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Weekly Preliminary OS Climate Risk Review (7/15/21)

By July 22, 2021 No Comments

This week’s climate non-disclosure dish is peppered with all our favorite ingredients and too tasty to overlook: governmental negligence, climate risk with existential implications, gross political incompetence, taxpayer bailouts, and more. That said, it’ll give you indigestion:

$31,085,000* Florida Keys Aqueduct Authority, Water Revenue Bonds, Series 2021B

According to Florida Keys Aqueduct Authority’s (FKAA) preliminary official statement (risQ Score 5.0; Flood risQ Score 5.0; Hurricane risQ Score 5.0) , the bonds are payable from all Pledged Revenues of the System, which comprise all “water production, collection, transmission, treatment, purification, storage, and distribution facilities and appurtenant facilities owned and operated by the Authority.” The proceeds will be primarily used to fund the cost of capital improvements to the System, such improvements referred to as the WIFIA Project, which is also partially financed through a $49 million loan provided by the Environmental Protection Agency through the Water Infrastructure Financing and Innovation Act (hence, ‘WIFIA’). The purpose of the supplementary EPA WIFIA loan is to “support infrastructure upgrades that will make the Florida Keys and its drinking water system more resilient to extreme weather events and climate change.” 

While the WIFIA Project consists of sub-projects aimed at replacing facilities and equipment damaged by Hurricane Irma, there is no explicit discussion of how the FKAA plans to make its infrastructure assets more climate resilient. The POS’ climate risk section leads with the usual copy & paste disclosure that we find all too often in Florida municipal official statements (“The State of Florida, and the area of the Florida Keys in particular, is naturally susceptible to the effects of extreme weather events…”). That boilerplate paragraph is then followed up with a few lines that address the potential impacts extreme weather may have on the FKAA’s Capital Improvement Program (CIP) during the upcoming ‘Forecast Period’ of October 1, 2021 – September 30, 2025: “Impacts due to the potential for extreme weather events could have a detrimental impact on financial operations and the CIP. The Authority’s location leaves it susceptible to fluctuations in operating performance and elevated capital spending due to hurricanes and flooding events, potentially associated with sea level rise. With regard to sea level rise, in addition to adverse impacts to the cost of future CIPs beyond the Forecast Period, there might be a reduction in water customers if areas now served by the Authority become inaccessible.”

Okay, okay…that looks like relatively strong climate risk disclosure…unfortunately, the climate risk section ends not with a bang but with a whimper: “The timing and scope of any such effects of sea level rise is speculative.” BoooooOOOoooo! What the Authority (that just received $49 million in federal financing to enhance its climate resilience) is telling us here is that the extent of its climate risk modeling is: scope(sea level rise) x timing(sea level rise) = speculative. We’re not surprised, given the fact that the Authority fails to account for or even mention “climate change” or “sea level rise” once in it’s 2020-2024 Capital Improvement Program Budget or 2021 Budget and Financial Plan

These omissions exist in stark contrast to FKAA executive leadership’s posturing on the topic of climate change in recent years. At the Southeast Florida Regional Climate Leadership Summit in early December 2019, now FKAA Executive Director Kerry Shelby spoke in front of an audience of over 500 scientists, legislators, government employees and industry leaders. Shelby touched on recent sea level rise-related weather events that have impacted the Florida Keys, as well as measures the Authority was considering in combating the emerging risks posed by climate change:

  • “We’re starting to see water puddling on the side of some of our major roads…it’s a concern for us, because our infrastructure that may be used to some tidal intrusion is now sitting in salt water for extended periods of time.”
  • “The biggest risk we’re concerned about right now is protecting that water supply and it’s something we’ve been doing for years. Climate change [and] sea level rise just happen to make it a little worse, because we get a lot of pressure from the salt water lens.”
  • “Our above ground infrastructure [consists of] a lot of tanks, a lot of pumping stations that are vulnerable to the threats from sea level rise. Any manholes and wastewater plants, we’ve all encountered that with flooding, especially with king tides when it’s salt water going back to our sewer plants and can very easily disrupt the treatment process.”
  • “Stormwater is something we’re not charged with fixing…we’d like to continue to see this as a priority. This is not that unusual by the way — *shows a picture of flooding on a street in Key West* — this is not a hurricane, this is just a summer rainfall … when a high tide was in town, so we want to see that continue to be a priority for all of our partners at the counties and cities, because this makes our infrastructure very hard to deal with — it’s underneath all of that [flooding], and we don’t know what’s going on with it.”
  • “The American Water Works Association has developed some key climate change initiatives for water utilities that we’re trying to incorporate into our water system…we’re trying to work with a lot of these agencies to maintain these partnerships and expand them so that we’re doing as much as we’re able to do about this climate change issue.”

