From Standard & Poor's RatingsDirect
In the U.S., hurricane season runs from June through November. But it's always earthquake season -- especially in the San Francisco Bay Area. April 18 marks the 100th anniversary of the devastating San Francisco earthquake, which destroyed wide swaths of the city.
Shortly after 5 a.m. that day, the Big One, as it became known, tore loose throughout the Bay Area. The earthquake's ripple effect was felt from southern Oregon to south of Los Angeles and inland as far as central Nevada. According to estimates by the U.S. Geological Survey (USGS), the 1906 7.9-magnitude earthquake resulted in at least 3,000 deaths, left more than 200,000 homeless, and destroyed more than 28,000 buildings in the San Francisco fire that followed.
As hard as it is for modern science to accurately forecast hurricanes, predicting earthquakes is far more difficult. The best that seismologists can do is calculate a rough probability of future earthquakes. Over the next 30 years, the USGS estimates that the chances of a major quake hitting the San Francisco Bay Area and Southern California are 67% and 60%, respectively. Even that uncertain forecast is sobering.
CREDIT QUESTIONS. With the 100th anniversary upon us, we at Standard & Poor's Ratings services take a look at two key questions: Is San Francisco prepared for the next Big One, and what would a 1906-magnitude quake do to the city's credit ratings?
The answer to the first question is a resounding "no." According to state studies, several hospitals, including San Francisco General, and schools throughout the region wouldn't be able withstand a major earthquake. Many older buildings were built with inadequate reinforcement and are at risk of collapse.
"No city can really be truly ready for a devastating earthquake -- there are too many unknowns," says Standard & Poor's Ratings Services' credit analyst Ian Carroll. "While tens of billions of dollars have been spent to reinforce buildings, roads, and bridges region-wide, many buildings and critical infrastructure need to be brought up to code."
BRIDGE REINFORCEMENTS. As an example, Carroll points to the impact of the 6.9-magnitude Loma Prieta earthquake in 1989. Most of the major property damage happened in areas of the city built on landfill. "Extensive damage occurred in the Marina District, on the northern edge of the peninsula, where many homes built on filled ground collapsed," says Carroll.
But that earthquake worked as a catalyst to change the San Francisco Bay Area's transportation infrastructure and building requirements. Despite the fact that some parts of the Bay Area's freeway system had to be demolished, Loma Prieta resulted in the retrofitting of all the area's bridges to better withstand earthquakes. The Bay Bridge project is under way, though far from finished as the east span replacement is still under construction. In addition, the city's Bay Area Rapid Transportation (BART) system is also undergoing an upgrade to toughen it.
The answer to the second question above is more complex and dependent on many factors. Although major hurricanes have been making headlines recently, the economic impact and human tragedy of a serious earthquake could be just as bad. Homes and businesses could be destroyed, both by shaking ground and other forces, such as fires from ruptured gas pipelines.
KATRINA EFFECT. What effect would such a calamity have on San Francisco's credit rating? S&P currently has a double-A rating on San Francisco's general obligation (GO) bonds. The rating reflects a broad and diverse economic base and good financial reserves, with about $325 million in reserves between the general fund and water fund. But even a city with an AA rating and good financial reserves would be hard pressed to handle a disaster like the one in 1906. In this worst-case scenario, the city's general-obligation rating would come under severe negative pressure.
Carroll notes that after Hurricane Katrina, the rating on New Orleans' GO debt was lowered to B- from BBB. "A major earthquake could result in the dislocation of population and economic losses with businesses moving out of town," he explains. "If all of those things happened at once and caught the city off guard, there could be lowered ratings across the spectrum of bonds, including the city's water bonds, school bonds, transportation bonds, and other municipal bonds," he adds. "The question as to how far the downgrades go would mirror the severity of the losses. It's really impossible to be more precise, given the unknowns."
In the case of an earthquake, S&P would attempt to ascertain the disaster's impact on the city tax base and subsequent budgets, capital-improvement programs, reserve margins, and debt profile. In the short term, reserves may be drawn upon to address immediate needs, such as emergency services and restoration of utilities, as well as debris cleanup. "The city will take a leadership role in addition to looking to others, including FEMA [Federal Emergency Management Agency], to get San Francisco back on its feet," said Carroll.
