The credit quality of issuers that do not disclose climate-related vulnerabilities, or their plans to address such risks, should be examined more closely by investors and considered riskier long-term investments than their public ratings may imply.

Given the “constant, widespread reporting of climate change perils, and the current abundance of free, public data,” bondholders can start to assume that any lack of related disclosure in a 2024 municipal bond offering belies a lack of issuer consideration of these risks, according to a report from Municipal Markets Analytics, Inc. 

MMA’s Matt Fabian co-authored the climate disclosure report.

Longer-term investors may also want to consider a non-disclosing issuer’s management “to be at least partially deficient and the borrower’s relative credit quality to be lower and more volatile than public ratings suggest,” the report said. 

Matt Fabian, a partner at MMA and lead author of the report, outlined how preparation for climate disaster, as opposed to actual climate vulnerability, should be a primary dog whistle indicating borrowers’ potential credit weakness. 

“It is an issue of management and competency,” Fabian said. “The question is whether managers have planned for climate-related threats. If there is no disclosure, investors can assume that the issuer has failed to consider these risks.”

Fabian said the firm is not suggesting that investors back away from new or outstanding bond issues; “rather, it implies allocating bonds to riskier portfolio buckets, seeking extra covenants and financial disclosures, employing a more robust annual surveillance process, and favoring the use of bond insurance a bit more.”

Between 2019 and 2023, the U.S. recorded 102 climate disasters. Total costs from these events surpassed $605 billion. With greenhouse gas emissions continuing to rise, there is an increasing likelihood that the global average temperature will become greater than pre-industrial levels by 1.5 degrees Celsius. 

Exceeding the 1.5 degree threshold is likely to result in more frequent and severe climate events — with changes in precipitation, sea levels, and other natural processes presenting a real threat to physical infrastructure. 

“When looking over decades, climate change will have a reasonable and real impact,” Fabian said. “It is very likely climate change will drive defaults at some point; there will at least be some distress and ratings are going to likely be pushed down.” 

It’s not only investors, but also regulators that are paying attention. SEC officials, including Muni Chief Dave Sanchez, have warned issuers that they need to be disclosing climate risks of which they are aware. Under the federal securities laws, witholding from investors information that would alter the total mix of information they use in making an investment decision can be fraud.

MMA’s recommendation comes as rating agencies continue to develop systems and build out analytics that would allow them to incorporate climate change projections into ratings. Alongside this development is what representatives from MMA call “increasing investor impatience.”

In April, S&P Global Ratings published a report entitled “Navigating Uncertainty: US Governments and Physical Climate Risks.” Throughout the report, the agency outlined the ways that exposure to climate risks could lead to financial costs, utilizing proprietary data on nine types of climate hazards to track their relationship with municipalities’ creditworthiness.

According to the report, nearly all counties are exposed to at least one climate hazard, with extreme hazards having the potential to manifest in severe direct and indirect consequences. Direct impacts include infrastructure and asset damage, disruption to operations, and full-scale redevelopment. Indirect impacts may materialize as greater financial risks, greater costs of debt, and economic and demographic changes. 

“Planning for infrastructure investments through adaptation may reduce potential risks, if and when they materialize,” the report reads. “Disclosure of these potential effects and risk management actions are an important input into our assessments of management planning. When material and relevant, we incorporate policies and practices into our overall assessment of creditworthiness.”

The potential impact of climate disaster varies by sector, with those characterized by higher insurance costs, limited control over revenues, and a lack of resources being the most vulnerable. Such less-resilient sectors include retirement, local housing, and local utilities. 

Sectors likely to carry above average climate-related risk over the medium term are likely to be characterized by a lack of internal resources, limited revenue dependent on the performance of a specific asset, and limited control over revenues due to competition. 

By contrast, less vulnerable sectors include state credits, state revolving funds, and bonds backed by the federal government.  

To MMA, S&P’s assessment highlights the heightened degree of investor interest in climate risk exposures. The firm points to a growing set of free, public data that showcases county-specific climate peril assessments as resources for governments. Resources include the FEMA National Risk Index, NOAA’s Climate Mapping for Resilience and Adaptation, and the EPA’s Creating Resilient Water Utilities assistance program. These initiatives present detailed hazard reports and physical risk projections that are easily harnessable and, for MMA, dismiss possible objections to disclosure. 

“These resources are so accessible… the information is out there. If government managers aren’t acknowledging the data, it is possible that they are wasting taxpayer and bondholder resources on less resilient projects that might be flooded, that might not be here in 10, 20 years,” Fabian said. 

Yet despite the focus on climate change’s impact on the market, Fabian does not view it as imperative for investors to look to states which pair disclosures with climate mitigation efforts. “It’s just not necessary at this point. What we can worry about now is how borrowers are thinking about and incorporating climate change into disclosures. We want to know: do they have a model?” he said.  

States like California, Alaska, and New York currently sit at the forefront of climate policy. As of this year, 33 states have released a climate action plan or are in the process of designing one, according to the U.S. Center for Climate and Energy Solutions. Alongside these developments are states which are rolling back climate-related policies. MMA doesn’t view this challenge as an excuse.

“State rules may make it more difficult to do the work, but local governments should not use state politics as a cover to not look long term. You can still be a city in Florida or Texas and think about your long-term risks,” Fabian said. “MMA is very optimistic about the market’s future amidst the necessity of climate change adaptation … but [borrowers] must still do the work they need to do.”

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