Weekly Preliminary OS Climate Risk Review (6/3/21)

By June 10, 2021 June 12th, 2021 No Comments

We jump up to a school district in Mid-Michigan, which has recently fallen victim to both severe flooding (a 500-year flood hit the area last year) and enrollment declines (down 43% since 2004). Compounding the issuer’s unsightly ESG profile are indications of historically poor governance and weak socioeconomic characteristics. Unfortunately, none of these credit negatives are properly disclosed in the preliminary official statement, published last week.

This week’s non-disclosure stand-out:

Beaverton Schools, 2021 School Building and Site Bonds, Series I (General Obligation – Unlimited Tax), $11,100,000

The School District encompasses 252 square miles in Mid-Michigan, serving cities and towns in both the counties of Gladwin (Flood risQ Score 3.6) and Clare (Flood risQ Score 3.0). The School District comprises three schools: the Beaverton Activity Center (preschool), Beaverton Middle School and Beaverton High School. Enrollment at the schools has declined consistently over the past decade, from a 10-year high of 1,328 students in 2011-12, to a new low of 900 students in 2021, a drop of over 32%. The drops in enrollment can’t be blamed on local competition within the District, given there are no private, charter or parochial schools located within the District’s boundaries. 

The proceeds of the issuance will be primarily used for making improvements to school buildings, acquiring and installing instructional technology, improving playgrounds, athletic fields and facilities, and parking areas. The bonds are secured by the full faith, credit and resources of the School District, and will be payable from ad valorem taxes on property value within the district.

Neighboring Midland County was hit with a 500-year flood event just last year, causing $175 million in damage. Aerial photo above shows the aftermath, taken by Gregory Shamus. 

Strange that the School District fails to disclose any flood risk, given that the County of Gladwin is no stranger to flooding. Last May, the County was included in a disaster declaration issued by Governor Gretchen Whitmer (along with counties Iosco, Saginaw, Midland, and Arenac), following a historically devastating flood event that ripped a hole in Mid-Michigan. The 500-year flood event resulted in $175 million in damage to neighboring Midland County (which has a lesser Flood risQ Score than Gladwin, of 2.0), catalyzing failure of 2 dams, and damaging and destroying over 2,500 homes and businesses. Only 8% of impacted property owners were holding flood insurance at the time, given that most of those properties were not included in the FEMA-mapped flood zones. While Governor Whitmer requested $245 million in federal disaster relief funding, President Trump only approved $43 million at the time. Even with the FEMA funding, there were people in Michigan that felt the impacts of the event months later. “State Farm denied our claim, so we haven’t any assistance, and everything we’ve done to restore the house has been with cash,” one resident in Billings (Gladwin County) claimed, still displaced two months after the storm swept across the State. According to the issuer’s POS, Billings (Flood risQ Score 4.6) is responsible for the largest portion of the 2021 taxable value within the Beaverton School District, at 29.56%; Tobacco Township (Flood risQ Score 3.8), also in Gladwin, is responsible for the second largest percentage, at 29.51% (POS B-5).

So, getting our ducks in a row here. Just last year, Mid-Michigan got slammed with a 500-year flooding event that hammered towns with property losses throughout the counties of Midland and Gladwin. The State only received less than one-fifth of the federal aid it requested, and people within the issuer’s highest taxable value city, Billings, were left without proper housing months after the event. Yet, the words {flooding, disaster, rainfall, climate} don’t appear once in the entire preliminary official statement. Got it.

Over $6.8 million of debt in this issuance is expected to mature after 2035 — the cone of uncertainty is far too wide to confidently project the state of FEMA’s National Flood Insurance and Disaster Assistance programs out to that long a time horizon. However, we’re already seeing FEMA policy starting to shift, with a recently introduced proposal to increase the threshold requirements for disaster declaration, as well as momentum behind NFIP’s Risk Rating 2.0, which intends to calibrate insurance premiums to actual flood risk. These policy changes would materially impact the foundational assumptions held by state and local governments in terms of ‘who is holding natural hazard risk when’. States like Michigan, and flood-prone municipalities like Gladwin County would be adversely impacted by these shifts in decades-old policy. And, that’s bad news for this week’s non-disclosing School District issuer, which is already seeing enrollment numbers falling rapidly and 500-year flooding events looking more like 100-year events. Sitting on the Tittabawassee River and Wixom Lake, the School District has direct exposure to inland flood risk. We’re projecting that a 500-year event, like the one that occurred in Mid-Michigan last Spring, would result in 30% property losses within the District, and by 2035, the District will sustain 29% property losses combined from inland flooding events. These value-at-risk numbers lead statewide, ranking 100th percentile, and fall in the 94th percentile nationally. Environmental risk is absolutely material for this issuer, despite the eyebrow-raising omission in its official statement.

