The Breckinridge municipal bond research team held 30 engagement discussions with issuers and SMEs during 2022.
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 $34 billion in tax-efficient bonds held in our clients’ portfolios as of December 31, 2022.
During the last five years, our research analysts have conducted more than 150 direct engagement discussions with municipal bond issuers.
Why are these issues material considerations?
Inpatient healthcare is ranked by the EPA as the second-largest commercial energy user in the U.S. Healthcare facilities consume close to 10 percent of the total energy used in U.S. commercial buildings. The healthcare sector is responsible for 8.5 percent of U.S. GHG emissions. Legislative attempts to limit these impacts and to incentivize energy efficiency and renewable energy may result in price volatility associated with fossil fuels and conventional electricity. Systems that are able to improve energy efficiency can decrease costs and limit exposure to fluctuations in energy pricing.1 Healthcare delivery organizations have realized that to best achieve their key mission of helping patients, they must also be good stewards of the environment, including the reduction of GHG emissions. Increased levels of GHG emissions have negative health impacts and have disproportionally impacted many poor and minority communities. In addressing climate change, management are confronting adaptation and mitigation challenges while ensuring care continuity and quality and patient safety.
Key Takeaways from our Discussions
Our engagement meetings with hospital management teams focused on steps taken to achieve the goal of NZ GHG emissions, the tracking and reporting of data, and key challenges. Hospitals understand the importance of GHG emissions reductions, and, increasingly, they acknowledge an intersection of climate, environment, and social determinants of health.
Very few health systems across the county have committed to a NZ emissions goal, largely due to the complexity of the challenges that the sector faces. None of the hospitals participating in our engagements have an NZ emissions goal. For example, older facilities can be a key issue in committing to NZ. In urban locations space for renewable projects is limited and older facilities are expensive to retrofit. Clean, renewable energy power generation can also be a challenge. The necessary increase in renewable energy capacity must come from electric services companies. One management team maintained that the only way to currently to accomplish NZ in the absence of new renewable energy projects, will be to purchase significant amounts of carbon offsets.
Hospitals recognize that energy investments can provide future benefits. Despite no formal NZ commitments from the hospitals we engaged with, actions are underway. In 2019, one healthcare system pledged to power 100 percent of its operations with renewable energy by 2030, which would reduce Scope 1 and 2 emissions by 54 percent. Another system is working with an engineering consultant to reduce energy use intensity by approximately 13 percent by 2027. A third targeted a 50 percent reduction in GHG emissions by 2032, through the Better Buildings Challenge, whose participants pledge to cut energy use by 20 percent over 10 years and share strategies and results. Another plan seeks to bring all facilities to Energy Star (ES)100 standards and allows ES75 operations.
Several systems are taking proactive steps to integrate climate and energy considerations in new construction planning. One established a goal for all new construction projects to achieve Leadership in Energy and Environmental Design (LEED) Silver status and retrofit existing facilities to reach LEED Silver where possible. Similarly, another stated that construction or renovation projects that cost $1 million or more focus on LEED certification. That system expanded its space by 17 percent, while cutting energy consumption by 4 percent over the same time frame.
Third-party organizations are working with the healthcare industry to address climate and energy concerns. Practice Greenhealth (previously, Healthier Hospitals Initiative) tracks international hospital sustainability efforts. The Low Carbon Pilot focuses on helping reduce CO2 emissions in buildings and manufacturing plants. The National Renewable Energy Lab (NREL) collaborates and facilitates financing for low carbon projects. Climate Central is focused on building more resilient power infrastructure to make reliable power available to the healthcare system during heavy storms and environmental disasters. The We Act: Waste, Energy/Water, Agriculture/Food, Chemicals, Transportation effort involves clinicians in sustainability plans.
