Why municipal bond analysts may rethink wildfire credit risks
The increasing number and ferocity of wildfires in the Western United States may force changes in the way municipal bond evaluators weigh their risks.
Rating agencies and bond analysts have historically pointed to Federal Emergency Management Agency payments, state reimbursements to localities hit by property tax losses, and insurance proceeds as ameliorating losses associated with wildfires and other natural disasters to lessen credit risks to state and local governments.
Moody’s Investors Service said in August that it expects most issuers impacted by several massive lightning-sparked wildfires in Northern California will emerge with their bond ratings intact.
As the frequency of wildfires increases, some of those long time suppositions are being called into question.
“All of those backstop measures that I have heard way to many times in the municipal bond sector, in perpetuity, is a crock,” said Chris Hartshorn, chief commercial risk officer for risQ, a company that models the financial risk posed by climate change for the municipal bond market. He was speaking at the Bond Buyer’s California Public Finance conference held online last week. “FEMA payments have been delayed more every year, property values are dropping and insurance payments are going up.”
Evaluating climate change risks from natural disasters from a historical perspective no longer works, he said.
California and Oregon have experienced devastating fire seasons as blazes consumed more than 1.4 million acres in California and 1.2 million acres in Oregon, according to fire officials in each state.
In Oregon, where most of the fires have been extinguished by welcome rain, 551,816 acres of state-owned lands burned, more than 13 times the average, according to the Oregon Department of Forestry.
California fires had destroyed 8,400 homes and buildings and killed 31 people by Oct. 30, according to the California Department of Forestry and Fire Protection. Almost two months remain in what the state considers peak wildfire season, and no significant rain has fallen.
When fires struck some regions of California historically, there were not people living there, said Suzanne Finnegan, chief credit officer for bond insurer Build America Mutual, also a speaker at the Bond Buyer conference. In recent decades there has been significant development in the wildland interface. “Those changes in development patterns have had an impact.”
California has made it a practice since 2016 to help backfill lost property taxes for localities in areas that have lost houses and the resultant property taxes to fires.
California appropriated $64.3 million to backfill cities, counties and special districts for fire-related property tax losses in the 2018 budget act, said H.D. Palmer, a Department of Finance spokesman. Another $63.9 million for schools was transferred automatically under the state constitution's school funding guarantees, Palmer said.
The state will make the decision about how much relief to provide to local governments and schools during discussions for the next budget.
As the costs mount, the state's relief role might have to change, Finnegan said. The view that FEMA is the insurance company for municipal governments when natural disaster strikes may also have to change, she said.
Though the state of California is large enough to absorb losses, and cities don’t often seek bankruptcy protection, Hartshorn said that smaller-scale issuers like retirement communities or hospitals could be financially wiped out by a single catastrophic event.
“There was a comment on an earlier panel that school districts may not be that impacted, because they can always move students to a different location,” Hartshorn said. “That is all good and fine, but you actually need people to want to live there.”
BAM evaluates climate change using FEMA maps and professional engineering maps to evaluate areas where there might be elevated risk from climate change.
“We make a determination as to whether we want to insure a particular credit by looking at areas with increased risk,” Finnegan said. “BAM’s policies run to final maturities on bonds. So, unlike the rating agencies, we can’t change our rates, or renew.”
BAM limits its “exposure to areas at high risk from wildfires, hurricanes, flooding or dam indemnification,” she said. “The continued development in the wildland-urban interface is something we have to consider. A lot of areas had have fires before, but there weren’t people living there then.”
The increase in the number and severity of fires in California and Colorado is something BAM considers when rating credits, Finnegan said.
“The other piece we think about is the availability of property and casualty insurance,” Finnegan said. “If that isn’t available it will devalue the properties. FEMA also isn’t quick to pay.”
States have been turning to FEMA for repeated disasters, she said. “After a certain number of claims over a certain number of years, FEMA will buy the property out, rather than making payments to the property owner. The property owner gets paid, but that property comes off the tax rolls.”
Local governments and agencies don’t have the same resources the state does, Finnegan said.
“The immediate losses from an assessed value perspective, or to sales tax revenues, or fees of this nature happen quickly, and it’s difficult for them to adjust,” she said. “In addition they have the cost of firefighting and risks to infrastructure.”
Stradling, a public finance-focused law firm, does look at the impact on state and localities differently, said Lawrence Chan, an associate.
“Very different analyses are conducted for school districts, states or local governments,” Chan said.
risQ, a spinoff of Northeastern University’s Sustainability and Data Sciences Lab, which is funded by the National Science Foundation, has escalated its surveillance of risk from wildfires since it launched a year ago, Hartshorn said.
Clients have been asking about the credit impacts from wildfires on a daily basis, he said. The company looks at it more in terms of future risk versus historic risk, and considers the loss of population to an area from fire damage, he said.
“We have become very strategic when looking at the health of an issuer from an underlying credit basis,” he said.
John Gresham, managing director and municipal analyst for Hilltop Securities, said it cautions bond investors to not be invested to heavily in any area to alleviate risk.
Hilltop Securities views certificates of participation in fire prone areas as more of a risk then general obligation bonds, Gresham said.
“Any COP in an area that has fire danger is a risk,” Gresham said. “It hasn’t affected how we do business, because we have always urged diversification and caution about exposure to any one area.
“In California, GOs are secured by school district-wide ad valorem taxes,” Gresham said. “That being said, I wouldn’t want to have all my money in one area that has significantly burned."