Flooding could leave billions of U.S. municipal debt underwater

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About a quarter of all U.S. infrastructure is at risk of severe flooding, a new study finds, which could affect municipal bond market prices by $ 4 billion and jeopardize the creditworthiness of city and state issuers.

New York-based climate research firm First Street Foundation released data this week showing that America’s infrastructure – including roads, hospitals and power plants – is more prone to flooding than previously known. previously estimated. This has serious implications for state and city coffers, for property values, and for mortgage-backed securities and municipal bonds.

Louisiana, Florida and West Virginia have some of the worst flood prospects in the contiguous United States, according to data from the First Street Foundation. In Louisiana, 45% of all critical infrastructure, a category that includes hospitals, fire stations, airports and power plants, are at risk of being rendered unusable by flooding this year.

39% of roads and 44% of social infrastructure are also threatened with closure – schools, government buildings and places of worship. In some cities in Louisiana, such as Metairie and New Orleans, the risk for all of these categories is close to 100%.

Municipal debt has long been a safe haven asset class popular with long-term investors, including pension funds and insurance companies. While the default rate on municipal bonds has historically been low, it could rise as cash-strapped cities struggle to meet the costs of extreme weather damage.

Muni bonds also tend to have maturities between 15 and 30 years; the average maturity issued last month was 18.6 years, according to the Securities Industry and Financial Markets Association. With climate change so rapid, that leaves a lot of time for disasters.

Investors also face the risk of geographic concentration. Owning munis issued by the state you live in offers investors certain tax advantages, so munis investors tend to have high exposure to certain regions. A severe weather event could therefore quickly wipe out an enormous amount of value in an armed portfolio.

“It is clear that (the climate) is a risk factor” in the municipal debt market, said Peter DeGroot, head of municipal bond research at JPMorgan. “The increasing frequency and intensity of weather events is a costly and complex problem for the federal government – as well as for state and local governments.”

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Flooding can affect municipal debt in a number of ways. There is the direct effect: a municipal bond issued to finance the construction of a hospital could lose value or risk defaulting if its source of income suddenly ends when the hospital is destroyed in a storm.

Natural disasters can also drive people and businesses away and reduce the value of existing properties, lowering a state or city’s tax base, another way to pay off municipal bonds.

Large-scale flooding is also extremely costly. Between 1980 and 2020, natural disasters caused damage worth $ 1.8 billion, according to the Government Accountability Office, about half of which was linked to hurricanes and tropical storms. Municipalities need to borrow more to pay for reconstruction and to build new climate adaptation infrastructure. This increases the credit risk of existing bonds as well as the cost of borrowing new funds.

Research by Paul Goldsmith-Pinkham at Yale University shows that municipal bond markets have already started to incorporate the risks of sea level rise.

The federal government has so far stepped in to help cities rebuild after major disasters. But as these events become more frequent, resources can be strained and local governments can take greater responsibility for funding recovery efforts.

Among the 10 states with the greatest risk of infrastructure flooding, two are also among the most indebted: Connecticut and New York. Connecticut has the highest tax-financed net debt per capita of the 50 states, the second highest tax-financed net debt as a percentage of personal income, and the second highest tax-financed net debt as a percentage of gross domestic product state, according to the rating agency Moody’s. New York is also in the top 10 in each of these categories.

There is anecdotal evidence of an overlap between municipalities with debt and those at high risk of flooding. Adding climate to a list of credit risks could exacerbate a difficult situation for these states and cities, making it even more difficult and costly for them to borrow.

One of two municipal debt defaults in 2020 – though not driven by climate costs – was in New Orleans, the city with the second highest flood risk in the country. In Stockton, California, one of the largest cities to go bankrupt, 75% of critical infrastructure and 94% of its social infrastructure are at risk of flooding this year.

“With a lot of these climate risks, we might not want to buy a small town on the coast that has a high risk of flooding, but we might be comfortable owning a bigger name with a better track record for a period. shorter, because we have to think about how to actually assess this calculated risk, ”said Alexa Gordon, portfolio manager and head of muni ESG at Goldman Sachs.

The three major US rating agencies – Moody’s, S&P and Fitch – have started to incorporate climate risk into their municipal debt ratings.

“Our analytical view has been that flooding is akin to other risks that a state or local government might face,” said Marcy Block, senior director of sustainable finance at Fitch Ratings.

“To the extent that flood risk becomes credit risk because it is beyond management’s ability to control, this would be reflected in our ratings and ESG relevance scores. “


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