We met with Health Care Without Harm (HCWH) as part of our engagement effort. HCWH’s goals is to reduce health care’s environmental footprint, helping industry members to become community anchors for sustainability, and leaders for environmental health and justice. HCWH’s NZ guidance is aligned with the Science-Based Targets initiative (SBTi). HCWH members must make significant decarbonization progress by 2030. Selected by UN for Race to Zero Campaign, HCWH recruits hospitals to its campaign. Some 14,000 hospitals/health centers in 21 countries joined the UN Race to Zero through HCWH.
Related to the focus of GHG emissions, while speaking with hospital management teams, we took the opportunity to ask about investment policies with regard to energy transitions. Two systems have chosen to join the Healthcare Anchor Network to focus on social determinants of health, including housing, food insecurity, job creation, employment, violence prevention, and access to primary care/behavioral health. One of these systems already set aside $10 million to address social determinants of health. Another system allocates about 2 percent of investments to green energy, like solar financing and water infrastructure projects in its service area. The investment committee of another system’s Board voted to eliminate all Carbon Underground 200 investments, which are the 200 largest coal and oil/gas companies in terms of potential emissions in reported reserves. Investment committees at other systems are considering restructuring their investment approaches to have more positive impact.
 Sustainability Accounting Standards Board, “Materiality Finder: Healthcare Delivery."
Carbon credits: Tools for offsetting or removing emissions
We raised the topic of carbon credits in several of our climate-related engagement discussions. Specifically, we asked management teams of companies, hospitals, and airports if they intended to use carbon credits to help meet their GHG goals.
In general, we found the responses to be thoughtful and well-reasoned. As we would hope, respondents prioritized absolute emissions reductions, by securing new sources of renewable power, for example. Carbon credits would only be used as a secondary or last resort if certain emissions proved impossible to eradicate. Interestingly, one hospital system representative we spoke with said that “everyone [in the sector] will have to purchase offsets” at some point given the energy intensive nature of healthcare delivery.
Carbon credits have been around since 1997, originating with the climate agreement known as the Kyoto Protocol. Yet, the market for the securities started to pick up recently after being dormant for many years.1 Given the increase in activity as well as relevance of transition risk discussions, we thought it would be helpful to provide a short explanation of carbon credits.
Colloquially, the terms carbon credit and offset are often used interchangeably. According to Ceres, however, they have different meanings. A carbon credit is equivalent to one metric ton of carbon dioxide equivalent (CO2) that has either been avoided or removed from the atmosphere. A carbon credit represents an offset that has been verified against the standards of a third-party registry. Examples of registries include Verra, which is the market leader in verifying credits, and the Gold Standard. Offset refers to the action of financing a climate mitigation activity, such as securing renewable power, to counterbalance a company’s own emissions. Companies can purchase carbon credits to offset their GHG emissions.2
A carbon credit is generated in one of two ways: 1) through the avoidance of emitting carbon dioxide, or 2) through the removal of carbon dioxide from the atmosphere. Avoidance projects include improved forestry and wetland management, while removal projects include reforestation and direction air carbon capture facilities. Credits are purchased under either compliance or voluntary regimes. A compliance market is regulated by mandatory national, regional, or international market emissions targets. An example is the California Cap and Trade program. The voluntary market enables companies as well as individuals to purchase carbon credits to offset their emissions on a voluntary basis.
An important element of a credit is that the end user, such as a corporation, can only use its carbon benefit when the credit has been officially retired. The process of terminating the credit, and labeling it as such in a registry, prohibits it from being improperly claimed by another.3
 Berkeley Public Policy, The Goldman School. Voluntary Registry Offsets Database
 Ching, C., Foster, C., & Richards, M. (2022). Evaluating the Use of Carbon Credits, Critical questions for financial institutions when engaging with companies. Ceres.
 Blaufelder, C., Katz, J., Pinner, D., & Weterings, J. (2020). How the voluntary carbon market can help address climate change. McKinsey Sustainability. Retrieved from: https://www.mckinsey.com/business-functions/sustainability/our-insights/how-the-voluntary-carbon-market-can-help-address-climate-change
We are speaking with management at airports to learn more about their efforts to reduce their carbon footprint to achieve NZ GHG emissions by 2050.
