Credit Downgrades for Unprepared States

Moody’s Takes Action on Climate Change

Moody’s investor Services, a credit rating agency known for its respected evaluations of state and local governments, has recently announced that it will now factor climate change risk into its assessments of creditworthiness.

What does this mean for climate change readiness? Hopefully plenty. From this point forward, governments that ignore or dismiss necessary climate-related changes to infrastructure and public services will see this reflected in the value of their government bonds.

Predictable changes in the climate are likely to increase the occurrence of extreme weather events, droughts, fires, floods, storms, and coastal surges. And with billions of dollars at stake given the high cost required to rebuild structures and shelter vulnerable populations—dollars that will be spent by taxpayers and insurers—unprepared cities will be deemed a higher credit risk than those that have taken preventative measures.

Smaller credit rating agencies have already taken this step, but the largest agencies—Moody’s, Fitch Ratings, and Standard and Poor’s—have been slow to respond to climate warnings, and collectively missed the subprime housing crisis altogether. Reluctant to make the same mistake again, Moody’s has released a series of statements including the following:

 “In addition to loss of life and threats to public health and safety, these [climate] events present a multitude of challenges in the form of compromised crop yields, economic disruption, damage to physical infrastructure, increased energy demand, recovery and restoration costs, and the cost of adaptive strategies for prevention or impact mitigation. These challenges can result in lower revenue, increased expense, impaired assets, higher liabilities and increased debt, among other effects.”

According to the agency, six factors will be used to determine the exposure and susceptibility of an area (like a state) from the expensive effects of climate change. Three of these will include 1) the share of economic activity that comes from coastal areas, 2) hurricane and storm damage as a share of the economy, and 3) the share of homes in the area that lie in a floodplain.

The agency made its announcement in November, and so far, no downgrades have taken place as a result of climate change readiness or the factors listed above, but cities and states have been warned: prepare for a changing world or face higher bond prices that may upset taxpayers and turn potential investors away. Even a symbolic move is significant; once states and municipalities start seeing the impact on their wallets, they’ll be more likely to take preparatory steps, including policy moves that control emissions and building codes that might avert a crisis long before it strikes.

To learn more about this announcement and to find out how it might impact your own investment strategy, contact our office.