Erika Smull is completing an internship with the Breckinridge Municipal Bond Research team while finishing her PhD at Duke University. This article is based on Erika’s current research about PFAS. Director, Municipal Research Andrew Teras and Senior Research Analyst Joshua Perez, CFA, also contributed to this report.

 

Much like the science and health implications that surround them, municipal bond issuers and investors are still developing their perspectives on risks associated with PFAS. PFAS are the family of forever chemicals that are the subject of growing local, national, and global concerns, even as understanding of them continues to develop.

First produced in the 1930s,¹ PFAS collectively refer to per- and polyfluoroalkyl substances widely used in industrial and consumer products. PFAS are used in Teflon and other nonstick cookware, food packaging, stain-resistant carpeting, waterproof products such as rain jackets, cosmetics, and in fire-fighting foam used at airports and military bases.

PFAS and Implications for Human Health

Although PFAS are often used to keep substances from sticking, they tend to stick around.

PFAS are called forever chemicals because they persist rather than degrade.

Because of their prevalence, PFAS can also be termed “everywhere chemicals”. PFAS are found in water, air, soil, and in animals such as fish. Over 95 percent of Americans have PFAS in their blood.

The accumulation and persistence of PFAS in the blood can affect human growth and development. Risks include issues with fertility and increased blood pressure in pregnant woman, lower birth weights and behavioral changes in children, higher risk of certain cancers, and hormonal impacts.

PFAs and Regulatory Considerations

The regulatory environment around PFAS is evolving. Unlike other chemicals dangerous or potentially dangerous for human health such as lead, there is no national maximum contaminant level (MCL) for PFAS. A national MCL is planned for Fall 2023. This standard will be promulgated by the Environmental Protection Agency (EPA) with assistance from other federal agencies focused on human health.

Currently, a nonregulatory and non-enforceable health advisory exists for some PFAS chemicals. This includes levels for drinking water at 70 parts per trillion (PPT) for PFOA (perfluorooctanoic acid) and PFOS (perfluorooctane sulfonate). The EPA believes these are safe thresholds for human consumption.

States can implement their own PFAS regulations in the absence of (or in addition to) federal regulations. Many have started this process, with some states drafting tougher standards than the federal government. Currently, 21 states have implemented a MCL regulation or notification requirement for certain PFAS or plan to do so within the next year. The Northeast leads the way in regulating PFAS in drinking water. Some states regulate PFAS in consumer products.

States could also move to regulate PFAS in biosolids, which could be regulated at the federal level beginning in 2024. Biosolids are organic solids that are a byproduct of wastewater treatment. They are removed from wastewater before it leaves the treatment plant and flows back out into the environment. Biosolids are a waste product that must be managed.

PFAS and Credit Implications for Municipal and Corporate Bond Investors

PFAS create modest credit risks for municipal and corporate bond investors. In the municipal space, PFAS remediation and management costs may crowd out spending on other priorities in municipal and utility operating budgets. The presence of PFAS also has implications for the future attractiveness, livability, and financial health of communities. For corporate investors, liability concerns are an emerging, albeit manageable, risk.

Municipal Credit

Cost and reputation risks are the most obvious credit risks for municipal investors. Both seem modest, for now.

Take drinking water, as an example. Municipalities may face the cost of building ion exchange/activated carbon treatment facilities to protect drinking water quality. Some of our conversations with issuers suggest that many water systems throughout the country face limited immediate risk to their drinking water systems. Where PFAS in drinking water are a material issue, issuers believe costs are manageable and will not be a major hit to operations. None of the issuers engaged are concerned with PFAS drinking water regulations. This is a positive development insofar as it suggests few communities will suffer tax base or economic decline on account of burgeoning PFAS-related drinking water risks.

The larger credit concern involves wastewater biosolids (Read more about biosolids here). Issuers estimate much larger potential costs related to wastewater management operations relative to drinking water. That’s because removing PFAS from wastewater may require incineration under the strictest regulatory guidance. Incineration is a common but expensive solution, and it is also carbon intensive. Burning biosolids adds to a utility’s CO₂ footprint; by contrast, when they are spread across farm fields and soil, they are used as fertilizer. Looming biosolids regulations are an example of disparate objectives that can exist across different government departments; public health officials generally focus on public health outcomes while water management professionals must balance public health goals and infrastructure cost ramifications.

Whether for drinking water or wastewater systems, all issuers expect PFAS to increase operating and capital costs. New federal funding in the Infrastructure Investment and Jobs Act (IIJA) may help to pay for some of the clean-up costs. Litigation and settlements with chemical companies are also an option. But there is a high likelihood that PFAS costs will eventually impact ratepayers.

Right now, PFAS treatment seems unlikely to be a major driver of new issuance for municipal bonds but further regulatory pressure in coming years could change that.

