Newswise — Wildfire season is approaching, threatening not only property and lives but municipal bond prices in the most vulnerable places.
A study from the University of Iowa’s Tippie College of Business found that communities more prone to wildfires pay higher interest rates on their municipal bonds as investors demand higher returns for the increased risk.
Those cities pay an additional .36% in interest on average, which can translate to thousands if not millions of additional dollars depending on the size of the bond issue.
That means taxpayers in the most affected cities had to pay an additional $4 billion in property taxes to cover the interest rate premium between 2000 and 2022.
Since bonds are a major source of funding that cities use to pay for community development projects, those extra financing costs either fall on taxpayers or limit improvement projects.
However, the study also found high risk communities can lower their financing costs by investing in wildfire mitigation efforts.
“Risk management matters,” said Thomas Berry-Stoelzle, professor of finance and study co-author. “Investors want to know if cities are taking fire mitigation measures when they consider buying a municipal bond.”
Wildfires have grown increasingly numerous and damaging in recent decades in both rural and urban areas as a result of climate change. In some cases, wildfires have wiped out whole cities or neighborhoods in Texas, rural California, Los Angeles and Hawaii. To determine their impact on municipal bonds, researchers examined more than 580,000 bond issues from more than 5,900 municipalities between 2000 and 2022. The average issue was just over $1 million and collectively were worth $616 billion.
They compared the cost of bond issues of communities in the same county but with different levels of wildfire risk. Berry-Stoelzle said this made sure that differences in local economies were not responsible for the differing interest rates, as cities in the same county will have similar economies.
The analysis revealed that:
–Vulnerable cities paid more than $3,800 in additional interest per year on an average bond issue compared to cities that had average wildfire risk. That number increased for the most vulnerable cities.
–Investor attention, as measured by Google searches for terms associated with wildfires and stories in local newspapers about wildfires, added even more to borrowing costs.
–When they looked at municipal bond issues going back to 1990, they found that investors started to price in wildfire risk after 2000. Berry-Stoelzle isn’t sure why wildfires started to matter after that year, but that’s when investors became more conscious of their increasing numbers.
–The wildfire premium is about two-thirds the premium investors demand for bonds from coastal cities subject to sea level rise, which earlier studies set at .53%.
–Researchers found the increased financing costs only in bonds with maturities of more than 1 year and less than 15 years, suggesting investors are less worried about damaging wildfires in the short term, and see them as just another risk in the long term.
However, Berry Stoelzle said these increased costs were reduced or almost disappeared in cities that spent more on such fire mitigation efforts as hiring more firefighters or wildland clearing. From a policy perspective, he said investing in fire mitigation can lead to a reduction in financing costs and create value for communities.