Bonds

While the toxic East Palestine, Ohio, train derailment doesn’t threaten bondholders, the wreck raises the specter of so-called “black swan” events and has the potential to influence credit analysis, ESG analysis and investing, risk disclosure, and how federal infrastructure funds are spent.

Local, state and federal authorities remain on the scene overseeing frequent water and air quality testing and Norfolk Southern Corp.’s disposal of the toxic waste unleashed in a fire and chemical spill after the Feb. 3 derailment of a 150-car train in the village of 5,000 near the Pennsylvania border.

The wreck derailed 11 tank cars carrying hazardous materials that subsequently ignited, fueling fires that damaged an additional 12 non-derailed railcars, according to a preliminary National Transportation Safety Board report.

As the dust settles, municipal bond market participants have issues to gauge, beginning with the long-term havoc such an event poses to population levels and the local property tax base — losses that can hit local schools reliant on such revenue streams hard.

Beyond the region, questions arise over the condition of rail infrastructure — which carries a B rating from the American Society of Civil Engineers — and what role that should play in credit and buy side analysis of local governments that host railroads.  

The derailment may also affect the way federal funds under the new infrastructure law are spent.

“I think investors that focus on ESG issues, particularly the E, will consider this event when buying bonds and on strategies,” Howard Cure, director of municipal bond research at Evercore Wealth Management LLC, said of environmental, social, and governance considerations that guide a growing number of bond investors.

“This could take the form of looking at financial reserves to see if an entity can withstand an environmental disaster until aid arrives. Or, if they are fortifying their infrastructure to prevent or mitigate a disaster,” Cure said.

Rating agencies and other credit analysts will continue to highlight these risks so that all investors, regardless of their emphasis on ESG, will consider these factors, Cure believes. “States will need to coordinate and help finance local efforts to mitigate these concerns. Lack of attention on a state level to fortifying infrastructure should be a growing concern,” he said.

A single event with limited damage might not drive a major shift in disclosure or analysis especially if severe fiscal damage is avoided but it definitely draws attention to the risk.

“I don’t think it’s a headline issue right now for the muni market but I do think this elevates and heightens concern over ‘black swan’ events,” said Richard Ciccarone, president of Merritt Research Services, using a term to describe an unexpected event with significant implications. “It moves the risk meter, but it’s not off the charts.”

The U.S. railroad industry averaged more than 2.9 derailments a day from 2019 to 2022, according to Federal Railroad Administration data, but the East Palestine train wreck has entered public awareness in a way others haven’t.

If the damage toll deepens or other events occur, Ciccarone sees market scrutiny intensifying on credits located in dense population or commercial areas where bondholders would face a higher threat level to revenues needed to repay bonds.

Ciccarone equated the potential to the shift in cyber-risks from a fear to a factor that is now addressed by governments and assessed by rating agencies and investors.

“We are in the diagnostics stage right now,” but rail safety is now lurking in the background for the market, he said.

East Palestine
The initial concern in a crisis event is liquidity. East Palestine has little debt outstanding and most is in the form of revenue bonds.

Norfolk Southern on Friday announced an initial $300,000 donation to the East Palestine City School District to support the district’s academics, athletics, extra-curricular activities, and its long-term contingency planning regarding the impacts of the derailment.

The railroad also reimbursed the East Palestine Fire Department $825,000 for fire equipment used in the derailment response. That follows $220,000 reimbursement to fund new equipment for the first responders. The company said those payments brought to $8 million its financial commitments made so far.

The village relies on $1.7million in annual income tax revenue and closed out 2021 with $3.6 million in balances across all funds including $688,000 in the general fund. Its property valuation was at $70 million, according to financial data. It had just $280,000 of GO bonds and $8 million of revenue bonds. In 2019 residents voted to increase the income tax rate from 1% to 1½ % with 40% going to the Police Fund, 40% going to the Fire Fund and 20% going to the general fund.

Columbiana County has not incurred any extraordinary costs yet and has been in communication with its bond counsel, said Auditor Nancy Milliken. The county has liquidity in the form of reserves if needed. Reserves could also smooth any delays in winning renewal of a 1% sales tax that must be approved every five years and was last renewed in 2019. The county can take multiple stabs at voter approval.

“We have very little debt,” most of which is in the form of self-supporting water and sewer bonds, Milliken said. “We have no financial issues.”

The county is watching the situation and depending on state, federal and railroad actions could consider aiding the village financially if needed but “it’s too early” to say if such action must be considered, Milliken said.

The county carries an Aa2 general obligation rating from Moody’s Investors Service after a 2021 upgrade on its $15 million of GO debt. The county benefits from healthy fund balances and alternative liquidity available of $23 million.

“The near-term financial effects for the village and state could be noteworthy. Lots of displaced residents and unusable land could drastically reduce property and sales tax collections. Fortunately, it looks like East Palestine has less than a half million dollars in outstanding debt, so the effect on bondholders would be minimal,” said Justin Marlowe, research professor at the University of Chicago’s Harris School of Public Policy. “The recovery would be long and difficult, but possible. But in the long run the federal government would, in effect, indemnify East Palestine.”

S&P Global Ratings rates only the state government— at AA-plus — and continues to monitor for any material near- and long-term impacts, said analyst Rob Marker.

“Currently, we do not view there to be a material effect on state finances,” Marker said.

