Private activity bond deal spins rice straw into high-yield tax-exempts
A California company will use private activity bonds to spin rice straw into a construction product.
The recently priced debt will help finance a factory that will culminate a two-decade-long effort to turn the rice straw, a waste product of rice farming, into medium density fiberboard.
The firm CalAg will build a plant on 273 acres in Willows, a city of 6,166 that is 85 miles northwest of Sacramento in California’s rice growing region. The plant, expected to open December 2018, would recycle roughly 275,000 tons of rice straw annually to produce 112 million square feet of MDF.
MDF has traditionally been manufactured using sawdust or wood fiber to create panel board, the building blocks for cabinets, laminate flooring, interior walls and molding.
“The project really got on track with the addition of a group of equity investors that are true value-add strategic partners,” said Jake Campos, a managing director with Stifel, Nicolaus & Co.
Stifel and co-manager Citi on May 24 priced $228.2 million of non-rated private activity revenue bonds through the California Pollution Control Financing Authority. That, combined with the $114.5 million equity investment, provides the funding needed to construct the plant.
A team led by Jerry Uhland, CalAg’s president, first began to formulate a process in 1997 to create MDF using rice straw.
The construction material manufacturer first received approval Nov. 17, 2010 from the CPCFA, a conduit issuer run out of the State Treasurer's Office, for $175.3 million in bond financing. The final resolution was amended and restated on June 17, 2014; and that was amended and restated on Dec. 6, 2016. The company received approval on an extension for up to $235 million in bond financing on May 16, ahead of its successful pricing the following week.
Years of consolidation in the timber industry resulted in the closure of sawmills and panel board plants throughout the northern half of the state, Campos said.
The closures were not a result of a lack of demand for MDF.
There are no operating MDF plants in California, so the state’s annual consumption of 300 million square feet of MDF is being met, in part, by two facilities in Oregon and another in Montana, according to studies in the bond documents. Going forward, the studies said, the western U.S. is projected to have an annual supply deficit of 100 to 150 million square feet of MDF.
“The demand for MDF has been increasing steadily for a number of years, partly from increased interest in its use for laminate flooring,” said Greg Lewis, an economist with Forest Economic Advisors, a company the conduit issuer asked to review a consultant’s report produced by Stephen Vajda Consulting for CalAg.
Forest Economic Advisors forecasts continuing recovery in the housing market with a resulting increase in consumption of MDF and other building products, Lewis said.
The project is expected to fill the supply hole in the California market by taking advantage of transportation savings over out-of-state competitors, according to bond documents.
The concept of using rice straw to make MDF was sparked by state legislation passed in 1991 prohibiting farmers from burning rice straw, the waste product of rice harvesting. Farmers burned the rice straw to help prepare the fields for the upcoming year’s planting season and as a way to dispose of it, but the process resulted in a smoky haze in the Central Valley.
After the Rice Straw Burning Reduction Act was passed, rice farmers began tilling the straw into the ground to create compost to fertilize the ground ahead of the next season. The problem is the decomposition process releases methane gas into the air and wastes water.
CalAg produced more than 100 tons of rice straw-based MDF using its formaldehyde-free process during pilot trials, according to the preliminary offering statement.
The project would reduce methane gas emissions by 57,000 tons a year and save 17.8 billion gallons of water annually that is used to re-flood the fields to aid in decomposition, according to CPCFA’s staff report.
The equity syndicate is composed of investors that recognized the business opportunity of the project and have a proven track record in the agriculture sector and the composite panel board market, Campos said. That syndicate provided the industry support that allowed the financing to come together, he said.
“At first glance, a lot of investors viewed the business as an ag-tech startup and didn’t envision the financing as a great fit for a tax-exempt bond portfolio,” Campos said. “This made it critical that Stifel and Citi work in tandem to canvas the entire audience of prospective buyers.”
The equity contributions break down to $40 million plus $4.8 million contingency funds from TIAA, a global asset management firm with $800 billion under management; $22.5 million from Columbia Forest Products; $20 million from ZC, a private equity firm that invests in housing and building products; and $5 million from Siempelkamp, the equipment designer, manufacturer and installation designer. The equity total includes the $22.2 million spent by CalAg on development costs such as permitting, engineering, pilot testing and to purchase land.
“There has been a core group of investors that have followed the project for years, and the addition of Citi and their high-yield franchise as a partner in underwriting really helped to ensure that the project had the attention of the market,” Campos said.
As the bankers met with accounts, Campos said, “we found that investors were able to appreciate the strength of the team, the structure of the construction and delivery arrangements and ultimately the market for the plant’s MDF product.”
The finance team had hoped to close in December, but $6 billion of outflows hit high-yield funds in a span of a few weeks, which Campos said is a big hit for a $100 billion market.
This year, the market has seen $4.5 billion to $5 billion of investment return to high-yield bonds, “so market conditions have without question improved, but these are still non-rated project revenue bonds and appeal to just a small corner of the $3.7 trillion municipal market,” he said.
The debt and equity financing is expected to cover the $290 million construction costs and provide a $22 million contingency fund, according to bond documents.
The bonds were sold to qualified institutional buyers and institutional investors in minimum denominations of $250,000 and in $5,000 increments above that amount.
CalAg self-certified the debt as a green bond transaction following International Capital Market Association green bond principles, according to bond documents.
“If any municipal bond is green, it is this one,” Campos said, but, “even so, we viewed the green label and third party review as a nice gesture to the market, but not ultimately a feature that would cultivate demand on its own from the green bond crowd.”
The order book validated that expectation, he said.
“Green bonds have been a great talking point, but the reality is that portfolio managers in the socially responsible and green space seem to have a difficult time reconciling risk appetite with yield expectations,” Campos said. “I think it is reasonable to assume that there will not be a meaningful pricing benefit for green bonds in our market until there is a greater pool of assets and a much more focused mandate on the part of these investors.”
The deal, expected to close June 14, was priced in three maturities to yield 7.12% with a 7% coupon in 2021 to 7.8% with a 7.5% coupon in 2032 and 8.05% with an 8% coupon in 2039.
Legal counsel on the financial team included Orrick, Herrington & Sutcliffe and state Attorney General Xavier Becerra as bond counsel to the conduit issuer; Morrison & Foerster LLP, special counsel to the borrower; and Nixon Peabody, LLP as underwriter’s counsel.