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Weekly Preliminary OS Climate Risk Review (12/2/21)

By December 9, 2021 No Comments

When prospecting locations to include in our Thursday blogs, we attempt to include a variety of targets. However, some states containing high-risk Issuers pop up week after week for nondisclosure. Texas is one such state, known for historical climate catastrophes, and needs to be addressed when issuers stay silent about risk to taxpayers and investors. 

Climate risk and credit risk are inextricably linked. Programs like a bondholder guarantee seem to offer certain protections against risk, however, underlying issues affecting that link could remain hidden.

This week’s issuer with zipped lips:

Angleton Independent School District (Brazoria County, Texas) Unlimited Tax School Building Bonds, Series 2022 ($15,000,000*)

Considering that Angleton ISD fails to mention any climate risk in their 188-page POS—there’s a lot to cover. Out of almost 200 pages, the word climate appears only once: as a piece of a boilerplate legal statement concerning hostile nations, cybersecurity threats, and changes to international trade. Simply put, the issuer sees climate as an outlier. The word flood is also only mentioned once in relation to tax rate and funding equity: The Commissioner may also adjust a school district’s ADA as it relates to State funding where disaster, flood, extreme weather or other calamity has a significant effect on a school district’s attendance. (pg. 41). This is very interesting because they acknowledge that climate does affect some school districts to the point of intervention, yet how the district has been impacted by past events or how it may be impacted in the future don’t make it into this disclosure. That’s where we come in. 

Angleton Independent School District and the Bonds

Established in 1897, the Angleton Independent School District encompasses 396 square miles in Brazoria County, within the Houston-The Woodlands-Sugar Land metropolitan area. Angleton ISD educates approximately 6,700 students from pre-K through high school, and serves a population of more than 37,000. Accredited by the Texas Education Agency, the District partners with colleges, universities, businesses, nonprofit organizations, community leaders. Proceeds from the sale of the Bonds will be used for the construction, acquisition, and equipment of school buildings in the District which include a new career and technical education building, a new transportation facility, renovation of existing career and technical education classrooms into general education classrooms at Angleton High School. For Central Elementary, renovation of the softball facility and an addition of a performance stage. The rest will be used for district-wide energy efficiency upgrades, new school buses, and paying the costs of issuing the bonds.

Angleton ISD’s Climate History

Any district within Brazoria County has a history with extreme climate. Angleton ISD is no different. Even if we stay within a timeframe of 10 years, there’s plenty to choose from. In June 2015, the Brazos River rose and flooded the school district enough to alter bus routes. This undoubtedly affects Angleton ISD’s attendance average. Hurricane Harvey, the $125 billion storm, made landfall in 2017 and flooded the entire district. A visual of the aftermath can be seen here. For a coastal district issuer to remain mum on Harvey is alarming. This year, Hurricane Nicholas closed all Brazoria County school districts except one, leaving behind power outages and debris. Again, none of this is mentioned in the POS. If the community doesn’t have electricity, no one is attending school. Disclosing these vulnerabilities would perhaps help the District acquire more funding rather than having it all rest in the hands of a Commissioner: The Commissioner may proportionally reduce the amount of funding a school district receives under the Foundation School Program and the ADA calculation if the school district operates on a calendar that provides less than the State-mandated minimum instruction time in a school year. The Commissioner may also adjust a school district’s ADA as it relates to State funding where disaster, flood, extreme weather or other calamity has a significant effect on a school district’s attendance (pg 33). If Angleton ISD considers ESG, this ‘G’ would need a considerable amount of restructuring to offer a more transparent view of equity.

Angleton ISD has a total risQ Score of 4.0 and an overall Social Impact Score of 48. Cumulatively, over the next 10 years, the expected property value-at-risk from all combined perils is 20.9% and GDP impairment is equivalent to 44.6%.

It’s no surprise that a coastal district would have an incredibly high margin of value-at-risk. Angleton ISD (risQ Score 4.0) is surrounded by other coastal districts carrying high risQ. Brazosport ISD (risQ Score 4.0) borders the south, while Danbury ISD (risQ Score 4.1) and Columbia-Brazoria ISD (risQ Score 3.8) borders the east and west, respectively. The District has seen colossal hurricanes and flooding enough to frequently stop the primary functions of the ISD. Property losses are 99th percentile nationally for combined climate perils. A 500-year inland flood event drives ~20% property losses and storm surge from Cat 5 drives ~44%. If you calculate for winter weather the risks compound more—February of this year saw $444,984 in freeze damages to the District, with $250,000 of insurance proceeds received as of November (pg. 41). 