State lawmakers this month added safety rules to the Department of Transportation budget in House Bill 23; the Ohio Legislative Service Commission’s Legislative Budget Office described the additional costs as likely minimal.

Federal reaction
The derailment comes on the heels of an unprecedented infusion of federal funds into the Federal Railroad Administration via the 2021 Infrastructure Investment and Jobs Act.

The IIJA allocated $66 billion in advance appropriations through 2026. The bulk of the money goes to Amtrak and the states, as most U.S. railroads are privately owned and responsible for maintaining the tracks and operating trains under Federal Railroad Administration standards.

The IIJA features about $8 billion for railroad safety, with $3 billion of that set aside for railroad crossings, which would not address the type of accident that happened in East Palestine, said Jeff Davis, senior fellow at the Eno Center for Transportation.

The outcome of the NTSB’s findings could dictate how some of the federal infrastructure railroad funding is spent, Davis said.

The NTSB’s Feb. 23 preliminary report suggested that one of the chief problems may have been with so-called hot wheel bearing detectors that were insufficiently spaced along the rail network.

“If that remains a finding in the final report, you’ll probably see a lot of the CRISI grants out of the IIJA are being diverted to focus around more of those bearing sensors,” Davis said, referring to the Consolidated Rail Infrastructure and Safety Improvements, or CRISI, program, which funds the safety, efficiency and reliability of freight and passenger rail.

Transportation Secretary Pete Buttigieg said part of the federal response will including deploying IIJA resources like CRISI as well as a Railroad Rehabilitation & Improvement Financing program to fund projects will modernize and improve tracks.

There are about one million daily shipments of hazardous materials by land, water, and air transportation modes, according to the USDOT’s 2022 Transportation Statistics Annual Report.

In 2021, more than 23,700 hazardous materials incidents, excluding pipelines, were reported. That included 378 rail hazmat incidents, with 25 of those being vehicular accident-related or derailments.

Despite the small number, rail derailments and vehicle crashes “may have major community impacts,” the report said.

The derailment has sparked a political backlash, with the Biden administration and Buttigieg coming under heavy criticism from Republicans. Lawmakers have launched several investigations in both chambers, with five committees set to hold hearings and probes in coming weeks.

With the long-term fallout of the accident still unknown, it remains to be seen whether congressional hearings and investigations will translate into legislative action, Davis said.

“No one has been hurt or injured so far, so it will depend on if there winds up being any measurable long-term consequences for pollution in the area,” he said.

The accident may also impact regulations around the growing use of rail transport for liquified natural gas, which has become a national security issue amid growing exports to Europe after the Ukraine-Russian war, Davis said. LNG is highly flammable and explosive.

Democrats have in the past sought to slow down rulemaking allowing for the bulk transportation of LNG by rail. The Trump administration approved a final rule allowing the LNG transport in 2020.

“Any movement of liquefied natural gas in our country should be closely monitored, with the highest possible safety measures in place, particularly through a densely populated state like New Jersey,” former Rep. Tom Malinowski, D-N.J. said in 2019 when he and former Rep. Peter DeFazio introduced a bill requiring review of the transport.

In a Feb. 23 visit to East Palestine, Buttigieg outlined a three-pronged approach with action on the executive and congressional levels and calling on railroads to act before they are required to.

Buttigieg urged Congress to pass rail safety measures, like increasing fines and expanding rules on high-hazard rail shipments and said he’s ordered the FRA to “step up focused inspection programs on any routes that are of particular concern because of community risk or because of the cargo.

“We need to raise the bar on what’s expected and what’s required,” Buttigieg said. “What we’ve seen is the industry goes to Washington and they get their way.”

Buttigieg said Congress should also consider changing how the federal government classifies hazardous material transported by rail, and Ohio Democrat Sen. Sharrod Brown and Republican Rep. Bill Johnson, who represents East Palestine, said last week they are considering legislation to do so.

Rep. James Comer, R-Ky., chair of the oversight committee, sent a Feb. 24 letter to Buttigieg asking for more information and blaming “infrastructure failure” for the accident.

In the House, the Transportation and Infrastructure, Energy and Commerce, and Oversight and Accountability committees have started investigations. The House transportation committee has jurisdiction over the DOT and the NTSB.

In the Senate, the Environment and Public Works committee is expected to hold a hearing as soon as next week, with Majority Leader Chuck Schumer expected to call on Norfolk Southern CEO Alan Shaw to testify. The Commerce, Science and Transportation panel is also investigating.

Disaster bonds
The Council of Development Finance Agencies believes the situation underscores the need for congressional action establishing a permanent disaster bond program.

“Over the past 22 years, Congress has passed bipartisan legislation, under the leadership of both Democrats and Republicans, to create special tax-exempt bond categories to provide federal assistance to aid disaster-affected states in recovery and promote economic development,” the CDFA said.

After September 11th, Congress created Liberty Bonds and after Hurricane Katrina and Hurricane Ike, Congress established Gulf Opportunity Zone Bonds and Hurricane Ike Disaster Area Bonds.

In 2008, the federal government authorized the $14.6 billion Midwestern Disaster Bond program permitting the use of tax-exempt bonds for qualified privately owned projects to generate economic activity in Midwestern counties that saw severe weather-related storm and flooding damage.  

“These bond programs were extremely impactful, but each required a special act of Congress, and it took months before capital became available. The delay left communities without the immediate resources needed to begin recovery,” CDFA President Toby Rittner said in a write-up on its policy proposals.

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