Global warming and the residual effects of climate change reflect a growing credit risk for state and local governments as extreme weather events increasingly disrupt the physical, economic and social makeup of communities across the country. As the frequency grows and intensity worsens, many municipal issuers are forced to address the growing climate challenge with increased spending, revenue generation and debt issuance, which may meaningfully impact their overall financial profile.
Further, future federal aid for state and local municipalities may become less reliable, increasing the importance of near-term actions to address climate change. Significant climate change events can have devastating social, economic and environmental effects for state and local governments, adding fiscal pressure at a time when tax revenues are declining due to the COVID-19 pandemic.
Broadly speaking, however, we believe these events do not pose a risk to the municipal bond market as a whole. Based on our analysis, history has shown no discernible total market yield correlation between large natural disaster events in the past.1
Nevertheless, for municipal issuers and investors, managing the environmental and fiscal impacts of climate change will remain a key challenge. Certainly, costs associated with regulatory changes, remediation expenses or recovery from natural disasters will increase, adding fiscal burdens to impacted municipalities.
Regardless of the type and magnitude of change, we anticipate climate effects to differentiate municipal issuers; some will benefit from rapid innovation and/or correct interpretation of social shifts and some will be at a disadvantage from facing increased costs or risk mitigation.
Sherri Tilley, investment strategist, Daniel Barton, head of research and Daniel Marques, senior portfolio manager, Mellon.
1 Source: Mellon Investment proprietary research. October 2020.