Forestry asset securitization – is it a viable exit plan?

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Swiss investment manager Forestry-Linked Securities is bringing a little of the old and a little of the new to the market with its forestry strategy.

The firm is pursuing an afforestation play in Latin America and has completed its first piece of capital deployment in the form of a 16,000ha transaction in Paraguay worth more than $25 million. So far, so familiar.

FLS chose not to raise capital through a blind pool fund and opted for a co-investment SPV instead, which has been backed by a $95 million commitment from a single European blue-chip investor and will remain open to other investors to participate.

The strategy is getting a little quirky now, but still nothing that warrants ringing the church bells.

The firm’s favored exit plan involves a securitization of its portfolio of forestry assets around 10 years from now, when it will be able to demonstrate roughly four years of distributions, steady cashflow and the data required for ratings agencies to rate its bonds.

This is the part where we may be veering into new territory for private market forestry strategies.

Of course, timber property securitizations have been done before – S&P Global has a 2003 article on the subject that has been updated several times, most recently in 2018, which makes it a useful primer. But has it been done by a GP before? Any evidence of that is thin on the ground.

In a nutshell, FLS’s bond would be secured by the land and the revenues to be derived from timber harvests and carbon credit sales over the life of the debt.

The key question then becomes, what is the likely rating that could be achieved by the debt product?

Fortunately for FLS, forestry has several characteristics in its favor.

The asset class has a reputation as a stable performer and can call on a 20-year average annual return rate of 7.2 percent, according to the NCREIF timberland index, while forestry managers have discretion as to the timing of harvests, which can be lined up to take advantage of price increases.

When trees are not harvested, they simply increase in value. Expectations of higher prices for afforestation-derived carbon credits could also play into the hands of FLS.

Where the firm will have to think carefully is with regard to the geographies in which it chooses to invest, as local transport and mill infrastructure, local labor, tree species, endangered wildlife and availability of off-take buyers will all have an impact on its rating.

“What is the demand and the price volatility of these assets? If the ratings agency decides that a portfolio of forestry assets is comparable to a portfolio of toll roads, for example, then you can start to build some reference around that,” a source told Agri Investor.

“Broadly speaking I think the idea has got substance, but the viability will depend on the rating,” the source added.

FLS’s proposition is by no means an unrealistic one, and it taps into the broader theme of expanding the capital pool from which private markets can draw.

The firm’s collateralized fund obligation is at least a decade away though – the intervening years could present developments in the market that make such an exit more commonplace, or perhaps even more eyebrow-raising, than it appears today.

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