Acute physical risks, caused by extreme weather events such as hurricanes, wildfires, and tornadoes can materialize at any time, and can cause significant physical damage and disruption. Across U.S. public finance (USPF), these events can have greatly varied credit impacts. Leading up to and immediately after the event, management teams are focused on emergency responses, public health and safety, and supporting the general welfare of residents. But while they are engaged in fulfilling their immediate responsibilities, credit market participants want to understand the potential short- and long-term impacts on credit. S&P Global Ratings strives to relay any such impact in our ratings.
(The most unanticipated event of 2020, thus far, has been the COVID-19 pandemic, which we view as a social event through its impact on health and safety. For a reference to our coverage of the credit effects of the pandemic, see "COVID-19 Activity In U.S. Public Finance.")
However, this report focuses on extreme weather events that have occurred recently and the potential credit implications. It summarizes our process and considerations for analyzing and updating the market about our ratings across our USPF sectors during and after an extreme weather event. We also highlight sector-specific issues that we view as key credit considerations during these events.
- For all sectors we assess ratings impacts on a credit-by-credit basis. We consider both the severity of the damage within the affected area and the individual credit strengths and weakness.
- All else being equal, the better the credit quality at the time of the disaster the more likely a credit is to avoid major deterioration thereafter. Areas with what we believe have high levels of physical damage and operational disruption and have weaker finances are more likely to be negatively affected, in our view, and may be placed on CreditWatch with negative implications or assigned a negative outlook prior to contact with management, if appropriate.
- We view the availability of federal grants and disaster assistance as a key component in stabilizing communities after extreme weather events, especially for areas with little to no support from private insurance. There are typically delays in receipt of aid, which underscores the importance of liquidity.
- Local governments and utilities are more likely to have ratings impacts given broad geographic footprints that make the likelihood of being hit by an extreme weather event higher. Since states are so much larger, environmental events are usually not significant enough to have a major effect. Higher education, health care, and housing--which have discrete assets, such as buildings--are a smaller target, so those not part of a larger system could be heavily affected by a direct hit but typically have strong planning and finances associated with these risks when appropriate.
Identifying When Rating Action is Necessary
Across USPF sectors, S&P Global Ratings analysts follow extreme weather events via many information sources, including federal and state agencies, weather trackers, wildfire reporting outlets, and issuer conversations. When an issuer is identified within the affected area, S&P Global Ratings will assess the issuer's financial flexibility. In particular we assess liquidity levels and upcoming debt service due dates, as well as other reserves or liquidity sources (lines of credit) available to provide financial flexibility before state and federal aid arrives.
In some cases we may move on the rating or outlook prior to having an opportunity to speak with management if we believe there is a high likelihood of credit deterioration and we will use CreditWatch negative or negative outlooks to convey this information to the market.
In making these assessments, there are many similarities across our USPF sectors regarding what will likely minimize negative credit impact (see chart 1).
Credit Rating Considerations
While liquidity, reserves, and disaster planning are important during and in the direct aftermath of a weather event, longer term recovery or credit traits may change. Chart 2 lists some of the sector-specific shorter and longer-term credit considerations.
Local government and other tax-backed pledges
Property tax-backed issuers: Credits without major operations, such as special assessment districts, municipal utility districts (MUDs), or redevelopment agencies, are reliant only on property tax revenues that are based on the value or use of the land. These entities have little to no operations and the physical boundaries of these pledges usually encompass an area smaller than a city. Thus, a weather event could affect the entire area of a specific issuer of this type. If all of the land and development in an area is decimated, property tax revenues could be severely affected. While in the short term the higher rated bonds of these types are likely to benefit from high reserves, or excess coverage, longer-term, rebuilding the tax base will be key to maintaining credit quality.
Priority lien: Priority lien bonds, ranging from sales tax to hotel tax, will also see an impact that varies given the hit from the weather event, as well as the breadth of the collection area. Some priority lien pledges benefit from a wider collection base, such as a city, broad county boundaries, or in some cases may even receive a portion of the pledge from the state. But if the collection area for a hotel-tax backed bond is tourism-dependent and a storm hits directly, there could be a prolonged period of rebuilding where collections are significantly lower. However, during the rebuilding phase it can also be common to see some revenues increase for a brief time when construction activity ticks up.
