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A climate analytics business is partnering with a municipal bond research firm in an effort to get a better handle on the risk climate change creates for municipal debt.

“Climate change is a burning fuse and no one knows how fast it is burning and where the explosives are,” said Thomas Doe, president of Municipal Market Analytics. “Market participants are beginning to assess how to incorporate that into their decision making.”

MMA is working with the firm risQ on software to evaluate the risk of climate change to municipal debt.

November's devastating Camp Fire in northern California, which killed 86 people and destroyed most of the town of Paradise, offers context.

The state has about a 7% chance annually of experiencing a wildfire as devastating as the Camp Fire in terms of relative building footprint exposure, according to a report risQ and MMA published in March.

The Camp Fire's path of destruction also resulted in 153,000 acres burned and the loss of 18,793 buildings, according to the California Department of Forestry and Fire Protection.

The risQ model analyzes such risks as how many of a municipality's buildings are located in areas adjacent to forests. The risk to the buildings in roughly 400 California census-designated places is equal or greater than the risk to Paradise, the report said.

“What you have in those situations are places that have built in areas heavily exposed to wildlands,” said Evan Kodra, chief executive officer of risQ.

The Cambridge, Massachusetts-based risQ partnered with MMA about six months ago to develop an application to track the risk to municipal debt from climate change, Doe said.

risQ, funded through National Science Foundation grants, decided to focus on the risks to California municipalities in its first effort to develop a wildfire risk model. By year-end, it plans to introduce a program that can evaluate climate change risks to credits across the U.S.

“It is important to address the risk associated with wildfires,” Doe said. “This is something people need to pay attention to.”

The average number of natural disasters that have caused at least $1 billion in damage has doubled over the past five years to 16 compared to the previous 20 years, according to a November blog post from Eaton Vance municipal portfolio manager Lauren Kashmanian.

"As the frequency and damage of weather-related events continue to rise, we believe incorporating climate change into the credit-evaluation process for state and local issuers is important for muni investors,” Kashmanian wrote.

Harvard School of Engineering and Applied Sciences researchers have concluded that by 2050 the number of wildfires in the West could rise by 50%, and across the U.S. the number would double, according to the Insurance Information Institute.

risQ’s wildfire risk model was developed in collaboration with the U.S. Forest Service. The company uploaded information on historical burns, weather patterns, satellite imagery around land cover and the likelihood and characteristics of flame intensity into the program.

“I am a climate scientist by trade,” Kodra said. “I spent a lot of time thinking about how to use climate science information outside of academia to drive change. I figured out the municipal market made the most sense, because from a climate change perspective cities and issuers are the same thing.”

risQ layered its climate risk program as an impairment amplifier to the MMA impairment database, which culls out vulnerable issuers and corresponding CUSIPs. Using the analysis, investors would have been able to identify before the Camp Fire that Paradise was exposed to heightened risk in terms of both the probability and potential financial severity of a wildfire, according to the report.

risQ selected two districts as anecdotal examples of how the analysis works.

The first, Rancho Murieta Community Services District 2014-1, is in a rural area east of Sacramento. It does not have as much forested area as Paradise, but because the majority of its buildings are located in the so-called wildland-urban interface area, it is actually more at risk than Paradise. Roughly 65% of the district’s buildings are exposed to severe fire.

In the Western Hills Water District Community Facilities District 1, an eight-square-mile water district east of San Jose, 99% of the built environment is exposed to a relatively high likelihood of wildfire risk, according to risQ.

risQ hopes to have a finalized product by year-end 2019 that will be able to analyze risks from heat, flooding, wind and wildfires throughout the country. The company has four full-time people and a six-person advisory board. It will identify the estimated tax revenue at risk to a current or future climate event given any particular issuance, Kodra said.

Kodra said he approached MMA about working on the project because of the firm’s municipal market expertise.

"They came to us seeing an opportunity in the complexity of the municipal market," Doe said.

The software would look at the tax laws, property values intersecting with the credit linked to the obligor, Kodra said.

"Climate catastrophes can impact the key revenue streams and economic health indicators of a given issuer — property value, sales tax, job quality and quantity, infrastructure, demographics — can play across relevant hazards — wildfires, floods, hurricanes and heat stress," according to the report. "risQ's model allows municipal market participants to make informed decisions across obligors by comparably measuring the tax revenue at risk from a variety of climate risks at investment relevant timeframes."

The Camp Fire's fiscal impacts continue to reverberate.

PG&E, an investor-owned utility, filed for bankruptcy protection in January claiming a $10.5 billion charge estimating potential fire claims. PG&E said in February it was likely its equipment ignited the Camp Fire. The value of its revenue bonds issued through the California Infrastructure and Economic Bank dropped 11% from mid-December to mid-January, according to Municipal Market Analytics.

Paradise has scheduled debt service payments of over $1 million annually through 2029 on capital appreciation pension obligation bonds issued by the California Statewide Communities Development Authority that are in jeopardy. The bonds are pooled, but Paradise is responsible for nearly half of the debt.

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Municipal analysts Natural disasters Buy side Predictive analytics Municipal Market Analytics California