All of America has watched with sadness as fires have ravaged the Los Angeles area. Now that the fires have been contained, it’s up to the owners and cities involved to rebuild. The cost will put massive strain on municipal budgets, and could require heavy borrowing. Fidelity Viewpoints discusses the potential affect this could have on the municipal bond market, writing:
While the wildfires in southern California are now mostly contained, the lengthy and expensive process of rebuilding what they destroyed or damaged is just beginning. The recovery will, of course, pose the greatest challenges for those who’ve lost homes and livelihoods, but it also has the potential to affect people who may live far from where the fires took place. Among them:
Investors who hold the municipal bonds of issuers that provide services in Los Angeles County where most of the fires took place. The appeal of muni bonds has always been a combination of tax-free income and low credit risk. However, since the fires, S&P Global, one of the rating agencies that evaluate the credit quality of bonds, has downgraded the credit for the Los Angeles Department of Water and Power. S&P Global and other ratings agencies such as Fitch also have put both the city of Los Angeles and the Southern California Public Power Authority on what they call “negative watch,” meaning their credit ratings could be downgraded because of the fires. Historically, downgrades have hurt bond prices while raising yields on new issues.
Analysts from Fitch Ratings explained their decision by saying, “Questions have been raised by the community and political leaders about the utilities’ infrastructure resiliency to fire, sufficiency of available water supplies for fire suppression, utility protocols and communications ahead of and during red flag events, and ultimately the source of the ignition for the fires. Resulting damage to utility infrastructure and the level of property destruction and personal injury to affected residents is not yet known. These rating factors have the potential to increase pressure on the city’s general operating budget and overall credit quality.”
Fitch says that being put on negative watch is not the same as a downgrade, but it means there’s a 50% chance the issuer will be downgraded in the next 90 days. Since the fires began, yields for these utilities’ bonds have risen, suggesting that the market also sees greater risk in them.
Part of what concerns the rating agencies is that California courts have held in past cases that utilities can be held liable for wildfire property damages. Fitch says that if that happened in the case of the Los Angeles fires, “The scale of the potential liability would likely lead to a multi-notch downgrade for the power revenue bonds and related projects.”
Beyond California: In harm’s way
While the California situation is in some ways unique because of the nature of the state’s legal system, governments, public utilities, and other municipal bond issuers across the country may also face rising risks from natural disasters that are more costly than in the past. Part of the reason is that many places that are at risk for natural disasters are also places where population growth and property prices are rising quickly. For example, many areas of Florida where hurricanes once posed threats only to mangroves and pine forests are now home to millions of people who have moved to the state in recent decades. The same is true in other fast-growing states like Texas, Georgia, and the Carolinas. Meanwhile, people continue to leave places like Michigan and upstate New York where disasters are infrequent.
Action Line: When you want to talk about bonds in your portfolio, email me at ejsmith@yoursurvivalguy.com. In the meantime, click here to subscribe to my free monthly Survive & Thrive letter.