Corporate Credit

The near-term impact for most companies with liability exposure for PFAS is relatively modest. Some companies are more exposed than others and significant adverse judgements against them can negatively impact credit metrics, but for most companies the financial impact will be manageable. Companies with exposure often have shared liability agreements that help to insulate them from significant balance sheet strain. Also, most chemical companies have reduced their use of PFAS compounds. Nonetheless, Breckinridge continues to monitor the issue closely. So long as PFAS compounds remain in production, they present risks.

PFAS is an evolving environmental issue that is likely to prove more salient for investors, ratepayers, and corporations in the years to come. While risks appear manageable for now, it is an important policy area to monitor. The credit implications of PFAS could change in the future.

 

[1] “What are PFAS?,” Rachel Ross, April 30, 2019
Rev #279242

DISCLAIMER

This material provides general and/or educational information and should not be construed as a solicitation or offer of Breckinridge services or products or as legal, tax or investment advice. The content is current as of the time of writing or as designated within the material. All information, including the opinions and views of Breckinridge, is subject to change without notice.

Any estimates, targets, and projections are based on Breckinridge research, analysis, and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.

Past performance is not a guarantee of future results. Breckinridge makes no assurances, warranties or representations that any strategies described herein will meet their investment objectives or incur any profits. Any index results shown are for illustrative purposes and do not represent the performance of any specific investment. Indices are unmanaged and investors cannot directly invest in them. They do not reflect any management, custody, transaction or other expenses, and generally assume reinvestment of dividends, income and capital gains. Performance of indices may be more or less volatile than any investment strategy.

Performance results for Breckinridge’s investment strategies include the reinvestment of interest and any other earnings, but do not reflect any brokerage or trading costs a client would have paid. Results may not reflect the impact that any material market or economic factors would have had on the accounts during the time period. Due to differences in client restrictions, objectives, cash flows, and other such factors, individual client account performance may differ substantially from the performance presented.

All investments involve risk, including loss of principal. Diversification cannot assure a profit or protect against loss. Fixed income investments have varying degrees of credit risk, interest rate risk, default risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer-term securities. Income from municipal bonds can be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the IRS or state tax authorities, or noncompliant conduct of a bond issuer.

Breckinridge believes that the assessment of ESG risks, including those associated with climate change, can improve overall risk analysis. When integrating ESG analysis with traditional financial analysis, Breckinridge’s investment team will consider ESG factors but may conclude that other attributes outweigh the ESG considerations when making investment decisions.

There is no guarantee that integrating ESG analysis will improve risk-adjusted returns, lower portfolio volatility over any specific time period, or outperform the broader market or other strategies that do not utilize ESG analysis when selecting investments. The consideration of ESG factors may limit investment opportunities available to a portfolio. In addition, ESG data often lacks standardization, consistency and transparency and for certain companies such data may not be available, complete or accurate.

Breckinridge’s ESG analysis is based on third party data and Breckinridge analysts’ internal analysis. Analysts will review a variety of sources such as corporate sustainability reports, data subscriptions, and research reports to obtain available metrics for internally developed ESG frameworks. Qualitative ESG information is obtained from corporate sustainability reports, engagement discussion with corporate management teams, among others. A high sustainability rating does not mean it will be included in a portfolio, nor does it mean that a bond will provide profits or avoid losses.

Net Zero alignment and classifications are defined by Breckinridge and are subjective in nature. Although our classification methodology is informed by the Net Zero Investment Framework Implementation Guide as outlined by the Institutional Investors Group on Climate Change, it may not align with the methodology or definition used by other companies or advisors. Breckinridge is a member of the Partnership for Carbon Accounting Financials and uses the financed emissions methodology to track, monitor and allocate emissions. These differences should be considered when comparing Net Zero application and strategies.

Targets and goals for Net Zero can change over time and could differ from individual client portfolios. Breckinridge will continue to invest in companies with exposure to fossil fuels; however, we may adjust our exposure to these types of investments based on net zero alignment and classifications over time.

Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.

The effectiveness of any tax management strategy is largely dependent on each client’s entire tax and investment profile, including investments made outside of Breckinridge’s advisory services. As such, there is a risk that the strategy used to reduce the tax liability of the client is not the most effective for every client. Breckinridge is not a tax advisor and does not provide personal tax advice. Investors should consult with their tax professionals regarding tax strategies and associated consequences.

Federal and local tax laws can change at any time. These changes can impact tax consequences for investors, who should consult with a tax professional before making any decisions.

The content may contain information taken from unaffiliated third-party sources. Breckinridge believes such information is reliable but does not guarantee its accuracy or completeness. Any third-party websites included in the content has been provided for reference only. Please see the Terms & Conditions page for third party licensing disclaimers.