Rising Above the Storm: Municipal Credit Resilience in the Face of Natural Disasters

Rising Above the Storm

Municipal Credit Resilience in the Face of Natural Disasters

December 15, 2023

Flood Disaster - Rushing Dark Dirty Waters During Flash Flood. Nature Disasters Photo Collection.

Marin Komlan, Senior Credit Analyst

In January 2023, California experienced a stream of atmospheric rivers over three weeks, resulting in 11 inches of rain that caused more than 700 landslides, power outages impacting over 500,000 people, and levee breaches.

More recently in early August, intense winds and dry weather conditions caused wildfires to spark in Lahaina and surrounding areas on the island of Maui, impacting around 1,550 properties and 2,200 structures. Costs were estimated at more than $1 billion and $5.5 billion respectively for these two weather events.

Data from NOAA confirms the perceived increase in severe natural disasters is more than just media hype. There were on average 8.1 weather events costing a billion dollars or more (CPI-adjusted) between 1980 and 2022; however, the annual average of the most recent five years (2018-2022) was 18 events. As of November 8, there have been 25 confirmed such events to affect the United States (U.S.) in 2023.

Despite the increasing frequency and growing intensity of natural disasters, an examination of the ratings history in the affected areas indicates minimal impact. The table below shows Moody’s and S&P’s general obligation ratings of affected municipalities before disaster events, and a year or more after. New Orleans (currently rated A2/A+) managed to regain its investment grade in May 2007, less than two years after the city was severely affected by Hurricane Katrina.

State and local governments in the U.S. benefit from a strong safety structure provided by the U.S. disaster assistance system, which helps areas affected by natural disasters recover quickly, and at times, emerge stronger. Within this framework, when disaster strikes, local governments face the costs to fund emergency response, infrastructure repair, and assistance for the most affected citizens. If the disaster is severe enough, state and federal governments will also step in to aid the municipality and reimburse local governments for some of their initial disbursements.

Empirical research appears to substantiate the observation that the financial strength of U.S. municipalities is typically not significantly affected by natural disasters. A 2019 study at the Rockefeller College of Public Affairs and Policy examined the financial impact of natural disasters on local governments in New York State during the 17 years between 1996 and 2012. The study suggested disaster events did not have a significant negative impact on the financial position of New York local governments during the year of the events. Interestingly, the study also found if a local government's unreserved fund balance was 15% or more of expenditures, its financial condition would improve after the disaster event. In fact, ratings agencies cite strong liquidity or reserves as one of the most important factors that help support credit quality during a disaster. Improvement to the financial condition of local governments in disaster affected areas is driven by the local economy experiencing a positive boost through a reconstruction stimulus, financed by state and federal transfers as well as insurance reimbursements. In essence, the region gains from an expedited process of redevelopment and infrastructure upgrades.

Another working paper published in February 2023 by economists at the Federal Reserve Bank of San Francisco used county-level data over the past four decades to examine the local economic impact of Natural Disasters. The paper found on average counties hit by natural disasters experience a medium- to longer-term boost in income per capita (eight years out). The study’s findings also suggested house prices increase over the longer run while population remains roughly unchanged. Increases in house prices benefit local governments by increasing their taxable base.

While acknowledging the uniqueness of each situation, our conclusion is in most instances, the credit quality of general government municipal debt should remain relatively resilient despite the increasing frequency of natural disasters. It is essential to note bonds relying on specific, narrow pledges come with distinct risks that require different analysis. Our confidence in the ability of a municipality to fully recover from a natural disaster relies on the ongoing resilience of the current safety system, with FEMA consistently providing timely aid to disaster-affected areas and insurance remaining widely accessible. Political opposition to FEMA’s funding, insurers exiting markets, or prohibitive insurance costs for residents could significantly destabilize the recovery effort, creating increased uncertainty during disasters.