Municipal

Blog October 13, 2017

Municipal Credit and the Path of Federal Natural Disaster Support

In our blog post Municipal Credit Implications of Hurricane Harvey, we highlighted our view that Hurricane Harvey would have only a limited impact on municipal credit quality in the Texas Gulf Coast region. But in that same piece, we noted that the Hurricane Harvey experience – and the muni market’s strong track record of managing through natural disasters – may not describe the future. This view is predicated on the reality that local government fiscal resiliency in the aftermath of natural disasters is partly because of federal aid, and on the assumption that in the coming years, federal disaster aid could become less generous.

As Figure 1 below illustrates, federal disaster aid has been increasing as a percentage of non-defense discretionary spending over the past several decades. The data shown here includes direct grant aid from the Federal Emergency Management Agency (FEMA) as well as payouts from federal insurance programs such as the National Flood Insurance Program (NFIP).

These aid payments are vulnerable to being lowered through legislative reform for a variety of reasons. First, federal deficits are expected to rise over the next decade, which suggests that discretionary spending, including spending on disaster relief and general fund transfers to close the NFIP deficit,1 will remain pressured. We note that the president’s initial FY18 budget2 reduced appropriations for FEMA.

Second, there is bipartisan support to reform the NFIP in a manner that reduces federal subsidies to homeowners in flood-prone areas. In its original form, the Biggert-Waters Reform Act (passed by the U.S. House in 2012 by a 402-18 vote) denied federally subsidized coverage to homes that flooded repeatedly (homes known as “Repetitive Loss Properties”).

Third, there is growing recognition that local resiliency planning can mitigate the costs of natural disasters. For example, in the wake of Hurricane Harvey, Harris County, Texas Judge Edward Emmett recently testified in front of the U.S. House Natural Resources Committee about the need for an updated flood control plan for all of Texas. It is reasonable to assume that future federal disaster aid may be tied to local efforts to mitigate long-term risks. This risk seems heightened given that climate change is expected to contribute to rising seas and more intense storms.3

Estimates of damage and impact related to hurricanes and the California wildfires remain fluid. For investors, the takeaway from potential shifts in federal support is that the credit profiles of some municipal credits are likely more vulnerable to natural disaster risk than previous history might suggest. In certain circumstances, considering an issuer’s preparedness for a natural disaster, both financially and in terms of long-term planning, should be an element of prudent credit analysis.

 

[1] As of March 2017, the NFIP owed the U.S. Treasury $24.6 billion, per FEMA reports.

[2] Budget found at https://www.whitehouse.gov/sites/whitehouse.gov/files/omb/budget/fy2018/budget.pdf, released in May 2017.

[3] Economic losses from weather events related to human-induced climate change and health costs caused by fossil fuels could increase to more than $360 billion annually in the coming decade, per The Universal Ecological Fund, The Economic Case for Climate Action in the U.S., September, 2017.

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