Falling enrollment + last year’s episode alone should keep any investors in the School District up at night. Mix in some fear, uncertainty and doubt surrounding federally-financed insurance subsidies and disaster bailouts, as well as the District’s worsening outlook for flooding events, and…oof. This is also a School District that faced a financial crisis just two years ago, after large accounting errors resulted in the fund balance falling below 5% (the Michigan Department of Treasury only announced in February of this year that the School District was no longer considered “financially distressed”). Though the District’s management has been switched since the accounting error, governance might well be an issue (unsurprisingly, the terms {accounting error, financially distressed} aren’t found in the preliminary official statement either).

Some of the residential demographics for the School District found in the risQ UI make for an ESG challenge, as the district clearly serves a less advantaged population, and in many ways playing E and G metrics against S metrics, while also navigating directionally poor fundamentals:

  • Median household income: $41,075 (13th percentile statewide)
  • Average owner-occupied housing value: $118,388 (14th percentile statewide)
  • Per capita income: $23,316 (28th percentile statewide)
  • Percentage of population below poverty level: 19% (81st percentile statewide)
  • Gini index (measure of economic inequality): 0.44 (79th percentile statewide)
  • Gladwin and Clare County population growth flatlined over past decade

All that said, failing to disclose its flood or climate risk in its official statement so soon after a major disaster only enhances questions as to whether the population are being served and investors are being informed appropriately.

Honorable Mentions

Houston Airport System, TX (risQ Score 4.0-4.2; Flood risQ Score 2.9 – 3.6)

Houston, we have a problem. Houston’s triad of airports—Ellington, Hobby, and George Bush Intercontinental—racked up risQ Score of 4.0, 4.0, and 4.2 respectively from roughly equal helpings of flood and hurricane risk. The POS does a decent job of disclosing the impacts of past severe weather events. This includes four major flood events in the past six years (pg 81) which resulted in delays, closures, and in the case of Hurricane Harvey $4 million in damage. Harvey also resulted in a 3.1% decline in enplanements in Aug/Sept of 2017 compared to the previous year (pg 60) while Winter Storm Uri this past February resulted in a 50-60% decline in enplanements compared to February 2020 (pg 25). The POS fails to reconcile these risks with climate change and the heightened threat that climate charged storms pose—the POS doesn’t mention ‘climate change’ once.

To combat flood and storm risk, Houston Airport System (HSA) maintains hurricane insurance jointly and severally with the City, but the policy only covers part of the total property value of the HAS (pg 60). The POS clarifies that Houston is actively pursuing FEMA grants to fund flood mitigation and flood damage reduction projects (pg 81). The HAS adopted a Sustainability Management Plan which covers mitigation efforts and energy efficiency projects, but is absent of climate resilience measures.

Norfolk Airport Authority, VA (risQ Score 1.9; Flood risQ Score 3.8)

Another risky coastal airport. Norfolk Airport sits in the 90th percentile nationally for property value at risk. A 1 in 100-year coastal flood puts ~9% of property value at risk within a 45 minute drivetime of the airport, with a 100-year inland flooding being just as damaging. The OS is cognizant of the risk it faces, recognizing that increasingly stringent emission regulations and extreme weather events pose challenges to airport operations and interrupt commerce and military activities. But while the risk is identified, the risk reduction strategies are not. Norfolk Airport doesn’t appear to be proactively improving its climate resilience and sustainability. The POS subtly casts doubt on climate related risk, stating that if scientific predictions are correct, storm and flood related hazards are expected to intensify.

Los Angeles City Department of Water and Power, CA (risQ Score 1.5; Hurricane risQ Score 2.6)

Last week we highlighted LA Water & Power for their copious efforts to improve water security through water conservation and mitigation measures. This week the Department is securing $433 million in bonds with electric system revenues, whereas last week’s bonds were secured with water system revenue. 

