Fat Private Equity Investment Buoys Restoration Industry
by Paul Quinlan, E&E Reporter
A private-equity firm has raised $181 million for wetland restoration, in what industry insiders are touting as a sign that for-profit ecosystem revival is finally coming of age.
At issue is the business of mitigation banking — reviving degraded swamps, bogs, marshes and other habitat to generate “credits” that can be sold to developers. Such transactions are aimed at satisfying regulators who require developers who damage or destroy wetlands to restore or protect habitat elsewhere.
Wetland mitigation banking has been around for some 30 years, but it has been slow to live up to its hype that it is a market-based solution to ecological ills caused by development in environmentally sensitive areas. Green groups question the ecological value of restored wetlands, and business analysts fret about mitigation banking’s regulatory uncertainty and uneven demand.
So the $181 million raised for Baltimore-based Ecosystem Investment Partners (EIP) is being celebrated by promoters of mitigation banking. EIP beat its $150 million target with large investments from typically risk-averse sources: a large university endowment, foundations and pensions — including $30 million from the New Mexico Educational Retirement Board, the state’s teacher pension.
“I think we’re probably at a breakaway point, if you will, in terms of institutional capital understanding of this space,” said Fred Danforth, a managing partner of EIP who founded the company in 2006.
Danforth discovered mitigation banking after retiring in 2002 from a Boston-based investment firm he helped found in 1987, Capital Resource Partners. An fly-fisherman and trustee of the Nature Conservancy in Montana, Danforth waded into his first restoration project when he bought a 1,900-acre former ranch in the Blackfoot Valley of western Montana. The property’s streams and wetlands were “unbelievably degraded” from decades of ranching and poor management, he recalled recently. So he and others went to work, he said, rebuilding 10,000 linear feet of streams to the correct depths and widths and restoring 260 acres of wetlands.
“I became fascinated by the opportunity to do this important work and overlay a business model that could generate more conservation and more restoration at a real significant scale,” he said.
Danforth assembling experts from the environmental and conservation worlds to form EIP and began fundraising. The first fund closed in 2008 after Danforth raised $26 million — about one-seventh the size of his second fund. The $181 million haul raised eyebrows across the industry.
“It’s good to see big-time institutional capital come into it, because we want to see the industry professionalized — not a lot of mom-and-pops,” said George Howard, co-founder and president of Raleigh, N.C.-based Restoration Systems, which banks 25,000 acres of wetlands and 60 miles of waterways in half a dozen states.
Randy Wilgis, president of both the National Mitigation Banking Association board and Environmental Banc & Exchange, a mitigation bank headquartered in Owings Mills, Md., said, “It’s just exciting, and it validates the entire market.” Danforth’s strategy involves acquiring large tracts of degraded but ecologically valuable lands in areas where development — and thus demand for offsetting credits — is expected to be high and regulations requiring wetland mitigation are strictly enforced. Danforth won’t discuss specific figures, such as the costs of restoration, permitting and maintenance or the price of credits.
Generally, EIP expects to acquire 10 to 15 properties priced between $5 million and $20 million and ranging from 1,000 to 10,000 acres, he said.
The heart of wetland mitigation has traditionally been major highway projects, and that is expected to continue, but Danforth expects other projects are on the horizon.
“If you think about pipelines and power lines and the siting of renewable energy … mining, oil and shale gas — all have significant impacts,” he said.
Regs, shale drilling spur business
Much of the recent growth for mitigation banking was spurred by the release in 2008 of new federal regulations governing mitigation banking that industry officials say brought clarity and predictability by laying out performance standards.
But that same year brought the collapse of the real estate market and a corresponding plunge in demand for mitigation credits. This put many small mitigation banks out of business and forced even the largest industry players into a holding pattern.
“It took a lot of the nonprofessionals out, which we welcome,” Howard said. “You had developers jumping into it to make a quick pop.”
The 2008 rules handed another gift to the industry: They indicated that mitigation banking was the preferred method for offsetting wetlands destruction, trumping both the do-it-yourself and in-lieu-fee options also available to developers. Experts, meanwhile, predicted that demand for credits would rise because of shale drilling and pipeline building and construction projects funded by the 2009 federal stimulus. Applications for new mitigation banks began rolling into the Army Corps of Engineers, which handles Clean Water Act permitting for wetland projects.