Property tax-backed (city/county): Most municipalities benefit from a range of revenues including property and sales taxes. When assessing the longer-term impact of a weather event, the composition of revenue types and the underlying economic activity will be key determinants in whether there is likely to be negative credit impact. Areas with more property tax or a single focus economy such as tourism can be more susceptible to rating impact.
K-12 public and charter schools
Unlike cities and counties or other tax-backed bonds, most school districts (traditional and charters schools) benefit from significant state funding based on a per-pupil funding formula. The key to understanding potential longer-term credit implications for school districts is to understand the implications of the weather event on enrollment and the state's funding response to the weather event. Typically, we have seen states provide at least level funding during weather events and not penalize schools that may lose students temporarily. However, longer term, should students not return, or families move more permanently, the schools will need to adjust their operations for lower enrollment.
Charter schools that tend to operate on more slim margins and with weaker reserve levels could be more vulnerable to events than their traditional K-12 counterparts. Their operations and debt service are highly dependent on per-pupil funding which could be negatively affected when students do not attend school due to environmental impacts. Charter schools with insufficient liquidity to withstand the immediate impact of any damage or missed days of school could face operating pressure. If a charter school has sufficient liquidity to address the short term, longer term the credit impact will move with enrollment trends.
Public power, rural electric cooperatives, water and sewer utilities
For this sector, revenues derive directly from user fees. Therefore, from a credit perspective, we are interested in any medium-to-long-term implications to demand, either a result of a material number of structures damaged or destroyed, long-term customer displacement, or because of service delivery interruptions or complications.
For example, for electric systems, there may be transmission or distribution lines down (with lengthy power outages), substations damaged, and the utility's generating fleet compromised. For water and sewer systems, wildfires and floods can harm raw water supplies and sometimes water and sewer infrastructure; the lack of power typically leads to boil water notices to customers. These situations could lead to revenue declines and/or large capital outlays.
California's stricter liability standard
For public power utilities, California's legal standard for assigning liability to utilities for wildfires compounds the physical threats. Whereas utilities in any state could be subject to lawsuits for wildfires they directly or indirectly cause because of negligence, the laws are significantly stricter in California in the favor of property owners (and insurers). Under California law, courts can apply the doctrine of "inverse condemnation" to both investor-owned utilities and public power utilities. The doctrine provides that if a state actor or a company providing services to the public, like an electric utility, is the substantial cause of property destruction, whether or not through negligence, it can be held liable for damages to affected property owners. In many cases, electric utility power lines or other related infrastructure has either been proven or alleged to be the cause, with damages in some cases in the billions of dollars, not to mention the human toll. The resulting significant personal and property damage has led many affected to bring substantial legal claims for damages against some of the state's electric utilities. Because of this, we are particularly interested in investigating the cause of wildfires in California.
Even during weather events, hospitals remain open when possible and work to provide services. So it is not surprising that--particularly in areas prone to environmental events--hospitals generally have plans and infrastructure in place to manage these challenges. Ambulatory sites of care may have plans like the main hospital, but may not have the same level of infrastructure in place to manage an event. This could cause more prolonged business interruption and loss of revenue from these sites of care.
We maintain ratings on health care systems as well as stand-alone hospitals in U.S. public finance. A health care system with multiple facilities and locations, compared to a single site, is likely to be able to manage an event better financially, because of the potential revenue and income diversity and because it can logistically use its broader footprint and multiple facilities to help manage care in the event that another facility is affected.
While an event could have an immediate impact on a credit, many times the impact, if it occurs at all, is broad and plays out over time, due to the lost business and revenue shortfall months after the weather event is over.
As with not-for-profit health care, in the U.S. public finance housing sector we maintain ratings on issuers with a broad footprint and as well as those with concentration in location. Credit implications will vary depending on the nature of the issuer.
For issuer credit ratings of state housing finance agencies (HFAs), and community development financial institutions (CDFIs), credit impact is less likely given the broad nature of these entities' asset bases. These are organizations with diverse loan portfolios disbursed either in various states throughout the country or in various locations within a state or municipality. The impact of an extreme weather event in one location is not likely to affect an entire HFA's or CDFI's loan portfolio.
