The Western Riverside Council of Governments is preparing its second-largest securitization of Property Assessed Clean Energy bonds financing energy efficiency renovations for California homeowners, according to Kroll Bond Rating Agency.

The deal, Hero Funding Trust 2016-1, will issue $217.5 million of class A notes provisionally rated 'AA' by KBRA that mature in September 2036. 

They are backed by 28 limited obligation improvement bonds from 27 counties.

PACE bonds are issued by local authorities to finance energy retrofit or renewable energy installations such as solar panels for homes and buildings. The long-term financing (from five to 20 years) is attached to a property as an assessment that is paid in twice-yearly installments to the county alongside property tax assessments.

California counties are by far the biggest issuers of PACE bonds, though lendingi is expected to pick up in Florida.

In this latest deal from the HERO platform, the assessments average an all-time high of $24,236, with average annual payments of $3,296. The WRCOG has been securitizing PACE bonds through its HERO Financial Trust platform since 2014.

The average weighted coupon of the bonds in collateral pool is at 7.94%, almost similar to the rate of the HERO 2015-3 bonds from last November. While the deal has yet to price, Kroll expects the notes to pay around 4.5%, which would result in 3.44% of initial excess spread available to cover losses.

The ABS note trustee is Deutsche Bank, and the structuring agent/bookrunner is Morgan Stanley.

While geographically dispersed across Northern and Southern California, more than 75% of the PACE assessments securing the bonds are concentrated in four SoCal locales: Los Angeles, San Diego, Riverside and San Bernardino counties. The largest pool of bonds hails from LA, with 3,029 PACE assessments totaling $77.8 million. The other counties are backing bonds issued through the Western Riverside Council of Governments and San Bernardino Associated Governments.

Two aspects of the securitization prompt concerns for KRBA. As Renovate America's previous deal, the liquidity reserve fund will not be funded at closing; rather, the nearly $4.5 million necessary will be paid by HERO on the first two semiannual payment dates on the portfolio.

The two payments equal about six months’ worth of interest, with plans to build the reserve up to 7%, or $14.3 million, of the collateral principal, equaling 18 months of interest. The lack of funding is considered a credit negative by KBRA since it adds a year for the time the liquidity reserve to reach its 7% collateral principal target balance.

Another concern is that state authorities and the Federal Housing Finance Agency are clashing over the first-lien claims of PACE assessments. Under California law, the assessments carry equal-lien priority status with real estate taxes and are senior to other tax-liens, including mortgages. (The assessments are attached to the property, making them transferrable to subsequent owners.)  

The FHFA, the conservator of Fannie Mae and Freddie Mac, has expressed concerns that such energy-retrofit financing programs contravene the terms of the mortgage companies’ loan guarantees. As such, Freddie and Fannie prohibit PACE financing with lien priority above mortgages and do not allow GSE-backed homeowners with a PACE lien to refinance. They also will not allow new homeowners to purchase a home with a first-lien PACE assessment with a Freddie or Fannie loan.

Despite state-level court validations of PACE first-lien status, and the fact federal officials have not filed objections to PACE claims in default judgments, KRBA believes “there remains a small but material risk” the FHFA could successfully challenge the California PACE program and impair the PACE assessments. About 38% of the properties are encumbered by a Freddie/Fannie mortgage. 

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