The municipal bond market is evolving as state and local governments increasingly issue debt to fund infrastructure projects aimed at mitigating climate risk. With a surge in climate-related disaster events and potential shifts in federal responsibility, these “climate resilience” bonds offer attractive, tax-exempt yields, particularly for wealthy investors. Nuveen’s Dan Close emphasizes the importance of identifying municipalities proactively fortifying their infrastructure, highlighting examples like Miami, New York’s Battery Park City, and Chicago’s Metropolitan Water Reclamation District.
A significant investment opportunity is emerging within the municipal bond market, often overlooked by investors. Traditionally, municipal bonds, or "munis," have financed critical public infrastructure such as roads, bridges, and water systems. However, a new impetus is driving their issuance: funding resilience against escalating climate risks.
Dan Close, head of municipals at Nuveen, highlights that state and local governments are increasingly leveraging munis to bolster their defenses against extreme weather events. The frequency and severity of climate-related disasters are on the rise, leading to substantial recovery costs. In 2024 alone, the National Oceanic and Atmospheric Administration's National Centers for Environmental Information (NCEI) documented 27 weather and climate events, each incurring losses exceeding $1 billion. This starkly contrasts with the 1980s, which saw an average of just 3.3 such events annually, costing approximately $22 billion each year.
Compounding this trend, the federal government is reconsidering its role in disaster response. Proposed overhauls to the Federal Emergency Management Agency (FEMA) could transfer a greater share of preparedness, response, and recovery responsibilities—and their associated financial burdens—to state and local authorities.
"Municipalities are opting to issue debt to fortify their infrastructure, ensuring a more effective response should a natural disaster strike," Close explains, noting that projects valued at around $63 billion are currently in development. These include both general obligation bonds and revenue bonds tied to essential services like water, sewer, and utilities.
For affluent investors, the appeal of muni bonds is further amplified by their attractive yields. Interest income from municipal bonds is exempt from federal taxes, and for residents of the issuing state, it's also free from local taxes.
Close told CNBC, "We've surpassed the point where long-dated, 5% AA-coupon bonds... are yielding over 5%, at a discount." He added that in high-tax states, where combined tax rates can reach 50%, these yields translate to a taxable equivalent of around 10% for the long end of the curve. Even the 10-year curve, yielding approximately 4%, offers an impressive 8% tax-equivalent yield.
Identifying Resilient Investments
While the overall trend is toward climate resilience, not all local governments are equally proactive in mitigating potential damage. Close cautions, "We believe the municipal market lags other fixed-income sectors in accurately assessing and pricing these risks."
He identifies a unique opportunity for investors: "For those credits that have invested diligently in hardening their infrastructure, we see opportunities where they are currently priced similarly to other disaster-prone areas, often without sufficient recognition for the protective measures they've implemented." Therefore, investors must conduct thorough due diligence, understanding a community's climate exposure and its strategies for managing those risks.
In a recent whitepaper, Close highlighted several municipalities leading the charge. Miami, for example, has its $400 million Miami Forever Bond program, issuing investment-grade bonds to fund projects such as seawall replacements and flood control pump stations. New York's Battery Park City Authority has secured $658 million through investment-grade revenue bonds for a permanent coastal flood barrier protecting Lower Manhattan.
The Nuveen All-American Municipal Bond Fund (FLAAX) includes Miami bonds, while various New York-focused Nuveen funds hold Battery Park City bonds. Further exemplifying proactive measures, the Metropolitan Water Reclamation District of Greater Chicago issues bonds to finance its Tunnel and Reservoir Plan, a vast system of deep tunnels and reservoirs designed to combat extreme rain and mitigate flooding. These Chicago bonds are held within the State Street SPDR Nuveen ICE Short Term Municipal Bond ETF (SHM).
