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Recap: Hearing on Climate Risk in Muni Market

Key takeaways from the Senate Budget Committee’s hearing on Wednesday, January 10, 2024.

This article recaps a Senate Budget Committee hearing held on January 10, 2024. Arguments and opinions expressed by hearing witnesses and summarized in this article do not necessarily represent the policy positions of the National Association of Bond Lawyers (NABL).

By: Brian Egan, Director of Government Affairs

The Senate Committee on Budget held a hearing entitled, “Investing in the Future: Safeguarding Municipal Bonds from Climate Risk,” on Wednesday, January 10. Witnesses included a municipal analyst, an issuer, a climate data researcher, and two academics who shared their insights on the risk posed by climate change to the municipal bond market.

Members of Congress unsurprisingly fell along partisan lines on the topic: with Democrats arguing that the federal government, local officials, investors, and credit rating agencies can and should do more to address the issue― while Republicans questioned the alarmist sentiments tied to the topic and focused on the threat posed by an increasing national debt to financial markets. All the witnesses generally supported the notion that climate change poses some level of risk to municipal issuers, and therefore, bondholders. They diverged in opinion, however, on the extent of and possible remedies to the problem of climate change and its impact on the municipal market.

Thomas Doe of Municipal Market Analytics and Megan Kilgore, City Auditor for Columbus, OH, both indicated more work is needed and that barriers do exist for issuers looking to build more resilient communities. Doe argued that the short window through which credit rating agencies assess future climate risks to issuers creates a disincentive for local officials to prioritize climate threat mitigation and resiliency investment. As he explained, “Investors’ positive expectations have inhibited issuers’ proactive action to reduce the consequences of future climate related risks.” Instead of borrowing more to invest in better infrastructure― issuers, he claimed, pursue smaller debt loads in the pursuit of higher credit ratings.

Kilgore agreed that ratings agencies’ climate risk window is short, but she emphasized the proactive ways the federal government can aid issuers in addressing resiliency. She compared the well-resourced large city she now represents, Columbus, with the countless smaller communities that have more limited resources such as her hometown along the Ohio River. Both, she argued, would benefit from a stronger federal partnership, but cautioned legislators to avoid “one-size-fits-all” solutions. Specifically, she offered three broad areas for policy reform:

  1. Provide clear financial incentives for both local governments and investors;
  2. Help local governments overcome human capacity barriers by creating a federal office to serve as the single point of knowledge;
  3. Help smaller and lower-credit communities achieve total funding needs.

Her third suggestion harkened back to a previous policy proposal that would create a “Super-BAB-type structure” where direct pay bonds would offer a higher rate for projects to enhance climate change mitigation and community resiliency.

Several of the witnesses called for specific attention to the role Federal Emergency Management Agency (FEMA) policy plays in masking risk and disincentivizing reform. Doe, Dr. Chris Hartshorn of Zeus AI, and Dr. Matthew Kahn of the University of Southern California all suggested that FEMA aid to issuers in the wake of a disaster has become a standard investor expectation. They asserted that such a supposedly given assumption leads investors to improperly price risk into the market. Doe indicated that FEMA aid initially serves as a backstop to impacted communities, and Hartshorn explained that this initial support masks financial pains but can quickly wane. Kahn raised that investors are not pricing in the risk of FEMA inaction in a future disaster.

One witness explored how the recent exit of insurers from select disaster prone areas may heighten climate risks. Hartshorn explained, property insurance companies have historically helped issuers quickly restore a key source of revenues― property taxes. By providing the financial resources needed for homeowners to rebuild after a disaster, insurers buoy property tax values for communities and help avert long-term drops in tax revenues. He prognosticated that the exodus of insurers from more communities will eventually translate to interest rate increases in the market as investors realize property tax receipts may take longer to rebound post-disaster and that increasing premiums could eventually lead to outflows of residents.

Most of the witnesses echoed that resiliency investment today is typically better than rebuilding expenses tomorrow. As Hartshorn pointed out, every $1 dollar of investment in resiliency saves the federal government $6 in future disaster recovery expenditures.

No one suggested that climate change poses an existential threat to the municipal market. In fact, most reiterated their belief that the municipal market can and likely will play a major role in financing necessary resiliency efforts. Nonetheless, they largely agreed that issuers may face higher borrowing costs in the future as investors improve their capacity to examine longer-term climate risks.

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