(Bloomberg) – Few parts of the U.S. are as exposed to thethreats from climate change as Ocean County, New Jersey.

It was here in Seaside Heights that Hurricane Sandy flooded anoceanfront amusement park, leaving an inundated roller coaster asan iconic image of rising sea levels. Scientists say more floods and stronger hurricanes are likelyas the planet warms.

Underestimating risk?

Yet last summer, when Ocean County wanted to sell $31 million inbonds maturing over 20 years, neither of its two rating companies,Moody's Investors Service or S&P Global Ratings, asked anyquestions about the expected effect of climate change on itsfinances.

Related: 6.8 million homes at risk for hurricane stormsurge

“It didn't come up, which says to me they're not concerned aboutit,” says John Bartlett, the Ocean County representative whonegotiated with the rating companies. Both gave the bonds a perfecttriple-A rating.

The same rating companies that were caught flat-footed by thedownturn in the mortgage market during the global financial crisisthat ended in 2009 may be underestimating the threat of climatechange to coastal communities. If repeated storms and floods arelikely to send property values — and tax revenue— sinking while spending on sea walls, storm drains orflood-resistant buildings goes up, investors say bond buyers shouldbe warned.

“They are supposed to identify risk to investors,” said EricGlass, a fixed-income portfolio manager at Alliance Bernstein, aNew York investment management firm that handles $500 billion inassets. “This is a material risk.”

Captial spending needed for future flooding

Breckinridge Capital Advisors, a Boston-based firm specializingin fixed-income investments, is already accounting for those risksinternally: Last year, it downgraded a borrower in Florida due toclimate risk, citing the need for additional capital spendingbecause of future flooding.

Rob Fernandez, its director of environmental, social andgovernance research, said rating companies should do the same.“Either incorporate these factors, or, if you say that you are,tell us how you're doing it,” he said.

Related: How rising seas could upend U.S.politics

S&P and Moody's say they're working on how to incorporatethe risk to bonds from severe or unpredictable weather. Moody'sreleased a report about climate impacts on corporate bond ratingslast November and is preparing a similar report on municipal bondsnow.

Fitch Ratings Ltd. is more skeptical.

“Some of these disasters, it's going to sound callous andterrible, but they're not credit-negative,” Amy Laskey,managing director for the local government group at Fitch, said inan interview. “They rebuild, and the new facilities are of higherquality and higher value than the old ones.”

For more than a century, rating companies have publishedinformation helping investors gauge the likelihood that companiesand governments will be able to pay back the money they borrow.Investors use those ratings to decide which bonds to buy and gaugethe risk of their portfolio. For most of that time, thedeterminants of creditworthiness were fairly constant, includingrevenue, debt levels and financial management. And municipaldefaults are rare: Moody's reports fewer than 100 defaults bymunicipal borrowers it rated between 1970 and 2014.

Destroy property & push out residents

Climate change introduces a new risk, especially for coastalcities, as storms and floods increase in frequency and intensity,threatening to destroy property and push out residents. That, inturn, can reduce economic activity and tax revenue. Rising seasexacerbate those threats and pose new ones, as expensive propertyalong the water becomes more costly to protect — and, in somecases, may get swallowed up by the ocean and disappear from theproperty-tax rolls entirely.

Related: Most U.S. flooding linked to climate change

Just as a shrinking auto industry slowly crippled Detroit,leading to an exodus of residents and, eventually, its bankruptcyin 2013, other cities could face the accumulating risks of stormsor floods — and then suddenly encounter a crisis.

“One of the first questions that we're going to ask whenconfronted with an issuer along the coast of Texas, or on the coastof Florida, is: How are you going about addressing, mitigating theimpacts of climate change?” Glass, Alliance Bernstein, said.And if local officials don't have a good answer to that question,he added, “We will not invest, period.”

When asked by Bloomberg, none of the big three bond raters couldcite an example of climate risk affecting the rating of a city'sbonds.

Kurt Forsgren, a managing director at S&P, said itsmunicipal ratings remain “largely driven by financial performance.”He said the company was looking for ways to account for climatechange in ratings, including through a city's ability to accessinsurance.