If executive leadership is aware of and concerned with the prospect of rising sea levels, then why the abysmal effort to quantify or address these risks? The fact of the matter is that the Florida Keys, like most coastal communities in the State, are facing somewhat of an existential climate crisis that is further exacerbated by government inaction and political posturing. Upcoming plans to overhaul the country’s National Flood Insurance Program through Risk Rating 2.0 (“RR2.0”) have been met with substantial political friction (Senate Majority Leader Chuck Schumer has continuously stalled its rollout). RR2.0 intends to calibrate insurance premiums with actual flood risk, and it is safe to assume that once the reformed program goes into effect, the housing market in South Florida will be one of the first areas to feel the impacts. FEMA even recently announced that over a million Floridians should expect to see flood insurance premiums rise next year. The last reformative measure that was instituted by the federal government aimed at making the NFIP financially viable was the Biggert-Waters Flood Insurance Reform Act of 2012, which pushed up insurance premiums so severely that the Act was quickly undone following overwhelming political pressure at various levels of government. Upon the passing of Biggert-Waters, coastal premiums in South Florida went ballistic — one Florida Keys homeowner who was originally paying a $1,900 annual premium on a $300,000 house saw that premium pop almost 2,500% to $49,000.

Above: 2026 GDP Impairment and property value-at-risk projections for the FKAA service area. The Authority’s Capital Improvement Program that runs through the end of 2025 doesn’t appear to explicitly account for climate change or sea level rise.

Premium increases resulting from RR2.0 are capped at 18% per year, and FEMA expects that these annual increases will result in half of policies reaching loss-neutrality in the 5 years, and 90% of policies reaching that equilibrium within 10 years. The most affluent (and, most mobile) Florida communities are expected to see the sharpest increases in insurance premiums — the wealthy area served by the FKAA has a Percent of Income Spent on Housing Score of 90.7, given the Keys’ relatively high housing values and costs (Average Owner Occupied Housing Value ($574,933) ranks 87th percentile and Median Monthly Housing Costs ($1,454) ranks 80th percentile, statewide). Given the near- and long-term impacts of the reformed NFIP on communities with high climate risk exposure, it’s no surprise that earlier this year, the Florida Keys local governments began formulating appeals to RR2.0, given the expectations of unsustainable increases in insurance, housing, and business operating costs within the area. They don’t want the market to actually reflect what the risks are.

An event the size of Hurricane Irma has a 25% annual probability of occurring by the year 2026, and would drive property losses of 56% and GDO impairment of nearly 85%. The entire ~$31 million principal amount matures in 2025, however the Authority’s Combined Debt Service Schedule extends out to 2049 (pg 22).

Increased hurricane and flood risk and the resulting impacts on costs of living are poised to disrupt the housing market in the Keys. Hurricane Irma was a Category 4 magnitude when it hit Key West — ~25% of homes in the Keys were destroyed and 65% of homes sustained major damage from the storm. The material impacts on property values and productivity within the region were evident, where some homeowners were still unable to rebuild or repair their homes even 2 years after Hurricane Irma struck. We project that hurricanes and coastal flooding will drive losses to 61% of property value within the FKAA service area over just the next 5 years (ranking 100th percentile, nationally). Hurricane storm surge alone is expected to drive 33% property losses by 2026 (Irma brought 5-8ft of storm surge to the Lower Keys). The numbers pop even higher when we look at expected GDP impairment within the FKAA service area, which for utilities is weighted relatively high in the risQ Score calculations given that loss of business activity directly affects utility revenue streams. Hurricane and coastal flooding events are expected to impair 83% of GDP in the FKAA area by 2026, ranking in the 100th percentile, nationally. The FKAA provides services to an economy that is heavily dependent on tourism: 35% of jobs are in the Accommodation and Food Services sector, a proxy for the tourism industry, which saw a years-long impact from Hurricane Irma. According to the FKAA’s most recent annual financial report, it took the tourism industry in the Florida Keys till January 2020 to make a full recovery.

