The U.S. municipal market has always faced credit exposure to hurricanes, floods, drought, fires, tornados, earthquakes, and other catastrophes. In addition to episodic event risk from natural disasters, S&P Global Ratings believes it is important to consider the current long-term credit implications of the physical impact of climate change that municipal debt issuers must contend with. In our view, municipal issuers face risks on two fronts: from the growing cost of extreme weather events; and more gradual changes to the environment affecting land use, employment, and economic activity that support credit quality. Indeed, S&P Global Ratings believes that what previously were viewed as the credit implications associated with transitory storms must now increasingly be viewed through the lens of climate change risk. An S&P Global Ratings' issuer or issue credit rating is a forward-looking opinion about overall creditworthiness and focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. We might revise our opinion as we assess how an entity's credit strengths and exposures change in response to current and emerging risks.
Management teams make choices today that could have long-term rating implications, and investment in infrastructure assets exposed to coastal flooding and rising sea levels illustrate this perhaps most clearly. The value of sustainable development and public investment in resilient infrastructure often only becomes more obvious after natural disasters, when the human costs and property damage are tallied. Governments' and municipal enterprises' planning for these types of risks is embedded in our criteria across all sectors, and we expect this will be more critical for credit quality as costs of infrastructure adaptation and regulatory-compliance increase. In addition, a future where the availability of federal disaster relief and insurance -- including to what extent policymakers confront the moral hazards of the National Flood Insurance Program (NFIP) -- is less certain compounds the risks. We believe organizations demonstrating current and long-term plans -- and reasonable attempts to fund them(including emergency preparedness) -- will be better prepared for these episodic risks Planning for climate change and mitigating risks is one component to our credit analysis and our opinion regarding the adequacy of management's plan is one of many factors that determine ratings.
S&P Global Ratings has published extensively on topics related to sustainable finance as well as the economic cost -- and credit implications -- of natural catastrophes and extreme weather events. This report answers frequently asked questions about how our analysis of climate change risks interacts with our existing U.S. public finance (USPF) criteria and rating definitions. Climate risk and exposure to natural disasters overlap, although not all natural disasters are necessarily attributable to climate change. As with other broadly applicable, long-term credit issues with near-term implications (for instance, pension and other postemployment benefits), we believe investors and other marketplace participants benefit from a clear understanding of the climate-related factors we consider material for municipal issuers, and how we assess the risk management. S&P Global Ratings is a strong proponent of increased disclosure and transparency related to climate risk exposure and acknowledges that it is a topic with evolving industry-reporting standards. Similar to other emerging risks, as the understanding of climate issues develops and information quality disclosed improves, S&P Global Ratings will continue to highlight how it captures these risks in its credit analysis and how they affect ratings. We monitor ratings and the current risks, potential risks, and credit strengths that underpin the ratings, and their impact could change.
Frequently Asked Questions
Does S&P Global Ratings differentiate between natural disaster risk and climate change risk?
From a credit perspective, our assessment of natural disaster risks that can impair an issuer's ability to repay debt is indifferent as to its root cause. This includes naturally occurring phenomena such as fires, earthquakes, tsunamis, and (to a lesser extent) climate-related events such as hurricanes, tornados, severe thunderstorms, or snowstorms. For example, the American Meteorological Society data indicate extremely violent tornadoes constitute less than 1% of the total and have not shown an increase in occurrence in the more than 50 years of that type of record keeping. Nevertheless, according to global insurer Swiss Re, the financial cost of natural disasters has increased and various studies have identified that a key factor for that is the growth in exposure in high- risk affected areas. While the precise impact of climate change on extreme weather events is still uncertain, different studies are pointing toward an increase in the financial impact of these events. Historically, issuers have mitigated these risks with prudent contingency planning and budgeting to ensure access to liquidity, commercial insurance, the historical availability of federal disaster assistance, and infrastructure investments made to limit physical damage (for instance, infrastructure hardening and seismic retrofits).
In the USPF context, we see climate-change-related risks as the near-term exposure to increasingly costly and possibly more frequent extreme weather; and the long-term accumulation of negative impacts from a changing environment. This includes the costs of mitigating and adapting to those changes, which can affect the physical assets of local governments, state governments, and municipal enterprise infrastructure owners; their services delivery; or other key functions.
How could climate change risk affect municipal market issuers?
