By J. Cullen Howe, Environmental Law Specialist, Arnold & Porter LLP
This blog has been following the controversy surrounding Property Assessed Clean Energy, more commonly referred to as PACE. Here's an update:
In the last several years, several states and municipalities have enacted legislation that authorizes the creation of finance programs, typically through the sale of municipal bonds, that allow residential building owners to make energy efficiency improvements and/or install renewable energy systems. These programs are referred to as Property Assessed Clean Energy, or PACE.
Briefly, PACE programs attempt to solve the up-front cost problem by allowing residential building owners to borrow this money at a low interest rate. The property owners then repay their loans over 15-20 years via an annual assessment on their property tax bill. PACE liens "run with the land," meaning that if the loan is not fully paid off before the property is sold, the remaining payment obligation passes to the purchaser. A PACE bond is a debt instrument (i.e., lien) where the proceeds are lent to property owners to finance energy efficiency retrofits, who then repay their loans over 15-20 years via an annual assessment on their property tax bill. These bonds can be issued by municipal financing districts or finance companies. The PACE lien is senior in right to a mortgage, making it attractive to investors. The program allows municipalities to create financing districts and to float bonds to investors to raise the money for the program.
FHFA's Stance Toward PACE Liens
In May 2010, Fannie Mae and Freddie Mac, government entities that guarantee more than half of the residential mortgages in the U.S., issued letters to mortgage lenders stating that these liens could not take priority over a mortgage financed by either entity. In July 2010, the Director of the Federal Housing Finance Agency (FHFA) (the federal agency that regulates Fannie Mae and Freddie Mac) issued a statement that PACE financing would increase homeowner debt burdens and "could create a greater potential for the loss of a home through a tax sale or foreclosure if the consumer cannot meet the extra debt burden." Following FHFA's statement, in August 2010, Fannie Mae and Freddie Mac announced to lenders that they would not purchase mortgages originated on or after July 6, 2010 (the date of the statement) which were secured by properties encumbered by a PACE lien. The net result of these actions has been that virtually all PACE programs across the country have been put on hold or discontinued.
California Lawsuit Against FHFA.
In response, several lawsuits were filed. One such lawsuit was filed by the State of California, several California counties and municipalities, and the Sierra Club in the Northern District of California, alleging violations of the APA, NEPA, and various state laws. In August 2011, the district court issued a potentially wide ranging decision partially denying the motion to dismiss. In the most important part of the opinion, the court held that that FHFA's July 2010 statement amounted to a final agency action and that, as such, it was subject to the APA's requirements for notice and comment.
Recently, in August 2012, the district court issued an opinion granting partial summary judgment in favor of California on largely the same lines as the August 2011 decision. As before, the court held that the agency was acting as a regulator when it took action concerning Fannie Mae and Freddie Mac and not as a conservator. The court held that FHFA's directives on PACE obligations amount to substantive rulemaking, not an interpretation of rules that would exempt it from the notice and comment requirement. The court ordered the agency to complete the rulemaking process now underway.
In January 2012, FHFA issued an advance notice of proposed rulemaking as well as a notice of intent to prepare an environmental impact statement (EIS) under NEPA concerning its policy. The rulemaking sought comment on three alternatives: (1) maintain the current directive prohibiting the purchases subject to first-lien PACE obligations, (2) retract the directive and permit Fannie Mae and Freddie Mac to purchase loans subject to PACE liens, or (3) adopt an alternative policy that permits Fannie Mae and Freddie Mac to purchase mortgage loans with first-lien PACE obligations under certain conditions.
FHFA received over 33,000 comments in response to its advance notice. After considering these comments, in June 2012, FHFA issued a notice of proposed rulemaking that essentially adopts the first directive preventing Fannie Mae and Freddie Mac from purchasing mortgages with PACE loans. The proposed rule directs the agencies to (1) cease purchasing any mortgage that is subject to a first-lien PACE obligation and (2) refuse to consent to the imposition of a first-lien PACE obligation on any mortgage. The proposed rule effectively implements the same policy FHFA began in July 2010.
The Notice also sought comment on three alternative rules. In the first, Fannie Mae and Freddie Mac would not purchase any mortgage subject to a PACE lien unless one of the following conditions was met: (1) repayment of the PACE lien is irrevocably guaranteed by a qualified insurer, which would be triggered by any foreclosure or other similar default; (2) a qualified insurer agrees to insure Fannie Mae and Freddie Mac against 100% of any net loss attributable to the PACE lien in the event of a foreclosure or other similar default; or (3) the PACE program itself provides for substantially the same coverage via a sufficient reserve fund maintained for the benefit of mortgage holders subject to the senior obligation under the program.
In the second alternative rule, FHFA would direct Fannie Mae and Freddie Mac not to purchase any mortgage subject to a PACE lien unless all five of the following conditions were met: (1) the PACE lien is no more than $25,000 or 10% of the fair market value of the underlying property, whichever is lower; (2) the current combined loan-to-value ratio is no greater than 65%; (3) the borrower's adequately documented income ratio is no more than 35%; (4) the borrower's credit score is not lower than 720; and (5) the PACE lien is or will be recorded in the relevant jurisdiction's public land-title records.
In the third alternative rule, Fannie Mae and Freddie Mac would adopt certain provisions of the PACE Assessment Protection Act of 2011, mentioned above. The rule would impose an number of requirements, including the following: (1) the homeowner must be current on all taxes and mortgage payments and must have not filed for bankruptcy in the previous seven years; (2) the PACE project has been subject to an audit or feasibility study; (3) the audit or feasibility study shows that energy or water savings from the PACE project will exceed its costs; (4) the total PACE assessment for a property does not exceed 10% of the estimated value of the property; and (5) the property owner has equity in the property of not less than 15% of the estimated value of the property. The comment period remained open until July 30, 2012.
Notwithstanding the above litigation, Fannie Mae and Freddie Mac's reluctance to provide mortgages for properties with PACE liens has put the program's future in doubt. Many states that financed their programs through stimulus funds are suspending or withdrawing their programs because of the deadlines involved with applying for these grants.
Reprinted with permission from Green Building Law Update Service.
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J. Cullen Howe is an environmental law specialist at Arnold & Porter LLP. Much of Cullen's work focuses on climate change, where he attempts to educate lawyers and the public at large on the enormous cooperation necessary to adequately address this problem. In addition to his work on climate change, Cullen is the managing editor of Environmental Law in New York, edits the Environmental Law Practice Guide, Brownfields Law and Practice, the Environmental Impact Review in New York, and has drafted chapters in the Environmental Law Practice Guide on climate change and green building. Mr. Howe is a graduate of Vermont Law School, where he was the managing editor of the Vermont Law Review, and a graduate of DePauw University, where he was a member of Phi Beta Kappa.
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