Our 2021 Municipal Engagement Approach
The Breckinridge municipal bond research team identified five key climate change topics across large sectors of the municipal market. Team members arranged engagement meetings with issuers and SMEs to explore the topics in depth.
During the first eight months of 2021, the team held nearly 30 direct engagement discussions with issuers and SMEs. These meetings were in addition to the numerous interactions the analysts routinely had with issuers and SMEs in the conduct of new security research and ongoing surveillance on the more than $38.5 billion in tax-efficient bonds held in our clients’ portfolios as of June 30, 2021.
As reported in a March 2021 commentary titled Muni-bond investors need straight talk about climate-change risk,1 a Brookings Institution examination of 590 U.S. counties with populations over 100,000 found that “the offering statements of just 10.5 percent of municipal revenue bonds mentioned climate change.” Revenues to repay investors in these bonds often are derived from physical projects such as tunnels, roads, and treatment facilities, which would likely suffer from adverse climate events.
Further, the Brookings study found that only 3.8 percent of general obligation municipal bonds mentioned climate change. Most municipalities issuing these bonds derive the bulk of their revenues from taxes on real estate. Real estate values likely would materially decline as hurricanes or wildfires continue to threaten ever larger geographical regions across America.
Climate change is a material risk and a risk multiplier for municipal bond issuers, in our view. Yet, the information about this material risk that is made available for investors is often inadequate.
In past years, our municipal bond engagement programs explored topics such as disaster recovery, infrastructure resiliency, community development, community access to and affordability of higher education, municipal utility rate design, social determinants of health, health care cost transparency, and in 2020, responses to COVID-19.
The year 2021 proved to be a critical year to focus on the clear and present risks of climate change and the responses, adaptations, and mitigation strategies of municipal bond issuers.
People living in certain areas within the same city are at higher risk from heat, largely because of a lack of greenery. The circumstance can produce heat island effects.2 Local governments can reduce heat vulnerability for residents through long-term planning to lessen future climate risks. By adapting to increasing heat, which we find often disproportionately affects underserved communities, and by pursuing climate resiliency, cities can enhance livability, attract, and retain residents, and build the tax base.
We held engagement meetings with municipalities and SMEs to examine how cities address heat stress and equity. Our meetings illustrated that while addressing excessive heat risk, cities also should plan for and respond to a broader range of extreme weather events. For example, one engagement meeting on extreme heat occurred during an extreme cold weather emergency that knocked out the city’s power.
Identifying and analyzing which neighborhoods are most vulnerable to extreme heat events—which we found are often those communities created by historical redlining—correlated with a range of inequities and vulnerabilities, including poverty, age, housing status, social determinants of health, and in 2020, COVID-19 impacts. For example, social distancing is complicated if neighbors gather in cooling centers to escape heat.
Data is essential. It supports and defines efforts to address physical risks and social and environmental justice. Data can pinpoint areas where mitigation and adaptation strategies can be deployed for greatest effect, including tree-planting, shade structures, energy-efficient appliances, green infrastructure, and built-environment modifications such as cool roofs and pavements.
Data collection and analysis are increasingly sophisticated and essential to mapping a municipality’s most serious heat stresses and most vulnerable communities. In one example, a city worked with a local university to institute urban heat island sensors to track and transmit data wirelessly to city planners.
Municipalities should address a range of climate risks. Marshalling and analyzing data to guide policy and practice are elements of equitably addressing issues, including heat stress. Staffing and funding strategic response plans through collaborative efforts within government and with community partners are essential to long-term progress.
As cities sought to address climate risks, we observed wide ranging efforts in depth and breadth. Some city administrations prioritize climate mitigation, adaptation, and resilience. They are supported in their efforts by coordinated and collaborative approaches across city departments, with involvement of local nonprofits, NGOs, foundations, and endowments. Other cities and regions are starting almost from scratch as municipal politics change. While some municipalities have comprehensive and up-to-date Climate Action Plans, other plans are more narrowly focused or have not been updated or outfitted for implementation.
