it creates. This collateral-based approach is commonly recognized by bond markets as “safe” and could potentially provide the basis for raising significant capital from public-bond investors. But the mortgage industry’s current problems highlight the limitations of this strategy. 

The U.S. economy has experienced tremendous downward pressure on real-estate asset values, exacerbating the distress of the mortgage industry and the financial sector that floated the bubble. Millions of mortgage loans are currently held in securities that have questionable asset/collateral value securing them. Roughly one quarter of U.S. mortgages are underwater and some homeowners are choosing to walk away from their mortgages because their houses are no longer worth what they owe or what they originally paid. PACE financing instruments could have inadvertently marginalized and deteriorated the collateral value available to mortgage holders on existing loans. This unintended consequence of PACE financing has some real and perceived negative consequences for a fragile mortgage industry whose recent collapse nearly sunk our global economy. In this context, it’s no surprise the FHA decided to step in. 

So where does this leave us? And where do we go from here? We have a depressed economy in dire need of job creation, more than 100 million homes across the country in need of energy tune ups, efficiency investment potential with real returns to investors, and millions of dollars in funding from the U.S. Department of Energy and the Obama Administration to jumpstart this multi-billion dollar industry. First, it’s critically important that we recognize the tremendous support and enthusiasm for clean-energy financing PACE recently created. Something we surely need to capture in our efforts to continue blazing ahead on the path to a more vibrant and restorative economy. Thankfully, other strategies are ready to pick up what PACE has started and deliver on the promise of financing clean-energy improvements. 

One approach is to focus on the ability to predict cash flows for clean-energy loans by monitoring and verifying the energy savings/performance of buildings that undergo energy-efficiency upgrades. With reliable, controllable, and verifiable savings from clean-energy improvements, private capital can finance these improvements with support from public funding. McKinsey and Company has estimated the investment potential for energy efficiency in the United States at $520 billion with returns of $1.2 trillion over the next 10 years. Private capital will chase this enormous market, and build an entire industry of clean-energy jobs in the process, when investors are confident in the security of their returns with clearly documented and proven energy savings. 

The U.S. Department of Energy recently awarded $450 million to 25 different cities and states to undertake innovative and collaborative approaches to financing energy efficiency. The “BetterBuildings” awards lay out a goal of leveraging private capital by ratios of at least 5:1. If successful, that will translate into approximately $2.75 billion in energy-efficiency work over the next three years, a substantial boost to this emerging industry. But even with 5:1 leverage, this is still only half of one percent of the $520 billion investment potential identified by the private sector. 

Another alternative to PACE is to work with utilities like the City of Portland and State of Oregon have done with the Clean Energy Works Portland program. Portland was recently awarded a $20 million grant from DOE’s BetterBuildings program. A new non-profit company, Clean Energy Works Oregon Inc., has been created to serve as the capital aggregation and service delivery platform for roll out of energy efficiency upgrades serving a wide range of customers, communities, and buildings. As the nation’s primary energy providers, utilities have an important role to play in attracting this investment. But this role need not be extensive or cumbersome to the utility companies. By serving as a pass-through conduit for on-bill repayment, utilities can offer investors and lenders a reliable repayment mechanism with low historic default rates. Utilities already provide financial and technical incentives for clean-energy initiatives, but the simple service of on-bill repayment may offer even more support for energy investment in the long run. And it’s a logical fit; utility companies exist to deliver energy services to their customers. By directly engaging utility companies and financial institutions in a positive dialogue, energy-efficiency programs across the country can still spark the growth in clean-energy investment that PACE had promised to deliver. The result may be stronger and more financially stable for all parties involved. 

At a very basic level, financing is a means to an end. If we can agree on the end goals of putting people back to work while achieving greater energy security for our nation and greater ecosystem security for our planet, there is no reason we shouldn’t be able to continually dream up innovative and effective ways to finance clean energy. PACE was one innovation. On-bill repayment is another. These tools only scratch the surface of our creative potential. The recent boom and bust of PACE doesn’t have to end in anything more than a lesson that we have a long road of innovation ahead for financing clean energy. Getting it right will require agility, patience, and collaboration. 

Aaron Berg is President & Founder of Blue Tree Strategies, a Portland-based clean-energy consulting company and is currently serving as CFO of Clean Energy Works Oregon Inc. 

This article was originally published on Clean Edge, August, 2010 and is used by permission.