Climate Change Could
Make Borrowing Costlier for States and Cities
A woman walks along a flooded street in Miami Beach, Florida. Miami-Dade County has been praised by analysts for its infrastructure investments focused on climate preparedness as credit ratings firms begin to focus on climate change. Lynne Sladky/The Associated Press
Someday soon, analysts will determine that a city or county, or
maybe a school district or utility, is so vulnerable to sea level
rise, flooding, drought or wildfire that it is an investment risk.
To be sure, no community has yet seen its credit rating
downgraded because of climate forecasting. And no one has heard of a
government struggling to access capital because of its precarious
geographical position.
But as ratings firms begin to focus on climate change, and
investors increasingly talk about the issue, those involved in the market
say now is the time for communities to make serious investments in climate resilience — or risk being punished by the financial sector in the future.
“We look not just at the vulnerability of state and local
governments, but their ability to manage the impact,” said Emily Raimes, vice
president with Moody’s Public Finance Group. “While we’ll be looking at
the data on rising sea levels and who may be more vulnerable, we’ll also
be looking at what these governments are doing to mitigate the impact.”
Moody’s has been especially vocal about its climate change concerns. The firm has issued numerous papers assessing climate risk, and two months ago it purchased a majority stake in Four Twenty Seven, a climate-risk data firm.
Emilie Mazzacurati, Four Twenty Seven’s founder and CEO, said
that the bond sector’s attention to the issue should prompt local governments
to make it a priority. “It creates an incentive for them to be better
prepared, because it’s going to cost them money if they don’t.”
Cities Borrow Big to Pay for Infrastructure State and local governments depend on municipal bonds to finance two-thirds of their infrastructure projects, and analysts are starting to consider how the bond market should adjust as its issuers face increasing risks because of climate change.  But some worry that punishing places for their susceptibility to
climate change will just make it more difficult for them to finance the
infrastructure improvements that might protect them. “Nobody has yet been penalized for having a bad environmental
policy or practice or system,” said Tim Schaefer, California’s deputy treasurer
for public finance. “I don’t know how much longer that’s going to go on. I’m
assuming not much longer.” Assessing Florida’s Future Governments large and small rely on the $3.8 trillion municipal
bond market for much of their infrastructure work. When officials want to build
a highway or a school — or a seawall or an emergency operations center — they
often issue bonds, bringing in the money needed to complete the project.
Investors are repaid with interest over a period that can run for decades or
more. About two-thirds of infrastructure projects in the United States
are paid for by municipal bonds, and more than 50,000 states, local governments
and other authorities have issued bonds to finance their work. Governments pay higher interest rates on those bonds when their
credit ratings are low. Firms such as Moody’s Investors Service and Standard
& Poor’s Financial Services issue the ratings assessments. “Investors are in a position of demanding a higher return when
they see greater risk,” said Kurt Forsgren, managing director of S&P Global
Ratings. Municipal bonds are considered a conservative investment, with a
current default rate of around 0.3%, according to Matt Fabian, a partner at
Municipal Market Analytics. To date, the bond market has done little to reflect
that the risk may be increasing. “There is almost no impact on muni bond prices with respect to
climate change vulnerabilities. Prices do not acknowledge the risk in climate
change,” he said. As more investors and firms study the risks, however, that might
change. “We are about a year away from climate change beginning to
affect the muni market — a little,” Fabian said. “Changes on the investor side
are going to happen first, [credit] ratings will come second, and issuer
behavior will be a distant third.”  Some investors already
have begun to factor climate change into their decisions. Eric Glass, a
portfolio manager with AllianceBernstein, said his portfolio opted to steer
clear of a recent three-decade bond in the Florida Keys, which is facing rising
sea levels. “What does
[the Florida Keys] look like in 30 years?” Glass said. “I don’t know. But I
know it’s not going to look like what it looks like today. That is a tough
calculus to make, and we’ve decided not to take it.” David
Jacobson, vice president of communications for Moody’s Public Finance Group,
called a downgrade over climate projections a “what-if type of thing.” Moody’s
ratings are based on what its analysts expect a government’s creditworthiness
to be in the next 12 to 24 months, he said, even though the bonds they issue
