As wildfire tore through Los Angeles in January, a financial ratings company made a decision that could mark a crucial shift in how a trillion-dollar market assesses climate risk.
S&P Global Ratings downgraded the credit rating of the Los Angeles water and power utility, citing “the increasing frequency and severity” of wildfires and signaling a potential awakening of the nation’s $4 trillion dollar municipal bond market to climate risk.
Short-term trouble followed the Jan. 14 downgrade of the nation’s largest municipal utility. The bond values fell, default risk rose and some bondholders sold at a loss. If the utility issues new bonds soon, it will have to pay higher interest rates to compensate buyers for the heightened risk.
Yet some experts called S&P’s move a watershed for a market they say has perilously ignored climate change and the risk of a disaster wiping out a city’s property tax base and forcing a bond default.
“I think we’re seeing the beginning of a crack,” said Alice Hill, who was National Security Council senior director for resilience policy in the Obama administration. “We know that with climate change, there’ll be bigger and worse disasters that will affect communities’ abilities to repay those bonds.”
The Los Angeles-area wildfires are estimated to have caused more than $250 billion in damage.
Ratings firms have previously penalized municipal bond issuers in areas struck by disasters. After Hurricane Helene in September, S&P took action against more than a dozen entities in North Carolina and Tennessee.
But the warnings and downgrades were based on property damage and the potential loss of tax revenue and cost of rebuilding — not on risks tied to climate change.
“It is a tipping point in the marketplace,” Thomas Doe, founder of Municipal Market Analytics, said of S&P’s downgrade of the Los Angeles Department of Water and Power. “They’re doing a negative action on a well-known credit issuer and are looking at long-term risks to a utility around climate.”
S&P said, “Physical climate risks are an increasing credit consideration.”
Municipal bonds are a backbone of government building and a safe investment for ordinary people seeking income that’s exempt from federal taxes. Individual investors own 40 percent of municipal bonds.
“They’re attractive for retirees, people who want to protect their income against taxes,” said Hill, now a Council on Foreign Relations senior fellow for energy and the environment. But with climate change, “there’s the risk that less-sophisticated investors will end up holding these tax-exempt bonds.”
After downgrading the Los Angeles utility two notches from a near-perfect AA- rating to an A, S&P issued warnings about other local utilities and the city of Los Angeles itself, along with a library district in Altadena, where the Eaton Fire killed 17 people and destroyed 9,400 buildings.
The concern combines near-term financial costs and long-term environmental patterns.
Wildfires could drain municipal tax revenue and expose utilities to huge liability. Under California law, utilities can be held liable “if their equipment is proven to have caused a fire,” according to Christian Neilson, director of municipal bond valuations at LSEG financial consultants.
Magnifying the financial peril is that “wildfires are becoming more severe and expansive,” S&P said. The “risks” are caused “at least in part by climate change.”
“It’s significant any time you see a downgrade and there’s a direct connection back to climate,” said Jeremy Porter, head of climate implications research at First Street climate modelers.
On Thursday, in an indication of expanded concern, S&P said it was assessing the threat of wildfire on the creditworthiness of all bond sellers in California.
The LA fires “highlight the changing risks of wildfire in California,” S&P said, citing conditions such as shorter rainy seasons. “Although the fires are contained, environmental conditions remain that present risk for additional events.”
‘They don’t want to talk about climate’
The municipal bond market is an economic powerhouse that funds 70 percent of U.S. infrastructure and pays millions of investors tax-exempt interest. Entities such as states, publicly owned utilities and local taxing districts build and improve facilities by borrowing money from bondholders at low interest rates.
Bond prices have not adapted to climate risk, some experts say, enabling them to maintain strong credit ratings and minimize borrowing costs even as climate change intensifies disaster damage.
“The accepted wisdom is that disasters don’t rock bond markets,” said Susan Crawford, a senior fellow in the Sustainability, Climate and Geopolitics Program at the Carnegie Endowment for International Peace.
Financial sector climate adaptations have been costly and disruptive. Property insurers have raised rates and dropped coverage in wildfire-prone areas of California as well as in hurricane-threatened parts of Florida, Louisiana and Texas.
Federal Reserve Chair Jerome Powell warned two weeks ago that in 10 to 15 years, “there are going to be regions of the country where you can’t get a mortgage.”
