Wildfires Abound

Author: Patricia Healy, CFA, Post Date: December 22, 2017

Natural disasters appear to be on track for a record year. Numerous wildfires in the West and back-to-back hurricanes in the Southeast raise questions about how the affected areas will fare in terms of people and businesses remaining in the area, the continuance of federal aid, and the availability of flood and wildfire insurance.

The Thomas Fire in Ventura and Santa Barbara Counties of California was on track to be the largest fire in California’s history; however, as of this morning, with lower winds and Herculean containment efforts, it is expected to be the second largest. The 2003 Cedar Fire in San Diego County burned 273,246 acres, killed 15, and destroyed 2,820 structures. By comparison, the Thomas Fire has so far scorched 272,000 acres, killed one person, and destroyed more than 1,000 structures. Reduced winds, topography, preparedness, and unflagging efforts to contain the fire were factors that may have kept the Thomas Fire from being as bad as it could have been. The Thomas Fire and three others that burned in Southern California in December are unusual because December is usually a low fire-incident month according to accuweather.com.

A recent article regarding the California fires noted that a number of insurance companies have their own fire brigades. Early on during a fire, the companies identify problems and conduct remediation to alleviate losses. Some have complained that those who are not insured by such companies are at a disadvantage, while others advocate for preparedness in the hope that individuals and communities will adopt preventative strategies to reduce damage. Incidentally, the article also notes that before the municipal fire departments became common, insurance companies had their own firefighters. The latest reporting by the California Insurance Commissioner (Dec 6th) stated that fire-related losses reported by 260 insurers as of December 1 exceeded $9 billion, mostly in connection with the October Northern California wildfires. One can only imagine what the total for the year will be.

When a major wildfire breaks out, the US President must first declare a natural disaster in order for the Department of Homeland Security and the Federal Emergency Management Agency (FEMA) to begin coordinating disaster relief efforts. Those efforts allow local governments and individuals to recoup some of the costs of rebuilding through FEMA and other relief funding, such as for Community Development Block Grants. The funding contributes at least 75% of rebuilding costs; for recent hurricane damage the reimbursement was up to 100% in some instances. The Army Corps of Engineers, among other agencies, helps to repair damaged military installations, highways, and other key assets.

There is legislation pending in Congress to approve an additional $81 billion in federal aid, which includes assistance for some of the California wildfires. If passed, the measure will bring total federal disaster funding this year to $137.8 billion, as reported by the National Association of Counties.

The initial costs to communities affected by natural disasters can be great; however, after a natural disaster there is usually a surge of economic activity that continues for an extended period as people and communities rebuild and money and workers flow into the area – increasing income tax and sales tax revenues to municipalities. In desirable locations like California or other coastal areas, earthquakes and wildfires, hurricanes and floods do not seem to deter residents from rebuilding.

The proposed tax bill could make residents and potential residents think twice about living in disaster-prone areas and in high-tax states. One provision would disallow deducting amounts spent on uninsured disaster-related losses, while another provision reduces deductibility of combined state and local income, property, and sales taxes (SALT) to $10,000, which would affect high-tax states with high property values such as California, New York, New Jersey, and Connecticut. The amount of federal taxes paid will go up for many, leaving less flexibility for local municipalities to raise taxes and or to sustain current rates in the face of citizens’ resistance. Realtor associations have noted that property values may well be affected by the tax bill, too. (http://www.cumber.com/the-muni-take-on-the-tax-bill-round-two/)

Increased weather variability and natural disasters have led municipal bonds rating agencies to take note and consider a municipality’s vulnerability to natural disasters as well as its preparedness both physically and financially. Moody’s notes in a November 28th report:

“Climate shocks or extreme weather events have sharp, immediate, and observable impacts on an issuer’s infrastructure, economy and revenue base, and environment. As such we factor these impacts into our analysis of an issuer’s economy, fiscal position, and capital infrastructure, as well as management’s ability to marshal resources and implement strategies to drive recovery. The interplay between an issuer’s exposure to climate shocks and its resilience to this vulnerability is an increasingly important part of our credit analysis and one that will take on even greater significance as climate change continues.”

For fires in particular, resiliency can include preparation such as efforts by localities to reduce brush, to use fire retardant materials for buildings, to let fires burn themselves out in unpopulated areas, and to conduct controlled burns on a regular basis to prevent damage.

In a December 12th piece Standard and Poor’s noted that they do not expect rating changes to the 35 municipal entities affected by the California wildfires that they rate, based on past experience with recoveries after natural disasters. However, S&P further noted that, “Going forward, we expect to more closely examine the degree to which local governments’ financial reserves and planning policies prepare them for the potential that climate change is elevating the risk of fires and flooding.”

The National Federation of Municipal Analysts (NFMA) recently updated its recommended best practices (RBPs) in disclosure for water and wastewater systems of local governments. The RBPs include requests for detail regarding resiliency and preparedness for the effects of climate change. As a side note, the new RBPs now also include cybersecurity efforts, since that is a rising area of credit risk. The work on RBPs in disclosure is one way the municipal analyst community engages with municipalities and their agents to improve disclosure. The proposed RBPs, which are in a 90-day comment period, can be found at http://www.nfma.org/.

At Cumberland Advisors we invest in high-quality municipal bonds that are supported by diverse economic bases and strong financial and management metrics. These municipalities are generally highly resilient to economic challenges and natural disasters. Macro trends such federal tax policy and disaster funding, as well as local tax policy and the economic and social amenities of a municipality, are considered in our ongoing analysis.

As always our thoughts go out to those affected by the wildfires and other disasters that have struck this year. We wish everyone a happy holiday season!

Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
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