Carbon Transition Risk is also absent from this POS. The Houston metropolitan  area is heavily dependent on the oil and gas industry, with ~10% of the region’s GDP dependent on it. Since 2015, the trend has declined, but the risk has not. Angleton ISD ranks 96th percentile for total per capita CO2 emissions, driven primarily by the industry sector (99th percentile). As economies shift away from fossil fuels, the region’s local economy could be affected. This could potentially lead to job loss (Low Prestige Employment Score 70), higher poverty rates (Poverty Concentration Score 36), and more adverse health issues (Persistent Health Obstacles Score 55). 

Conclusion: An Example of Bondholder Guarantees Disincentivizing the Pricing in of Climate Risk

This Angleton ISD issuance is among the most exposed in the country in terms of both physical climate risk and carbon transition risk. It matures in 2045, over which time hurricane, flood, heat and drought risk will continue to amplify. The inevitable transition away from fossil fuels leaves the community’s carbon intensive economic and industrial future uncertain and exposed. 

Surely this is cut and dry credit risk investors should avoid? 

Not quite, or at least not in the conventional sense. The debt is guaranteed by the Texas Permanent School Fund Guarantee Program — essentially (and quietly) pushing the risk from bond investors to taxpayers. 

We recently published research (follow us on Medium!) showing that the bond market does not price in climate risk. Among other things, that article called out this broad issue exemplified by an aspect of the 2018 tragedy of Paradise, CA that largely went under the radar: California state guarantees manage to ease the worries of bondholders and—as an indirect consequence—encourage redevelopment in the same high risk area where wildfire risk is only getting worse because of climate change. There are multiple reasons why the systemic risks around climate change continue to fester without hurting investors (for now…), but bondholder guarantees are certainly a big one. 
The problem with this issuance is similar. Programs for bondholder guarantees, which are intended to decrease investor risk and simultaneously decrease borrowing costs are actually creating incentives to perpetuate climate risks. This is ultimately a frog in a boiling pot of water situation for all stakeholders of the municipal debt market. Investors concerned about systemic risks (and that should be all investors, ESG or otherwise) related to this bond should be concerned.

Honorable Mentions

Eastern Municipal Water District, CA (risQ Score 3.8, Wildfire risQ Score 4.3) $22,220,000

Eastern Municipal Water District services the westerly third of Riverside County which is located in Southern California. The District suffers from high wildfire risk; despite being in the 99th percentile nationally for property VaR from wildfire, the POS mentions “wildfire” just twice and includes no discussion of localized risk or adaptation. The District’s service area has a Social Impact Score of 77, with a Percent of Income Spent on Housing Score of 90 and a Nonwhite/Minority Population Score of 86. Once again, we see the interconnection of race, housing unaffordability, and high wildfire risk. The omission of substantial wildfire disclosure seems ill-advised.

Heat stress and drought risk are also on the horizon. The number of days with max temperatures above 95°F is expected to increase by 40-50 days under RCP 8.5 conditions. Similarly, the number of months with extreme drought conditions under RCP 8.5 ranks in the 99th percentile nationally. However, the District “does not expect that its water supply will be significantly impacted by climate change,” maintaining that its water supply has shown resilience to dry conditions in the past (p. A-7). 

The District derives around half of its water from local sources and the other half is purchased from the Metropolitan Water District of Southern California (MWD)—which sources water from the Colorado River and the State Water Project (p. A-7). In October, California declared a Statewide drought state of emergency (p. A-9). Then in November, MWD also declared a drought emergency and encouraged member agencies dependent on state project water to use increased conservation measures. Similarly, the Colorado River has faced water shortages which has led to water cuts in other states. While some of MWD’s other sources of water—including Diamond Valley Lake and Lake Skinner—have proven robust in light of persistent drought issues in California, a warming climate could spell trouble in the future. 
While the District doesn’t seem to overtly acknowledge the drought risk, it is preparing for it. As part of its Capital Improvement Plan, the District will invest over $100 million in wastewater, recycled water, and other related projects (p. A-10). The District also has a Water Shortage Contingency Plan to regulate the delivery and consumption of water during water shortages (p. A-19).  In 2019, the District began the Mountain Avenue West Groundwater Replenishment Facility; the facility is designed to allow imported water from Northern California to seep into the District’s local groundwater aquifer (p. 13 of Annual Comprehensive Financial Report). Let’s hope these actions will prove sufficient in the face of climate change.

