Bonds and Bank Loans

Public entities often secure financing for resilience and adaptation projects through municipal bonds, including general obligation bonds and revenue bonds, or through loans from banks.^{See footnote 1} An increasing number of bond-like instruments and bank-like institutions that focus on support for environmental and social concerns support resilience and adaptation measures. Note, however, that municipalities face debt limits — limits in the amount of debt they accrue through the issuance of bonds (also known as debt securities) and other means.^{See footnote 2} 

Traditional Bonds

Traditional municipal bonds that include explicit attention to climate change and related social concerns include ‘green,’ ‘social’, and ‘sustainability’ bonds. These bonds generally function the same way traditional municipal bonds do: government entities secure funds from investors in exchange for a government guarantee that the bond and interest (which is tax-exempt) will be paid according to an agreed payment schedule.^{See footnote 3} Although these bonds often provide lower returns, they appeal more to socially- and environmentally-responsible investors who value the lower risk. The New York City Housing Development Corporation (NYCHDC) is a leading issuer of sustainability bonds, using them to finance mortgage loans and subsidies for affordable LEED-certified housing in New York City.^{See footnote 4} Although such traditional bonds address environmental and social concerns, they do not automatically include attention to who pays. Application of an equity lens to these bonds requires additional assurances that repayment costs do not disproportionately impact low-income and disadvantaged communities. Using a regressive tax to pay off these bonds, for example, would increase rather than decrease attention to equity.^{See footnote 5} 

Impact Bonds

Environmental impact bonds (EIBs) and social impact bonds (SIBs) - also known as ‘pay for success’ bonds — often offer opportunities for attention to equity in how bonds are repaid.^{See footnote 6} Similar to traditional bonds, these bonds allow entities to secure funds for an environmental or social concern but, unlike traditional bonds, they also enable these issuers to share risks with investors and usually to secure new sources of revenue for bond repayment.^{See footnote 7} 

Risks for issuers, such as municipalities, are reduced because issuer repayment is tied to a specific social or environmental outcome and not just to a fixed payment schedule. Investors agree to receive a reduced financial return when outcomes are less than expected, and issuers can use these cost savings to modify the project to further improve outcomes. These investors, in turn, benefit when outcomes exceed expectations, securing a larger return on their investment.^{See footnote 8} 

Entities structuring these bonds attempt to ensure that outcomes can be measured, valued financially, and used as investment ‘assets.’ The goal for the issuer is to ensure that the financial value associated with the measured outcome provides a financial benefit that exceeds costs associated with inaction. For example, for an EIB-funded stormwater management project in Atlanta, economic modeling predicted that the outcomes, including reduced flooding and reduced combined sewer overflow events, would provide millions of dollars in benefits to the city of Atlanta as compared to a no-action scenario. As described in a case study of this bond, several economically and environmentally stressed neighborhoods benefitted from the project.^{See footnote 9} 

Financial benefits associated with an outcome might provide a source of revenue to pay off the bond or related interest. For example, when impact bonds support measures that help specific beneficiaries avoid costs, these beneficiaries can contribute to bond repayment with these savings.^{See footnote 10} A recent EIB to prevent coastal erosion in Louisiana, described in the case study below, provides one such example.^{See footnote 11} The project’s likely outcome — reduced flooding of an important coastal road and port — should provide critical protection to local property and business operations. Assuming this protection is provided, these local asset owners can help pay interest on the bonds in exchange for this benefit. Similarly, for an EIB project in Iowa, financing is being used to increase crop cover on agricultural fields to decrease nonpoint source pollution.^{See footnote 12} The potential for decreased nonpoint source pollution provides the potential for a tradable ‘credit’ under the Clean Water Act. This credit can be monetized and used to contribute to payments on the bond.^{See footnote 13} 

Impact bonds have offered opportunities for attention to equity in a few ways. First, they have attracted a new set of impact investors that prioritize attention to principles of equity while seeking to secure a better financial return on their investment.^{See footnote 14} Second, when impact bonds or related interest can be repaid using cost savings, it is less likely that disadvantaged local communities will bear a disproportionate share of the bond repayment burden.^{See footnote 15}

Most impact bonds to date have required upfront support from philanthropic and nonprofit organizations to ensure their success, (i.e., these entities have provided funds to structure the investment, identify interested investors, and issue the bonds).^{See footnote 16} Moreover, most investors to date have been ‘impact investors’, willing to assume more risks to support environmental and social benefits in addition to financial benefits. An exception was the EIB in Atlanta, which was a public offering. Additionally, identifying bonds that meet all the criteria for success — measured, valued financially, and used as investment ‘assets — and structuring these bonds, can be difficult. Measuring outcomes also poses significant challenges.

However, as entities such as Quantified Ventures gain more experience structuring impact bonds, and the resiliency ‘assets’ are more easily priced on capital markets, it is likely that reliance on philanthropic, NGO, and government funds and support will be reduced. In any event, great potential exists to use impact bonds for a variety of equitable adaptation measures and outcomes, (e.g., impact bonds can fund measures to increase energy efficiency in low-income housing), and money saved through the reduced energy bills can be used to pay off the bond and/or interest on the bond.

Banks and Other Lending Institutions

Green banks, and similar lending institutions, are mandated to invest in climate-friendly projects and attract additional private investment into the climate mitigation and adaptation space.^{See footnote 17} Currently, they are relatively limited in number in the United States, but, with the support of groups such as the Green Bank Network and the American Green Bank Consortium, they are becoming more prevalent. Lending through these institutions does not necessarily include attention to equity, but it can, and has.^{See footnote 18} These entities are capitalized in various ways, including, for example, through surcharges on electricity rates, public grants, foundation grants, etc.,^{See footnote 19} and fall into three general bank models: (1) quasi-public corporations that permit private investment in the bank to enable loans that leverage private capital (e.g., Connecticut’s Clean Energy Finance and Investment Authority (CEFIA))^{See footnote 20}; (2) repurposed finance authorities that have shifted from a grant to a lending model and combined the authority’s funds with private funds; and (3) a combined infrastructure bank with a clean energy finance bank to fund energy projects.^{See footnote 21}

Additionally, states and municipalities are adopting laws and policies to promote traditional bank loans to low- to moderate-income (LMI) borrowers for resilience and adaptation efforts. Generally, these laws and policies reduce lender risks associated with climate-related ‘assets,’ such as residential solar assets.^{See footnote 22} 

Finally, an increasing number of Community Development Financial Institutions, which are institutions that offer financial services to low-income and disadvantaged communities, are lending for resilience and adaptation projects.^{See footnote 23} The Low Income Investment Fund (LIIF) is one example, providing financing for energy-efficient housing measures through its Green Finance Program.^{See footnote 24} 

Considerations of Bonds and Bank Loans

Lessons Learned

• Not all bonds labeled ‘green’ and ‘social’ achieve meaningful results. Carefully consider whether a bond will perform to expectations.
• Application of an equity lens to these bonds requires additional assurances that repayment costs do not disproportionately impact low-income and disadvantaged communities.