California wildfire challenges: Effects on the fixed income markets

The devastation and destruction caused by the California wildfires that started in early January along with the recent rainstorms and mudslides will have a  substantial impact on individuals and communities for some time to come. Now, municipal and corporate bond markets are mirroring investors’ concerns about what started or exacerbated the blazes and the size of recovery costs. Amidst such uncertainty, it’s essential to have trusted pricing to support investment decision-making and compliance requirements. 

• The potentially unprecedented scale of the destruction from the California wildfires has investors worried about the possible medium- and longer-term impact on municipal and corporate debt issuers.
• Certain municipal bond issuers – such as the Los Angeles Department of Water and Power – and the corporate bonds of local utilities are experiencing significant spread widenings. 
• In periods of uncertainty like this, it’s important to have a robust source of pricing for municipal and corporate debt with California wildfire exposure. 

The wildfires that have caused so much damage in Los Angeles County, California and neighboring areas in January have devastated families, communities and businesses. With insured losses as of this writing estimated to exceed $150-250 billion, this is also potentially the largest wildfire insured loss event in US history. It will take time for the full scale of this disaster and its unfolding challenges to be understood, but municipal bond and corporate debt investors are starting to try to price them in. In response, the US Securities and Exchange Commission is monitoring how the wildfires are influencing the markets.

The primary focus of the municipal markets now is the Los Angeles Department of Water and Power, which is the largest municipal utility in the US. It delivers water and power to most of Los Angeles County, including the Pacific Palisades. Its debt has been under pressure – it has widened up to 50 basis points at the long end – for several reasons: 

• In California, utilities are legally liable if their equipment can be proven to have caused a fire. However, at this stage the causes of the fires have not been officially determined, amid press reports suggesting that they may have been a result of arson. 
• Rating agency Standard & Poor’s lowered its rating on both the power system and water system’s utility on 14 January by two notches, from AA- to A (Power)  and AA+ to AA-(Water), citing concerns about "adequacy of the utility's reserves and insurance coverage at the current rating level” and “heightened potential for litigation, liabilities, and future costs surrounding the adequacy of existing water system assets and emergency preparedness during the ongoing wildfires.” 
• Litigation against the utility has already begun. A lawsuit accuses Los Angeles Department of Water and Power of mismanaging water supplies during the fires, and additional litigation is anticipated by the markets. 

The utility continues to have a strong credit rating, and it also could raise customer rates and issue debt to meet recovery costs. However, investors are keeping in mind that in 2019, Pacific Gas & Electric filed for bankruptcy after it was found liable for causing a number of wildfires in Northern California that burned thousands of acres and led to more than 100 deaths.

Other California Municipal issuers in the effected and neighboring areas have also seen up to 50 basis point widening since the scale of the fires became evident. General Obligation (GO), School Districts and local utilities are just some of the credits that are experiencing this movement.  Investors are concerned about the impact of the fires on tax receipts. For example, property tax receipts could suffer in areas directly affected by the fire, while sales tax revenues might see pressure in LA and in adjacent areas. The US municipal market is about $4 trillion in size and California is the country’s largest municipal bond issuer.

The fires are having a negative effect on some corporate bonds, too. For example, Southern California Edison, a subsidiary of Edison International, was hit by multiple lawsuits on 13 January. The litigation is claiming that the utility’s electrical equipment started the Eaton Fire in the Pasadena area, which burned 22 square miles. Edison International, in a statement, said that there were no interruptions or operational/ electrical anomalies in the Eaton area around the time of the start of the fire.

While insurers have seen their bonds suffer after natural disasters in the past, now the debt markets are showing confidence in the risk management skills of those companies. Most insurers have put in place measures to mitigate losses due to wildfires, such as reinsurance programs, geographic diversification, and robust capital reserves.

The effect of the California wildfires will continue to play out across the debt markets long after the last of the flames are extinguished. In fast-moving and challenging bond market conditions such as these, it is important to have a source for pricing that is reliable, consistent, and independent.  

LSEG Pricing Service provides global coverage on all fixed income securities and over-the-counter derivatives.  This includes difficult to value assets and dynamic assets such as these securities affected by the wildfires.  Our evaluation specialists are monitoring the situation in California and reflecting market sentiment into our levels throughout the day.