Breckinridge enhanced and updated its municipal water/sewer sustainability framework, reflecting a commitment to continuous improvement in investment research. 

Within water, sewer and, where relevant, storm water management operations, the investment implications of challenges such as climate change, contaminants, and aging infrastructure, are significant. Breckinridge has sought to incorporate these risks in our water/sewer sustainability framework for several years, but recent attention on the water sector and the ongoing challenges it faces warranted a closer look at new framework metrics. 

Breckinridge routinely monitors and comments on changing conditions within the municipal water/sewer sector (See Investors’ Scrutiny of Water Risks Should Not Dry Up). 

Examples of recent research and news about water challenges across the U.S. include the Colorado River Compact¹ and the need for states involved to reduce their water use, goals of the Joe Biden administration to remove all lead pipes across the country,² and the EPA’s intent to formally regulate certain forever chemicals³ in drinking water at the federal level within the next year or two. In a February 2024 report titled Effective management will be crucial in lessening credit risks from water stress,⁴ Moody’s Investors Services highlighted many of the relevant risk issues, especially pertaining to drought. 

The Moody’s report also speaks to implications across all municipal sectors of the emerging risks, noting that, “Without effective management and ongoing investment, water intensive industries and populations could contract, hampering states’ economic and revenue growth. At the same time, worsening droughts can add to states’ public health and emergency management expenses.”

Complicating the challenges for municipal water/sewer utilities are emerging pollutants that are finding their way into drinking water sources. For example, with the EPA’s proposed rule that would regulate certain PFAS chemicals, utilities likely will face mounting costs to address the toxic, so-called forever chemicals. In addition, the sector faces cost pressures to address other contaminants including pharmaceuticals, harmful algal blooms, and oil spills. 

Yet the ability of utilities to recoup costs for upgrades, adaptations, and maintenance by raising customer rates could be limited by a service area’s affordability factors, creating additional credit quality and sustainability risks. 

As sector risks evolve, Breckinridge responds by enhancing its sustainability research frameworks for relevant material factors across sectors that we believe may ultimately impact long-term credit quality. The work includes incorporating more information as additional data sources emerge and current data providers gather, assemble, and deliver more consistent and comprehensive data. The goal of the work is to bring data to the municipal research team that is both scalable and repeatable across the municipal market, enabling greater comparability. 

In the case of the municipal water/sewer sector, Breckinridge’s new framework enhances the data relevant to climate risks as well as socio-economic vulnerabilities. With regard to climate, in addition to drought, heat, and wildfire risks, the enhanced framework also integrates updated data about other physical climate risks such as toxic chemicals in waterways, hurricanes, flooding, and carbon transition risks. The framework also considers environmental or health regulations relevant to the service area and strategic climate planning.

New data integrated in the framework includes socio-economic factors⁵ related to service area income and wealth metrics. The data enhances assessments of customers’ ability to pay for municipal water/sewer utilities services in defined geographical areas as well as their potential capacity to pay future rate increases. 

The framework also is enhanced to help analysts develop a clearer picture of a state’s institutional issues, initiatives, planning, and investments. For example, analysts take into account policies that inhibit or promote regional collaboration across water utilities.

As risks across municipal market sectors continue to evolve with changes in the economy, the climate, and the communities that rely on essential services municipal bond issuers deliver, the ongoing development and analysis of data is critical to more effective risk assessments and improved investment insights.

[1] The Colorado River Compact of 1922 was the first time in U.S. history that more than three states negotiated an agreement among themselves to apportion the waters of a stream or river. The agreement divided the river into two basins: The Upper Basin (Colorado, New Mexico, Utah and Wyoming) and the Lower Basin (Arizona, California and Nevada), established the allotment for each basin, and provided a framework for future management of the river. . (Colorado River Compact, Water Education Foundation).In May 2022, seven U.S. states that depend on the overused Colorado River agreed to cut consumption in an effort to help save a river that provides drinking water for 40 million people and irrigation for farmland. farmland (“Western states reach 'historic' deal to help save Colorado River,” Reuters, May 22, 2023.)

[2] Through the Biden-⁠Harris Lead Pipe and Paint Action Plan, the administration signaled to local, state, and federal partners its goal to accelerate replacement of lead pipes in the next decade with funding included in the Infrastructure Investment and Jobs Act. (Fact Sheet: The Biden-Harris Lead Pipe and Paint Action Plan, The White House, December 16, 2021.)

[3] Known colloquially as forever chemicals, PFAS — short for per- and polyfluoroalkyl substances — are chemicals that make certain products nonstick or stain resistant. Research indicates that these chemicals can be dangerous. Exposure to PFAS is linked to cancers, weakened immune systems among children, weight gain, and other health problems. In January 2024, the EPA proposed deeming the chemicals "hazardous constituents" under the Resource Conservation and Recovery Act. (“Our Current Understanding of the Human Health and Environmental Risks of PFAS,” The Environmental Protection Agency).

[4] Effective management will be crucial in lessening credit risks from water stress, Moody’s Investors Service, Sunny Zhu, Nicholas Samuels, Hetty Chang, Matthew Butler, and Timothy Blake, CFA, February 26, 2024.

[5] Breckinridge Senior Research Analysts Michael Bonanno, Ruth Ducret, and Erika Smull, PhD, worked on enhancing the firm’s municipal water/sewer sector sustainability framework and authored this article. Erika’s doctoral dissertation included publication of Rising Market Risk Exposure of Municipal Water Service Providers in Distressed Cities and Accounting for Residential Nonpayment Risk for Water Utility Financial Sustainability, which reported the results of her research into considerations of how federal funding and policy, central bank decisions, and market sentiment affect municipal utilities and the population that they serve, as well as the need to understand the change in nonpayment due to changes in water rates.

BCAI-03222024-em48xt7z (3/28/2024)

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