Financing Risk and Betting on Prevention

How credit agencies are shifting the perspective on cities' proactive climate change initiatives

By Amelia Taylor-Hochberg, CBI Climigration Intern

It shouldn’t be surprising, but it bears stating outright: retreat is expensive. In the ongoing case of America’s “first climate refugees,” resettling the 99 remaining Biloxi-Chitimacha-Choctaw Native Americans on Louisiana’s Isle de Jean Charles is slated to cost $48 million. Shockingly, however, the cost of doing nothing could likely be even higher, in the form of ever-rising flood insurance payments and rebuilding costly infrastructure after more frequent (and violent) natural disasters.

It’s a familiar struggle, prevalent in industries like healthcare and criminal justice — how to weigh costs of prevention against costs of future, post-disruption reconstruction. Even when it’s shown that preventative measures can result in lower costs than reactive ones, doling out money to prevent something from happening just feels more painful than the same amount of money spent on fixing something. And with retreat, it can feel like only a loss — of land, community and a tax base. But recently, a sea change in the way cities are able to fund their resiliency strategies is gradually emerging.

CBI has covered a variety of methods for financing retreat strategies before, both standard and more creative. But at the end of 2017, Moody’s Investor Service, one of the “big three” credit rating agencies, announced a major change to the way it evaluates state and local bonds, which stands to make a huge impact on retreat financing. According to a report issued in November, Moody’s said it would incorporate local climate change mitigation strategies into its ratings for cities — so if a coastal city isn’t doing anything in response to imminent flooding threats brought on by climate change, their credit rating could suffer, and interest rates could increase.

One of Moody’s managing directors, Lenny Jones, told Bloomberg, "What we want people to realize is: If you’re exposed, we know that. We’re going to ask questions about what you’re doing to mitigate that exposure... That’s taken into your credit ratings." Here’s a tidbit direct from the Moody’s report:

Credit risks resulting from climate change are embedded in our existing approach to analyzing the key credit factors in our methodologies. Our analysis of economic strength and diversity, which signals the speed with which an economy may recover, captures climate-driven credit risks such as economic disruption, physical damage, health and public safety, and population displacement.

Moody’s isn’t the only one of the “Big Three” credit rating agencies taking note of climate change. In October 2017, just a month before Moody’s published its report, Standard & Poor issued a FAQ also explicitly addressing the credit impacts of climate change: “In addition to episodic event risk from natural disasters, S&P Global Ratings believes it is important to consider the current long-term credit implications of the physical impact of climate change that municipal debt issuers must contend with.” And a September 2015 report from Fitch Group points directly to the problem of reactive, vs. preventative, measures when it comes to climate change: “local governments that respond hesitantly to climate change may face higher mitigation costs and potentially much higher disaster recovery costs in the future, particularly should federal support mechanisms decrease over time.”

This could really ratchet up the pressure on cities’ climate-planning initiatives, but how precisely Moody’s evaluates a municipality’s credit worthiness based on such initiatives (or lack thereof) is still not public knowledge. At the very least, this could become a new standard for credit rating companies, as more investors demand to know how climate change impacts are being handled.

But in terms of evaluating specific climate resiliency strategies, how Moody’s will treat retreat is not yet certain — it firstly wants to see that a plan, any plan, is in place. Moody’s 21 page report makes no explicit mention of planning for “retreat”, but does lay out how population displacement and relocation as a result of climate shocks can adversely affect local economies.

John A. Miller, a water resources engineer who has worked on the 2017 reauthorization of the National Flood Insurance Program and now deals in floodplain management policy, doesn’t think retreat will be encouraged in the credit evaluations: “From a municipal credit rating standpoint, there’s more interest in the adaptation aspect of climate change,” he told CBI in a phone interview. “Their core interest, at the end of the day, is getting paid back — so whatever provides the safest economic returns will be most attractive. It’s harder to balance the books like that with retreat. “Credit rating companies are very myopic,” Miller said. “What they really look at is what can affect revenue — from a municipal standpoint, they want to make sure they get paid back. They only consider things that can affect that, and not necessarily the final horizon of climate change impacts.”

Jenna deAngelo, a program manager at the Lincoln Institute of Land Policy, pointed out that this announcement could also impact how much local governments rely on state and federal aid. As climate change impacts persist and intensify, the aid available is stressed even more, and could potentially run out — FEMA’s flood insurance program is already billions of dollars in debt. DeAngelo told CBI over email, “it’s so important for municipalities to evaluate their own source revenues and how they can put in place policies and systems that will improve their fiscal health.” It’s also up to Moody’s to be critical when evaluating responses to climate change: is a city simultaneously building a floodwall in one area while building new housing within the floodplain of another?

Moody’s announcement could also have political ramifications. In areas that refuse to acknowledge climate change at all, it may be politically disadvantageous (or at least require a lot of euphemisms) to try to push certain initiatives in order to meet Moody’s criteria. There are still many unknowns, but by putting climate change at the forefront of credit rating systems, the money is bound to talk about retreat sometime soon.