To recap:

  1. FKAA provides water and wastewater services to a community exposed to an existential level of climate risk, and is..
  2. Led by individuals that acknowledge the material risks posed by climate change and sea level rise, however…
  3. The Authority fails to effectively quantify and explicitly account for climate risks in their Capital Improvement Program or financial disclosure documents, while…
  4. Depending on federal government financing for (what appear to be poorly informed) climate resilience projects, despite the fact that…
  5. The community’s political leaders are fighting against paying their fair share into the federal flood insurance program, although the…
  6. U.S. federal government continues to bail out the Florida Keys government and homeowners year after year ($769 million in NFIP paid claims between 2000 – 2020 to property owners in Monroe County)

Yuck. We’ve lost our appetite. Unless you own a house in the Keys or identify as ESG atheist, there’s good reason to skip this sale entirely.

Honorable Mentions

Temenos Place Apartments, TX (risQ Score 2.8; Hurricane risQ Score 2.4)$16M

Given recent history, any Houston area issuer should make some mention of climate risk, but its lacking from this POS. Maybe some leeway can be given as the overall risk here is lower than many patches of dirt in the area and even more so given that smaller and or less resourced issuers are often the worst positioned for such analysis. To it, last week we highlighted socioeconomic metrics in Harris County and Houston, with Houston ranking worse off in key metrics such as poverty concentration, affluence, and persistent health obstacles. This apartment project—designed for low-income tenants—is an opportunity to look at contrasting socioeconomic issues within the City of Houston. 

The POS specifies that rent prices for the Temenos units cannot exceed 30% of the household’s income and that the units are for families that earn less than 60% of the median gross income for the area (pg D-2, D-3). On one hand, this affordable housing project could be viewed as an effort to diversify a well-to-do area of Houston: the area within a 6-minute drive time has a Social Impact Score of only 10.7, a low Poverty Score (19.1) and a low Persistent Health Obstacles Score (5.0), as well as high Educational Attainment and Prestigious Employment opportunities — all indications of an economically robust community. However, the Social Impact Score climbs quickly further away from downtown Houston, with a 15 minute radius showing a Social Impact Score of 40, a higher Poverty Concentration Score (50.2) and Persistent Health Obstacles Score (59.0), as well as slightly less Educational Attainment and Prestigious Employment opportunities. The gap grows even wider at a 20 minute distance, where the Social Impact Score jumps to 59.5. Think of this as a Social Impact donut where this project allows for some of the hollow middle to be addressed.

At various drive time distances, one thing remains consistent — a relatively high ranking for Percent of Income Spent on Housing, which is all the more reason that affordable housing is a must-have for the area. Considering the fact that the Nonwhite / Minority Population Score is high across the city (85.6), an investment in Temenos Place indeed supports a housing development project aimed at providing affordable housing to minority communities in a traditionally wealthy area of the City. 

City of Wheeling, Combined Waterworks and Sewerage system (risQ Score 2.2; Flood risQ Score 4.6)$76M

These bonds have been given the BAM Greenstar bond designation, according to the Green Bond Principles developed by the International Capital Markets Association (ICMA). Located along the Ohio River, this city sits in the 97th percentile for inland flood property VaR nationally. One would think the POS would discuss some kind of resiliency plan, considering they mention that the City has experienced localized flooding in the past (pg 28). However, we find no mention of climate resilience, flood management or any kind of climate risk mitigation initiatives. The POS does a poor job of disclosing the impact of weather related risks, providing only one statement in the entire document that mentions that “the occurrence of natural disasters could damage facilities of the system, impair operations and the ability to generate revenue” (pg 28). The City, already feeling the effects of impaired operations in recent weeks, has no adaptation strategies in place at all, outlining a very concerning outlook for the system.

