Bonds

From politics to disclosure to funding, issuers are navigating a tough climate

The flooding in Vermont last summer illustrates climate change’s impact on U.S. localities and their financial responses.

Severe floods that were triggered by several days of heavy rainfall in Vermont left homes washed out and businesses and municipal facilities with severe physical damage.

It also left some of the rural communities in the state, which weren’t accustomed to dealing with such large-scale repair and rebuilding needs, in greater need of finding funding and the most cost-effective financing structures to do so. 

A flooded playground and field in Waterbury, Vermont, on Dec. 19, 2023. A storm that barreled into the Northeast flooded roads and downed trees, knocked out power to hundreds of thousands, forced flight cancellations and school closures, and killed at least four people.

Bloomberg News

The floods that hit the state last summer were considered to be the worst natural disaster since Hurricane Irene’s storm surges in 2011 swept away buildings and damaged roads, bridges, dams, and other infrastructure statewide, causing around $750 million of damages. 

As a result of that storm, the state began focusing on climate adaptation and mitigation, providing incentives for communities, and changing standards for road and bridge construction. 

Despite these efforts, and because the communities that were hit in 2023 needed money quicker than the federal government would have likely been able to deliver through the Federal Emergency Management Agency (FEMA), — the more substantial rebuilding money often takes months or even years to arrive — some leaders in the state decided to find a way to provide it more cost effectively and faster.  

The Vermont Bond Bank, which focuses on finding innovative ways to fund resilient infrastructure for communities, was given another opportunity to help those hit hardest to rebuild smartly.

The bank established a Municipal Climate Recovery Fund (MCRF), which provided nearly $15 million of loans for 18 communities across the state. In many cases, the subsidized loans they received in late March of this year were the first financial assistance they saw since the immediate aftermath of the flooding.

Bond Bank Executive Director Michael Gaughan said it created the MCRF with support from the state treasurer. The MCRF is one of only three other similar statewide programs nationally and no other program matches its flexibility, he said. The communities pay 1.3% interest on the loans for seven years, and interest only the first two.

“Essentially we were able to provide a medium-term bridge loan to give these communities breathing room and at a very low rate,” Gaughan said, adding, the traditional route some smaller communities might have taken, a bank loan, would have been much more costly given current short-term interest rates. 

With a myriad of challenges facing state, city, county, and local governments to fund vast infrastructure needs amid a shifting climate and severe weather events, there are officials like Gaughan and others across the country that have begun to address them head on. 

Many participants in the public finance industry say resiliency planning is essential to address not only the backlog of repairs and updates to current infrastructure but also in building projects that can weather the climate-related changes yet to come.

“We’re really seeing the impact of climate change on U.S. cities,” in the form of flooding, much more intense heat and cold in parts of the country not typically accustomed to these changes, as well as stronger storms, said Peyton Siler-Jones, sustainability program manager at National League of Cities. Without transformative action it’s “going to get much worse.”

In a survey on municipal infrastructure resilience and its obstacles released mid-month, the NLC reported that only 24% of the responding municipalities are using climate data in their capital planning. Seventy percent said they have not conducted climate-risk assessments of their infrastructure.

Some communities are using “every lever at their disposal to address climate challenges — from zoning and building codes, public engagement and awareness campaigns, public-private partnerships, local infrastructure investments, and more,” said Amy Bailey, director of climate resilience and sustainability at the Center for Climate and Energy Solutions.

Siler-Jones noted that about 400 cities have hired sustainability directors, or chief resilience officers, a position that was unheard of even in the early 2000s.

A Moody’s Ratings report noted cities are using actions affecting engineering, including building seawalls and improving drainage; pursuing reforestation; developing targeted policies, laws and regulations, such as zoning; using technology to help with saving water and setting up community engagement campaigns to ensure the public understands why they are doing what they are doing. 

Bailey pointed to Denver, Miami, and Ann Arbor, Michigan, which have introduced revenue streams or adopted tax levies to address climate change needs. New York City recently announced a plan to adopt a process called climate budgeting to ensure the city budget aligns with and supports its climate goals, she added. Other cities may follow suit.

At least 130 cities in the U.S. are planning or pursuing climate-change related projects, CDP North America Associate Director Richard Freund said. CDP, a nonprofit that runs an environmental disclosure system, also in its 2023 global snapshot said that the U.S. leads in the number of publicly disclosed climate-related infrastructure projects.

Across the globe in 2023, 636 cities across 86 countries publicly disclosed 2,346 climate-related infrastructure projects, the firm said. That includes 434 projects in the U.S.

“Many projects are relatively small-scalewith 40% of projects reporting cost estimates below $500,000,” the firm said. “Some 74% of these projects were disclosed by small and medium-sized cities with less than 500,000 inhabitants.”