Why are these issues material considerations?
The aviation sector accounts for 2.5 percent of global GHG emissions.1 Airports account for 2 percent of the sector’s total carbon emissions,2 with airlines representing the remaining 98 percent. At airports, GHG emissions are caused by gasoline and diesel fuel for airport vehicles and ground support equipment (GSE), fossil fuel for electricity and heating, jet fuel for auxiliary power units (APUs) that power aircraft at airport gates, and other sources. Airports that pursue NZ goals address a significant operating cost—energy consumption—and leverage business opportunities to help customers reach their own NZ goals.
Key Takeaways from our Discussions
While the aviation sector’s GHG emissions may be a small portion of global emissions relative to other industries, the fact is the significant amounts of energy required to move travelers through the air and to support operations on the ground creates a significant carbon footprint. Reducing that footprint is an ongoing challenge, especially as air travel demand grows.
Airports face a difficult balancing act; responding to increased demand for services from airlines serving passengers and cargo, while addressing sector’s commitment to achieve NZ GHG emissions by 2050.3
Airports are targeting aggressive GHG reduction goals. Several management teams told us they seek 80 percent reductions by 2030 and NZ emissions in operations by 2050.
GHG reduction plans at airports we reviewed during our engagement tend to target Scope 1 and 2 GHG emission reductions. Strategies to reduce Scope 1 and 2 emissions often include energy efficiency through energy retrofits, proactive maintenance, and electric building and ground transportation systems. One airport is targeting 100 percent renewable energy by 2035, with all concourse expansion projects featuring roof top solar. Another requires all new building construction to achieve LEED Gold-certification. Another airport highlighted additional initiatives including using crushed concrete from onsite demolition projects to construct new runways. This activity lowers trucking costs and related emissions.
Because they do not control aircraft fuel use or passenger vehicle trips to and from an airport (both sources of Scope 3 emissions), Scope 3 GHG emissions are typically not included in airport GHG emission calculations. However, airport management teams we spoke with are alert to opportunities to address Scope 3 emissions in cooperation with airlines and passengers as a potential business opportunity.
Airports are helping airlines source sustainable aviation fuel (SAF), while providing improved energy consumption tracking and reporting to tenants. Airports also are improving passenger access to their facilities, which can reduce travel times and related GHG emissions. Newer airplanes, more fuel-efficient models, planes powered by lower-carbon fuel alternatives, and airfield modernization also can help the aviation sector more broadly achieve its emission reduction goals.
There are a number of third-party organizations that are working with airports to address GHG emissions. Airport Council International (ACI) develops policies, programs, and best practices to advance airport standards. ACI set an NZ goal by 2050 for all airports. Airports use Airport Carbon Accreditation (ACA) standards for carbon reporting. ACA independently assesses and recognizes airport efforts to manage and reduce carbon emissions. The Federal Aviation Administration can help secure environmental grants to fund projects that can lower emissions. One airport we engaged with works with the Carbon Disclosure Project’s Public Authorities initiative.
Several of the airport management teams we spoke with also are participating in efforts undertaken by their home city or state to achieve wider GHG reduction goals. Airports also are working cooperatively with airlines operating in their facilities, other businesses, and with energy providers that often have their own GHG reductions plans.
Most of the airport management teams participating in our engagement effort do not make the use of carbon credits a central component of their GHG reduction efforts (see Carbon Credits: Tools for Offsetting or Removing Emissions above). They want to reduce emissions as much as possible before buying credits. One management team said that use of carbon credits is considered the “last mile” after all other possible reductions are made, while another stated, “quite a lot can be done to reduce energy use and emissions first.”
 “Airports and environmental sustainability: a comprehensive review,” Environmental Research Letters, Fiona Greer et al, October 8, 2020.
