Incorporating ESG: Illinois School Capital: Planning and Bond Issues
By Steve MahrK-12 schools represent the nation’s second-largest sector of public infrastructure spending, and energy is the second-largest expense for schools, after salaries and benefits, according to the American Society of Civil Engineers and U.S. Department of Energy. Infrastructure and energy are recurring and consequential topics for Illinois school districts, and the application of “ESG” — Environmental, Social, and Governance — principles and strategies in your capital planning and bond issuance processes may help prioritize important facility and infrastructure improvement decisions as well as save financial resources.
The concept of ESG was first introduced in the mid-2000s. Its initial focus was on establishing goals for nations and multinational companies on topics such as environmental stewardship, affordable housing, and organizational structure. Throughout the past 20 years, the concept and its applications have changed as challenges related to the environment, society, and workplace changed. Today, these topics are top of mind for many local governments, including Illinois school districts, as funding related to energy efficiency becomes more common. This article focuses on best practices for the application of ESG to Illinois school district capital planning and bond issues. In particular, this article focuses on five areas of importance.First, we discuss recent state and federal legislation as well as legal borrowing authority for Illinois school districts related to energy infrastructure. Second, we outline ideas for how to incorporate ESG into your capital improvement plan. Third, we talk about ESG and its relationship to credit ratings for schools. Fourth, we examine the importance of ESG disclosure language in your Official Statement, which is the document about your district that investors read to make an informed investment decision when purchasing municipal bonds. Fifth, we conclude with information on what a green bond is and possible applications to schools.
Legislation at the state and federal levels related to energy infrastructure has been significant in recent years. In 2021, Governor JB Pritzker signed legislation that increased financial support for wind and solar generation projects and investment in electric vehicle infrastructure. The law also included material changes to the Adjustable Block/Illinois Shines Program, which provides solar incentives to schools, and created the Public Schools Carbon-Free Assessment Program. In Washington, D.C., the Infrastructure Investment and Jobs Act as well as the Inflation Reduction Act (IRA) became law in 2021 and 2022, respectively. The IRA has been described in the media as the single largest investment in clean energy solutions in American history, but, while these pieces of legislation are substantial attempts to incentivize investment, the magnitude of infrastructure needs and the high price of energy typically results in school districts incurring the lion’s share of upgrade costs.
Importantly, school districts have been at the forefront of energy efficiency, thanks in part to authority granted in the Illinois School Code and Illinois Local Government Debt Reform Act. The School Code authorizes school boards to borrow money for energy conservation projects in certain circumstances. The School Code also authorizes the use of guaranteed energy savings contracts. Additionally, the Debt Reform Act grants bond issuance authority that may be used for energy projects. For example, the Debt Reform Act authorizes “alternate bonds” as well as “debt certificates,” both of which are good tools for repaying debt from energy savings. The School Code and Debt Reform Act options are important to keep in mind, as well as grants and other incentives, whether your district is thinking of a standalone energy efficiency project or a master facilities plan.
The Government Finance Officers Association (GFOA) has been ahead of the game on developing best practices related to ESG for government finance personnel. GFOA approved a best practice in 2010 on “Environmentally Responsible Practices in Capital Planning.” The best practice identifies four key components — policy, financing, analysis, and communication. The policy component recommends principles such as good stewardship and environmental safety be incorporated at the initial stages of a capital improvement plan. A tangible strategy is the use of an environmental factor when scoring capital needs. The financing component makes the point that there are a multitude of financial tools for environmentally responsible projects and that those tools can be strategically combined.
For instance, cash on hand, state grants, federal grants, certain government low-interest loans, leases, traditional borrowing mechanisms granted by Illinois law, or even tax credits, subsidies, and deductions passed through the businesses partnering with you on energy-saving projects may be pieces of the puzzle for your district. The analysis component recommends an approach that (1) takes a long-term perspective because, although start-up costs may be higher, environmentally responsible projects and materials can help reduce costs over the life of an asset and (2) understands initiatives to address energy consumption over the long term are often difficult to measure. Of course, resources and professionals are available to assist with measurement and assessment. Lastly, the communication component notes that to be effective stewards, school districts should educate taxpayers and families on the potential positive impacts of incorporating environmental responsibility into facilities planning.
The facilities plan itself can serve as a method of communication, especially when it clearly states how projects relate to specific environmental considerations, improve quality of life, and save money.
After developing a facilities plan, if the need for borrowing in the form of a bond issue is established, a credit rating will often be part of the borrowing process. Equifax and Experian are to a personal credit score as Moody’s Investors Service, Inc. (Moody’s) and Standard & Poor’s Global Ratings (S&P) are to a school district credit rating. These institutions translate the complex variables of a school district into a more or less objective scale that then determines a credit rating. A school district’s credit rating is one of the most important determinants of borrowing costs and may be a source of pride for school leadership.
