Infrastructure funds target wildfires as muni market scrutiny grows

Bonds

Yuba Water Agency officials say it’s only sheer luck that’s kept its 313,000-acre watershed in California’s Central Valley from burning.

Several watersheds around Yuba’s, which suffer the same dry, overstocked conditions amid the state’s extended drought, have experienced megafires, said Joanna Lessard, the agency’s project manager for the watershed resilience and forest health program. 

“We’ve just been lucky,” Lessard said. “We feel enormous pressure to increase the pace and scale of needed forest health treatments.”

Forest restoration work is part of the North Yuba Forest Partnership to reduce the threat of wildfire in the California region.

Yuba Water Agency

Those efforts will get a boost from new money in the $1.2 trillion Infrastructure Investment and Jobs Act. The water agency’s partner, the North Yuba Forest Partnership, will receive $34.8 million from the IIJA for forest restoration treatments. That includes $6.8 million this year, which the agency will use to treat 4,500 acres, with the remaining funds used to treat another 16,900 acres.

“The first-year funding is easily two to three times what we would have to spend in a given year,” Lessard said. “This money really provides a lot of opportunities and a lot of pressure.”

Like most climate-driven risks, wildfires are becoming more frequent and severe across much of the West, driven by heat, drought, overgrown forests, and development in the so-called wildland-urban interface.

Nearly a quarter of the contiguous U.S. – mostly in the West – is at moderate to very high risk of severe wildfires, according to the U.S. Forest Service. This week, New Mexico is battling a fire that officials warned may be the most destructive in state history.

As the most wildfire-prone state in the nation, California has seen the seven largest fires in state history in the last four years. The fires have burned over 2.5 million acres of land. In 2018, the Camp Fire destroyed the city of Paradise, an event that caught the attention of municipal bond market for what Moody’s Investors Service dubbed “an extreme example of a wildfire’s negative credit implications.”

Municipal bond buyers and other market participants are increasingly focused on wildfires and other climate-related events as potential portfolio risks. Of the roughly $3.9 trillion of outstanding muni debt, roughly $240 billion is exposed to significant wildfire risk, according to risQ, a firm that models climate risk for the municipal market.

Regulators are also paying close attention. The Securities and Exchange Commission is weighing an expanded climate-change disclosure regime that as of now would apply only to public companies — including investor-owned utilities like California’s PG&E, whose equipment failures sparked the Camp Fire and several other recent, devastating fires — but which is expected to carry ramifications for the muni market.

Meanwhile, the Municipal Securities Rulemaking Board wants more information on ESG practices in the muni market.

Climate change considerations can provide an opportunity for muni buyers looking to make positive investments, said Evan Kodra, risQ’s co-founder and CEO.

“I can’t think of a better opportunity to actually do something about climate change than muni bonds, because it’s very infrastructure intensive to do something about climate change and infrastructure is what the municipal market is all about,” Kodra said.

The infrastructure bill President Biden signed in November dedicates $5.4 billion over 10 years for wildfire risk reduction and ecosystem restoration with tools like prescribed burns, thinning forests, burying power lines and restoration of burned areas.

The money will fund projects on federal lands that experience many of the fires, provide state and local grants, establish community wildfire protection plans, fund research, and raise firefighter salaries.

With the IIJA funds, the U.S. Forest Service plans to treat up to an additional 20 million acres on national forest lands, and up to an additional 30 million acres of other federal, state and tribal land.

The new law also streamlines the environmental permitting process and establishes new emergency action authority aimed at accelerating projects.

“In terms of federal forest management, it’s probably the most significant legislation in 20 years,” said Lawson Fite, a partner at Marten Law and co-chair of the firm’s natural resources practice.

“The bill is really written trying to look at things from a landscape perspective,” he said.

“We’re talking about a very large area and the current condition has developed over four or five decades, so moving the needle even a little is a very significant thing to do,” Fite said. “Nothing is going to change overnight. It’s a long process to create change on the national forest landscape.”

Ruins left by the 2018 Camp Fire that destroyed Paradise, California. Wildfire risk is increasingly a focus for municipal bond investors.

Bloomberg News

Forest Service Chief Randy Moore, testifying Wednesday at a Senate Appropriations subcommittee hearing on the department’s $9 billion budget request for fiscal 2023, said the agency has released a 10-year wildfire strategy plan that will focus first on 10 landscapes. The IIJA money will fund the initial work, which includes the North Yuba River watershed.

Last year was the most expensive wildfire season in U.S. history, noted subcommittee chair Sen. Jeff Merkley, D-Ore., who added that Oregon last year experienced a fire so large it created its own weather system.

Alaska has also already faced a fire this year, said Sen. Lisa Murkowski, R-Alaska, who urged Moore to scale up its firefighting work.

“We have talked about a lot of the resources that are coming as a consequence of the infrastructure bill and I think there’s opportunity and promise but we are talking an awful lot about how to build capacity and I hope you’re right, Chief, that you’re going to be able to get the necessary folks in time for what we fear will be a tough fire season,” Murkowski said.

The Forest Service and infrastructure funds are focused in particular on improving fire conditions in the wildland-urban interface, rural and former wildland areas that are seeing more development.

“You see a lot of single-family construction in the WUI and a lot of muni bonds fund that,” said risQ’s Kodra. “From an investment risk point of view, if that muni bond is exposed for 10 to 30 years, there’s a good chance that something could happen there.”

RisQ and Municipal Market Analytics last year published a paper on wildfires and housing that focuses in part on the risks for the muni market. Of the nearly $300 billion of outstanding debt held by more than 800 impaired issuers, 8.3% of it is exposed to significant wildfire risk, the paper said.

The credit risk has yet to translate into any market penalty, though more disclosure may change that.

The city of Paradise never defaulted despite the near total loss of the town, making its scheduled bond payments through insurance settlements and a state bill providing the city with backfill payments for lost property taxes for three consecutive years, according to Moody’s.

Kodra says those types of investor protections can end up discouraging housing policies that decrease wildfire risk.

“The system is constructed with a lot of protections from default, which drives a lot of complacency and it falls on the public to clean that up and that becomes a taxpayers’ problem versus an investor risk,” he said.

With California’s famously expensive housing, stopping sprawl is difficult but investors can play a role, Kodra said.

RisQ recommends that investors should “tilt their portfolios” toward projects that encourage climate-change friendly development like urban densification and away from paper like community facilities district bonds that fund new residential tracts in the wildland-urban interface.

“As asset managers become more concerned about the risk and there’s momentum there, then issuers will need to start worrying it also,” Kodra said.

Meanwhile, the Yuba Water Agency is partnering with another type of investor to accelerate funding for its projects.  

In 2018, the agency partnered with the firm Blue Forest Conservation, whose tagline is “fighting fire with finance,” to launch the first so-called Forest Resilience Bond. The tool will tap private investors to raise upfront money for projects identified by the Forest Service, with the debt payments coming from various federal, state or local agency funds.

The $4 million 2018 Yuba bond is backed by the State of California and the water agency, which pays interest from its revenue.

A second Yuba Forest Resilience Bond was floated in 2021, and the IIJA money will be one of the streams used to pay back investors, Lessard said.

With the bond’s proceeds and the fresh IIJA dollars in hand, the agency is set to continue work within the next few months, though finishing the entire project is expected to take a decade, Lessard said.

“It’s a race against time and nature,” she said.

 

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