Henry Shilling, Moody's senior vice president for environment,social and governance risks, said the company is planning to issuea report this summer that explains how it will incorporate climatechange into its municipal ratings. “It's a bit of a journey,” hesaid.

Last September, when Hilton Head Island in South Carolina issuedbonds that mature over 20 years, Moody's gave the debt a triple-Arating. In January 2016, all three major bond companies gavetriple-A ratings to long-term bonds issued by the city of VirginiaBeach, which the U.S. Navy has said faces severe threats fromclimate change.

Boston one of 10 cities most financially exposed toflooding

The threat isn't limited to smaller cities. The World Bankcalled Boston one of the 10 cities globally that are mostfinancially exposed to flooding. But in March, when Boston issued$150 million in bonds maturing over 20 years, Moody's and S&Peach gave those bonds top ratings.

Of course, predictions are hard, especially about the future.While scientists are generally united about the science of climatechange, its pace remains uncertain. And what all of that will meanfor communities and their likelihood of paying back bonds is not asimple calculation. Ocean County continued to pay back its currentdebt load after Sandy, and will still have a lot of oceanfrontproperty if its current coast is swamped. The oceanfront just won'tbe in the same place.

Related: Climate is already making Americansmove

The storms or floods “might be so severe that it's going to wipeout the taxation ability,” said Bob Buhr, a former vice presidentat Moody's who retired last year as a director at Societe GeneraleSA. “I think this is a real risk.”

In May 2016, 117 investors with $19 trillion in assets signed astatement calling for credit ratings to include “systematic andtransparent consideration” of environmental and other factors.Signatories also included rating companies from China, the U.S. andelsewhere, including Moody's and S&P.

Continue…

In this aerial photo, people survey destruction left in thewake of superstorm Sandy, Wednesday, Oct. 31, 2012, in SeasideHeights, N.J. (AP Photo/Mike Groll)

Not doing enough to prepare

Laskey, of Fitch, was skeptical that rating companies could orshould account for climate risk in municipal ratings.

“We're not emergency-preparedness experts,” she said in a phoneinterview. “Unless we see reason to think, 'Oh, they're not payingattention,' we assume that they're competent, and they're doingwhat they need to do in terms of preparedness.”

That view is at odds with the picture painted by engineers,safety advocates and insurers. Timothy Reinhold, senior vicepresident for research at the Insurance Institutefor Business & Home Safety, a group funded by insurers,said local officials aren't doing enough to prepare for the threatsof climate change.

“While most coastal communities and cities have weather-relateddisaster response plans, many older, existing structures withinthese communities are not as durable, or as resilient as they couldand should be,” Reinhold wrote in an email.

The types of actions that cities could take to reduce their risk— including tougher building codes, fewer building permitsnear the coast and buying out the most vulnerable properties— are politically fraught. And the benefits of those policiesare typically years away, long after today's current leaders willhave retired.

Spur cities to deal with threat

The weakness of other incentives leaves the risk of a creditdowngrade as one of the most effective prompts available to spurcities to deal with the threat, according to Craig Fugate, directorof the Federal Emergency Management Agency under PresidentBarack Obama.

“They need cheap money to finance government,” Fugate said in aphone interview. If climate considerations meant higher interestrates, “not only will you have their attention. You'll actually seechanges.”

Related: Kerry says climate change may flood lower Manhattanby 2100

Fugate also said rating companies were wrong to assume thatcities are well prepared for climate change, or that their revenuewill necessarily recover after a natural disaster.

As an example, he cited the case of Homestead, a city south ofMiami that bore the worst damage from Hurricane Andrew in 1992. Thecity's largest employer, Homestead Air Force Base, was destroyed inthe storm; rather than rebuild it, the federal government decidedto include the facility in its base closures.

Fugate said climate change increases the risk that somethingsimilar could happen to other places along the coast — andthey won't ever be able to bounce back as Homestead eventuallydid.

“If that tax base does not come back,” he warned, “they cannotservice their debt.” Asked about rating companies' insistence thatsuch risks are remote, Fugate scoffed. “Weren't these the samepeople telling us that the subprime mortgage crisis would neverhappen?”

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.