For standalone rental housing bonds, such as Section 8 or age-restricted rental housing, there is a higher likelihood of credit impact from a severe weather event than in diverse portfolios. These bonds generally lack asset diversity and are typically backed by either a single multifamily asset or a small pool of multifamily assets, typically in the same geographic area. As such, they are more susceptible to the effects of such events.
For public housing agencies, which serve a specific municipality, credit implications will vary with the severity and concentration of the extreme weather event. In addition, since the majority of PHA revenue is received from the federal government, credit actions will happen only in extreme situations.
Higher education has seen its share of event risk over the past several years. However, when focusing specifically on extreme weather events, higher education ratings have not tended to be as affected as other sectors (with the high-profile exception of Hurricane Katrina's impact on Tulane University). The minimal impact may in part be a benefit from location in some instances, but also, in our opinion, that sound enterprise risk management programs are in place and followed promptly. Colleges and universities also benefit from greater financial flexibility in the form of endowments and reserves which can be used to offset weather related costs.
Unique to the higher education sector is brand recognition which in some cases helps insulate the institution from having negative impacts on demand, enrollment or fundraising.
Among rated transportation infrastructure entities (airports, ports, toll road and transit operators) fortunately (or unfortunately), because of their role as critical infrastructure providers needed to assist in evacuation and recovery efforts, most have well-established and developed disaster planning and response protocols and assets that have been hardened over recent years in response to the events, often with dedicated federal grants and Federal Emergency Management Agency monies. What we have observed in practice is that extreme weather events disrupt operations and can result in damage whose cost is largely recovered through insurance or federal disaster relief. While it may take time to resolve and re-open transportation assets and service, only in limited examples (e.g. Hurricane Maria that struck Puerto Rico and neighboring islands in September 2017) has service interruption and physical damage negatively affect long-term credit quality.
The state sector is one of the highest rated sectors within S&P Global Ratings. The credit strengths inherent in many of the rated entities reflect those cited above as mitigating measures controlling the credit impacts of extreme weather events. States are often large areas where the physical impact of any event could be felt with great variation.
State management teams typically have instituted emergency planning and response protocols to address weather events. Additionally, states' relatively larger budgets, diverse revenue base and strong capital market access allow operations to continue even while facing revenue interruptions. These factors provide considerable flexibility to states and typically limit immediate credit impacts. However, long-term credit pressures to states will depend on the magnitude and duration of the event as well as the state's ability to address the unanticipated disruptions to its budget and economy, relative to the sector.
At times, states have stepped in to stabilize insurance markets following storm events. While this has benefits from an economic standpoint it can create contingent liabilities.
- Through The ESG Lens 2.0: A Deeper Dive Into U.S. Public Finance Credit Factors, April 28, 2020
- U.S. Higher Education Is Learning To Manage Its Own Risk, Dec. 2, 2019
- Near-Term Rating Stability Does Not Preclude Longer-Term Challenges For Hurricane Harvey-Affected Texas MUDs, Sept. 5, 2017
- An Overview Of U.S. Federal Disaster Funding, Sept. 19, 2017
- How To Evaluate Potential Rating Impacts For K-12 School Districts In The Wake Of Natural Disasters Like Harvey And Irma, Sept. 11, 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
- Florida Hospitals Show Resiliency Before, During, And After Hurricane Irma, Sept. 19, 2017
This report does not constitute a rating action.
|Primary Credit Analyst:||Lisa R Schroeer, Charlottesville (434) 529-2862;|
|Secondary Contacts:||Kurt E Forsgren, Boston (1) 617-530-8308;|
|David N Bodek, New York (1) 212-438-7969;|
|Geoffrey E Buswick, Boston (1) 617-530-8311;|
|Theodore A Chapman, Farmers Branch (1) 214-871-1401;|
|Suzie R Desai, Chicago (1) 312-233-7046;|
|Paul J Dyson, San Francisco (1) 415-371-5079;|
|Jane H Ridley, Centennial (1) 303-721-4487;|
|Jessica L Wood, Chicago (1) 312-233-7004;|
|Marian Zucker, New York (1) 212-438-2150;|
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