Question: Borrower has requested the consent of lender with respect to the following: (1) the construction and installation of a new solar system to be installed on the roof at the collateral property to provide electricity to the property, and (2) the execution of Property Assessed Clean Energy (PACE) financing agreements with the PACE financing entity or authority and the project developer to finance the project. Can the lender approve the installation of the new solar system and the borrower’s execution of related PACE financing instruments and, if so, what issues must the servicer consider?

Answer: Yes, the lender can approve the use of solar panels and other energy-generating or energy-saving facilities financed with PACE financing agreements, provided that the transaction (1) is an acceptable transaction under the due on encumbrance and loan modification provisions of the applicable pooling and servicing agreement, (2) is otherwise an acceptable loan modification from a credit perspective after consideration of potential risks, especially with respect to the requirement that mortgage liens be subordinated to PACE financing, and (3) complies with any necessary rating agency requirements.

Property owners are exploring PACE financing as a favorable means of financing the costs of onsite facilities for energy generation and energy savings. Although there are potential benefits of anticipated reductions in operating costs, the required mortgage lien subordination and other risks must be carefully considered by loan servicers. Among other issues, the reliability of the projected savings in energy costs must also be evaluated in light of the instability of energy markets and prices and the difficulty of making accurate projections for future energy costs. 

Established by statute in a majority of states, PACE financing serves as a tool to provide access to capital for clean energy and energy-generating and energy-efficiency projects, such as solar panels, insulation improvements, electric vehicle charging stations, and upgraded heating and air conditioning systems. The financing is secured by a lien on the related real property, with payments billed and collected as part of the property tax assessment. Similar to a property tax lien, a PACE financing lien is superior in priority to mortgage liens and other liens. In part because of its tax-like superior lien priority, PACE financing interest rates are typically less than market rates offered by banks and other conventional lenders for similar projects. PACE financing requires an audit and a projection of savings in energy costs anticipated to be realized from the energy generation or improved efficiency of the installed facilities, as well as a demonstrated net savings to the property owner after consideration of the cost and repayment of the financing. Because PACE financing is established at the state level, enabling legislation varies from state to state, and a loan servicer and its legal counsel should review all applicable statutes. See Mark Palmer’s “So Bright You Have To Wear Shades: PACE Financing for Solar Panels and Other Alternative Energy Facilities” in the 2017-18 edition of the Servicer Survival Guide for a discussion of issues associated with PACE financing requests.

PACE financing liens and the proposed facilities to be installed require consent under customary loan document provisions relating to additional encumbrances and indebtedness. PACE financing also typically requires rating agency no-downgrade confirmations under pooling and servicing agreements, whether pursuant to specific terms related to PACE financing under more recent pooling and servicing agreements or, even if PACE financing is not specifically referenced, under the due on encumbrance provisions, as a superior lien, and, depending on the language of the applicable pooling and servicing agreement, possibly under the consent and modification terms. Because PACE financing is used to alter the collateral property, consent is also required under the alterations provisions of loan documents, subject to any permitted alterations and cost threshold terms that may be included as an exception to such consent requirements.

In addition to the usual underwriting performed for consent requests for an additional encumbrance, new indebtedness, and alterations projects, the following information related to PACE financing must be reviewed by loan servicers and legal counsel: (1) the applicable state legislation; (2) the audit and projected savings in energy costs; (3) the company that will coordinate and administer funding; and (4) the requested mortgage lender consent form and other proposed PACE financing documentation. Concerning the audit and projected savings in energy costs, in particular, one must consider the reputation of the firm that prepared the audit and projection, as well as the assumption statements included as part of the savings projection.

In evaluating PACE financing requests and the related risks and how to mitigate such risks with credit enhancements and other conditions, we have, based on transaction-specific information, recommended certain credit enhancements and conditions, including the following: (1) new or adjusted reserves for deposit of PACE financing payments, often including an advance deposit and retention in the reserve of an amount equal to an annual payment due in connection with the PACE financing; (2) a reserve in the full amount of the PACE financing loan (although borrowers may elect not to undertake the PACE financing project if such a large reserve is required); and (3) a guaranty from a borrower affiliate to cover any gap between the projected net savings achieved by the PACE financing project and the actual savings realized. With such credit enhancement requirements to mitigate PACE financing risks, PACE financing and the related improvements may be appropriate for certain projects, and each project and request should be carefully considered.