But for bonds the picture has been different, said Bob MacKnight, vice president of nature and climate solutions at S&P Global Sustainable1. The “municipalities in locations with higher risk of extreme climate events pay roughly the same rate as lower risk communities,” he said in a recent presentation.
Crawford said the result is that “physical climate risk is not being priced into the municipal bond market,” adding that “no entity — neither the rating agencies or the municipalities — have much of an incentive to put the risks on the table.”
With no federal requirement to disclose climate risk, bond issuers “are so worried about their own credit ratings that they don’t want to talk about climate risk,” Crawford said. “They know that talking about physical climate risk makes it likely that residents will leave or it will depress property values.”
Breckinridge Capital Advisors found that about 30 percent of bond offerings mention “climate change” at least once. The rate was roughly 3 percent when President Donald Trump took office in 2017 and peaked at around 45 percent in late 2021, when then-Securities and Exchange Commission Chair Gary Gensler first said the SEC would issue a climate-disclosure rule.
The rule is tied up in a federal court challenge that the SEC recently said it would temporarily stop defending.
The climate risk to the municipal bond market is unknown because most issuers lack the resources to calculate it, said Porter of First Street. “There is a lot of credit risk in the muni bond market that has not been identified,” Porter said.
Some experts and officials said climate change poses little threat to municipal bonds, which have a tiny default rate and long maturity periods that give issuers time to rebuild their revenue sources.
“The $4 trillion municipal bond market is very resilient,” Iowa Sen. Charles Grassley, a Republican, said at a Senate Budget Committee hearing in 2024 titled Safeguarding Municipal Bonds from Climate Risk. “Where there’ve been defaults in municipal bonds, it’s been in places that’ve been mismanaged for decades, such as the city of Detroit.”
In a Feb. 18 analysis, JPMorgan Chase wrote, “We do not forecast any payment defaults to occur for any city, county or school district adversely impacted by the Los Angeles fires.”
The analysis is titled, “Municipal bonds today offer U.S. taxpayers a rare, compelling opportunity.”
Trump’s ‘backhanded’ support of climate adaptation
Municipal bonds could face pressure to adapt to climate change from an unlikely source: Trump.
His comments in recent weeks about reducing federal disaster aid to states raise the prospect that municipal bonds would lose an entrenched layer of financial protection against disaster costs.
The municipal market is paying close attention to Trump’s talk about major changes such as abolishing the Federal Emergency Management Agency and putting states in charge of disaster rebuilding.
“Municipal bond investors have always found that after disasters — hurricanes, specifically — there was an initial decline in the price of the bonds. Then FEMA money would come in and provide the support for the rebuilding and everybody’s made whole and the world goes on,” said Doe, the municipal market analyst.
“Without FEMA’s backstop, investors might look at climate risk very closely,” Doe added.
FEMA has continued to provide disaster aid since Trump took office. He created a council to review the agency, putting Homeland Security Secretary Kristi Noem and Defense Secretary Pete Hegseth in charge of delivering recommendations by late June.
FEMA has become a crucial source of financial and logistical support for states as disasters become more destructive. The agency spent on average about $45 billion a year on disasters from 2022 to 2024, according to a recent Congressional Research Service report, named “FEMA: Increased Demand and Capacity Strains.”
The agency pays at least 75 percent of eligible recovery costs and has paid 90 percent or 100 percent following catastrophic disasters such as the Los Angeles wildfires and Hurricane Helene.
“Right now, municipal bonds are proving to be pretty secure, safe investments,” said Hill of the Council on Foreign Relations. “But if there’s no federal aid, these municipalities will be struggling to pay back these bonds.”
“Over time I believe we’ll see much more stress on the ability of communities to repay these bonds,” Hill added.
In addition to making municipal bonds riskier, a loss of federal disaster money could compel state and local governments to undertake their own climate adaptation with projects to reduce their exposure to disaster damage. Bond offerings for climate-related projects would highlight climate risk.
Doe understands the irony of climate adaptation being indirectly encouraged by a president who is dismantling climate policies.
“Trump is erasing climate change. But everything he’s talking about is putting state and local governments in charge of their infrastructure and giving them the responsibility for climate,” Doe said. “In a backhanded way, his policies are going to end up generating a wave of adaptation investment.”