ESG and Municipal Bonds: Taking the Local View | Lord Abbett
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Fixed-Income Insights

How do environmental, social, and governance concerns factor into our credit analysis of local municipalities? First in a series.

(This article is from the fourth-quarter 2019 edition of The Muni Quarterly.)

This is the first in a series of articles exploring ESG considerations in different sectors of the municipal bond market.

Local municipalities are supposed to operate in the interest of the public good (think education, transportation, sanitation, and so on), and their debt issues would seem to be logical candidates for inclusion in environmental, social, and governance (ESG) strategies. Nevertheless, it is not always easy operating in the public good, and factoring ESG considerations into our credit analysis involves looking beyond reported financial data and metrics to other sources—news outlets, public databases, professional and industry associations—to understand how these local municipal-bond issuers might be performing with regard to the ESG standards that have become increasingly important to investors and community residents alike.

One first principle to keep in mind is that public works are inherently limited by the tax bases that fund them, so when considering ESG factors in municipals we look at relative outcomes rather than absolute outcomes. For example, looking at student graduation rates relative to poverty levels in a given school district will give us a better idea of the social good being provided than just looking at student outcomes alone, and assessing teacher pay relative to cost of living in the area will tell us more about the municipality’s governance than simply checking to see that teachers were given on-schedule raises.

One other perspective that we find useful in assessing ESG effectiveness is by looking at things from the constituent’s point of view. How are government policies and legislative actions affecting life “on the ground” for residents of these municipalities?

Starting with those considerations, what are some of the ways we assess local muni-bond issuers through each of the ESG lenses?

Chart 1. What Are Some of the Issues Examined in ESG Strategies?

Source: CFA Institute.

Perhaps the most tangible social good provided by local municipalities is public education. Data from the National Association of State Budget Officers indicates that one-fourth of all state spending is on K-12 education. How do we measure the social impact of all that tax money? One way is through student outcomes. The State of Michigan provides a useful example, as it publishes annual scores for every public school in its system, which can be easily accessed by parents and muni credit analysts alike. Incorporating graduation rates and scores on proficiency tests, the School Index can be further broken down to see how economically disadvantaged students are performing versus their peers in the same building. Transparent reporting like this, while not yet standard in every state, is becoming more popular and is an indispensable tool in analyzing social responsibility.

With labor disputes raising the issue of teacher pay to national attention, another way we look for social responsibility on the municipal level is by checking that teachers are paid fairly in relation to the cost of living. Higher pay is not only correlated with better student outcomes, but also directly influences teacher retention, which in turn contributes to budgetary stability for school districts.

We also look at what the school districts do outside of their stated mission, and what kind of assistance they offer to the more vulnerable groups they serve. Many community colleges offer reduced tuition for veterans, and some secondary school districts are starting to offer bilingual or English proficiency programs for ESL students. Again, we find that programs with ESG intentions have a secondary effect of bringing more students into the district, and thus increasing the average daily attendance count that is the main consideration of state funding formulas.

Local governments can address critical environmental issues through procedural and legislative means. Many large metropolitan municipalities seek LEED (Leadership in Energy and Environmental Design) certification for their new building projects. There are four levels of LEED certification, corresponding directly to measures of sustainability, energy efficiency, and indoor environment quality. Buildings that become certified have the dual benefit of saving energy and resources, as well as costing less to operate because of those efficiencies. In addition to the environmental benefits, LEED certification also requires transparent reporting of energy and water usage, which adds concrete data to the conservation conversation.

Though environmental regulations are typically handed down from the federal government, one area where the primary responsibility falls on the local government is in noise control. One way that local governments prevent noise pollution is through land-use planning–for example, requiring that a proposed quarry be built sufficiently far from existing residential buildings. They also set noise control ordinances on everything from the decibel output of music festivals to the duration of car alarms. In terms of indoor environment, local governments can set building codes to require new or remodeled buildings to include elements that protect inhabitants from exterior noise.

Municipal investors have long focused on whether local-government issuers have strong budgetary practices, timely audits and a multi-year capital plan. Therefore, when evaluating the governance of municipalities, we look at additional factors outside of what typically gets picked up in a pure credit rating. One such factor is diversity in leadership. A democratically elected official will generally represent the specific needs of the community that elected them, so one strong indicator of responsibility in governance is representative diversity in non-elected positions, such as school superintendents. To make sure that the diversity is a good representation of the underlying population, we cross check demographic data from the most recent U.S. census estimates.

An area of growing importance to municipal governance is cybersecurity. According to data analysis firm Recorded Future, more than 40 U.S. municipalities have been hacked in the past year, including large cities such as Baltimore, Albany (N.Y.), and Atlanta, prompting the Department of Homeland Security to issue a memorandum in July urging state and local governments to take immediate action in securing their networks.1 Ideally every local government would employ its own cybersecurity specialist to design secure systems and respond immediately to threats. We recognize that this is not possible in every municipality, so there are a few other cybersecurity measures we look for. Due to the nature of cybercrime, where a small number or even one single malicious program is used to attack many interconnected systems, it is important that the response is coordinated. Credit analysts must also account for other complex scenarios. For example, municipalities with insurance protection against network intrusion may actually face a greater risk of a ransomware attack.

Though local governments may operate with ESG goals as a key priority, the efficacy of their actions, relative to the means through which they accomplish these actions, is what really matters to citizens and ESG-aware investors alike. To this end, a large part of integrating ESG into our credit analysis of local governments is trying to step into the shoes of the constituents in order to figure out how what we’re reading in the audit is reflected in the quality of life of the community. We look forward to expanding on how we integrate ESG considerations in other sectors of the municipal bond market in future issues of The Muni Quarterly.


1”CISA, MS-ISAC, NGA & NASCIO Recommend Immediate Action to Safeguard Against Ransomware Attacks,” U.S. Department of Homeland Security, July 29, 2019.


The Fourth Quarter 2019 edition offers insights from our analysts on key topics for municipal bond investors, along with essential market information.

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