In January 2021, Moody’s published a new rating methodology related to public school districts. ESG considerations are part of that new methodology. For example, natural disaster risks and risks associated with dependency on carbon-intensive industry can influence credit quality. In October 2021, S&P updated its rating framework for public school districts with ESG examples. An important component of the Moody and S&P rating methodology is something called “Institutional Framework” or “Management.” The rating agencies view school districts favorably for having long-term capital plans, debt policies, and other policies approved by your board of education, such as a fund balance policy. A positive example cited by S&P related to their “Management” component is a master facilities plan demonstrating a school district’s approach to infrastructure that increases energy efficiency or mitigates physical risks (such as flooding). A higher credit rating, all other things being equal, results in lower borrowing costs, and a higher credit rating may be achieved by providing rating agencies with ESG-related information and establishing policies like those mentioned above.
In addition to ESG best practices in capital planning, GFOA has ESG best practices for disclosure in bond issuance documents (i.e., the Official Statement). In short, GFOA recommends three steps in drafting appropriate ESG disclosure. The first step is to identify risks with the help of your finance team. The second step is to consider how material risks could impact school district operations and finances, and the third step is to identify any proactive policy actions that could be or have been taken by your Board of Education to address such risks. Additional disclaimers can properly shape the discussion of environmental risks because certain environmental risks are oftentimes unknowable and may be uncommon in your area of Illinois. While it’s important to disclose ESG risks, it’s also a good practice to disclose other ESG information about your community.
An example of information related to the S-Social in ESG that can be included in your Official Statement to potentially lower your interest cost is related to the Community Reinvestment Act (CRA). The CRA, enacted in 1977, requires the Federal Reserve to encourage particular financial institutions — think of banks and savings associations — to help meet the needs of the communities in which they do business. One method of compliance for these institutions is to purchase municipal bonds from the lower and moderate-income portions of their communities. However, to ensure metrics set forth by regulators are being achieved, the disclosure language in a school district’s Official Statement typically needs to include relevant socioeconomic statistics, like median family income, and data on students qualifying for free or reduced-price meals under the National School Lunch Program. There are other examples of ESG-related information that investors appreciate reviewing in Official Statements. This is a topic that is most appropriately discussed with your bond financing team.
Once your credit rating is in hand and the ESG disclosure language in your Official Statement is satisfactory, school districts — in certain instances — may be able to designate their bond issue (or a portion of their bond issue) as a green bond, social bond, or sustainable bond. These special designations could lead to decreased borrowing costs because of increased interest from particular investors that target such designations due to their investment portfolio directives.
Let’s focus on green bonds as an example — there is currently a lot of interest on the topic. A school district’s green bonds, like traditional bonds without an ESG label, offer investors a stated return on investment. The key difference is that green bonds include a commitment to use the bond proceeds for projects that expect to have an environmentally positive outcome. These projects might include energy efficiency initiatives, electric buses, and environmentally-responsible buildings and controls — think HVAC — that meet specific standards. Most investors seeking ESG designations require, or at least prefer, a third-party certification of the validity of the ESG label. School districts should critically evaluate the potential benefits and associated costs of such a label. There are important legal considerations and potential ongoing disclosure requirements to ensure compliance with the commitment to spending bond proceeds on environmental projects.
School districts across the country, including in Pennsylvania, Texas, and California, have issued green bonds recently. The City of Chicago, in January 2023, was marketing approximately $150 million worth of social bonds with the expectation of using funds to plant trees, clean up and sell vacant/blighted property, and purchase electric vehicles among several other uses. Similar to a credit rating upgrade, a green bond designation may be an opportunity for school leaders to share positive news with constituents. Furthermore, the sale of green bonds can even include a provision that prioritizes the orders of your school district residents in your bond sale. It may be a win-win for your community. Illinois school districts have many bond financing options, and an ESG designation — such as green bonds — may be applicable and appropriate for your district under the right circumstances.
Consider reaching out to your bond underwriter, legal counsel, or municipal advisor for additional information on these topics and potential impacts, including costs and benefits. ESG principles and strategies can help guide decision- making and may help save dollars. If you are in the middle of strategic planning for facilities, consider how ESG principles might be prudently incorporated for long-term student and community well-being. Alternatively, if you are expecting to issue bonds, you might ask your finance team for additional information on ESG topics that should be included in your credit rating presentation and Official Statement. Additionally, you might ask about the viability of a portion of your bonds being designated as green bonds.
In conclusion, ESG is a growing and changing topic that presents opportunities as your district develops future capital plans and pursues the most cost-effective funding options.
Steve Mahr is a Vice President of Stifel Public Finance, which specializes in raising capital to build and maintain essential infrastructure in the communities they serve. Stifel, Nicolaus & Company, Incorporated (Stifel) has prepared this article that consist of factual or general information that should not be construed as advice, and unless otherwise agreed, Stifel is serving as an underwriter, or seeks to serve as an underwriter on a future transaction, and not as a financial advisor or municipal advisor.