Sound urban planning that includes measures for adapting to extreme heat in both the short- and long-term is an effective way for cities to respond to the heat island effect while fulfilling their mission to protect and provide vital services to the community.
—U.S. Environmental Protection Agency
States can play a central role in addressing climate change at local levels, often filling a void left with lack of direction at the federal level. Local and regional entities address climate change risks across a wide range of concerns, including air, water, land use, power, GHG reduction, transportation, trade and commerce, and coastal and inland natural systems. States can facilitate and advocate for climate change, often brokering resources and expertise among local government, while advocating regionally and nationally for coordination, direction, financing, and action.
We held engagement meetings with states that are taking proactive roles so that we could develop a deeper understanding of how they are planning for climate change and the role the federal and local governments play in these efforts.
In meeting with state executive leadership teams, five key themes emerged: 1) a one-sized solution will not address every state’s need, 2) state support of local efforts varies widely, 3) regional and state collaborations can be helpful, but also are flawed and have their own challenges to address, 4) the federal government can be an important partner to the states to an extent, and 5) a focus on social and environmental equity in solutions is growing.
States tend to see an important part of their role to be providing resources—sometimes financial, sometimes expertise—for local governments as they identify climate hazards and plan and implement adaptation, mitigation, and resiliency programs.
Since the early 1990s, state and local governments moved to fill some of the climate policy void left by the federal government’s inaction.
—"Climate Change Policymaking in the States: A View at 2020”
All of the states that we met with are addressing the need to reduce GHG emissions, a critical factor when planning for climate change, but their approaches differ. One state publicly discloses its targets and progress in a dashboard, a level of disclosure that leads among states we met. Another state sponsors an infrastructure bank, which is a model for providing local governments with funding.
Still, funding is insufficient at the federal, regional, state, and local levels. Without adequate funding, local governments cannot execute their plans for adaptation, mitigation, or resiliency.
States also find frequent shortfalls in technical expertise at the local level. States are in a position to offer economies of scale by providing technical assistance to local governments as they identify and implement priority projects. These collaborations can accelerate progress on implementation.
The federal government can be an important source of financial support for state and local governments in pursuing mitigation, adaptation, and resiliency. Washington’s most important role, based on our conversations, may be for the federal government to lead by promulgating effective climate policy that provides a supportive context for local actions. This would help to avoid political in-fighting and other roadblocks that may stymie progress at the state and local level.
Social equity is a growing consideration during deliberations, planning, and deployment of climate adaptation and mitigation projects. One state noted it is prioritizing those projects that clearly address social and environmental issues. Another state representative commented on a heightened priority the state is placing on “equitable transitions for environmental justice populations” (See Justice Concepts Integrated in Administration’s Environmental and Climate Initiatives.)
In some cases, states are playing important roles as collaborators and, to varying extents, enablers of climate risk mitigation, adaptation, and resiliency efforts.
Increased effort and support from the federal government as well as regional collaborations are critical to advancing progress in addressing the myriad of pressing climate challenges at the state and local level.
Providing clean water and effective wastewater management are essential municipal services. They are an important factor to a community’s quality of life. The presence or absence of high-quality delivery of these services can be the difference between attracting and retaining residents and businesses, which supports property values, compared with economic and population declines.
Delivering high-quality water/sewer services is difficult enough considering aging infrastructure that many municipalities must maintain and refurbish. Add in climate change effects, including increasingly common extreme rainfall events and drought conditions we have observed, and the task municipalities face in maintaining these services grows more complicated.
As the population grows, agricultural demands, energy production, and industry expansion will increase water demand while extreme weather spurred by climate change will threaten drinking water supplies. Properly managing our scarce water resources is therefore more important than ever.
—"Urban Cities Confronting Climate Change Through Water Management: New York City as an example”
We held engagement meetings with large municipal water/sewer authorities and sector SMEs to explore the issues and risks more fully. During our meetings with these issuers and professionals, we discussed innovative and proactive efforts to maintain, refurbish, and adapt clean water and wastewater capabilities to changing climate conditions.
