In the most recent attempt to do well by doing good, Bank of America clients (BAC) are hoping to profit from a future drop in re-incarceration rates among former New York inmates.
The deal, announced this week, will use $13.5 million from wealthy investors to fund training programs that aim to bring 2,000 ex-convicts back into the workforce.
If the efforts prove successful, the state of New York figures to reap savings, because it will be housing fewer prisoners, each of whom costs the state about $60,000 annually. The state would then use that savings to repay clients Bank of America's Merrill Lynch arm.
The transaction is known as a social impact bond a type of financing that was pioneered in the United Kingdom but has rarely been used in the United States.
"We do think that this is transformational. And we do think that it is something that our investors are looking for," says Liam O'Neil, a managing director at Bank of America. "We think that this was the first of its kind. And everything that we did was done with a view toward establishing a template for future offerings."
In some ways, the deal resembles a 2012 transaction involving Goldman Sachs (GS). Under that arrangement, Goldman stands to earn money if the recidivism rate drops among certain inmates at New York's Rikers Island jail complex.
B of A's arrangement, announced Tuesday, is different in two significant ways, though.
First, the 2012 transaction offered substantial protection to Goldman, because Bloomberg Philanthropies provided a 75% guarantee against losses. The B of A deal includes a far smaller guarantee 10% from the Rockefeller Foundation.
Second, the transaction announced this week is the first U.S. deal that's being funded by institutional investors and high-net-worth investors, rather than by a large financial institution.
"Merrill is not taking any risk. Their clients are taking the risk," says Tracy Palandjian, chief executive officer of Social Finance Inc., which structured the transaction.
Investors will get repaid if the 2,000 ex-inmates have significantly better rates of employment and recidivism than a similarly situated group of former convicts who do not receive job training.
In the worst-case scenario, investors will lose 90% of their capital. Under the rosiest outcome, they will earn a 12.5% annual rate of return. The expected annual return is in the middle single digits.
"This project is a win-win for our state," New York Gov. Andrew Cuomo said in a news release, "facilitating the reentry process of individuals into the community by boosting employment opportunities and thereby reducing recidivism rates, but requiring payment for services only if these goals are met."
Supporters of social impact bonds hope that this type of financing can be used eventually to address a variety of social ills, including childhood asthma and early-term births among teen mothers.
"The jury's still out," Palandjian says. "But if we can make it work, the potential is tremendous."
Bank of America's O'Neil says there is demand for financial products that are designed to address social problems.
At the same time, he acknowledges that specific investors have a variety of pet causes, and he says that some investors want to see social impact bonds establish a solid track record before they will be willing to pull the trigger on an investment.