 “Airports addressing their CO2 emissions,” Airport Carbon Accreditation, January 2023.
 “The aviation sector wants to reach net zero by 2050. How will it do it?” World Economic Forum, December 8, 2022.
Pursuing Airport Best Practices
The Airports Council International (ACI), a trade association, represents 1,950 airports worldwide. A few of the airports we engaged with highlighted ACI’s value, with one noting that it “brings intellectual capital to build best practices.” In addition to programs and services related to a variety of airport operations, including air cargo and security, ACI established an NZ emissions by 2050 goal that applies to emissions that airports directly control.
In a report, the ACI described several ways in which airports can decarbonize. Most of the airports we engaged with are already pursuing some of them, including shifting to zero- or low-carbon emission vehicle fleets and installing onsite renewable power.
Why are these issues material considerations?
The average total cost of a data breach in critical infrastructures was $4.82 million in 2022 for organizations in the financial services, technology, energy, healthcare, education, and public sectors.1 For example, during 2021 and 2022, media reported hacks either intended to interrupt or successfully affect operations and services at a health care facility, a municipal water company, and a public school district, to name three examples. An effective cybersecurity regime can protect organizations’ information technology (IT) systems and data from digital attacks, including ransomware. Material credit implications can include service interruptions, the costs to recover from attack, delayed revenue collections, reputational risk, and loss of public confidence. Rating agencies continue to develop their approach to considering cybersecurity in risk management assessments. Uncertainty about an issuer’s risk exposure and preparedness could negatively influence agency credit risk analysis.
Key Takeaways from Our Discussions
During our engagements with water utilities management teams and experts in the field of cybersecurity, we learned that the threat to critical information infrastructure is growing quickly. As we heard during a meeting: It is not a matter of if an attack will occur, but rather when an attack will occur. Preparedness for what has become a virtual inevitability varies among corporate and municipal bond issuers across sectors. Reported incidents of cybersecurity attacks demonstrate that public safety and private information are at risk.
While efforts to defend against the threats are numerous, perhaps a testimony to the rapidly evolving skills of potential attackers is the fact that there is not an out-of-the-box solution at this time. IT security talent is expensive and hard to attract. Insurance premiums are rising quickly, creating an affordability issue. Nevertheless, water systems need to prepare defenses against an eventual attack, ready a strategic response when an attack occurs, and identify ways to manage the impact of any exposure.
Practical efforts we discussed included a multi-layered information security program focused on security maintenance, enhancements, training, and response activities integrated and prioritized with other routine information systems work. Separating IT and cyber teams is intended to enable more urgent response to cyber events. One utility’s cyber team is in biweekly contact with the FBI to share information.
Another agency’s program includes separating operating systems from the internet, so it does not overlap with the administrative IT system, with communication between facilities employing microwave technology rather than the internet. A simulated cyber attack drill included the utility’s IT staff as well as the National Guard, the FBI, and private sector utilities. A cybersecurity notification system that connects all utilities in one state, allows one utility to alert all other participants in the notification system in the event of a cyber incident.
We learned there are efforts underway in certain governmental and non-governmental organizations to reduce the likelihood and severity of damage cyber incidents can present to economies, critical infrastructure, or public- and private-sector computer networks.
In one example, a statewide agency is working with cities and towns to encourage municipalities to boost their efforts to assess cyber vulnerabilities, offers workshops and training with goals for team training, threat sharing, response training, and best practices to help with next steps.
In addition, industry groups, including the American Water Works Association develops and provides educational and training programs about best practices. An assessment tool helps utilities examine how they are using various technologies and generates a customized, prioritized list of controls that are most applicable to utilities IT infrastructure. Utilities can use the tool to guide implementation of critical controls to mitigate cybersecurity vulnerabilities and comply with cybersecurity mandates in America’s Water Infrastructure Act of 2018.
