Bonds

Water and sewer utilities would need to issue three to four times as much debt as they have been to fund the level of projects the Environmental Protection Agency says they need, according to Moody’s analysts.

The EPA estimated in a 2018 report that $743 billion in water infrastructure improvements are needed to meet the country’s drinking water and wastewater needs.

The majority of those costs will be borne by the utilities, Moody’s analysts said.

“Historically the federal government had funded a great deal of the local infrastructure, but federal funding has been declining,” said Eric Hoffmann, a Moody’s senior vice president and manager.

Even if you add up the $111 billion included in Biden’s water infrastructure bill, the $35 billion in the federal Drinking Water and Wastewater Infrastructure Act approved by the U.S. Senate in April, the revolving funds for water and sewer and Water Infrastructure Finance and Innovation Act (WIFIA) loans, it’s only about 25% of what the EPA says is needed, Hoffmann said.

To achieve the needed improvements, given federal underfunding, water and sewer utilities would have to issue three or four times as much debt, said Leonard Jones, managing director of Moody’s public finance group.

Muncipal water and sewer utilities sold more bonds in 2020 without increasing rates, because they didn’t want to further burden ratepayers given the pandemic-induced job losses, Jones said.

The additional bond sales didn’t pressure ratings because most of the water and sewer utilities Moody’s rates are “well-managed and have sufficient reserves,” Jones said.

Nationally, sales of general obligation and revenue water and sewer bonds — including new money, refundings and combined sales — increased by 18.5% to $43.4 billion in 2020 compared to the prior year, according to Refinitiv data.

Sales have fluctuated since 2015 averaging $38 billion and peaking at $46 billion in 2016 in the sector, according to the Bond Buyer-Refinitiv 2020 Yearbook.

There has not been a big increase in issuance that would chip away at the mountain of improvements the EPA report indicates are needed, Jones said.

“Last year was a record year in the muni industry,” Jones said. “There was not a big increase in issuance that would cover this. On average, we have seen slight increases, but not enough to stop the decline in these water and sewer assets.”

A Moody’s report released on May 7 warns that climate threats and aging infrastructure portend rising credit risks for many water and sewer utilities.

“Rapidly escalating infrastructure needs due to aging systems and growing climate challenges — drought, heat, floods, hurricanes and others — expose municipal water and sewer utilities to substantially increased costs, higher debt loads and rising customer rates,” according to the May 7 report authored by Hoffmann, Leonard and Moody’s analyst Michael Wertz.

Nearly half of the continental U.S. is in drought, according to the April 27 U.S. Drought Monitor report. In April, drought conditions intensified or expanded across the West Coast, northern Rockies and Plains, the Northeast and the eastern Great Lakes.

While most states experienced below-average rainfall in April, the situation was marginally worse for four Western states — California, Washington, Oregon and Idaho — which experienced their 10 driest Aprils on record, according to the National Oceanic and Atmospheric Administration.

Moody’s hasn’t given negative outlooks to any water enterprises as a result of the emerging drought, nor are any on ratings on watch for downgrade, Hoffmann said.

“I don’t know of any in California that are even on consent decree, where the EPA flags a wastewater system for repairs,” Jones said.

California Gov. Gavin Newsom included a $5.1 billion drought resilience package and $2 billion for wildfire and emergency response in the May revisions to his fiscal year 2021-22 budget last week.

Newsom regularly references what he calls the “hotter hots, and the drier dries” resulting from climate change when he supports environmental legislation.

He said the drought resilience package was “imperative to safeguarding the future of our state in the face of devastating climate change impacts that are intensifying drought conditions and threatening our communities, the economy and the environment,” during a press conference announcing the package last week that was part of his May budget revisions.

The water proposal included $1.3 billion for drinking water and wastewater infrastructure. It comes on top of a $7 billion in bond authority for water projects approved by voters in 2016. An $8.9 billion state water bond measure in 2018 targeting crumbling infrastructure and for drinking water for disadvantaged communities failed with 51.9% of voters opposing the measure.

Newsom declared a drought emergency for 41 of the state’s 58 counties on May 10 citing above-average temperatures and dry conditions for April and May. Earlier in April, Newsom stood in a dry creek bed in Mendocino County and declared a drought emergency for Sonoma and Mendocino counties.

He directed the state’s water board to consider modifying requirements for reservoir releases and to take other conservation measures.

Exposure to climate risks varies across the country, presenting different infrastructure challenges based on location, according to Moody’s.

Oregon Gov. Kate Brown declared a drought emergency in April for Klamath County saying the Klamath Basin faces drought conditions not seen in decades.

The Oregon governor said she is working with the White House, the Department of the Interior and the Department of Agriculture to get help and relief where it is needed most.

The primary focus in Oregon from that effort was on helping farmers by doing such things as approving emergency groundwater use drought permits for irrigation, but she is also seeking federal funding to improve water quality, she said.

Washington State lawmakers approved two climate change bills in late April including one that makes the state the second after California to adopt a cap-and-trade measure that makes businesses pay through an auction system for carbon emissions. The cap-and-trade plan includes water improvements among programs that can seek funding through the program.

“We finally have meaningful climate legislation that reflects the values and priorities of Washingtonians, and that respects the science of climate change,” Washington Gov. Jay Inslee said in a statement in April.

Nationally, “improvements in water distribution and transmission are generally the greatest need, but the level of other needed investments reflects localized risks,” Moody’s analysts wrote.

In California, water storage represents 14% of total water infrastructure needs, while in Florida and North Carolina, which are facing elevated exposure to hurricanes and extreme rainfall, water storage accounts for only 7% of total infrastructure needs, Jones said.

Recognizing its growing exposure to sea level rise and flood risk, Miami voters approved a $400 million bond measure in 2017, of which $192 million was dedicated to flood mitigation.

Smaller utilities will face greater risk from the substantial investments needed that will eventually result in increased debt and customer rate increases, Jones said.

Large utilities with well-managed capital assets, strong customer bases and rate flexibility will be the best positioned to handle future infrastructure needs, according to Moody’s.

“From a big-picture perspective, places like Los Angeles Department of Water and Power are the places that are doing okay,” Jones said. “They are not the places in the report that we are referring to that will have the problems.

“It is places that are lot less wealthy, have a smaller service area and haven’t kept their infrastructure up to date — those are the places we are more concerned about,” Jones said. “We are less concerned about the big, sophisticated places with a lot of resources.”

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