We spoke with a number of authorities that are integrating social and environmental issues in their capital spending plans, including the concerns of historically underserved communities. (See Justice Concepts Integrated in Administration’s Environmental and Climate Initiatives and see our discussions of environmental and social justice in our engagement report Cities Address Heat Island Effect Adaptation, Mitigation as Guided by Justice Considerations.)
Underserved communities have seen a number of incidences of negative effects from deteriorating water and sewer systems in recent years, as reported in high profile cases including Flint, Michigan, Dos Palos, California, and Newark, New Jersey.3
As one authority approached enhancements to its infrastructure, it engaged with the community for 18 months about a green infrastructure/stormwater management plan, educating residents about the project and discussing potential job creation and neighborhood revitalization.
Another authority is in early stages of considering the potential effects of climate change on water/sewer operations, with no specific GHG emission reduction or climate resiliency plans. The authority participates in regional planning council efforts. Further, prompted by our engagement, management at the authority began to reach out to nearby communities to learn more about their approaches to water/sewer mitigation, adaptation, and resilience. The authority and its banking advisors enthusiastically participated in our engagement, stating that investor questions are important drivers of bond issuer action.
Our engagement meetings on the climate risks confronting municipal water/sewer service providers offered a definitive reminder of risk dimensions confronting them. Stormwater management is a prominent area of concern for some, while drought, erosion, conservation, and clean water supply are more prominent concerns for others.
Our engagement highlights that the authorities that are positioned well to confront these risks are those innovative authorities that take a systemic approach. They work collaboratively with certain departments—operations and maintenance, engineering, and finance—as well as local and regional communities to tackle multiple risks during capital planning to address supply, storage, pipelines, treatment plants, pump stations, and other infrastructure and contingencies.
In discussions with authorities and SMEs, we confirmed that many issuers will look to enhance their climate reporting if driven by constituencies, local political officials, or if and when they experience environmental emergencies. Waiting until that eventuality can place a municipality at a significant disadvantage for recovery and progress. Continual planning needs to be undertaken and practical progress accomplished before emergencies arise to maintain quality of life and control long-term costs.
Increasingly, municipal power providers are instituting or adopting mandates to transition away from carbon for power production. For these municipal bond issuers, two considerations are key in our credit and sustainability assessments: resources and reliability. We seek to assess which electric resources will compose the renewable energy output, and what system reliability will be during and after transition based on expected peak needs.
We held engagement meetings with municipal power providers in major metropolitan and wide geographic service areas—including one organization encompassing both power and water services—to discuss approaches to moving away from carbon production. In addition, we consulted nonprofits facilitating clean-energy transitions.
Like investor-owned utilities, municipal power providers face a multi-dimensional challenge on their path away from carbon-based energy production, including meeting customers’ still-growing capacity demands while simultaneously retiring fossil-fuel generation plants and replacing them with carbon-free alternatives.
While most municipal power providers we met have defined target goals on a path away from carbon-based operations, their integrated resource plans—and one integrated system plan—reflect disparate strategies to reach the goals and have made varying progress on them.
Their individual challenges require further consideration when assessing the issuers. While one municipal power provider must mitigate the risk of wildfires, another is seeking to address water resource demands in a drought prone area. Several municipal power providers should develop service and rate plans that equitably address disparate residential and commercial needs.
Renewable energy solutions—solar, wind, geothermal, biodiesel, green hydrogen, nuclear—offer alternatives for companies and customers. As consumers more frequently choose to adopt alternative means of powering their homes, utilities may have the opportunity to account for emission reductions realized through customers’ initiatives in combination with reductions that the utility may achieve. First, the utilities must implement policies and procedures for capturing the benefits that consumers are achieving from renewable energy solutions. During our engagements, we have spoken with utilities that have not taken these steps.
One engagement highlighted for us, as well as for the municipal power providers, is that by understanding its customer types and needs and integrating their progress with those of the power provider, the utility can take into its own accounting the progress realized by the customer. Purchasing rooftop energy counts toward utility goals and when timed with battery storage can be less disruptive to the overall aim of maintaining reliability.
