The revelation that the top securitizer of PACE loans was masking borrowers’ financial difficulties is a black eye for the rating agencies involved. But in fairness, they have little data to go on in this asset class.
Kroll Bond Rating Agency and DBRS both rated the bonds backed by Property Assessed Clean Energy loans, which are funded by local governments and repaid via an assessment on a homeowner’s tax bill. Yet they were not necessarily in a position to know that the venture capital-backed Renovate America made payments on behalf of some overstretched borrowers, as The Wall Street Journal reported last week.
Renovate America told The Wall Street Journal it did not disclose the payments, which totaled about $175,000 over two years, because they were not "material." The company also says it has ceased the practice.
It’s true that the size of the payments pales in comparison to the more than $2 billion of loans that Renovate America has originated in California and other states. However, the fact that many of these borrowers missed their first payment could be viewed as a red flag.
“That’s something that people pay attention to, because that causes one to ask about the origination process,” said an analyst at rating agency that does not rate PACE securitizations. Investors may wonder “what happened … for [borrowers] to misunderstand what their obligations were,” this person said.
Officials from Kroll did not respond to calls and emails from ASR regarding Renovate America’s payments on behalf of customers.
DBRS responded with a written statement that it “continues to monitor PACE origination and underwriting practices with respect to consumer protection regulations, in a manner consistent with other ABS asset classes.”
Assessing default risk on PACE assessments differs from many ABS classes. The default data given to agencies such as DBRS is not compiled by Renovate America’s issuing trust, but through the reports issued by Deutsche Bank, the trustee of Renovate America’s asset-backed platform. And agencies that rate pace bonds – KBRA, DBRS and Morningstar Credit Ratings – are estimating potential defaults using alternative methods.
In KBRA’s case, it’s local property tax default history, according to presale reports.
In its statement, DBRS noted that though it receives “assessment delinquency, default and foreclosure data across [Renovate America’s] entire HERO program,” the agency chooses to use an internal RMBS analytics model involving combined LTV, homeowner FICO scores, prior mortgage delinquencies and mortgage seasoning when determining its long-term default stress assumption for each HERO PACE securitization.
The revelation was particularly awkward for Morningstar Credit Services, even though the firm has not rated any securitizations of bonds from California agencies backed by Renovate America PACE financing.
Morningstar has been a cheerleader for the PACE industry, and is the only agency to have issued a triple-A rating for an asset-backed PACE bond (Ygrene Energy Fund’s Goodgreen 2016-1 deal). DBRS and Kroll have rated these securities no higher than double-A.
Last month, Morningstar published a seven-page report addressing what it described as “misconceptions” about PACE. In particular, the report defended the use of lien-to-value ratio, as opposed to FICO scores, to assess credit risk. It pointed out that PACE liens do not travel with the borrower; rather, when a property is sold, the new owner inherits the lien.
The report also downplayed the difficulty homeowners may face if they try to sell or refinance homes encumbered by PACE liens. Federal Housing Finance Agency guidelines prohibit Fannie Mae and Freddie Mac from acquiring or insuring mortgages encumbered by PACE liens. Given the dominant role Fannie and Freddie play in the secondary market, it stands to reason that their inability to touch these mortgages would make lenders hesitant to write them.
Morningstar argues this policy has “limited impact on the property’s marketability” since owners can prepay what may be upwards of $20,000 to $25,000 of future assessments attached to their house when they sell. The rating agency did not mention the possibility that FHFA might one day challenge these liens in court – a risk that rival agency KBRA has called remote but material.
While a PACE assessment raises a property’s overall lien-to-value ratio, Morningstar stated in the report that any increased risk to the underlying mortgage is “likely minimal.”
Morningstar did not return requests for comments at press time.
Only KBRA, DBRS and Morningstar Credit Services rate PACE bonds. To date, none of the big three rating agencies, Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings, have rated bonds backed by PACE assessments.
Moody’s, S&P and Fitch either declined to comment or could not be reached to discuss whether they had plans in the works to begin rating such bonds.
But any of the rating agencies may soon be in a position to evaluate the risk of Renovate America’s bonds based on actual performance data, if and when they analyze new and outstanding deals.
The company “has been working with the assessment administrator to provide delinquency data in our monthly investor reports, and we expect that process will be done in the near future,” it said in statement emailed to Asset Securitization Report.
Spokesman Greg Frost said this effort has been underway for about six months, and predates the disclosure that the company paid assessments on behalf of some borrowers.
To some extent, all new asset classes pose similar dilemmas for rating agencies. They must balance the limited performance history of a new product with the risk of losing potential business to competitors who may be less conservative.
And bonds backed by PACE assessments, which are both high-yielding and environmentally friendly, have proven a big hit with investors. Renovate America, the largest PACE provider, alone has issued nearly $2 billion of bonds backed by PACE assessments.
Yet PACE poses some unusual risks, to both consumers and investors.
Lending groups have opposed the program, since it creates super senior liens that would get repaid ahead of their mortgages. Last year, the Mortgage Bankers Association said many lenders were upset that the Federal Housing Administration, a part of the Department of Housing and Urban Development, went the opposite path from the FHFA and endorsed the use of PACE programs with FHA products.
In a statement released Wednesday, Mortgage Bankers Association President and Chief Executive David H. Stevens said the trade group continues to view the recent growth of PACE loans “with great concern.”
He said the MBA has been working with policymakers to help them understand the implications for borrowers. “These liens are clearly loans, extremely expensive ones at that, and lack many of the disclosures and consumer protections that traditional mortgage lenders must rightfully adhere to.”
A law that took effect in California in January introduced consumer safeguards, including providing consumers with complete financing terms in advance of signing any documents, full disclosure that an owner may be required by the mortgage lender to fully pay off the PACE assessment before refinancing or selling the property, and allowing homeowners to cancel the contract within three business days of signing.
Editor’s note: This story has been revised to reflect that DBRS receives trustee reports' credit performance data on PACE assessments in Renovate America deals.