Wall Street ESG loans make U.S. companies pay little for missed targets

(Bloomberg) – When American Campus Communities Inc. announced it had signed a $ 1 billion sustainability line of credit in May, its executives decided to take a victory lap.

For the first time, they said, the company was tying its borrowing costs to goals ranging from improving energy efficiency to having a diverse workforce and boards. The largest university apartment owner in the United States even issued a press release touting its commitment to environmental, social and governance goals.

What the statement did not say was that the financial incentives included in the loan were largely meaningless. American Campus Communities did not incur any additional costs for not meeting its ESG goals and would only save a hundredth of a percentage point in interest – barely $ 100 per year for every $ 1 million drawn – if it achieved all of its goals.

And that, it turns out, is hardly the exception in the area of ​​ESG lending.

Bloomberg analysis of over 70 sustainability-linked revolving lines of credit and term loans in the US since 2018 shows more than a quarter contain similar provisions: no penalty for not meeting targets fixed, and only a tiny discount if the goals are met. Other companies that have widely publicized similar deals, including JetBlue Airways Corp. and Prudential Financial Inc., refused to disclose details of their loans.

As U.S. companies grapple with scrutiny of their ESG efforts, companies are increasingly looking to Wall Street to help polish their credentials. Yet critics say more and more companies are presenting overly polite pictures of their commitments and results. The results suggest that while bank lending offers companies one of the easiest routes to access ESG finance, the route is also one of the least ambitious.

“This is simply misleading,” said Peter Schwab, portfolio manager at Impax Asset Management, one of the largest fund managers dedicated to sustainable investments. “There really is no significant financial impact. I don’t know why some companies even care.

American Campus Communities attributed the terms of its deal to the company being a “early adopter” in the sustainability lending market, and said its public comments ensure the company is held accountable to lenders. and to shareholders of its ESG commitments.

“At the end of the day, it’s really lender-driven,” said Ryan Dennison, the company’s senior vice president for capital markets and investor relations, of the price adjustments the company has achieved. . “We could either do nothing or do something and express some of our ESG goals and work on them. “

Sustainability-linked loans should not be confused with the so-called green bonds that have swept global finance in recent years – and which themselves face great skepticism.

For one thing, loans don’t limit what businesses can do with the funds. Instead, lenders agree to tie interest rates to certain ESG measures. Businesses, in theory, should benefit from lower borrowing costs if they meet their goals and face penalties if they do not.

Banks also tend to keep revolving credit facilities on their balance sheets rather than spreading the risk over investors. Businesses can use them as needed, although they often leave them unused for years.

Ridiculous penalties

This is a relatively new form of financing, especially in the United States. About $ 93 billion in sustainability-related loans were valued this year, or seven times the $ 13 billion arranged in 2020. Yet, this is only a fraction of the nearly $ 1.5 trillion in loans. syndicated in the United States since the start of the year, according to data compiled by Bloomberg.

Some industry watchers expect economic incentives to become more aggressive as the market grows. And of course, some companies are using them as part of a wider range of tools to help achieve (and communicate to investors) their environmental and social goals.

But in other cases, sustainability-linked loans have apparently become a way for companies to brag about their ESG good faith while risking the bare minimum, potentially adding to concerns about the so-called greenwashing that has emerged in it. other areas of sustainable finance and has attracted attention. regulators.

Read more: Fund managers feel heat in SEC crackdown on ESG labels

Bloomberg used public documents and information obtained from companies to analyze 77 revolving credit facilities and term loans that included sustainability adjustments.

About 40% of borrowers agreed to pay a five basis point penalty if they didn’t meet their goals in exchange for a five basis point discount if they hit their goals, a total variation of 10 points. basic.

Two borrowers, Millicom International Cellular SA and Diana Shipping Inc., set the adjustments at 10 basis points in both directions.

To find out more about sustainable finance:

SEC Chairman Gensler orders review of funds’ ESG information

On the opposite end of the spectrum, more than a quarter of companies had incentives that amounted to a single base point if they unsheathed their guns, as the American Campus Communities did. When credit lines remain untapped, sustainability adjustments do not apply or amount to a maximum basis point.

“Most of the upward or downward price adjustments are minimal,” said George Serafeim, a Harvard Business School professor who focuses on business performance and social impact, by email. “It seems to me more of a symbolic gesture than a serious effort to price and integrate climate risk into the contract.”

Almost all of the members of this club at some basic point are real estate investment companies, or vehicles that own large real estate portfolios and distribute most of the income they generate as dividends. Among them are multi-billion dollar companies such as Simon Property Group Inc., one of the largest owners of shopping malls in the United States, and Welltower Inc., one of the largest owners of retirement homes. elderly.

Many REITs likely choose such arrangements simply because their peers have done so, said Nathan Cooper, a partner at Hogan Lovells who helps organize sustainability-linked loans.

“This is a formula that already exists and is approved by the banks and poses no downside risk to the REIT,” Cooper said via email. “You see now that companies and banks are a bit more conservative with price adjustments and are wary of the risk of falling prices on a new concept. “

Simon Property Group did not respond to requests for comment, while a representative for Welltower declined to comment.

Read more: Former ESG Insiders Reject Company Green Goals As Toothless Hype

While the financial impact may not be significant for companies, there is a reputational risk if targets are not met, according to Arthur Krebbers, head of sustainable finance at NatWest Markets in London.

“It is too narrow to view these loans solely from the angle of an incentive for direct pricing,” Krebbers said. “What worries them much more is the wider reputation and the impact on the market if they have to reveal that they have not achieved a sustainability goal they set for themselves.”

The bankers’ dilemma

For lenders such as Bank of America Corp., JPMorgan Chase & Co. and BNP Paribas SA, the world’s three largest underwriters, corporate membership is a delicate balancing act.

Some bankers who work in ESG finance have said that if their institutions want to encourage their clients to become better corporate citizens, there is only a portion of their bottom line that they are willing to sacrifice. Lines of credit are often a profitable product that banks offer businesses to build relationships and attract more lucrative businesses down the line.

But therein lies a fundamental dilemma, say observers.

Banks are reluctant to give too large a discount to borrowers who meet the targets because they fear the loans will become too heavy. If the penalties are too high, on the other hand, they risk scaring customers away.

Better incentives can be found in the sustainability bond market, where fund managers with specific mandates to invest in ESG debt typically impose heavier penalties on companies that miss their targets. Penalties for bonds typically vary between 25 basis points and one percentage point depending on the issuer, according to market experts.

Advocates of stricter standards in the industry say another critical issue is ensuring that the goals set by companies are ambitious and force companies to stray from their current path.

American Campus Communities listed three main ESG goals when it closed its revolver four months ago. In addition to energy efficiency improvements, it sought 30% representation of women, racial or ethnic minorities and members of the LGBTQ + community on its board of directors, and targeted 70% for its workforce.

But by the end of 2020, the Austin, Texas-based company had already met both of its diversity goals, according to its annual ESG report.

Impax’s Schwab said ideally companies would commit to significantly improving their metrics and inflicting hefty penalties if they fail to meet them.

“We are extremely supportive of companies that measure and set goals,” he said. “Businesses are starting to get a little more serious, but it’s not enough.

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