The Name of the Game is Bonds, Conservation Bonds

In late 2002 and mid 2003 The Nature Conservancy issued a series of bonds on the financial markets worth US$ 325 million. They were the first of their kind and could herald a new era in the use of innovative finance by conservation organizations. The Ecosystem Marketplace looks at these unique deals. When most people think of bonds, they think of large multi-million dollar corporations such as Exxon, General Electric, and Coca Cola -or they think of the Treasury bonds issued by the US Government- they don’t see bonds as a way for environmental non-profits to raise money for conservation. But that could all be changing. In December of 2002 and June of 2003 The Nature Conservancy (TNC) issued two separate bond issues worth a total of US$ 325 million to the US financial markets, bonds that it says are helping it save millions of dollars in interest costs and that will allow the organization to do millions of dollars more conservation than it would have otherwise been able to do. On a more fundamental level, the bonds may one day help change the way conservation organizations operate and are financed, at the same time that they provide some interesting indications of how conservation -and conservation organizations- are valued by financial markets. “The thinking behind these bonds,” says Kevin Schuyler, Vice President and Director of Finance and Investments at TNC, and one of the deal’s architects, “blossomed in 2002 when we began looking for opportunities to better structure our balance sheet.” He explains that TNC has assets worth about US$4 billion: US$3 billion in the form of land, and US$1 billion in financial assets, primarily in an endowment. Given this structure, he says, it made sense to leverage these assets and issue debt. He notes that in today’s world, most businesses understand that they need to achieve an optimal balance between debt and equity, a lesson that TNC and other conservation organization’s had not embraced. “In business terms,” explains Schuyler, “these deals have taken TNC from the equivalent of 100% equity to something less, which brings down our cost of capital? They help us optimize our balance sheet.” And the savings were immediate. Schuyler says that when the first bonds were sold, in 2002, TNC immediately saved US$2.6 million in interest payments when it essentially re-financed a loan that had been taken out to pay for the construction of the organization’s headquarters building. Over time, however, says Schuyler, the bonds could help the organization do much more conservation than it could have done otherwise. “These bonds,” Schuyler says, “will over time be paid using traditional contributions that come into TNC, as well as via our endowment income. Now our endowment is invested in a diversified portfolio of financial instruments that return about 8%. These bonds, on the other hand, are paid back at a rate of about 3% interest. So the difference is about 5%. A difference of 5% on US$300 million adds up to US$15 million per year, so the way I see it, these bonds will allow TNC to do at least US$15 million dollars-worth of additional conservation than would otherwise have been possible.” Michelle DeKoven, a senior business consultant at TNC, agrees. She says the deal was essentially the same as when individuals take out home loans. “We wanted to use the financial markets to leverage our assets, particularly given current interest rates,” she explains. She also says that the TNC bonds were interesting because most of the non-profits that traditionally issue bonds are usually universities, hospitals, or other cultural organizations, so this was a first for conservation organizations. She adds that, as a result, the credit rating agencies -agencies such as Standard and Poors and Moody’s, which determine the credit-worthiness of bond issues- had to do some new thinking about how to rate the transaction. “I give the credit rating agencies a lot of credit,” says Schuyler. “They spent much time and energy understanding TNC and seeing why we are quite a bit different from the standard non-profits, the Universities and Hospitals, that usually issue bonds. For instance, while TNC, Hospitals and Universities all typically own land, TNC does not depend on its land to stay in business. In other words, we are not dependent on our capital assets to achieve our mission. Selling our land doesn’t put us out of business, in fact it is our business. Also, unlike Hospitals and Universities, we can regulate our cash flow pretty quickly, again without putting ourselves out of business.” All of this, he says, gives bond-buyers a high degree of confidence that the TNC bonds will be paid back. Indeed, according to Amy Reznik, the editor of “Bond Buyer” magazine, one of the key differences between the TNC bonds and traditional non-profit bonds, was that, in the TNC deal, land -which is usually excluded from the value of resources of a non-profit in a ratings determination- was considered an asset. “Essentially,” she says, “they had to convince all concerned that their land holdings operated as a sort of revolving fund. That, since they re-sell land to other conservation buyers, its land is an asset just like the paintings in a museum.” In the end, the rating agencies were convinced and Moody’s gave TNC a long-term credit rating of Aa3, while Standard and Poors rated them an AA-, just a few steps short of the highest possible credit ratings (Aaa and AAA respectively). Moody’s, in its report on TNC wrote: “Most of the land TNC purchases is not held permanently, but is ultimately sold to permanent holders including local conservation organizations and governmental conservation programs. In fact, TNC generally purchases land with an identified exit strategy. Essentially, TNC operates as a large revolving fund, having successfully cultivated a diverse and growing marketplace of buyers for conservation lands.” Beyond the credit ratings given by Moody’s and Standard and Poors, Schuyler points out that what is interesting about the TNC bonds is that they are currently trading at levels far above what their ratings would indicate. “If you look at how these bonds are trading,” he says, “you will see that they trade at a rate of between six and eight basis points above LIBOR [the London Interbank Offered Rate which is generally used to gauge interest rates], which is in the same range as many bonds that are rated AAA.” This, he argues, shows that the market is willing to pay more for the TNC bonds than for similarly rated bonds, in part because of the organization’s conservation mission. “Partly,” he says, “this premium is based on the TNC brand. People know the quality of the work we do and are willing to pay more for it. But in part this is a conservation premium. In fact, I would say that there is no more pure way to demonstrate people’s willingness to pay for conservation and the environment.” In addition to being the first bond of its kind ever issued by a conservation organization, the TNC bonds are unique in that they are the first that allow a non-profit to convert, at its discretion, some of the money from taxable into tax-exempt bonds. Doing this, however, would mean that the money raised via the tax-exempt portion of the bonds could only be used for projects in the US. According to “Bond Buyer’s” Reznik, one of the more interesting aspects of the bond deal -one that convinced her magazine to award the deal an “honorable mention” in the magazine’s 2004 “Deal of the Year” competition- was the fact that TNC issued the bonds through an organization called the Colorado Educational and Cultural Facilities Authority (CECFA), which is unique in that it can issue tax-exempt bonds not just in Colorado, but in all US states (so long as part of the money is used in Colorado). TNC’s Schuyler argues that, had it not been for the CECFA’s ability to issue tax-exempt bonds in multiple US states, the deal would not have been possible. “Their unique ability allowed us to lower the sometimes substantial transaction costs associated with issuing tax-exempt bonds. Without them we would have needed more lawyers, more time, more consultation, and more money.” The TNC bond deal was certainly innovative, but is it transferable? Will other conservation organizations be able to similarly leverage their balance sheets? “Others could do this,” says Schuyler, “but TNC was in a particularly strong position to make this work. In order to do this sort of deal, the conservation organization needs to have a significant amount of un-leveraged assets on its balance sheet. Not all conservation organizations have this.” But where they do, adds TNC’s DeKoven, these sorts of bonds can be “very powerful tools for achieving more conservation.” Ricardo Bayon is the managing editor of the Ecosystem Marketplace. He can be reached at [email protected]