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Natural disasters test—but don’t break—municipalities’ resilience.
Devastating wildfires continue to rage in the Los Angeles area, and our hearts go out to the families and communities that are suffering. Investors are also understandably concerned about the financial health of municipal bond issuers undergoing such environmental crises. But municipalities have historically shown resilience in the face of major natural disasters, and we believe they will demonstrate the same strength this time.
State and Federal Support Does the Heavy Lifting
Collaboration between state, federal and local agencies is crucial in addressing and mitigating the financial impact of natural disasters. Through grants, subsidies and disaster relief funds, state and federal support can alleviate much of municipalities’ financial burdens—aiding not only in recovery efforts but also in maintaining investor confidence.
For example, the Federal Emergency Management Agency (FEMA) reimburses at least 75% of emergency costs for local governments, as well as for uninsured or underinsured households and businesses. Additionally, on January 9, President Biden announced that the federal government will cover the costs of wildfire response efforts, including debris removal, shelter and salaries for first responders, for 180 days.
Further support comes from the California FAIR Plan Association, a syndicate of insurers licensed to conduct property and casualty business in California, and which is neither a state agency nor funded by taxpayers. The FAIR Plan provides basic fire coverage to California residents when traditional carriers are unavailable.
Case Study: The 2018 Camp Fire in Paradise
In California, wildfires are a recurring issue, and recent examples can provide valuable lessons for investors. In November 2018, the Camp Fire devastated Paradise, California. It was the deadliest and most destructive wildfire in California’s history, causing 85 fatalities, destroying nearly 19,000 structures, and burning over 153,000 acres. The town of Paradise was approximately 90% destroyed, displacing thousands of residents and causing significant economic and environmental damage.
In the aftermath, however, only bonds issued by the redevelopment agency of Paradise defaulted. These bonds were backed solely by tax revenue from a specific commercial district and had no claim on the town’s general reserves.
Other bonds issued by Paradise have made all scheduled debt-service payments and are currently rated A– with a stable outlook by S&P. Paradise was able to meet its debt service obligations thanks to support from the state, which provided financial assistance to compensate for lost property-tax revenue for three years. The town also secured federal funding through FEMA and other federal programs that aided in its rebuilding efforts.
Evaluating Market Risk from the Los Angeles Wildfires
Wildfires and other natural disasters may prompt investors to reassess the risks associated with municipal bonds in high-risk areas. Investors may become more cautious of bonds issued by municipalities in these areas and may demand higher yields in these markets.
So far, however, we have not seen a significant repricing across California municipal bonds, though some bonds closest to the unfolding disaster in Los Angeles have begun to trade at wider spreads, reflecting the market’s natural repricing of risk.
Investor confidence is crucial for the stability of the municipal bond market. Three factors give us confidence in California’s ability to weather this disaster:
- The underlying strength of the state’s economy. California has the fifth largest economy in the world and comprises 14% of US GDP.
- Substantial cash reserves at the state and local levels. California has $21 billion in its rainy-day fund and borrowable resources of around $90 billion. Los Angeles County reports a general fund reserve of $5.4 billion.
- Access to federal assistance, including FEMA. FEMA can reimburse up to 75% of damages for local governments, businesses and households.
The current wildfires in Los Angeles are an evolving situation, and we are closely monitoring and analyzing the potential impact on municipal bonds. However, we expect that—as in the past—recovery efforts will be supported by a combination of federal and state assistance, as well as state and local reserves. In the meantime, we extend our deepest concern to those affected by the disaster.
Related: The Expanding World of Private Credit: What Lies Ahead