can run for decades. “The things
that are happening right now or in the next 24 months weigh a whole lot more
than things we think will happen in 15 to 20 years,” said Lenny Jones, a
managing director at Moody’s. “We’re not scientists.” Credit-rating
firms have always acted conservatively, said Justin Marlowe, a professor at the
University of Washington who studies public finance. To some critics, that
reluctance to downgrade pre-emptively is leaving the market unprepared for the
onslaught of climate effects that so many local governments will face. That’s the
conundrum facing the municipal bond market right now: If the market fails to be
proactive about future risks, it could lead to billions in ill-fated
investments in communities at the forefront of climate change. But making it
more expensive for governments with environmental liabilities to borrow money
could prevent them from making the improvements needed to strengthen their
infrastructure. And just
because a city is likely to be struck by sea level rise or wildfire doesn’t
necessarily mean it will default on its bonds. Further effects like crop yields
and population shifts — and their impact on a tax base — could prove even
harder to project. “It’s a
pretty big step from ‘we have economic impacts’ to ‘this is going to affect
their long-term ability to repay their bonds.’ There’s a really big
difference,” Mazzacurati said. “[Ratings firms’] focus is really about counties
who repay their debt. That’s it. There can be really important impacts that are
not going to be reflected in the bond rating, and that doesn’t mean the bond
rating is off.” Disaster Fallout So far, the few climate-related credit downgrades have come
after specific disasters. New Orleans and Port Arthur, Texas, experienced
credit downgrades after major hurricanes. And after a fire nearly destroyed
Paradise, California, last year, the pool of pension obligation bonds it was a
member of saw its credit downgraded. As New Orleans rebounded, its credit improved. The city adopted
a resilience strategy, bolstered its levee system and pursued other projects,
such as turning green space into water reservoirs during periods of flooding.
Today, the city sees its biggest climate threat as extreme rainfall, which has
increased in frequency in recent years and flooded parts of the city. Leaders in New Orleans are asking voters to approve $500 million
in new bonds, which would pay for infrastructure improvements such as the replacement
of outdated pipes, as well as other goals like affordable housing. City
officials say it shows New Orleans is “doubling down” on its infrastructure
program. “The environment is changing. More water’s coming down in a
shorter period, and we have to respond to that,” said Norman White, the city’s
chief financial officer. “Our first responsibility is to the citizens of
New Orleans. Fortunately, that lines up with investors.” Coastal cities across
the country are building seawalls to stave off rising oceans. Others are
elevating roadways to prepare for more frequent flooding. Some are requiring
sturdier new construction and retrofitting existing buildings to withstand
severe weather events. Communities in drought-prone areas may focus on projects
such as water storage, while those with flooding concerns must fortify their
sewage infrastructure. Last year,
Moody’s surveyed the 50 largest U.S. cities; 28 responded. Among them, they had
240 climate resilience projects, totaling $47 billion. Some 60% of the projects
were to combat flooding. Florida’s
Miami-Dade County has been praised by analysts for its infrastructure
investments focused on climate preparedness. Ed Marquez, the county’s deputy
mayor, said future financing is a “concern,” but officials are trying to
address that with capital plans focused on dealing with the changing climate. “This is a
many-year process as we fix our infrastructure, as we add new infrastructure,
as new science comes on board,” he said. “Miami is still growing. People are
still coming. Investors are buying our bonds. We’re telling them what the odds
are, but it’s odds that they’re willing to play.” Statewide,
Florida remains in good shape creditwise, despite the challenges many of its
communities are facing. Ben Watkins, the state’s director of bond finance, said
that’s likely to continue, even amid hurricanes and rising sea levels. Even the
most devastating hurricane seasons have ended up being a “blip on the radar” in
terms of Florida’s credit health, he said. But concern remains for smaller
governments within the state. “People are
dying to come to Florida and coming to Florida to die,” he said. “Until that
changes, we’ll have the economic engines to be able to access credit.” Cities with
climate change risks should follow Florida’s lead and borrow now for local
projects, said Fabian, the analytics researcher. “As investors get smarter about climate change risk, it will become more expensive for governments with the largest need to borrow,” Fabian said. “Their costs to borrow could certainly be higher. Acting earlier is almost always cheaper.” |