Wheeling scored moderately low on the Social Impact Score with 37.6, driven by the Income Spent on Housing (28.4), Low Educational Attainment (26.5) and Prestige Employment (38.3). With a population made up of 92% white residents, the socioeconomic disparities are evident. Covid testing and positivity rates in cities like Wheeling show a large inconsistency among black residents (one or less tests per 1000 people, six times lesser than the state average) and residents experiencing food insecurity. For a moderately affluent community with only 15% below the poverty line, such a poor disclosure and focus on climate change vulnerabilities need to be addressed. 

Norwalk, CT (risQ Score 1.9; Flood risQ Score 3.9) – $92M

Zero mention of any climate risk whatsoever in a 180-page POS is confusing and honestly troubling, given the history of severe weather events in Norwalk, CT. The City sits on the northern coastline of the Long Island Sound with the POS boasting that its “extensive waterfront” is a major economic factor, while at the same time somehow failing to mention potential risks posed by coastal flooding. With over $91 million in bonds and a maturity date extending out to 2041, this is outright neglect from a City with “…a highly educated populous” (pg 19-20). While this is true — Low Education Attainment Score (15.8) — the City is not exempt from extreme events yet it pretends that it is. I suppose ignorance is bliss? The level of actionable intelligence provided in the POS doesn’t reflect the apparently high level of intelligence of those living in the City.

We could go back as far as the 1950s, but we’ll keep it within the last few years. Let’s go with 2018 for starters. Heavy rain caused flash flooding severe enough to shut down Interstate 95, leaving hundreds of residents without power in June. In September we see something similar with 4 miles of interstate congestion and lane closures. Several vehicles were rendered useless on roadways following a heavy downpour in late October of that same year, leaving officials to deal with waterlogged vehicles throughout the City. A visible pattern emerges.

Jumping ahead to 2020 and Tropical Storm Isaias. It hit Connecticut so hard that it left hundreds of thousands of homes without power for over a week. This led to the Attorney General prompting an investigation into the utility companies for accountability. This month, Elsa arrived with 6 inches of rain in 24 hours. In Norwalk, the waterfront comes to you. With a population abundant with affluence and education, it’s puzzling how they could leave this out considering a significant amount of money is going into planning the City’s future (pg 22). With a Percent of Income Spent on Housing Score of 89.5 and combined property value-at-risk at the 90th percentile nationally, a vision this myopic doesn’t warrant being first in line for subsidies or bailouts when an event comes and extends the Long Island Sound waterfront into an architectural swimming pool for Norwalk.

Alvin Independent School District, TX (risQ Score 3.6; Hurricane risQ Score 2.9)$32M

Alvin Independent School District sits southeast of Houston and regular readers of these newsletters will know this means significant climate risk. The District is in the 99th and 97th percentile nationally for property VaR from hurricane flood and hurricane wind respectively. Such large climate risk warrants disclosure and, in this regard at least, the POS came through. The POS acknowledges the District’s susceptibility to coastal hazards; the area has experienced several 500-year flood events since 2015 (pg. 41). Hurricane Harvey and Winter Storm Uri both engendered significant property damage and power outages. The District incurred more than $200,000 in damages from Uri (pg. 41). Unfortunately, the POS doesn’t cover adaptation or mitigation strategies. Brazoria County where the District is located, has a Hazard Mitigation Plan that includes jurisdictional level actions ranging from public outreach, updated building regulations for resilience, and coastal restoration plans, however, climate change is not mentioned once. Texas’ Coastal Resiliency Master Plan details adaptation projects along the coast—including some in Brazoria County.

Unfortunately, there is more than just climate risk on the horizon. The area’s heavy reliance on oil and gas signals carbon transition risk. Three of the top ten taxpayers in 2020 were oil and gas related industries (pg. A-4). The POS notes that disruptions in the global oil market (aka transitioning to renewable energy) may adversely affect the oil and gas industries and thus taxes collected in the region (pg. 41). Though Texas dominates the US’ wind energy production, several recent pieces of legislation inhibits the transition away from fossil fuels. The combination of climate risk and carbon transition risk poses threats to property tax and ergo the operation of the School District. 

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