A new way of financing solar is taking off in the solar industry: pre-paid, Property Assessed Clean Energy (“PACE”) funded Power Purchase Agreements (“PPA”). At this point in solar’s mainstream transformation of our electric supply, most people are familiar with the acronym “PPA”. In case you missed it, however, PPAs are arrangements where a company installs and owns a solar system on someone else’s property to whom they sell the power the system generates over a period of time often lasting twenty or more years and with options to purchase the system provided at strategic times. In the most recent twist on this structure, property owners are using PACE funds to pre-pay their PPAs with zero money down.

In areas with PACE legislation, such as most of California, property owners can receive a loan to finance their purchase of retrofits for “energy and water efficiency, electric vehicle charging infrastructure, and clean energy improvements” through a loan that is attached to the property, rather than an individual, and paid back through an annual assessment on the property’s tax bill. The loans are repaid over the selected term (over the course of somewhere between 5 and 25 years). PACE proceeds can be used to retrofit both commercial and residential properties. These PACE programs are serving as a market mechanism to supplement existing and former rooftop solar programs, such as the California Solar Initiative and the California Energy Commission’s New Solar Homes Partnership. Financing programs, such as PACE, play an increasingly important role as incentives offered through these programs phase out over time.

PACE financing programs can be set up and administered under either of two different statutory frameworks: the Improvement Act of 1911 (Improvement Act) as amended by AB 811 or the Mello-Roos Act under a city’s charter authority or as amended under SB 555. Both the Improvement Act and Mello-Roos Act authorize creation of special tax districts, voluntary contractual agreements for financing between an authorized entity and the property owner, use of available funding from any source including existing bond issuing statutes and attachment of assessments to the property. Given the two different enabling legislations for PACE programs, the statutory and technical differences among the PACE programs differ depending upon whether the applicable government entity has chosen to create their program under the Mello-Roos Act or the Improvement Act. The differences and perceived advantages between these statutory frameworks are beyond the scope of this newsletter article, but it should be noted they exist and most operational PACE programs in California were formed under the AB 811 amendment to the Improvement Act.

In the past, residential PACE programs faced hurdles to implementation due to lien seniority issues and the Federal Housing Finance Agency (FHFA). Because PACE liens take seniority over existing mortgages, the Federal Housing Finance Agency (FHFA) raised concerns that residential PACE financing may result in additional risk to mortgage lenders. For instance, PACE assessments have priority over other property-based debts in a foreclosure. This priority allows PACE programs to offer lower interest rates. Due to these concerns, in August of 2010 Fannie Mae and Freddie Mac announced they would no longer purchase mortgages for homes with first lien priority PACE obligations, leading many PACE administrators to suspend their residential programs. In September of 2013, Governor Jerry Brown signed Senate Bill 96 into law, authorizing CAEATFA to establish a PACE Loss Reserve Program (the Program) to assist in addressing FHFA’s financial concerns and support these residential PACE financing programs. CAEATFA launched the Program in March of 2014. Many PACE administrators have already enrolled in the PACE Loss Reserve Program and continue to offer residential PACE financing in a growing number of areas in California. In addition to protecting first mortgage lenders from losses attributable to PACE liens, the Program will collect necessary data on the performance of PACE financing over time, something FHFA has stated is required to better understand the actual risk to mortgage lenders. The information the PACE Loss Reserve Program collects will be valuable to policymakers and may inform future best practices and standards for residential PACE financing. PACE Programs submit claims directly to CAEATFA under CAEATFA Regulation Section 10083 & 10084. As of the date of this newsletter, CAEATFA has not received any claims against the Loss Reserve.

There are many benefits to applying PACE funds to prepay a PPA. The most obvious benefit is that the property owner can save their cash while capitalizing on the benefit of project costs being lower due to the provider retaining the tax incentives and passing the benefit on to the property owner as a lower lease or services payment. Since the PACE loan runs with the property, theoretically, this means that an owner would not be required to pay off the lien if they sold the property although this has not always been true in practice for residential owners due to buyer uncertainty and Federal Housing Finance Agency scrutiny. In addition, the tax assessment correlates with the useful life of the improvement and does not require an initial down payment like other types of financing. In regard to the PPA itself, a PACE financed, pre-paid PPA is subject to the contractual assessments requirements per California State & Highway Code Section 5899.2. This section requires modification to the typical PPA to comply with requirements related to the PACE assessment contract. Of course, other legal considerations also must be taken into account depending on the specific solar project structure, such as possible modifications to the PPA’s terms related to events of default, design risk, changes in project assumptions, definitions of key terms, payment structure, and conditions to obligations that might be modified by the PACE funded pre-paid PPA structure.