Credit Rating Agencies are Connecting the Dots Between Credit Risk and Municipal Resiliency

by | Dec 7, 2017 | Economics, Sustainability

Back in 2015, it came to our attention that Moody’s had evaluated the effect of flood reduction efforts on municipal debt levels and tax bases in Virginia’s Hampton Roads metropolitan region. Moody’s Investors Service noted that “Coastal cities in southeastern Virginia’s Hampton Roads region are becoming more vulnerable to flooding risk caused by weather-related and tidal flooding, and will require continued capital investment and effective planning to mitigate negative credit effects on the municipalities”.

“Meadows are important ecosystems … Native plants are vital to creating a natural, sustainable landscape” and a healthy credit rating

Just last week, Moody’s announced that it now incorporates climate change considerations into its credit ratings for state and local bonds. According to Michael Wertz, a Moody’s vice president, “If you have a place that simply throws up its hands in the face of changes to climate trends, then we have to sort of evaluate it on an ongoing basis to see how that abdication of response actually translates to changes in its credit profile.”

This makes Moody’s the first of the country’s big three credit rating agencies to publicly outline how it weighs climate change risks into its credit rating assessments, but we expect other rating agencies to follow and, further, that other climate related exposure risks beyond flooding may also be included in rating assessments.

Credit Valley Conservation May Soon Get Credit for their Porous Pavement

The cost of an increased number of unbudgeted, climate-related flooding lawsuits is the driving force behind reduced credit ratings. According to this 2017 study by Natalia Moudrak and Dr. Blair Feltmate of the Intact Centre on Climate Adaptation, “Local governments can leverage land-use regulations to guide the development away from high flood risk areas and can encourage the adoption of flood-resilient residential community design standards. A combination of these efforts can help local governments reduce lawsuits … by mitigating risks to communities and demonstrating that they acted in ways consistent with what courts might find as an appropriate standard of care. Failure to reduce flood-related lawsuits may increase future insurance costs to local governments.”

A Cistern-atic Approach to Credit Risk Management

The Intact study goes on to point out that the credit agencies are increasingly make the connection between flood recovery costs and municipal default. “Credit rating agencies (e.g., DBRS, Moody’s and Standard & Poor’s) are beginning to examine the potential for communities to be impacted by substantial flood recovery costs which, in turn, could cause a municipality to default on a bond. If the probability of a weather-induced default is material, the municipality may receive a downgraded credit rating.”

An “Empty” Lot – Reduced Flood and Credit Risk?

Climate-related flooding lawsuits may soon be joined by lawsuits related to a duty of care for restricting carbon emissions. According to this article in The Economist entitled “Climate-change lawsuits”, cases related specifically to the negative effect of carbon emissions are on the rise. Joana Setzer of the Grantham Institute, a think-tank in London, has observed an increase in cases filed per year in the U.S. to 20, up from only a couple in 2002. According to the article, “The targets are governments, which campaigners argue are doing too little to avert climate change, and big energy firms, which they hold responsible for most greenhouse-gas emissions.”

Dysart et. al. Managing Stormwater and their Credit Rating

This increase in carbon emission lawsuits is fuelled by data-backed meteorological attribution studies that are more confidently assigning damages from climate change. The Carbon Disclosure Project notes that “municipal bond analysts evaluating the likelihood of repayment for municipal bonds would be remiss to ignore an issuer’s exposure to risks posed by climate change impacts.” The CDP asks, “Given the widespread impacts of climate change, an analyst might ask: which city governments are aware of climate risks to businesses and which are not? Are cities adequately preparing for these risks? And if they are not, does this lack of preparation suggest that the city government might be falling short in other, more immediate management priorities?”

The responsibility for active mitigation of flood risk and carbon emissions will become unavoidable for municipalities seeking to protect their insurance and bond costs. While land use planning, building codes, risk planning and preventative investments have thus far prevented any significant credit impact from flooding, according to the Moody’s report, the effect of continued development, sinking land, and recurring storms will necessitate “further capital investment and effective planning to mitigate negative credit effects”. Moody’s also notes that stormwater and flood control management requires both hard and soft investment to mitigate risk by “minimizing runoff through the use of pavers or other permeable surfaces for parking; and the incorporation of natural features such as swales and ponds into the stormwater runoff and impoundment system”.

With the credit rating agencies now turning their attention to management and mitigation of climate-related risk, it is just a matter of time before they also delve into the effectiveness and sustainability of the measures used to control for these risks. In the end, it won’t be a matter of whether municipalities can afford to invest in more sustainable infrastructure and water management, but whether they can afford not to.

Update – Natalia Moudrak, a director of the Infrastructure Adaptation Program at the Intact Centre on Climate Adaptation has a good article on the Canadian perspective: “Climate Change and Credit Risk – Are Canadian issuers ready for Moody’s new focus on climate change risk?” 

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