With PACE Program in Limbo - Part 1

With Property Assessed Clean Energy (PACE) in a sort of indefinite limbo, efforts are underway to find alternative methods to finance retrofits of existing buildings. Congress will soon begin considering legislation that may give federal credit enhancement -- some kind of guarantee -- to loans for energy efficiency retrofits. Guarantees as high as 90% of the debt are contemplated. Leaving aside the fact that the guarantee will not begin to solve the fundamental problem, the violation of the mortgage covenants underlying the permanent financing that caused PACE to founder, the coverage levels raise a more troubling issue. The energy services company (ESCo) industry argues that the loan guarantee will address the foreclosure problem (or host risk) and that therefore mortgage lenders should accept it. Savings performance, the argument goes, is not a risk. Why? Because the ESCo guarantees the savings. Even in the lending community, one occasionally hears the "performance guarantee" mentioned as a sort of backstop for financing, a credit enhancement.

It would help to advance the debate around energy efficiency investing to eliminate or at least to temper this unhelpful fiction. The guarantee is not, in fact, a financial structure or an element of a financial structure. The guarantee is a legal agreement that aims to limit, to the maximum extent possible, the circumstances under which the guarantee can be called and establishes a framework for resolving disputes through engineering methodologies over which the ESCos have vastly greater mastery than their typical clients. Even if successfully called, compensation would materialize after engineering analysis, modeling, and verification -- and still later in the case of litigation. There is no financial reserve backing an ESCo guarantee. It is not in any sense a first loss or other credit enhancement to an energy efficiency project. In very important ways, therefore, there is no difference between performance risk and "host risk" -- the guarantee does not offer any bankable way to distinguish whether cash flow problems that jeopardize a property's financial stability are the result of the host's challenges or the failure to achieve savings.

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