Is protecting the asset protecting the asset class? Essays on the financial implications of flood risk for infrastructure finance

Abstract

This thesis consists of three empirical studies on flood risk and the financial performance of infrastructure assets.

The first essay examines the impact of flood risk exposure on infrastructure loans probability of default. I estimate infrastructure assets expected damage from flooding for 952 airports, ports, and power plants around the world. I find that the expected damage from flood increases the probability of default of infrastructure project finance loans. A standard deviation increase in the expected damage from flood increases the probability of default by one percent. I find that the effect of expected damage from floods is higher for longmaturity loans, as well as projects including financial risk mitigation mechanisms such as Power Purchase Agreements. These findings have important implications for infrastructure financing as they indicate that flood risk might erode some of the core characteristics that make infrastructure an attractive asset class to private sector investors.

The second essay investigates the impact of flood management policies on airport investment and the resulting financial constraints. Specifically, it examines the effects of flood insurance, building codes, and public adaptation investment on the investment decisions of 100 United States airports located in flood-prone areas. In the chapter I estimate the financial loss from extreme precipitations and flooding using novel data from the United States Federal Emergency Management Agency, and a differences-in-differences framework leveraging the introduction of the 2012 Biggert-Waters reform of the National Flood Insurance Program.

The findings reveal that while flood insurance costs negatively influence overall airport investment, they do not significantly affect investment-cash sensitivity.

On the other hand, the introduction of stricter building codes and public adaptation investment leads to increased cash usage for investment purposes, particularly among airports exposed to extreme precipitation and flood risks. Furthermore, the analysis suggests that the observed increase in financial constraints resulting from stricter building codes and public adaptation investment is driven by asymmetry of information rather than the materiality of flood risk.

The third essay examines how flood risks impact municipal bond structuring decisions in the United States. Using county-level data on more than 12,000 municipal bonds issuance, flood damage, and federal flood protection investments, this chapter analyzes the factors that influence the choice between general obligation (GO) bonds and revenue bonds. The results indicate that higher flood damage significantly increases the likelihood of GO bond issuance, with municipalities favoring the perceived security of GO bonds. An instrumental variable (IV) approach, employing federally funded flood protection as an instrument for flood damage, is used to address potential endogeneity. The study also shows that federal investments in flood insurance and protection infrastructure are associated with decreases in GO bond issuance, suggesting that they may mitigate some local fiscal pressures.