As part of our engagement program, we met with an academic with cyber defense experience and expertise in critical urban infrastructure, renewable energy policy, and water equity in older American cities. This SME consults with municipal issuers on cybersecurity readiness. In general, his view is that municipalities are not adequately prepared to prevent a cybersecurity attack. He maintains that a credible municipal cybersecurity program is inexpensive, requiring a half-time employee and $10,000 in yearly software and resources expenses. With the guidance of an 18-question survey, the employee could conduct inventories, patch software, and review vendors and online partners to enhance cyber defense readiness.
 “Cost of a data breach report 2022” IBM, July 2022.
Why are these issues material considerations?
A secular trend of declining enrollment and more school choice options could negatively impact school district credit fundamentals. Some districts could receive less state aid, face more competition, or suffer weaker tax base and economic growth.
Key Takeaways from our Discussions
Through our engagement effort, we explored trends underlying school district enrollment losses for students in kindergarten through grades 12 that have disproportionately affected large urban school districts. For example, based on data from Return 2 Learn, during the COVID pandemic large school districts experienced higher rates of disenrollment (-3.3 percent) from 2020 to 2022 compared with small- and medium-sized school districts (-2.4 and -2.7 percent, respectively). In fact, small- and medium-sized districts saw small enrollment increases during 2021 to 2022, while enrollments in large districts declined 0.4 percent. During the same 2020 to 2022 period, urban school districts experienced a 5 percent enrollment decline, while suburban and town/rural schools districts saw declines of 2.5 percent and 1.6 percent, respectively. In fact, town/rural districts saw a 1 percent improvement in enrollment from 2021 to 2022.1
We met with management teams guiding some of the largest public-school districts in terms of student enrollment in the U.S. Enrollment in each of the districts exceeds 100,000 students. All but one experienced enrollment losses over the last decade, with most losses exceeding 20 percent in aggregate during that time. While disenrollments in large, urban school districts accelerated during the COVID pandemic, long-term pandemic effects are still evolving and uncertain.
Other more longstanding trends underlying enrollment changes are not new phenomena but, rather, continuations of issues that have emerged over time.
The sources of enrollment pressures beyond the pandemic vary across districts, with factors including demographics, cost-of-living, charter school proliferation, and state statutory frameworks—including school-choice options. Each contributes to enrollment trends in different orders of magnitude from district to district.
Demographic and cost-of-living influences are related and typically have significant influence on enrollment. In addition to live births, demographic patterns are influenced by inward and outward migration to and from school districts. Housing costs are a key determinant of migration patterns. Districts that are located in areas where housing is increasingly unaffordable are likely to experience continued difficulty retaining school-age children.
We learned that, as they relate to public school enrollment trends, the appeal of charter schools may be waning in some parts of the country. For one school district we reviewed, we noted the pace of enrollment in charter schools and market share losses for public schools is slowing as the charter-school experience ages. This could suggest perceived issues of school quality or reliability have emerged for charter schools operating in that district.
In addition, political and legislative context matters. We spoke with school district leadership in areas where state statutory frameworks including recent legislation tend to support increased competition for public schools. Even in the one-district we spoke with that is seeing growth in school-aged population and increased K-12 enrollment in public schools, legislative support of school choice and voucher programs may negatively influence public school enrollments in the future.
Creativity and branding of their program offerings by public school districts may have influence on enrollment decisions going forward. One district spoke in detail about its efforts to tailor educational programming based on a range of personal and educational factors, to bring greater diversity to their curriculum in an effort to retain current students and attract new students. Another district is focusing on improving the school experience for its youngest students—kindergarten-aged children—with one goal being to potentially retain those students through older grades.
Public schools will continue to wrestle with cost pressures related to labor—including part-time and non-academic staff—and aging infrastructure that, over time, may not align with present student needs. The impact of these pressures on maintaining and, perhaps, growing enrollments will continue to combine with other trends moving forward to influence the ability of public schools to attract and retain students and funding support.