In the last few years, “our conversations with municipal governments reveal that many communities are taking climate issues into account as part of their traditional capital planning process,” said Adam Stern, co-head of research at Breckinridge Capital Advisors.

“However, it is difficult to tease out the incremental change in financings specifically addressing ‘climate’ projects,” Stern said. “Adaptation and mitigation efforts appear to be incorporated in old-fashioned bond deals for schools, roads, and bridges.”

How that translates into the amount of bonds issued by state and local governments labeled green or sustainable to address the infrastructure needs has been complicated by politics as many governments have pared back using labeled bonds due to pushback from their own state lawmakers and executives.

Data from various sources does show an increase in this type of debt as state and local governments try to balance investor interest with disclosure issues and the costs associated with labeling bonds.

An S&P Global Market Intelligence report released May 17 noted the growth in sustainable municipal bonds has been modest, at 12% year-over-year, with issuance rising to $10.1 billion in Q1 2024 from $9.0 billion in Q1 2023. 

“This modest increase signals a deceleration in sustainable bond issuance following a brief resurgence in the fourth quarter of 2023,” the report said.

The report also pointed out green bonds represented the largest share of sustainable issuance, accounting for $4.9 billion of sustainable issuance in Q1 2024. 

When Moody’s looked at “sustainable” U.S. municipal bonds issued from 2010 to 2023, it found 40% were issued for mitigation, 22% for adaptation, and 38% for other purposes. It defines mitigation as efforts to reduce an issuer’s contribution to climate change or to avoid its impacts.

One thing is clear: the cost of not addressing climate’s impact on infrastructure in the U.S. is adding up. And regardless of whether a bond is labeled, some market participants expect muni issuance to grow substantially in the next five to 10 years as weather events cause more costly damages that need to be repaired.

How state and local governments tell the story of what they are doing to fix things will also become more important as investors, regulators, ratings agencies and taxpayers demand information.  

“More issuers are discussing ‘climate change’ in offering statements,” Stern said. “These mentions of ‘climate change’ likely relate to material disclosure obligations … not projects, per se.”

Many investment firms are responding to climate change not so much by buying ‘green’ bonds as by looking at how prepared issuers are for the changes climate change will bring, Freund and others said. 

Bond issuers including New York City are starting to take steps to address climate change.

Bloomberg News

Some larger issuers that Freund pointed to as examples of having good disclosure through the CDP’s public authorities program include the Long Island Power Authority, the Los Angeles Department of Water and Power, the Electric Power Board of Chattanooga, and the New York Power Authority. The last deal took the honor of The Bond Buyer’s Northeast Deal of the Year Award in 2020. It subsequently issued its first 100% green bond deal to finance priority transmission projects in 2022 that funded rebuilding and modernizing the state’s electrical grid, bringing cleaner energy sources downstate. It came to market again in the fall of 2023

The San Francisco Public Utility Commission, which has been a leader in finding ways to talk to investors, both domestically and internationally, is an example of an issuer with strong disclosure on environmental issues in their use of proceeds reporting, Freund said. 

Freund said he expected the development of formal rules affecting municipal issuers to show the nature of “green bonds” or the extent of addressing climate risk. Currently, if a fund says a certain percentage of its municipal bonds are invested in climate-friendly bonds, there are no rules to regulate the claim. However, within the next five years there will be a formalization of the reporting and more pressure to report the information, he said. 

The Securities and Exchange Commission has talked about forcing this sort of disclosure on large companies whose stocks are traded, Freund said.

How issuers disclose will also be important for how ratings agencies view the credits.

An October S&P Global Ratings report that looked at the effect of environmental and social factors on credit ratings said, “increasing frequency and severity of climate-related risks could result in environmental and social factors becoming more material, influential, and certain in our credit analysis over time.”  

Sustainable1, a division launched in April 2021 and acts as a centralized group for S&P Global’s climate risk research, in April of this year created the Municipal Climate Physical Risk dataset. It tracks current and future climate hazard exposures of U.S. localities and their municipal bonds through the 2090s.

“States, cities, and towns across the U.S. are seeing an increasing frequency and severity of extreme weather events caused by climate change,” Steven Bullock, managing director, Global Head of Research and Methodology at S&P Global Sustainable1, said in an April statement. It “poses growing risks to municipal bonds which often have long maturities and therefore higher vulnerability to the longer-term effects of climate change compared to other investments.”

As more data becomes available, state and local governments should be prepared to better tell their stories.

“We’re seeing a lot of big data from buy side firms evaluating physical climate risk, which is important but the data models are not as well equipped to tell the story of resilience,” Gaughan said. “But in my view, the rating agencies will become more important over time as more investors rely upon climate data. Rating agencies can take the time to evaluate capital plans and investments for their furtherance of adaptation and resilience measures, which will tell the whole story of climate related credit risk.”

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