More than 75% of the West is in an extreme or exceptional drought, with over 58 million people living in a drought area—and expectations are that it will get worse. For comparison, just 2.4% of the West was in an extreme or severe drought at this time last year. Severe droughts can lead to greater instances of climate shocks, such as wildfires, which impact some municipal bond issuers. However, the degree to which the drought will affect issuers is not uniform, and there are steps that investors can take to mitigate any potential impact on a portfolio, which we discuss below.
We are cognizant and sensitive to the human and personal toll that the drought and climate shocks have. However, we are going to focus our attention on the impact it may have on the muni market only.
Over 44 million Americans are living in an extreme or exceptional drought area
Source: U.S. Drought Monitor, as of 06/22/2021. S = short-term impacts, typically less than six months (agriculture, grasslands). L = long-term impacts, typically greater than six months (hydrology, ecology). SL = short- and long-term impacts. Latest map is available at https://droughtmonitor.unl.edu/
The drought and severe heat wave could lead to negative credit implications for some muni issuers, but we anticipate that most issuers will be able to adequately manage through the risks. The drought and heat wave could impact issuers in numerous ways, such economic disruption leading to reduced revenues, increased expenses due to recovery efforts, damage to physical infrastructure, increased energy demands, and the potential for outmigration.