ESG: Getting to Know Social Bonds | Lord Abbett
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Fixed-Income Insights

The social bond designation is an important starting point in our detailed assessment of municipal securities’ adherence to ESG criteria.

Read time: 4 minutes

By Yeida Reyes and Derek Gabrish, Research Analysts

[This article is from the forthcoming edition of the Lord Abbett Muni Quarterly.]

Social bonds represent a growing segment of the global bond market with approximately $148 billion of issuance in 2020, a significant increase from the $18 billion issued in 2019. Social bonds raise funds to finance or refinance projects that mitigate a specific social issue or seek to achieve positive social outcomes. These bonds can be self-designated (assessed and quantified by the issuer) and/or verified by an external party.

These types of bonds are not new to the municipal bond market, but rather most have been issued for decades, so we have a lot of experience analyzing them. The only difference today, in most cases, is that they are now getting explicitly characterized as social bonds to make sure the public can understand that many of the issuers that have historically borrowed money through the municipal bond market have always been strong ESG issuers.

The International Capital Market Association (ICMA) has published a set of “social bond principles” that provide criteria for eligible projects to be considered social bonds. According to the ICMA, social projects typically fall into the following categories:

  • Affordable basic infrastructure
  • Access to essential services
  • Affordable housing
  • Employment generation and programs developed to prevent or alleviate unemployment stemming from socioeconomic crises
  • Food security and sustainable food systems
  • Socioeconomic advancement and empowerment

ICMA’s social bond principles call for an analysis of the use of proceeds, the issuer’s process for project evaluation and selection, and the active management of proceeds and annual reporting until full allocation. Appropriate management of proceeds is accomplished by crediting proceeds of a borrowing to subaccounts or otherwise tracking the funds to ensure intended use. In addition, the ICMA recommends an external review to provide a second party opinion, verification, certification, or a scoring/rating.

Current Focus: Housing and Education

Most of the social bond issuance thus far has been in the housing and education sectors. Affordable housing is one of the project-specific areas highlighted by the ICMA. There are a variety of affordable housing programs financed in the municipal bond market by social bonds including multifamily housing, which restricts occupancy to low-income renters; workforce housing, which restricts occupancy to middle-income renters; and single-family housing loan portfolios backed by loans to income-qualified buyers. Charter schools have qualified as well due to the social benefits of education coupled with the socioeconomic advancement and empowerment of students from underserved communities.

A recent example of a social bond is the April 2021 $100,000,000 Residential Mortgage Revenue bonds issued by the Texas Department of Housing and Community Affairs. Oregon-based financial consultancy Kestrel Verifiers provided a second party opinion to the Department’s social bond designation. The use of proceeds aligns with the goals of affordable housing, access to essential services, and socioeconomic advancement by providing financing for low- and moderate-income, first-time homebuyers. Proceeds of the bonds will be used to construct housing for low- and moderate-income individuals and families.

Thus far, the largest charter school social bond was issued in August 2020 by Equitable School Revolving Fund (ESRF) in the amount of $171 million. The bonds were also verified by Krestel Verifiers. The transaction provided funding for 22 different charter school projects across the country serving low-income and underserved students and intended to improve public education for children. Use of proceeds conformed to essential services and socioeconomic advancement project categories.

How Does the Social Bond Designation Relate to ESG?

Social impact is a key component of the ESG score we use when assessing potential investments. While there is significant overlap between the social bond framework and broader ESG frameworks, at Lord Abbett, we look beyond a project-based approach analysis and review the issuer/obligor holistically to assign an internal ESG score. We apply the spirit of the United Nations’ Sustainable Development Goals (SDGs) to assess the social benefits generated by an obligor.

Our scoring of municipal debt issued by charter schools offers an example of our approach. While charter schools in general are set up to address the growing disparities in educational opportunities and academic outcomes among students of different economic backgrounds, our ESG score attempts to rank entities relative to one another across the following SDGs:

  • Quality Education (SGD 4) – we look at academic performance as measured by school ratings and test scores as compared to local school districts, student retention, teacher retention, teacher credentials, parent satisfaction, and other similar metrics.
  • Poverty Reduction and Economic Growth (SDG 1 & 8) – high school graduation rates, post-graduation outcomes, and breadth of offerings such as technical education programs are all factors that we consider.
  • Reduced Inequalities (SDG 10) – programs such as bilingual education and English proficiency, mental care and college/career counseling, and the concentration of low-income students served as measured by percentage of students qualifying for free or reduced lunch are key factors. We also evaluate the response to acute events like the COVID-19 pandemic, where an entity’s ability to acquire and deploy the necessary resources to adapt and shift to remote learning without leaving the most vulnerable students behind has been critical.

Charter schools with the strongest social scores tend to operate in under-resourced communities and provide strong educational outcomes. This aligns with lower credit risk because an academically high- performing school will typically show robust demand (waitlists) and is less likely to face obstacles such as charter reauthorizations.

On a project level, we take a deeper dive beyond the social bond designation by analyzing factors such as environmental impacts of a project and climate change risk. For example, a housing project analysis would prompt a review of any environmental studies that accompany that project. In certain areas such as California, we also look at seismic reports given the increased risk of earthquakes.

A Final Word

Every time we review a new investment, we assign it an ESG rating, and for as long as we hold it, we review our ESG rating at least annually and sometimes more frequently. While sectors such as housing and charter schools clearly have strong social intentions, our ESG methodology goes deeper to compare entities’ actual performance to help us determine a more meaningful, results-based rating.

 

Article sources:

https://www.icmagroup.org/assets/documents/Regulatory/Green-Bonds/June-2020/Social-Bond-PrinciplesJune-2020-090620.pdf

https://sdgs.un.org/goals

https://www.bloomberg.com/news/articles/2021-01-11/social-bonds-propel-esg-issuance-to-record-732-billion-in-2020

 

IMPORTANT INFORMATION

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

This material is provided for general and educational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Lord Abbett product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice.

References to specific securities and issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. The securities referenced may or may not be held in portfolios managed by Lord Abbett and, if such securities are held, no representation is being made that such securities will continue to be held. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable.

A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. Investments in Puerto Rico and other U.S. territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems.

Environmental, social, and governance (ESG) criteria are a set of standards for a company’s operations that socially- conscious investors use to screen potential investments.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action, as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in this commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

FIXED-INCOME INSIGHTS

 

    Muni Quarterly

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