The implications can be broad: from the direct costs of increasingly expensive weather events, to the long-term implications of coastal land use, including the viability and variability -- economic and otherwise -- of property exposed to sea level rise, which exacerbates coastal flooding and increases high tides, which can reduce the property tax base many public finance entities rely on. In addition to the environmental implications of sea water encroachment into coastal areas, infrastructure, and fresh water aquifers, the higher average and extreme temperatures associated with climate change can have many effects: increase electricity loads in many regions; cause or contribute to droughts and desertification; affect crop production, soften pavement and make roadways more susceptible to wear and tear; make rail tracks buckle; and prevent aircraft from taking off under some conditions. For example, all else being equal, warmer weather will result in lower sales for utilities with peak demand in the winter (while also lowering demand associated with electric heating) and for those utilities that have summer peaks driven by greater need for air conditioning, higher temperatures could increase demand, potentially imposing additional capital costs. As noted, the costs of mitigating and adapting to climate change could strain the debt metrics of entities responsible for financing the adaptation costs, potentially leading to downgrades. Alternatively, the potential rating impact of higher leverage might be neutral, if sufficiently offset by the quantifiable benefits of mitigating long-term risks associated with climate change such as long-term cost savings..
How are municipal issuers responding to climate change?
Overall, we see some municipal issuers recognizing, measuring, and reporting their impact on the environment as well as documenting how operations and capital planning are changing in response, but this is not widespread. The State of California leads these endeavors and has undertaken extensive efforts to understand how climate change affects all core functions of government, including energy, land use, emergency management, public health, transportation, water, and agriculture.
We also have observed growing recognition of these risks by many issuers who are particularly exposed to coastal flooding and king tides, which occur not only during extreme weather events but are increasingly common during regular high tide. Virginia Beach and Norfolk, Va., and Miami Beach are already dealing with this. The tiny towns of Isle de Jean Charles, La., and Newtok, Alaska, are already preparing to abandon their waterfront locations and move to higher ground. Newtok has lost its port, landfill, and sanitary sewer lagoon and believes the loss of its drinking water supply is imminent. In our view, the area of focus post-Hurricane Harvey, perhaps not just for the Houston metropolitan statistical area, will most likely be on drainage and flood control infrastructure. For most municipalities drainage and flood control are a responsibility of the general government; some local governments have created separate storm water enterprises with a distinct fee structure and security pledged to revenue bonds, but this is less common.
We have seen that some state and local governments recognize the value of enhancing infrastructure's climate-change resilience and adaptability. Adaptation is defined as adjustments to natural or human systems in response to actual or expected climate change. This is most often associated with raising river or coastal barriers, building higher bridges, and increasing the capacity of storm water systems. We continue to monitor these types of effects on impacted municipal issuers and their efforts to mitigate or adapt to climate variability (see "Climate Resilience Can Protect Ratings From Sea-Level Rise And Threats To U.S. Coastal Infrastructure," published Oct. 22, 2015, on RatingsDirect.)
Can municipal market issuers access the insurance market to mitigate climate change risk, and are some types of risks not insurable?
Insurance is an important tool to mitigate the financial consequences of natural catastrophes, and governments and municipal enterprises can use insurance to mitigate their own exposure. More importantly, they can benefit significantly from high insurance coverage in their local economy as it becomes more resilient to the impact of natural catastrophes. While there is still uncertainty regarding the precise impact of climate change on extreme weather events, it is likely that climate change could make some risks uninsurable or too expensive to insure. Still, local authorities could help maintain the insurability of local risks by investing in adaptation (that is, flood protection) or by constraining development in high-risk areas.
Often, insurance in high-risk areas is subsidized to increase penetration and improve the resilience of communities. The NFIP insures in high-flood-risk areas at below the risk cost. While subsidized insurance helps improve the economic resilience of high-risk areas, it does not give an accurate price signal about the vulnerability of those areas, and many view it as encouraging development. In fact, some observers point to the moral hazard of the NFIP and contend that government involvement in providing disaster assistance dissuades people from making fully responsible choices that would reduce overall risk. If policymakers confront the NFIP's moral hazards and reduce the scope of coverage it provides, or increase premiums in line with the underlying risk, development or redevelopment of coastal lands might be constrained as they become uninsurable. Then, when confronted with the full costs, people will be economically discouraged from doing so.
How do S&P Global Ratings' existing criteria for USPF incorporate climate change risks? Would ratings reflect the absence of or inadequate planning?
All of our USPF criteria include an assessment of management, including to what extent long-term planning is in place and actively used. Our Waterworks, Sanitary Sewer, And Drainage Utility System criteria and proposed criteria for Transportation Infrastructure Enterprises specifically identify climate risk assessments in our analysis of management and operational characteristics. For example, our water utility criteria include an assessment of drought planning, whereby regional or statewide water plans provide high-level frameworks; establish best practices for resource management; and define priorities among users, such as homes and agriculture. Our electric utility and wholesale cooperative criteria have long evaluated environmental regulation including those associated with transitioning to less carbon-intensive production, the current regulatory climate notwithstanding.