Companies such as Resource Environmental Solutions of Baton Rouge, La., and Houston’s Mitigation Solutions are among companies actively pursuing the shale mitigation market. Restoration Systems sponsored the first bank in Pennsylvania targeting mostly gas-line construction associated with shale drilling, Howard said.
“There’s still plenty of growth in mitigation banking, even in a stagnant or declining economy,” Howard said. The Army Corps doesn’t compile complete mitigation bank statistics from all 38 of its districts. But Dave Urban, EIP’s director of operations and past president of the National Mitigation Banking Association, keeps an informal and incomplete tally of the number of federal bank applications approved: 10 in 2008, 68 in 2009, 78 in 2010, 86 in 2011 and 38 so far this year.
“In 2009 and 2010, you just started seeing a flood of mitigation bank applications,” Urban said. “Now I think you’re seeing a lessening of application because, I think, people realize that in spite of a rule, the process is still balled up in local issues.”
‘No net loss’
The bottom line in the wetland-mitigation business is that swamps are valuable.
Once seen as mosquito-breeding nuisances, wetlands are now protected as sponges for recharging aquifers, filters for polluted stormwater and collection basins for floods. They are also nurseries for multibillion-dollar fisheries and breeding grounds for migratory waterfowl.
For too long, wetland values went unrecognized. Most landowners sought to drain or fill them. By the 1980s, the wetland area in the United States had shrunk to 53 percent of its size when the nation was founded. Soon enough, plugging drainage ditches and returning these lands to their previous, swampy condition would become brisk business.
In 1989, President George H.W. Bush declared a “no net loss” policy toward wetlands. Enforcement by federal agencies opened the door to mitigation banking by requiring that marshes and other wetlands destroyed had to be replaced with new ones either created or restored.
A 1990 memorandum of agreement between the Army Corps and U.S. EPA followed that laid out guidelines for determining the type and level of mitigation necessary.
Developers began to set aside portions of their projects, where they would attempt to create or restore wetlands. Studies found these tiny, scattershot restoration efforts typically performed poorly. They were also difficult to inspect.
Oversight problems were highlighted in a 2005 report by the former General Accounting Office (now the Government
Accountability Office), which found that the Army Corps had failed to check up on mitigation projects done by real estate developers to offset resource destruction.
The 2008 regulations are aimed at solving those problems. They require developers confronting wetlands to strive to avoid destruction and then to minimize impacts. If destruction is “unavoidable,” rules say, builders can look to mitigation.
Industry promotes legislative fix
But mitigation bankers say there are still regulatory uncertainties.
One of the biggest headaches, they say, involves uncertainty over where a bank must be located to service a particular project. Regulations call for a “watershed approach,” meaning banks must be within the same watershed. The methods used to define a watershed can be inconsistent and vary among 38 Army Corps districts, according to the National Mitigation Banking Association, the industry’s trade group.
The industry is also pushing legislation sponsored by Sen. Mary Landrieu (D-La.) in the Senate (S. 664) and Rep. Charles Boustany (R-La.) in the House (H.R. 2058) to allow the sale of mitigation credits to be treated as capital gains for tax purposes. Neither bill has gained traction.
Distrust still lingers among some environmentalists who note the poor early track record of the mitigation banking industry and argue that banking can, without proper oversight, encourage wetland destruction.
“I think banking has a lot of potential promise, but the combination of the profit motive and the science just all have a tendency to work against genuine replacement of the wetland functions,” said Jan Goldman-Carter, wetlands and water resources counsel at the National Wildlife Federation. “The bank is essentially paying for wetlands destruction somewhere else.”
Urban, an environmental engineer and former Army Corps permit officer, says the cure to poor oversight is greater transparency. Boundaries of watersheds and siting of mitigation banks are dependent on factors ranging from flora and fauna to soil types and are not always conducive to simple rules.
“There’s some people who advocate simple solutions, but simple solutions are not always the right solutions,” he said. “It keeps all boiling down to transparency,” Urban added. “We want the administrative process to be transparent and to include people like us who have expertise in this world who could be helpful.”
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