The fourth securitization of Property Assessed Clean Energy (PACE) bonds via the HERO Funding Trust is slightly more geographically diverse.  This time, the collateral includes PACE bonds issued by the County of Los Angeles.

HERO Funding Trust 2015-3 will offer $201 million of bonds backed by 32 limited obligation improvement bonds issued by either LA County, the Western Riverside Council of Governments, or San Bernardino Associated.

Renovate America, headquartered in San Diego, CA established and administers all three PACE programs.

The PACE bonds backing this deal are secured by 8,939 assessments levied against 8,818 residential properties in 26 California counties. The average PACE assessment is $23,243 with an average annual payment of $3,197.

Kroll Bond Rating Agency assigned 'AA' ratings to $201.5 million of fixed rate, class A notes to be issued by the trust. The notes have an expected maturity date of Sept. 20, 2036 and a legal final maturity date of Sept. 20, 2041.

The major structural difference between this transaction and the previous two deals is that the liquidity reserve account will not be funded at closing. Instead it will be funded on the first and second payment dates from payments of interest on the PACE bond portfolio.

On the first payment date, an amount equal to 1.00% of the aggregate PACE bond principal amount, or $2.07 million, will be deposited into the liquidity reserve account. On the second payment date, an additional $2.07 million will be deposited. The two deposits are equal to approximately 6 months of interest. The liquidity reserve will gradually build up to 7.00% of the outstanding collateral principal amount, which equals approximately 18 months of interest.

However, the expected amount of accrued interest from the PACE Assessments’ origination date until the homeowners’ first payment was deposited into a capitalized interest account. These proceeds will be used to fund the liquidity reserve account until the first two semiannual payment dates of the transaction, according to the presale report.

According to KBRA, the use of the capitalized interest account to fund the liquidity reserve account is a credit positive, since the proceeds are already deposited in the capitalized interest account and there is no reliance on the performance of the transaction collateral to fund the liquidity reserve account.

The PACE Bond Portfolio’s weighted average coupon is 7.93%. KBRA’s analysis assumes an ABS note rate equal to 4.50%, resulting in 3.43% of initial excess spread available to cover losses.

Under California law, PACE assessments have equal lien priority with real estate taxes and other special assessments and are senior to all non-tax liens, including mortgages.

The Federal Housing Finance Agency, the conservator of Fannie Mae and Freddie Mac, believes that they contravene the terms of mortgage insurance provided by the two companies. This means that there is a risk that the FHFA could challenge the validity of a PACE lien in court, resulting in an impairment.

KBRA views this risk as remote, but has nevertheless applied a stress test assuming 64% recoveries on the risk that 36% of mortgages in the pool encumbered by Fannie or Freddie mortgages defaulted and had their PACE liens nullified.

Renovate America has also agreed to buy back any non-conforming PACE assessment. The program administrator will advance to the counties an amount equal to the outstanding principal balance of the non-conforming PACE Assessment plus interest to the next payment date.  The agreement provides investors with additional comfort that the PACE Assessments comply with the material guidelines established for the PACE program, according to the presale report.

This obligation was not a requirement of any party in HERO 2014-1 and HERO 2014-2.

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