Similarly, a component of criteria for assessing general obligation (GO) debt of state or local government is our Financial Management Assessment. It includes assessing policies and practices such as long-term financial and capital planning, and maintaining a minimum level of reserves. Our tax-backed debt analysts evaluate the potential long-term impact to the market value of the tax base, both in terms of depression of prices and any actual elimination of properties (and resulting loss of population) if rebuilding after a natural disaster were disallowed. If this happens, we would also assess the impact to financial capacity if the local government buys properties in the flood-prone areas. Our rating assessments include an analysis of the area's economic structure and diversity. In an area that relies heavily on tourism, for example, the extent of damage to existing structures and the speed of recovery would have a greater impact on credit quality than in areas with a deeper and more diverse economies.
To the extent we viewed risks associated with exposure from climate change as material to the rating, the absence of such a plan would be a credit negative. In our view, all else being equal, municipal issuers that have plans -- and reasonably attempt to provide funding for those long-term plans, including emergency preparedness -- will most likely exhibit relatively less risk to creditworthiness from exposure to climate change. However, planning for and mitigating climate change risk is just one factor in our analysis.
Has S&P Global Ratings raised or lowered ratings because of climate change risks?
In USPF, credit impacts from climate change have largely focused on the fallout from natural disasters S&P Global Ratings' research has shown that, with some exceptions, natural disasters have had limited impact on municipal ratings in the U.S. Downgrades have been isolated and less common, even as the affected areas increasingly include large and growing population centers. Not surprisingly, issuers who have prepared for natural disasters by maintaining strong liquidity positions and building resilient infrastructure have seen credit stability. They have benefited from the economic activity from rebuilding, the availability of federal and state aid, federal policies supporting coastal development, and other factors mitigating risks to the long-term viability and composition of tax bases.
However, several local governments and municipal enterprises in the New Orleans area and Galveston, Texas, were downgraded following hurricanes Katrina, Rita, and Ike. In these instances, the economic and financial damage from the hurricanes was long-lasting and severe enough to change our view of many issuers' medium-term growth prospects and ability to generate sufficient tax revenues before exhausting external liquidity, as well as their long-term viability at their pre-disaster rating levels. Katrina made landfall on the Gulf Coast on Aug. 29, 2005, leading to widespread destruction, an outflow of residents, and massive rebuilding costs in New Orleans. Taxable assessed value (AV) fell 22% and we lowered the GO debt rating to 'B' from 'BBB+'. However, the city ultimately recovered with current taxable assessed value (AV) exceeding pre-Katrina levels, as well as the rebounding of what we consider a strong tourism industry and strong sales tax growth with the population now at 81% of pre-Katrina levels. The New Orleans Sewerage and Water Board -- which we downgraded to 'B' from 'A' after Katrina -- did not default on its capital market bonds even with a mass exodus of the city's population and the already-poor system condition even before the hurricanes. This was in large part to its board of liquidation, which oversaw much of the utility's finances post-Katrina and Rita. However, the board relied for a number of years on one-time and non-operating revenues and there was some forbearance and forgiveness of some state obligations. Years later, despite the current A/Stable rating, operational challenges remain. Similarly, New Orleans International Airport dealt with the significantly reduced traffic levels. Our rating on it fell to 'BB' before recovering. We currently rate the airport's debt 'A-', with a stable outlook.
What is the status of disclosure with respect to climate risks?
Market participants have taken measures in response to calls by global investors, lenders, insurers, and others for better information related to climate risks and proposed a set of voluntary and consistent financial risk disclosures. In late June 2017, a Task Force on Climate-Related Financial Disclosures of the Financial Stability Board released its final report with 11 recommendations for all organizations -- including public-sector organizations -- to improve transparency of climate-related risks with a focus on governance, strategy, risk management, and identification of specific metrics and targets (for more information, see "Credit FAQ: How the Recommendations Of The Task Force On Climate-Related Financial Disclosures May Figure Into Our Ratings," published Aug. 16, 2017). While the U.S. municipal market might adapt improved climate disclosure standards voluntarily, we have observed that government and not-for-profit enterprises often await formal guidance, accounting standards, or guidelines for financial reporting or final requirements as determined by regulators. S&P Global Ratings has been a vocal proponent of improving disclosure, recognizing that the availability and quality of information in this area at the state, local, and regional levels might be limited now but is improving.