Lakeland Electric, FL (risQ Score 3.5, Hurricane risQ Score 2.9) $131,810,000

Lakeland Electric serves the city of Lakeland and surrounding communities within a 15-mile radius of the city. Lakeland Electric is a city-operated utility that owns 3 generating assets and serves roughly 136,000 accounts (pg. 27). As the POS states, the bonds are for equipping the City’s McIntosh Power Plant with an additional 120 megawatts of natural gas-power capacity, which is replacing their coal-fired Unit No. 3 that was retired in 2021 (pg. 3, 27-28). The City is switching to a less carbon-intensive fuel source, however, switching from coal to gas is a lateral move and does nothing long-term for the tax base, or significantly ease the pace of Carbon Transition Risk

How does the rest of the POS stack up in terms of climate risk disclosure? Overall, not bad!

The POS amply discusses one of the biggest threats the City’s electric system faces – Carbon Transition Risk as utilities adapt to increasing regulatory and social pressures for less carbon-intensive energy sources. In 2019 the EPA issued the Affordable Clean Energy Rule which directed states to develop CO2 emission standards for coal-fired generating units; this law was preceded by the Clean Power Plan in 2016 which also set emissions limits on electricity generating units within states (pg. 49). Both laws have since been revoked, however in 2021 President Biden issued executive orders that prioritized climate change including pausing new oil and natural gas leases on public lands and offshore and introducing a plan to achieve a carbon-free electricity sector by 2035. These impeding regulatory-driven initiatives stand against the backdrop of consumers’ expectations for conservation, more renewable energy, and efforts to mitigate greenhouse gas emissions (pg. 47). At this time, the POS doesn’t specify how Lakeland Electric would choose to adapt to pressures to cut emissions or lay out plans for what its generation fleet may look like in the future. Currently, Lake Electric’s service area is the 94th percentile for per capita CO2 emissions from the electricity sector. 

Beyond discussion of liabilities stemming from carbon transition, the Issuer does a fair job in its discussion of weather-related risks that could impair the utility system. The POS includes the frequency used Florida climate risk disclosure that amounts to say, Florida is susceptible to natural disasters that could be made worse by climate change (pg. 54-55). Hurricane damage can be particularly impactful. In 2017, Hurricane Irma—which resulted in Florida’s largest ever recovery effort—left approximately ⅔  of FL without power. Lakeland Electric customers were without power for 3 – 12 days and the storm cost the utility $10.4 million in repairs. Hurricane precipitation-induced flooding, the service area’s most perilous hazard, engenders ~17% GDP impairment; the annual probability of such an event is 4.5%.

Faced with the need to transition towards renewable energy sources and mitigate hazards posed by hurricanes, perhaps the bond market can offer some solutions. Recently, Virginia Beach voters approved up to $567 million for infrastructure projects funded by a .0007% increase on real estate taxes; this could serve as a model for other climate-related infrastructure. Overall, Lakeland Electric is forthcoming about the risks it faces both in terms of Carbon Transition Risk and physical risk that are exacerbated by climate change, however there is a lack of discussion on how the city plans to adapt to these pressures. 

Marie Selby Botanical Gardens, FL (risQ Score 3.8, Hurricane risQ Score 3.1) $31,195,000

Marie Selby Botanical Gardens is seeking to be a world-class example of environmentally conscious building design. The bond proceeds will be used for various facilities projects at the Botanical Gardens, including a Research Center and Living Energy Access Facility (LEAF). The new developments will be built above hurricane storm surge flood zones to protect it from storms and sea level rise (Kestrel Verifiers pg. I-7). The LEAF renovation will include a solar array that will produce more electricity than the complex consumes on an annual basis – making it the first net-positive botanical garden complex in the world (pg. A-5). Project leaders hope that the sustainability-minded approach will serve as a public model for eco-friendly architecture and landscape design that will revolutionize the way the public thinks about our built environment (pg. A-4).

The facility’s proximity to the coast warrants several design considerations. The area within a 6-minute radius of the facility ranks >93th for property value-at-risk from hurricane wind and storm surge and the annual probability of a hurricane event is ~1.7%. To insulate from this risk,  Marie Selby will use hurricane-resistant glass for its greenhouse and bolster the sea walls surrounding the property (A-6). Another concern along the coast is nutrient runoff carried by stormwater that contributes to red tides in Sarasota Bay and kills marine life. To mitigate this hazard, the Botanical Garden is incorporating building design solutions that utilize rain gardens which filter stormwater runoff. The stormwater management system is noteworthy due to the location of Selby Gardens and the ongoing challenges of nutrient pollution from runoff in Sarasota Bay (Kestrel Verifiers pg. I-6); the stormwater filtration system will treat stormwater runoff and return clean water to Sarasota Bay (pg. A-5).

The Marie Selby Botanical Gardens mission is to connect people to the natural world, which it does in part through its laboratories, research centers, classrooms, and 25,000 on-site living plants. Beyond this, it will soon exemplify building sustainability principles and could inspire others to adopt the same.

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