By Roy L Hales
As the Wallstreet Journal once put it, “Morningstar stands alone” in their field. The Chicago based research firm has provided the leading qualitative and quantitative analysis of more than 540,000 investment stocks, mutual funds, and similar vehicles. Thus their opinion of the Property Assessed Clean Energy (PACE) program is weighty and their new report makes it obvious that Morningstar approves of PACE.
Morningstar Approves Of PACE
The title says it all: “Clearing the Air—Addressing Three Misconceptions of PACE.”
So what are these misconceptions?
- PACE programs should use FICO scores as underwriting criteria
- PACE increases the risk to mortgages
- There isn’t sufficient oversight for the PACE program
Morningstar analysts Phoebe Xu, Stephanie K. Mah and Brian Sandler write, “We believe that a PACE assessment does not materially increase the risk to the underlying mortgage, as energy efficiency improvements should bolster property values and lead to tax and utility savings. As recognition of the nuances in this asset-based obligation becomes widespread, acceptance should fuel future growth.”
Using FICO Scores
Their report makes it very clear that PACE is not a mortgage and needs to be considered with different metrics. Though major PACE programs collect FICO scores, their key consideration is the lien-to-value ratio. This is because “PACE lending is tied to the asset and not to the creditworthiness of the property owner.”
In their analysis of existing PACE programs, the authors found:
- “Morningstar has not observed any major PACE originators pursuing originations to borrowers with weaker credit. Indeed, borrowers associated with (Ygrene’s) GoodGreen 2016-1 Trust, rated by Morningstar in November, had a weighted average FICO score above 700.”
- “the assets in (Renovate America’s) HERO Funding 2016-4 had a weighted average PACE lien-to-value ratio of 6.68% and a weighted average combined lien-to-value ratio of 62.74%.”
Alleged Risk To Mortgages
Doesn’t increasing a homeowner’s monthly payments mean added risk to existing mortgages?
Actually, the increased risk is both minimal and usually offset by other factors:
“While a PACE assessment increases a borrower’s debt, Morningstar believes these financed improvements often increase a property’s resale value. Moreover, the cost savings from such enhancements can partially offset a homeowner’s debt burden. Property owners often achieve cost savings such as lower energy and water bills from PACE-financed improvements and savings from the tax- deductible interest portion of PACE payments.”
Is There Sufficient Oversight?
PACE programs are operated as partnerships with local governments, who set their own,
“guidelines and policies, including eligibility criteria, fee structures, and interest rates. California and Florida, two of only three states that currently offer residential PACE financing, have had courts validate their programs.Morningstar believes that the PACE program’s oversight by government authorities and the evolving consumer-disclosure framework will increase transparency and consumer protection. For example, Gov. Jerry Brown signed Assembly Bill 2693 (PACE Preservation and Consumer Protections Act) into California law. The law, effective Jan. 1, 2017, introduced more safeguards, including providing consumers with complete financing terms in advance of signing any documents, full disclosure that an owner may be required by the mortgage lender to fully pay off the PACE assessment before refinancing or selling the property, and allowing homeowners to cancel the contract within three business days of signing. Separately, the Department of Energy in November published best practice guidelines for residential PACE programs, which outline procedures for state and local governments as well as originators to follow. Likewise, the guidelines suggest a ‘more rigorous’ approach to protect consumers, including verbal confirmation of PACE terms with property owners.”
As of the end of 2016, $3.40 billion in funding has been used for residential PACE projects. Morningstar expects another $2 billion to be provided this year. As more states make PACE available to their citizens, this will increase.