Batten down the hatches: Municipal bonds and hurricanes

Timely insights from portfolio managers and industry experts on key financial, economic and political issues.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.

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      By Lauren KashmanianMunicipal Portfolio Manager, Eaton Vance Management

      New York - With hurricane season rolling around again, we expect to see dramatic images of wind and water damage to coastal communities and heartbreak for their residents. How do we incorporate the increased environmental risks from climate-related events into our investment decision-making process?

      As managers of municipal bond portfolios, we need to assess the underlying credit strength of issuers in hurricane-prone regions. So we conduct our own analysis, including metrics such as the share of gross domestic product (GDP) generated in a coastal zone, the percentage of property values in a floodplain and recent flooding activity in the area.

      Risk-mitigating measures put in place

      When evaluating such cities, we find that one of the most important considerations is whether the community has enacted any resiliency plans to combat risks from weather-related events. In New York, for example, the economy's entire GDP is generated in a coastal area, where there's increased risk of flooding damage. In preparation, New York has devised a 10-year, $20 billion resiliency plan to protect the municipal infrastructure, which we include in our evaluation of the city's credit condition.

      Based on our assessment of the measures put in place to mitigate these storm-related risks, we believe many coastal communities can continue to improve and defend existing infrastructure - especially in important and economically viable areas like New York.

      Federal aid and insurance payments to the rescue

      In some cases, where significant amounts of federal aid and insurance payments have been deployed, major rebuilding can take place right away, causing property values to return to normal soon after the storm. In fact, assessed values may end up being higher if larger homes are rebuilt, with the potential for a positive impact on underlying credit strength.

      Whenever federal aid plays a major role in the recovery, we think it's still critical to examine the liquidity of issuers as well as the timing of the reimbursements. The main implication of this assessment has been that strong credits tend to remain strong, while weak credits continue to face challenges.

      Ability to act quickly to defend and rebuild

      In other cases, we may see higher credit risk when municipalities are unable to respond quickly enough during major weather events. For example, the location of a coastal city in Maryland puts it at particularly high risk of being affected by a major storm or environmental event. With a small full-time population and an economy reliant on tourism, the surrounding county has limited resources to defend or rebuild infrastructure.

      For some municipal credits, the risks and added infrastructure costs could become burdensome. That's why it's even more imperative to monitor these coastal areas as their susceptibility to climate change rises.

      Bottom line: Despite the apparent evidence of more severe destruction from weather-related events in recent years, we've experienced no storm-induced defaults in the muni market. Nevertheless, we find it prudent to be proactive, so we attempt to incorporate key metrics related to the risks of climate change - and mitigation considerations - into our internal credit rating and investment process.