TOURIST ATTRACTION. With a population of almost 800,000 and an area of 49 square miles, San Francisco -- the fourth-largest city in California -- boasts a reputation that's much larger than its actual size. A major tourism destination in the U.S., its iconic sights include the Golden Gate Bridge, Fisherman's Wharf, Pier 39, Alcatraz, Ghirardelli Square, Chinatown, cable cars, Union Square, Lombard Street, and Golden Gate Park. As a destination for tourism and business travel, with about 15 million visitors annually, the hospitality and services sector is a mainstay of the economy.
"If a devastating earthquake were to hit San Francisco, it would at least temporarily affect the city's status as a tourist and business destination, and it might take years to get back to the way it was," adds Carroll.
San Francisco's other leading employment sectors include local government, higher education, financial and legal services, health care, retail, and biotech. The University of California at San Francisco employs 18,600 people. Retail giants including Gap Inc. (GPS) and Levi Strauss have headquarters in the city as well as sizable workforces. "If a large number of companies fail to recover from the disaster or even permanently relocate, it could hurt the city's employment base, retail sales, and income levels," says Carroll. "This could have negative ramifications on bond ratings over the longer term."
WATER MATTERS. San Francisco, of course, is hardly sitting still. In addition to improving its transportation infrastructure, it's also taking great steps to better prepare its water system for an earthquake. However, the city's $4.5 billion water system upgrade project won't be completed until 2015. "If a major earthquake were to hit before the project is completed, it could inflict major destruction to the water system infrastructure," says Carroll. The city would have five days of water supply stored in reservoirs already in the city that it imports from the Hetch Hetchy reservoir in the Sierra Nevada Mountains. "After the project is completed," added Mr. Carroll, "the system could be up and running in 24 hours" after a quake.
A substantial component of the plan is to build greater reliability and redundancy into the water-supply infrastructure that runs from Hetch Hetchy to the Bay Area, as well as to increase the Tuolomne River yield.
Regardless of a natural disaster, investors who purchase municipal bonds are going to look at whether they are going to get paid. Accordingly, investors place a high value on bond insurance. In the event of a catastrophic earthquake in San Francisco, bond insurers are expected to make regularly scheduled principal and interest payments.
NO BOND BLOODBATH. "How bad things become for bond insurers will depend on when revenue starts flowing again in the city," says Standard & Poor's managing director Richard Smith. "Short of total devastation, it shouldn't be that bad for bond insurers because they employ a variety of risk-management tools, including single issuer and regional limits and natural hazard exposure criteria, all designed to diversify their risks and to minimize their exposure to any single credit or event," he adds.
Hurricane Katrina didn't turn out to be the Armageddon that some predicted for the bond insurers. "In reality, there's an uneven pace to recovery efforts," says Smith. "Some credits have come back faster than others, but the insurers' risk management regimes proved successful in limiting the overall impact of the storm," he added. "Should there be total devastation in San Francisco because of an earthquake, the level of risk to the insurers hinges on the question: Will the city be rebuilt?"
HOUSING HIT. And what about the city's real estate sector? San Francisco's robust housing market, where the median sales price for a residence (including condos, apartments, and single-family homes) is about $750,000, adds needed revenues to the city's coffers via property taxes. If a major earthquake were to hit, the Association of Bay Area Governments estimates that about 155,000 housing units in the region, and 37,000 in San Francisco alone, could be wiped out. One reason for such devastation is that much of the housing stock in San Francisco tends to be quite old and not built with today's earthquake code requirements.
"If homes are destroyed, it could result in less property tax revenue for the city, which, in turn, would have a negative effect on the city's GO bonds," says Carroll. "Over the past few years, the buying and selling of real estate has provided additional revenues," he added. "Despite rebuilding efforts, a major quake could discourage some people from living here at least temporarily."
The USGS estimates that more than 1 million earthquakes occur in the world each year, but many go undetected because they hit remote areas or are of very small magnitude. But estimates are just estimates. The reality is that no one can predict when the next Big One will hit San Francisco. The question is not if, but when the earth will split. Says Carroll: "Despite the fact that the San Francisco Bay Area economy is on solid economic footing with a stable credit outlook, nobody can know what the next Big One will be like."