As it relates to market information, many parties are attempting to quantify potential economic costs from climate change. A 2017 study published in the journal Science examined the very long-term (through 2099) effects on labor productivity, mortality, energy demand, and crop yields showing the lower Midwest and South being the most exposed to declines in GDP and indicating positive GDP impacts in parts of the Pacific Northwest and New England. A 2015 study by the nonprofit organization Climate Central compared U.S. states' exposure to and preparedness for climate risks, including extreme heat, drought, wildfires, and inland and coastal flooding; then assigned grades ranging from A to F (see map). With respect to coastal flooding, the report examined the population currently residing in the 100-year coastal floodplain and projected the population at risk assuming the sea level rises by 2050 for each coastal state. Predictably, Louisiana and Florida have the highest risks compared with the other 22 coastal states, with 21% and 18% of their population, respectively, living in the 100-year coastal floodplain. Florida has 3.5 million people living in the 100-year coastal floodplain, followed by 950,000 in Louisiana and 430,000 in New York. Overall, the report noted that states are better prepared for coastal flooding than for other climate risks, but did not estimate the costs of improving resiliency. We consider several sources of information, including our proprietary research as well as third-party studies such as the ones mentioned above, to inform our forward-looking view of the potential credit impact.
Source: Climate Central; http://assets.statesatrisk.org/media/NationalSummary.pdf
How do S&P Global Ratings' credit rating and outlook time horizons align with long-term risks related to climate change?
The question of rating horizons -- specifically, whether the credit rating horizon is long enough to capture climate-related risks -- is important. Credit analysts must consider the visibility and certainty about what risks can form, how they can be mitigated, and if so, at what cost.
Within our ratings process, issuer credit ratings can change. This reflects not only the issuer's changing fundamentals but our evolving views of that issuer's future fundamentals. In our experience, a foreseeable financial forecast horizon is generally less than two years for a speculative-grade rating (rated 'BB+' and below) and generally no more than five years for an investment-grade rating ('BBB-' and above), reflecting that investment- and speculative-grade-rated entities are differently vulnerable to the many factors in the business, financial, natural, and social environments. If we have a high degree of visibility and certainty about risks and opportunities that an issuer could face beyond the horizons described, we factor those into our ratings, as appropriate.
By their nature, many climate-related risks such as sea level rise, water scarcity, and changes to environment affecting economic activity extend well beyond typical credit rating and outlook horizons and, in some instances, bond maturities. However, we have long identified and factored in many risks (for instance, regulation and evolving capital requirements) that are now viewed as attributable to, or associated with, climate change and we believe our existing criteria for USPF issuers do incorporate and broadly address these risks.
Also, rating actions might depend on future policy actions that impose new costs or create opportunities for rated entities. However, a rating can, necessarily, only reflect the effects of a given policy action once that policy is highly certain (for example, if a related law or regulatory requirement has been, or is close to being, adopted) and once we understand its potential credit implications better. The credit implications of potential climate policy actions for a specific industry or company will only become clear in our ratings once the action is imminent.
How will S&P Global Ratings assess climate risk?
An S&P Global Ratings' issuer credit rating is a forward-looking opinion about an obligor's overall creditworthiness and can change. We assess credit risks associated with natural disaster and climate change under our existing criteria. As noted, we have historically highlighted risks the market now views as climate-related. We will continue to incorporate these risks into our reviews, in proportion to their impact and materiality on credit quality and relative to the other factors in the analysis. Complementing the climate risk elements in our existing criteria, , we anticipate seeking additional insight from management to help us gauge preparedness for issuers we view as having credit exposure. Some questions could include:
- Have you undertaken an assessment of your current vulnerabilities to natural disaster and long-term climate change risks?
- How are infrastructure assets exposed to climate change risk, and how are you mitigating any risks?
- Does your capital planning incorporate any costs to address any exposures or investment in adaptation?
- Have you sought insurance and other forms of risk mitigation?
- How would long-term changes in the environment affect population and demographic trends, land use, employment, and other parts of your local economy?
What has S&P Global Ratings' research on the impact of climate risks on credit quality revealed to date?
S&P Global Ratings has published extensively on topics related to sustainable finance as well as the economic cost -- and credit implications -- of natural catastrophes and extreme weather events on corporate entities, sovereign governments, insurance companies and re-insurers, municipal infrastructure assets, and the broader U.S. economy. (See S&P Global Ratings' Climate-Related Research section for a partial list.)
