Prior to Hurricane Laura making landfall in Louisiana and the wildfires in California and parts of the West igniting, the U.S. had already experienced 10 different billion-dollar natural disasters this year.1 The frequency and costs of major natural disasters have been rising over the past 40 years, and we think it’s a risk that municipal bond investors should pay attention to. Beyond the human toll, climate shocks have the potential to erode a municipality’s tax base, create economic disruptions, strain liquidity and impair assets, among other issues. We don’t believe that climate shocks pose a significant risk to the muni market as a whole, but they do pose a risk to some issuers—and that risk isn’t currently priced into the muni market, in our view.
While we don’t want to minimize the human toll, and we’re well aware that climate change has become a hot-button issue, municipal bond investors can’t ignore the fact that natural disasters such as hurricanes, floods, wildfires, and droughts can have a major financial impact on the areas in which they occur. Leaving aside the question of why the pace of natural disasters has been accelerating, we will take a look below at how climate and weather disasters may affect issuers in the municipal bond market.
The number of natural disasters costing at least $1 billion has increased since 1980
Source: National Oceanic and Atmospheric Administration (NOAA), National Centers for Environmental Information (NCEI), “Billion-Dollar Weather and Climate Disasters: Overview” (https://www.ncdc.noaa.gov/billions/). Data as of 07/08/2020.
Note: The annual average does not include 2020.
Disasters historically haven’t affected the broad market
Historically, most municipal issuers affected by natural disasters have been able to manage through the financial impact caused by the disaster. No state or local government rated by Moody’s Investors Service has defaulted on its bonds due to a natural disaster. However, downgrades are a possibility (when a bond is downgraded, its yield rises and its price generally falls).
Natural disasters don’t appear to pose a risk to the broad muni market either. We haven’t seen yields rise across the board following past natural disasters. Higher yields would mean that muni investors, on average, are more concerned about the increased risks—but historically, yields have been relatively unchanged following a major natural disaster.
The muni market has been resilient to past natural disasters
Source: Bloomberg Barclays Municipal Bond Index, as of 8/27/2020 and National Oceanic and Atmospheric Administration (NOAA), National Centers for Environmental Information (NCEI), “Billion-Dollar Weather and Climate Disasters: Overview” (https://www.ncdc.noaa.gov/billions/), as of 07/08/2020. Yield to worst is a measure of the lowest possible yield that can be received on a bond that fully operates within the terms of its contract without defaulting.