Our conversations suggested that, while enrollment losses may create financial challenges for public school districts, we could not establish a direct relationship between student counts and credit quality. Our observation is based on the fact that districts involved in our engagement effort actually saw improved financial health over the decade, based on 10-year general fund balance trends through 2021.
We explored the ways in which coastal municipalities are addressing the challenges of sea-level rise (SLR) and flooding risks through gray and green infrastructure, changes to building and zoning codes and land use management, as well as managed retreat.
Why are these issues material considerations?
Risks posed from SLR include infrastructure and property damage and functional loss, land use changes, adverse environmental impacts, freshwater loss, public safety and health risks, population loss and inconvenience and economic disruption. These risks and attendant investment costs of adjustment, protection, and restoration have implications for the credit quality of city and county bond issuers. SLR, including coastal erosion, and nuisance flooding resulting from increasingly intense storms that can affect property values, with negative consequences for the tax base, operational costs, and capital expenditures. Municipalities can adapt to SLR: protecting the coastline with flood defenses; reducing the impact of coastal flooding by upgrading and adapting buildings and infrastructure; and retreating from at-risk areas. Addressing SLR and flooding risks increases demands on limited financial resources.
Key Takeaways from Our Discussions
During our engagements with municipal bond issuers dealing with threats from SLR and flooding, we learned that while there are many tactics to adapt, manage, and mitigate these risks, a one-size-fits-all solution does not exist. States, the federal government, and regional partnerships can help move the ball forward, while assets owned by city-, state-, county-, and federal-level governments in SLR-exposed areas create cross jurisdictional issues that can complicate planning.
Among the tactics considered by municipalities addressing climate risks are the use of natural infrastructure, manufactured physical structures, and policies that control or eliminate increasing SLR exposure and flooding risks—including building codes in at-risk areas and moving people to higher ground. We also learned that demographics and socioeconomic changes can influence the trajectory of SLR/adaptation planning.
Among the planning steps we discussed with municipal management teams were conducting vulnerability assessments which helps inform capital planning, incorporating climate resiliency in zoning and land use planning, reviewing potential building code changes, establishing maps detailing areas at heightened risk from SLR, working with those homeowners exposed to elevated SLR risk, exploring green infrastructure solutions, and looking at the equity impact of SLR on neighborhood housing, transportation, and safety using an environmental justice framework.
Adaptation, risk mitigation, and management tactics of SLR range from the technological—using flood sensors in vulnerable locations to better understand where and when flooding occurs to using satellite navigation software on smartphones to direct drivers away from impacted areas in real-time —to the physical— such as surge barriers, tidal gates, floodwalls, levees, pump stations, and green infrastructure measures to control flooding, such as rain gardens, berms, and bioswales.
Municipalities are partnering with a number of governmental and non-governmental organizations in their planning and responses. Entities cited in our discussions included the Army Corps of Engineers as well as various public-private partnerships, academic institutions, and large taxpayers that may be developing their own climate resiliency programs.
Financing SLR projects is a challenge. State and federal support can be helpful, while local governments are challenged to fund SLR projects due to pressure to limit tax hikes or imposition of new assessments or taxes. During engagement discussions, we learned that inflation is a concern and could lead to projects being downsized or put on the backburner, for example. In addition, municipalities discussed how they are addressing climate resiliency and environmental justice in previously neglected neighborhoods.
Municipalities must balance sometimes differing levels of willingness among residents to support the advancement of SLR adaptation projects. One method we discussed was building engagement and support among citizens through forums and surveys to gauge residents’ sentiments and interests. In one engagement, we learned that certain demographic segments of residents were less interested in paying for climate projects and were hesitant to change anything in the community. Often these long-time residents were house-rich and cash-poor, as prices of coastal properties have appreciated dramatically over time. Newer, more affluent residents appeared to be less sensitive to additional taxes or fees, more open to change, and are anxious to address physical climate change and the risks it presents for their properties.