Another major difference between the two issuances is the frequency and depth at which wildfires are discussed: last week’s issuance mentioned “fire” 27 times while the more recent tripled usage up to 93 times. The more frequent discussion could be due to the fact that electric systems can cause wildfires and that the Department is currently involved in two wildfire lawsuits stemming from electrical equipment (pg 81). To prevent these problems from arising, the Department has implemented wildfire prevention plans as far back as 2008 which include vegetation management programs with buffer areas around equipment. 

Aside from mitigating wildfire risk, the Department is working diligently to reduce emissions from its power generation. The State’s current targets aim for 44% of retail electricity sales to be from renewable sources by 2024 and 60% by 2030 (pg 62). To that end, the Department partnered with the National Renewable Energy Laboratory during the LA100 study to identify pathways to achieve a 100% renewable energy portfolio no later than 2045. The study is being used for strategic long-term resource planning to “ensure a just and equitable renewable-energy transition” (pg 37).

Fontana CFD No. 90 (Summit at Rosena / Gabion Ranch Phase 1), CA (risQ Score 2.9; Wildfire risQ Score 4.1)

We certainly have a different opinion than the Issuer’s when it comes to wildfire risk in the district. If you take their word for it, “The District is not aware of any particular risk of wildfire within the District” but this stands in stark contrast to our data placing this CFD in the worst 10% of Mello Roos districts (the highest wildfire risk cohort anywhere), and with 100 and 500 year wildfire event property losses of 34% and 100%, respectively. So they don’t have access to our data, but even the less granular and specific CAL Fire and Resource Assessment map has the District’s northern and eastern boundaries bordering Very High Fire Hazard designated zones. Perhaps the Issuer knows this and is doing some clever worksmithing with the subtle inclusion of the word “within” in their statement, or perhaps it’s a lack of due diligence on their part to recognize that the District is essentially in a high-risk area. Whichever the reason, it doesn’t look good for the Issuer on this point. 

We do agree with the Issuer, however, on their point that property damage due to wildfire could result in uninsured losses and affect the ability to pay the Special Taxes (pg 40). We just see that risk as being a touch more evident and specific than the OS lets on.

Water District No. 14 Calcasieu Parish, LA (risQ Score 3.9; Flood risQ Score 3.8)

This Louisiana issuer is in a hot spot for coastal hazards. The district is in the 95th percentile nationally for property value at risk (VaR) from a combination of inland flood, hurricane storm surge, and hurricane flood. A cat 4 hurricane (such as Hurricane Laura which tore through the region last August) puts 48% of property value at risk. One would expect that this level and recency of risk would be matched by exemplary climate disclosure, but alas no. The POS neglects to mention climate change, flood, or hurricane a single time. It’s a water district. They should know better.

Savannah State University, GA (risQ Score 3.2; Flood risQ Score 3.7)

Savannah State University takes home the 99th percentile for combined risk in the state for both GDP and property value. With a projected foot of sea level rise, tidal flooding is expected to become increasingly commonplace. Though the POS lauds it’s emergency management and marine science curriculum, it overlooks these glaring climate risks. The only time the POS mentions flood is in the context of its property insurance (pg 314). The university seems to have more sustainability issues on their hands with enrollment down 30% in 2020 compared to 2016. Though the university falls short on the E component of ESG, it is a designated Historically Black College or University (HBCU), with 83% of students identifying as Black or African American. However, this also brings the overlay of climate risk and race and affluence into the spotlight. The neighborhood in which the campus sits is in the lowest 20% of campuses nationally in terms of poverty, lack of health insurance and stressed renter populations. This is not of the university’s doing, but some leadership in mitigating climate risk in historically disadvantaged communities bears some thinking about.

FBC EpiCenter (risQ Score 3.3; Flood risQ Score 2.5)

The FBC EpiCenter is a multipurpose facility secured by county lease payments. One purpose is to serve as a storm shelter and disaster relief center in the case of catastrophes. Ironically, the POS does a pretty poor job at disclosing the risks posed by those perils. The facility lies in Fort Bend County which sits in the 85th percentile nationally for combined risks predominantly thanks to hurricane flood and inland flood. The concession in the POS that the county is exposed to natural disasters is a nice nod to climate hazards, but doesn’t quite reflect a risQ Score of 3.3. The county’s Hazard Mitigation Plan doesn’t reference climate change, but the document outlines jurisdictional level risk reduction strategies.

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