Local governments should carefully structure a private capital commercial financing program with a watchful eye toward project credit quality, particularly at the start of a program, to attract funding with low interest rates. In one program under development in California, capital providers quoted an interest rate range of 7% to 15% for a pool of projects, depending on the type of projects included.
The warehoused approach has a number of potential advantages over the other two approaches due to its on-demand availability; but in the current tight commercial lending environment, it is difficult to secure a large commercial line of credit without a substantial credit enhancement from the sponsoring program (and may not be possible even with credit enhancement). Therefore, either the pooled bond or owner- arranged approach is a more viable option in the short term for local or state agencies.
That said, the pooled bond approach is also dependent on the bond market having an understanding and appetite for this kind of debt. Initially, there may not be much market enthusiasm for it, or the bond may be at interest rates that are not very attractive, particularly if the pool includes a number of undesirable projects. Boulder, Colorado, however, had success in issuing a PACE bond based on a pooled approach in late 2010.
The lingering question as to whether or not the OCC will support commercial PACE (see Section 1.1) has caused some local governments to be concerned about the impact that could have on the warehoused approach (for those instances where the plan is to eventually do a take out of the financed projects) and the pooled bond approach. The concern is whether the OCC uncertainty will either render take out or bond issuance impossible, or will cause the interest rates to be exceptionally high.
The caveats noted above have led a number of communities to structure their new commercial PACE programs to use the owner-arranged model to launch their programs more quickly and with more certainty. This enables them to start getting projects done and to start gathering statistics on repayment and default rates. Those statistics are expected to be helpful in building the case for banks and investors that commercial PACE is low risk and, therefore, banks and investors should support pooled bond and warehoused approaches for commercial PACE and offer attractive rates.
Each grantee should consider the above caveats in light of the grantee’s unique situation and decide which capital sourcing approaches work best in the local context at program launch.
Choose Credit Enhancement and Apply ARRA Funds
Credit enhancement refers to techniques used by debt issuers (in this case the local government) to raise the credit rating of their offering and thereby lower their interest costs. Stated another way, credit enhancement simply refers to the steps taken to artificially improve the likelihood that lenders or bond investors will be paid on time and in full. Reducing risk increases the comfort of those key stakeholders and increases the odds that they will participate in a PACE program.
Commercial PACE already provides a relatively secure means of repayment by including the payment obligation in the owner’s property tax bill. In the context of PACE, credit enhancement is generally used to provide even greater assurance that full payments to lenders would be made even if the property owners fail to pay their taxes on time. There are two primary methods used to “credit enhance” PACE.
First, and most commonly, the program planner creates a reserve fund to make up for any shortfalls in PACE assessment receipts. This reserve, described in more detail below, is almost always essential for an assessment bond to achieve an investment grade rating (a highly desirable goal because it broadens the
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