Credit Rater Moody’s Investor Services To Examine Government Sector Response to Climate Change Challenges – the Ripple Effect on the Corporate Sector
Moody’s Investor Services, Inc. is one of the Big Three of credit rating agencies for governments and corporations.
Part of Moody’s Corporation (NYSE:MCO), the service issues ratings and tracks debt on about 170,000 corporate, government and structured securities (i.e., 11,000 corporate issuers, 21,000 public finance issuers,72,000 structured finance obligations in 41 countries).
American states, cities, towns, municipalities, school districts, special tax districts – all have bonds issued to raise capital for projects and general obligations.
The ratings assigned by the Big 3 and other raters are based “risk,” and the ability to pay the debt. Where there is risk to ability to pay, warnings are issued.
U.S. coastal cities and states were warned last week by Moody’s Investor Services, Inc. to address climate change risks or face another risk – the possible downgrades of their bond issues.
Moody’s tells its clients that is incorporating climate change considerations into its credit ratings for state, city and municipal bonds (fixed-income “munis” are a very large market for a wide range of investors).
Public sector issuers without sufficient adaptation and mitigation strategies are going to be at risk of Moody’s taking action on their credit rating for bond issues.
If these government issuers don’t address the risks they face due to rising seas or more powerful storms or other weather-related factors, we might assume that they are moving toward credit downgrades and possible even toward default.
That would have an effect on local finances, including adjustment of tax rates, possible cuts in services, layoffs, hampered ability to raise money at a reasonable rates, and more.
The ripple effect would reach to companies doing business in the local municipality, city, state or region. State finances could also be affected (as more funds are needed by cities and municipalities for emergency response, building of resilience in infrastructure, etc.).
Think about the many ways that the U.S. corporate sector could be affected by all of these events. And, the more localized consequences if their “home city” or town comes under financial stress as these events occur.
Which would increase human suffering in the wake of more powerful storms, rising seas, rising temps, strained infrastructure. That would affect corporate employees, suppliers, partners, customers, other stakeholders.
The Rationale From Moody’s
Moody’s explains: “Climate shocks or extreme weather events have sharp, immediate and observable impacts on an issuer’s infrastructure, economy and revenue base, and environment. The events can cause economic challenges like smaller crop yield, infrastructure damage, higher energy demand and escalated recovery costs.”
And so, across the country, the bottom line is, city leaders need to identify, recognize and begin mitigate climate risks. They could and should partner with the corporate and business sectors in that effort.
Climate change risks could be short-term (think of a hurricane a summer drought), which could of course inflict serious damage; or, could be more systemic and long-term (such as steadily rising temperatures or risking waters in low-lying regions) and pose a lingering and constant threat.
How the community will address these risks is key.
The credit ratings issued by Moody’s for investors will reflect the risk and mitigation of risk. There are six indicators for that, according to Bloomberg; these are used to examine:
- The exposure and susceptibility of the state to physical aspects of climate change;
- The share of the economy in coastal regions of the state;
- Extreme storm damage, considered as a share of the economy;
- The percentage of homes in a flood plain.
The indicators are applied in seven climate regions, NPR reported. (Consider, the Midwest, Southwest, Northeast – all have different geographies and economic conditions to evaluate and rate.)
Moody’s is the first among the Big Three of municipal and corporate credit rating agencies to take this action.
Moody’s bond ratings are important for the municipal or state issuer and for the buyer of the bonds. The higher the risk/the higher the interest rate charged. The rate charged can and does significantly affect the cost of capital.
A ratings downgrade can have dramatic effects on an issuer’s financial situation; taxes may have to be raised to cover the additional costs.
These states and their cities are in initially focus for Moody’s: Texas, Florida, Georgia and Mississippi.
The Company’s official statement is labeled: “Moody’s: Climate change is forecast to heighten US exposure to economic loss placing short- and long-term pressure on US states and local governments.”
- The Union of Concerned Scientists said the Moody’s action will encourage municipal issuers such as towns, cities and states to take measures to reduce risk of climate change.
- Next City told its subscribers that Moody’s rates about 8,600 local government issuers each year; these get rated on an annual basis; cities should pay attention.
This Is About Debt and Risk
“Debt” is the key in the raters’ work – raters consider how the debt incurred in the bond that is issued to be repaid. What the risks are of possibility of non-payment (default).
Factored in: to be able to repay debt, public sector issuers may have to raise taxes, cut costs, (often, both) and work toward recapturing their previously higher debt rating. And in all of this there is risk to consider.
The impact of climate change-related events are a complication as well.
Help Beyond the City’s Resources
Moody’s points out that public sector issuer resilience to extreme climate events is enhanced by a variety of local, state and federal tools to improve immediate response and long-term recovery from climate shocks. (Agencies like FEMA are available to assist.)
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As the November 28th announcement was sinking in with cities and investors, as example of a downgrade impact, Moody’s downgraded the City of Decatur’s (Illinois) general obligation bond credit rating, issuing a “negative outlook” for improvement of the city’s financial condition.
High (and rising) pension costs and economic & financial pressures on the city are straining its finances. The city council is going to vote on measures to address the situation. The city’s reserve fund will likely to be drawn down to help address matters.
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The Business Insider points out the kinds of damage that can occur at the city level: Hurricane Sandy hit New York City square on (in the downtown of Manhattan Island, which is surrounded by river and sea water) and inflicted damage to the electrical system, hospitals (NYU Medical Center had to close); the subway system (one tunnel was closed for a year to be rebuilt); and kept employees away from vital financial services firms’ offices.
The states of New York and New Jersey had severe damage in many areas as the storm pushed the incoming Atlantic Ocean tides above nine feet in height (in 2012).
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Broward County, Florida is held up as an example of a local government being queried by Moody’s now.
The Atlantic Coast city reports that it was asked about how local government is working to respond to rising sea levels and flood protection. (Broward is second in total population among the Sunshine State’s counties and has been hit by a number of hurricanes in recent years, such “Irma”.)
The County is addressing climate change issues as part of the bipartisan Southeast Florida Regional Climate Compact, formed at the 2009 Southeast Florida Climate Leadership Summit.
The Compact is a collaborative local effort to foster sustainability and climate resilience on a regional scale.
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Moody’s Also Rates Corporations
For companies, Moody’s ratings changes from time-to-time could pose challenges as well as various types of risk is constantly examined.
“ESG” issues are in focus. Pharmaceutical manufacturers and distributors (both favorites of many investors) face rising risks, the company says, related to the opiod crisis in the United States.
Moody’s says this about ESG issues:
Market participants are focusing more on the potential for ESG issues to impact investment decisions and assist in the development of a more sustainable economy.
We capture ESG considerations into our analysis and ratings when we believe that such factors materially affect a debt issuer’s credit quality.
Moody’s examines corporate debt by market segments, such as: Aerospace & Defense; Automotive; Consumer Products; Healthcare; Manufacturing; Metals & Mining, and many more.
References
- The Moody’s Climate Change statement: https://www.moodys.com/research/Moodys-Climate-change-is-forecast-to-heighten-US-exposure-to–PR_376056
- South Florida Climate Compact: http://www.southeastfloridaclimatecompact.org/
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