In general, negative rating actions attributable to natural disasters or climate risks as a proportion of total rating actions have been small. However, we believe it could increase if climate risks increase and those risks are not adequately mitigated. Among corporate issuers, subsectors with the greatest exposure to environmental and climate risks have been the oil refining and marketing, regulated utilities, and unregulated power and gas subsectors; the greater focus on climate risk in our criteria for these segments reflects this. If the severity and frequency of climate-change-related events continue to rise, we expect the regularity of climate-related corporate rating actions to accelerate in coming years (see "How Environmental And Climate Risks Factor Into Global Corporate Ratings," published Oct. 21, 2015). Our research, which modeled the effects of natural catastrophes of all types on sovereign ratings, showed that some would be negatively affected, particularly those most exposed to severe weather. Insurance would only partially mitigate the risk and credit implications.
The U.S. economy's breadth and diversity complicate measuring economic effects of climate change in terms of lost or lower GDP. In the Northeast, for example, rising sea levels and the possibility of Superstorm Sandy-like storm surges would threaten infrastructure already in desperate need of refurbishment. Meanwhile, in the Southeast, more than one-third of residents live in counties along the coast, and one-third of GDP comes from those areas -- meaning that if significant coastal acreage were unproductive due to coastal flooding or sea level risk, there would be an outsized effect on the region's economies, through the loss of arable land, the disappearance of tourist areas, and the destruction of property.
S&P Global Ratings' Climate-Related Research
- Credit FAQ: An Overview Of U.S. Federal Disaster Funding, Sept. 19, 2017
- In A Storm's Aftermath: Assessing The Impact On Local Government Credit Quality, Sept. 13, 2017
- How Long 'Til We Get There? Major Post-Hurricane Recoveries In Recent Years, Sept. 7, 2017
- Near-Term Rating Stability Does Not Preclude Longer-Term Challenges For Hurricane Harvey-Affected Texas MUDs, Sept. 5, 2017
- Beyond Green Bonds: Sustainable Finance Comes Of Age; April 26, 2017
- Policymakers Play A Role In Preparing Financial Systems For Climate Change Risk, Nov. 10, 2016
- Evaluating The Environmental Impact Of Projects Aimed At Adapting To Climate Change, Nov. 10, 2016
- Climate Finance A Year After Paris: Driving Politics Into Action, Nov. 8, 2016
- Climate Change-Related Legal And Regulatory Threats Should Spur Financial Service Providers To Action, May 4, 2016
- The Heat Is On: How Climate Change Can Impact Sovereign Ratings, Nov. 25, 2015
- Insurers May Anticipate A Smooth Road Ahead On Climate Change, But Their View Could Be Restricted, Nov. 16, 2015
- Economic Research: Reversing Global Warming Requires Nothing Less Than A Global Effort, Nov. 16, 2015
- Climate Change: Building A Framework For The Future, Nov. 13, 2015
- Climate Resilience Can Protect Ratings From Sea-Level Rise And Threats To U.S. Coastal Infrastructure, Oct. 22, 2015
- How Environmental And Climate Risks Factor Into Global Corporate Ratings, Oct. 21, 2015
- Storm Alert: Natural Disasters Can Damage Sovereign Creditworthiness, Sept. 10, 2015
- Countries And Companies Are Taking Steps To Counter Climate Change And Natural Catastrophes; April 21, 2015
- Climate Change Will Likely Test The Resilience Of Corporates' Creditworthiness To Natural Catastrophes, April 20, 2015
- If Flood Defenses Don't Keep Up With Climate Change, Flood Re Could Increase Risks To U.K. Insurers; Oct. 1, 2014
- Economic Research: For The U.S. Economy, Climate Change Is A Case Of Pay Now--Or Pay More Later, Sept. 18, 2014
- Climate Change Could Sting Reinsurers That Underestimate Its Impact, Sept. 3, 2014
- Working With Governments To Increase Disaster Resilience Can Open New Doors For Reinsurers, Aug. 27, 2014
- Dealing With Disaster: How Companies Are Starting To Assess Their Climate Event Risks, May 21, 2014
- Are Insurers Prepared For The Extreme Weather Climate Change May Bring?, May 19, 2014
- Credit FAQ: As Investors Seeking Higher Yields Eye New Catastrophe Bond Issues, What Are The Key Risks?, Nov. 11, 2013
- Environmental Regulation Starts To Squeeze Utilities' Credit Quality, Nov. 14, 2012
- Ready For The Big One? How Natural Disasters Can Affect U.S. Local Governments' Credit Quality, Oct. 27, 2011
Only a rating committee may determine a rating action and this report does not constitute a rating action.
|Primary Credit Analysts:||Kurt E Forsgren, Boston (1) 617-530-8308;|
|Theodore A Chapman, Dallas (1) 214-871-1401;|
|Secondary Contacts:||Miroslav Petkov, London (44) 20-7176-7043;|
|Peter Kernan, London (44) 20-7176-3618;|
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