For more than a century, rating companies have published information helping investors gauge the likelihood that companies and governments will be able to pay back the money they borrow. Investors use those ratings to decide which bonds to buy and gauge the risk of their portfolio. For most of that time, the determinants of creditworthiness were fairly constant, including revenue, debt levels and financial management. And municipal defaults are rare: Moody’s reports fewer than 100 defaults by municipal borrowers it rated between 1970 and 2014.
Climate change introduces a new risk, especially for coastal cities, as storms and floods increase in frequency and intensity, threatening to destroy property and push out residents. That, in turn, can reduce economic activity and tax revenue. Rising seas exacerbate those threats and pose new ones, as expensive property along the water becomes more costly to protect — and, in some cases, may get swallowed up by the ocean and disappear from the property-tax rolls entirely.
When asked by Bloomberg, none of the big three bond raters could cite an example of climate risk affecting the rating of a city’s bonds.
This is climate risk: risk to fundamental variables such as economic activity, property values, and tax bases caused by natural factors (such as storms and floods) that may be exacerbated by our changing climate.
Climate risk has yet to be fully and sytematically incorporated into investigations into municipal creditworthiness.
Will your municipality will be be able to make timely and full payments on its then current debt load after a storm or flood, or repeated storms or floods, negatively influences economic activity?
What happens when the storms or floods are so severe that they “wipe out the taxation ability? I think this is a real risk” observes Bob Buhr, a former vice president at Moody’s who recently retired as a director at Societe Generale SA.
Predictions are imperfect, especially about the future; no one, no algorithm, no model can perfectly predict the future. The pace of climate change remains uncertain. What climate change, and concomitant effects on communities, community tax revenues, and the likelihood of any community being able to pay back bonds “is not a simple calculation.”
To date, the major ratings agencies are not asking questions about the expected effect of climate change on the economic activity and future tax revenues of US municipalities that look to “cheap money” (municipal bonds) to finance government.
Last September, when Hilton Head Island in South Carolina issued bonds that mature over 20 years, Moody’s gave the debt a triple-A rating. In January 2016, all three major bond companies gave triple-A ratings to long-term bonds issued by the city of Virginia Beach, which the U.S. Navy has said faces severe threats from climate change.
Investors, including 117 investors with $19 trillion in assets, say it would be prudent to include “systematic and transparent consideration” of environmental and other factors in order to identify systemic ESG risks in debt capital markets.
In other words, bond buyers should be warned. If storms and floods decrease property values and tax revenues while increasing spending on mitigating infrastructure such as sea walls, storm drains and flood-resistant buildings, pay back to bond buyers may be impacted.
Property owners – both residential and commercial – might take note.
Should your municipality meet a storm or flood that significantly impacts economic activity and the ability to collect tax revenues, it might be stressed and its ability to make scheduled payments on its municipal debt obligations might be impacted.
This will influence the municipality’s credit. If the credit is downgraded, the municipality will have to pay greater interest on its debt. To pay higher interest, it will have to collect more tax revenues. That means greater economic activity and/or higher taxes.
And/or, the municipality might have to reduce services. Municipal services include physical infrastructure (such as roads, bridges, water) and civic benefits such as fire departments and schools.
If such services are reduced, how prepared are you in your private capacity to initiate efforts and implement necessary steps towards the robust resilience (basically the ability to bounce back after a shock or multiple shocks to the system) and operability of your real estate holdings (residential, commercial, …)?
Do you have the means (financial, intellectual, technical, etc.) and the time to “do it yourself” (e.g., water, energy, transportation)? How do you use your real estate holdings? How long do you expect to own them? What are your expectations of resale value?
Moving to high ground might help manage the risk.
Food for thought.
See:
“Rising Seas May Wipe Out These Jersey Towns, But They’re Still Rated AAA” | Christopher Flavelle, Bloomberg, 25 May 2017
“Credit ratings agencies embrace more systemic consideration of ESG” | PRI, Principles for Responsible Investment, 26 May 2016
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