Special thanks to Jenna deAngelo at the Lincoln Institute of Land Policy for her expertise and commentary in contribution to this post.

Creative Financing for Managed Retreat

By Amelia Taylor-Hochberg, CBI Climigration Intern

How Novel Financing Models Could Help Make Managed Retreat More Manageable

When considering migrating entire communities out of natural hazard risk areas, homeowners and local governments deal with a whole new can of financial worms. Governments may lack the funds necessary to buy out all needy areas, and banks aren’t attracted to assets that will literally and figuratively be underwater. Homeowners are between a rock and a hard place: as property values fall due to increasing risks, they may not be able to sell at a price that allows them to buy elsewhere.

This difficult subject has been the focus of CBI’s ongoing webinar series, “Funding & Financing Coastal Retreat”. The latest webinar, held on October 25, focused on creative mechanisms from within the private and public spheres to finance retreat due to climate change. In contrast to the federal government’s Hazard Mitigation Grant Program, where homeowners can voluntarily seek buyouts with FEMA money (post-disaster), these strategies can be more proactively employed to reduce risk in a wider variety of cases.

A range of financial tools were discussed in the webinar, from more traditional options, like municipal green bonds, to emerging models, like social impact bonds and catastrophe bonds. Green bonds have been used by municipalities and city agencies to finance sustainability projects like infrastructure upgrades, but have not yet been used to finance managed retreat. The more novel solutions for supporting sustainability and climate resilience work — such as catastrophe bonds, conservation mitigation credits, and social impact bonds — may be potential tools for managed retreat projects. However, using any financial tool requires a source of repayment to the investor(s). For managed retreat to access any of the financing tools discussed, an economic value has to be placed on the remediated land, and a repayment source must be identified.

One untested but intriguing avenue brought up by Jenna deAngelo, program manager at the Lincoln Institute of Land Policy, brought up one intriguing avenue to minimize federal government involvement and taxpayer risk in coastal retreat buyouts: mortgage contingent loans. With these loans, at-risk homeowners cede their property to the government, which then issues them a commercial loan tied to the value of their home, rather than their income. The homeowner can then use the loan to buy another property elsewhere. The government now holds the mortgage to the home, and can sell it on the commercial market, transferring risk from the taxpayer to the private market. If the occupant moves out of the house or passes away, the government retains the net equity and can sell the house and pay off the loan. Alternatively, the government could keep the house and turn it into public housing, as selling it could mean a loss, depending on the real estate market. This possibility in turn brought up a larger discussion of equity issues surrounding climate-related displacement, and how financial support of communities is related to their socioeconomic makeup.

Although these kinds of loans haven’t been tried before within managed retreat strategies, they could offer an innovative approach to financing risky futures, compared to the context of federal funding. Mark Skidmore, professor in Government Finance and Policy at Michigan State University, as well as the Director of the North Central Regional Center for Rural Development, pointed out that current federal disaster assistance programs are not risk-adjusted to where they are actually applied — so those living in risky areas (and the state and local governments) have no incentive to take risk-reducing precautions. This ultimately encourages people to to stay in risky areas, rather than seeking safer (both financially and environmentally) land elsewhere.

To learn more about creative financing strategies for managed retreat, you can watch the entire webinar here. Outlines from the featured presentations, as well as cited resources, can be found here. The webinar was hosted by CBI’s Bennett Brooks and Osamu Kumasaka.

Jenna DeAngelo is a program manager at the Lincoln Institute of Land Policy. Prior to joining the Lincoln Institute, Jenna was a senior benefits administration analyst at Xerox Business Services and a human resources analyst at the MBTA. Jenna earned her B.S. in Economics and M.S. in Urban and Regional Policy, both from Northeastern University.

Katie Grace Deane is associate director of research and field development at the Center for Community Investment. Prior to joining the Center, she spent 7 years at the Initiative for Responsible Investment at the Harvard Kennedy School where she led research on public policy and impact investment, sustainable investment trends, and place-based frameworks for community development. Katie began her career as a research analyst at the Tellus Institute, where she researched corporate sustainability performance indicators and the effects of university endowments on employment and the community. Katie has a BA from Williams College in Political Science with a Concentration in Leadership Studies, and is a member of the Miss Hall’s School Board of Trustees.

Mark Skidmore is Professor and Morris Chair in State and Local Government Finance and Policy at Michigan State University. He is also Director of the North Central Regional Center for Rural Development (NCRCRD). Mark holds tenure system appointments in the Department of Agricultural, Food, and Resource Economics and Economics. He has served as a consultant on a range of issues including economic development, government public finance and policy, and price determination. Recent research areas include economics of the public sector, economic development, and the economics of natural disasters. He has published the results of his research in journals such as Economic Inquiry, Economics Letters, Journal of Urban Economics, National Tax Journal, and Public Choice. Much of Mark’s research and outreach focuses on public finance policy and the relationship between public finance policy and economic development.