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Climate change poses new threat to US cities' long-term creditworthiness

Amid projections of increased climate-related disasters and worsening chronic issues such as flooding, U.S. cities' adaptation efforts are increasingly being looked at as a factor in creditworthiness.

Some of the largest cities in the U.S. are starting to mitigate the physical risks of climate change by upgrading their flood management infrastructure and making other investments. In early 2019, cities were collectively working on about 240 climate-related projects totaling $47 billion, according to Moody's Investors Services. Moody's expects cities to issue a growing number of debt and bonds to help finance the projects.

But as climate impacts escalate, the ability of cities to attract investors to buy those bonds may depend on whether they can show that climate change-related risks will not keep them from paying off the debt. Credit ratings analysts are increasingly exploring those questions in meetings with local officials.

The analysts say, "We're rating your bonds, and are you going to be able to pay them back given what's occurring in your city?" Honolulu Mayor Kirk Caldwell said July 17 during a hearing held by the U.S. Senate Democrats' Special Committee on the Climate Risks. Hawaii's Climate Change Mitigation & Adaptation Committee estimated in 2017 that if unaddressed, frequent flooding in the state caused by rising sea levels could result in $19 billion in economic losses, with the greatest potential loss in Honolulu.

An official of another city struggling with sea-level rise, Miami Beach, Fla., Assistant City Manager and Chief Resiliency Officer Susanne Torriente, said during a March climate conference in Baltimore that she is becoming increasingly aware of the need to communicate to investors and bond rating analysts the proactive steps her city is making to adapt to climate change.

"We're sharing that information now," Torriente said. "This financial world is a whole new audience ... a very important audience, of decisionmakers."

Climate change can chip away at a city's creditworthiness

Moody's Vice President Michael Wertz said that while climate change is rarely the main reason behind a credit downgrade, a city could struggle to pay back its bonds if it is dependent on one source of tax revenues, such as beach tourism, that could be disrupted by climate change. Cities may have similar trouble if a large number of its residents and businesses decide not to rebuild or relocate after repeated disasters blamed on climate change.

Given Moody's Corp.'s increasing focus on climate issues, the firm recently bought a majority stake in climate-risk data provider Four Twenty Seven Inc.

The United Nations' Intergovernmental Panel on Climate Change warned in 2018 that the world will see an uptick in the number and severity of climate-related disasters such as wildfires, hurricanes, flooding and drought if it continues on its current global-warming trajectory.

SNL Image

A cyclist rides past an area flooded during an especially high tide in Miami in October 2018.
Source: AP

Moreover, flooding in U.S. coastal cities that decades ago happened only during a major storm can now occur on sunny days when a steady breeze or a change in coastal currents overlap with a high tide and rising sea levels. Such "nuisance" flooding is contributing to overwash and beach erosion, overwhelming stormwater systems, disrupting harbor operations, closing roadways, degrading subsurface infrastructures such as pipelines, and hurting property values, the U.S. National Oceanic and Atmospheric Administration, or NOAA, said in a July report.

The NOAA found that the annual rate of high-tide flooding is rapidly increasing in more than 40 locations. Washington, D.C., for example, could see the average annual number of flood days increase from three in 2000 to 120 by 2050, the NOAA forecast. Similarly, Miami could experience 55 more high-tide flood days by 2050 compared to 2000. And Morgans Point, Texas, just south of Houston, could see as many as 215 flood days annually by 2050, compared to its average of four flood days in 2000.

Federal funding is not sure thing

City officials and investors typically assume that the federal government, largely through the Federal Emergency Management Agency, will step up to fund recovery from a disaster, experts said. But FEMA may not always be willing to back recovery for projects in areas that were already known to be vulnerable and where the city could have prevented the damage, leaving the city or state to foot the bill.

For example, California announced in April that it will issue nearly $300 million in bonds to fund water infrastructure projects, including to repair the Oroville Dam that failed in 2017 due to heavy rains and has reportedly already cost the city more than $1 billion in repairs. A U.S. Department of Energy-funded study found that global warming may have contributed to the dam’s failure.

California issued the bond about a month after FEMA refused to reimburse the state for more than $300 million in repair costs because the dam had preexisting problems the state should have fixed before the event, according to The Sacramento Bee.

Cities may also find themselves deep in debt or unable to pay for necessary remediation projects as climate-related costs increase, experts said. The federal government is in the early stages of creating programs and funds tied to adaptation efforts, said Laura Lightbody, a project director at The Pew Charitable Trusts, which has studied the issue of disaster funding.

"We're really good at handing out money after disasters happen but there aren't enough available funds at all levels — local, state and federal — to do activities like buying out repeatedly flooded properties and enhancing stormwater management systems before a disaster happens or [for projects that] are not tied to a disaster happening," Lightbody said.

Investment community slow to react

The Intergovernmental Panel on Climate Change's report served as a bit of a wakeup call to municipal bond investors and prompted some to begin talking about whether they should consider the risks the report described when making investment decisions, said Matt Fabian, a partner at Municipal Market Analytics. Yet because the municipal bond market has significantly more demand than supply, investors may be hesitant to forgo a municipal bond because of perceived climate risks, Fabian noted.

"Right now, the municipal bond market is grappling with this question of when is climate risk high enough that it's a reason to say no to a bond," said Emily Robare, head of environmental, social and governance research for Gurtin Municipal Bond Management. A team at Gurtin has started to tackle this issue, including by asking "where can we get data, what metrics do we want to look at, [and] how do we incorporate climate risk into what we're looking at," Robare said.

The lack of pressure from the investor community means cities and localities have little to no incentive to disclose their climate-related risks. Columbia University and The Brookings Institution recently found that most local governments that depend on revenues from the coal industry are not disclosing those risks nor are they discussing how climate policies are causing declining coal production and threatening the future economic health of their local communities.

Because "investors don't have the ability to discipline or discriminate against issuers that don't take action … we are relying for the most part on the states setting policy to encourage climate change adaptation and mitigation," Fabian said.

Climate adaptation efforts are often a bigger priority in localities that have recently experienced major disasters or an increased number of extreme weather events, Robare and Lightbody said.

"Politics certainly plays a role but for a lot of people, [climate change is] just something they haven't been exposed to ... on a personal level," Robare said. "In a large part of the United States, it's easy to be complacent because you look out your window and everything looks normal and you don't realize exactly how far along everything is."

Instead of not purchasing bonds from cities that are especially vulnerable to climate risks, some investors are buying shorter-term bonds, according to Fabian. For instance, Miami Beach voters in 2017 approved $400 million in bonds, about half of which will be dedicated to tackling sea-level rise risks, including by raising public roads and seawalls and improving stormwater drainage. Despite those efforts, some investors remain wary.

"Right now, some investors will not buy Miami for longer than 10 years," Fabian said. That trend is overshadowed by the continued willingness of many investors to buy 30-year bonds from Miami, he added.

While Cedar Rapids, Iowa, does not share the same coastal flooding concerns as Miami, Cedar Rapids is experiencing more frequent flooding. After a 2008 flood wreaked havoc on the city's downtown, city representatives lobbied the state of Iowa to create a flood mitigation grant program in 2013. Using a combination of funds, including from the state program, a U.S. Army Corps of Engineers grant, and from municipal bonds, the city is building a flood control system, part of which is already operational and helping to pump floodwater out of the city.

Cedar Rapids' flood control efforts are a prominent topic in the city's credit ratings' presentations, Deputy City Manager Sandi Fowler said. "The flood control system, we believe, is not only protecting the investment of our community, the economy of our community, but also ensuring that our economy continues to be attractive to investment."