This points to the fact that municipal power providers must avoid complacency. As the U.S. electric grid and its customers become equipped to achieve aims for differentiated energy supply—both clean and dirty—customers will be able to assume an increasing role as energy-provider and storer, in addition to being the utility’s consumer.
We believe that there was authentic and genuine give-and-take in our engagements. Municipal power providers demonstrated interest in our views and definitions of sustainability to inform their future planning. We have observed a shift in the philosophical view of some service providers to seek to better understand their customers and comparative-advantages they share. More recently, we note that shared goals can advance each party’s interests.
Actual progress is more difficult to document in some cases, which means investors must be discerning in their examination of a utility’s progress away from carbon.
In the context of electric utility climate resilience planning, measures to gird against coming climate consequences should be evaluated and implemented in a manner consistent with emission reduction strategies. Thus, for example, electric utilities should consider investments to support distributed renewable energy resource deployment instead of hardening fossil fuel infrastructure.
—Climate Risk in the Electricity Sector: Legal Obligations to Advance Climate Resilience Planning by Electric Utilities4
Housing affordability is becoming an increasingly difficult challenge for American cities and towns. Recent studies suggest that sea-level rise and coastal flooding due to climate change will threaten the future availability of affordable housing.5 Housing Finance Authorities (HFAs) that do not address climate adaptation and mitigation face risks to real property, the value of current housing stock, and residents’ health and welfare.
Extreme weather events fueled by climate change are exacerbating the intertwined crises of affordable housing and homelessness and thus require timely intervention by federal, state, and local governments.6
—The Center for American Progress
We held engagement meetings with affordable housing developers and financiers as well as SMEs who are addressing the supply of safe and affordable multi- and single-family housing for low- and moderate-income residents across America. To help frame the challenges that climate risk poses for affordable housing, one executive outlined a strong relationship between affordable housing and climate risks, putting those dependent on affordable housing at extreme risk of losing their homes.
In some states, the primary tool that HFAs utilize to incorporate climate resiliency in awarding Low Income Housing Tax Credits is the Qualified Allocation Plan (QAP). In those instances, a QAP may have a dedicated climate section that requests information about climate adaptation and risk mitigation for new construction. Developers seeking financing can gain points by qualifying for standards such as National Green Building, Net Zero Energy, Passive House, and Energy Benchmarking, for example.
Increasingly, new developments are incorporating Leadership in Energy and Environmental Design (LEED) building approaches. Creative programs are helping affordable housing developers, owners, and financiers protect buildings and residents from climate change events. For example, one program offers free tools and guides for assessing portfolio and property climate vulnerability and developing actionable strategies.
Trends in passive housing design were common topics among the agencies and authorities we met. Passive housing employs principles to attain measurable and rigorous levels of energy efficiency within a specific quantifiable comfort level. New construction employing passive housing techniques may prove more sustainable over time.
Financing adaptation and mitigation for existing affordable housing stock can be more complicated than for new construction. Addressing the climate risks threatening current affordable housing stock requires responses to a wide range of climate change risks, depending on location, including flooding, hurricanes, extreme heat, and fire, among others. Tax credits or government-sponsored financing for resiliency projects could spur additional upgrades for existing affordable housing.
As HFAs seek to anticipate and respond to climate risks, they face challenges similar to those faced by other municipal agencies. As one SME observed, HFAs historically have been slow to adapt. Implementing climate resiliency initiatives is no different. Being involved early in planning is essential.
Further, while some federal programs and data sources support the efforts of affordable housing owners, operators, and managers to better understand and plan for risks, others offer limited or outdated data that is not forward looking. In addition, while fortified housing standards exceed typical building codes to deliver superior performance during severe weather or disaster events, no template exists to endorse ESG for a real estate entity.
The effort to provide affordable housing faces significant barriers frequently, including community opposition, lack of funding, limited financial support through tax credits, escalating material and labor costs, and complex regulations. Climate risk further complicates an already difficult proposition.
By working with HFAs pursuing affordable best practices for the housing industry, we believe we can better identify providers that will address community affordable housing needs on an equitable basis, while maintaining an ability to meet bondholder obligations.