What Is Happening And How Could It Affect Credit?

The federal government is reconsidering FEMA's role in disaster preparedness, response, and recovery activities, a financial and operational responsibility it currently shares with state and local governments. FEMA is the primary federal agency tasked with coordinating response and recovery efforts, but is considering shifting the natural disaster recovery costs to states and local governments. These potential modifications come on the heels of the announcement earlier this year of the elimination of the Building Resilient Infrastructure and Communities (BRIC) program and the cancellation of applications from 2020-2023, returning any grant funds not yet distributed to the disaster relief fund or the Treasury.

In January 2025, a White House executive order established the Federal Emergency Management Review Council, which, among several items, is tasked with reviewing FEMA's responses to disasters and evaluating if FEMA could serve its function as a support agency, providing supplemental assistance to states instead of "supplanting state control of disaster relief." The council's recommendations have not yet been developed, and several other policy proposals have been made informally that align with the objective of increasing state and local government involvement in disaster response and recovery. In our view, these potential changes are subject to modifications, including by Congress, but could alter the landscape and balance of risk-sharing for disasters among federal, state, and local governments.

Potential changes to the federal disaster assistance framework could include:

• A proposal to raise the threshold for per capita damage required for a state or local government to obtain a disaster declaration by up to 400%, made by former acting administrator of FEMA Cameron Hamilton;
• Limiting the cost-sharing portion of disaster recovery (also proposed by former administrator Hamilton in a memo to the OMB); and
• Redefining FEMA's role to place greater emphasis on state and local governments' preparedness and response to disasters.

In our view, raising eligibility thresholds and devolving a higher share of disaster recovery and mitigation costs could have both near- and long-term effects on state and local government credit, including on financial performance, reserves and liquidity, economic growth, and debt and liabilities (see chart 1).

Chart 1

Various FEMA Programs Support Disaster Funding

FEMA currently operates several programs related to disaster recovery. The largest of these is public assistance funded through the disaster relief fund (DRF), which provides financial assistance directly to states and local governments in the wake of an event. Other FEMA programs provide assistance to individuals affected by disasters, as well as programs for mitigation infrastructure (e.g., floods or other natural disasters). In addition to FEMA, other agencies such as the U.S. Department of Housing and Urban Development and the Small Business Administration provide disaster relief funds; however, FEMA provides the majority of federal relief funds (63% since 2017).

Since 2017, FEMA has obligated over $160 billion in disaster relief funds, not including the pandemic response. Some of the largest recipients of federal funds include Puerto Rico the U.S. Virgin Islands, California, Texas, New York, and Florida. According to FEMA's National Risk Index (which does not report on territories), these states are among those with the highest expected annual losses from disasters, where expected annual loss is a function of exposure to physical risks and economic value at risk. On a per capita basis, Puerto Rico was the largest recipient of federal disaster aid between 2014 and 2024, followed by Alaska, D.C., Louisiana, New York, and Vermont.

Chart 2

What We're Watching

While a potentially larger share of funding for disaster recovery and hazard mitigation could be shifted to states and local governments over time, we note that combined federal disaster aid obligated over the 10-year period from 2014-2024 represented only 5% of total state and local government expenditures in 2022. While this appears small in aggregate, a loss of federal disaster relief funds would disproportionately affect state and local governments most vulnerable to disasters and could be material to credit.

As the summer storm season approaches, many states maintain high reserves--with average reserve levels at approximately 17% of projected revenue for fiscal 2026--and are generally well-positioned to withstand short-term revenue disruptions or unanticipated expenses with their budgets. This, in part, could help mitigate the immediate shocks associated with disaster events. Some states have other sources of liquidity designated specifically for disaster response, ranging from rainy day funds with set-aside funds for disasters to transfers of annual appropriations when prior-year funds lapse. However, over the long term, we believe a higher degree of uncertainty related to federally funded programs for future disaster planning, response, and recovery poses new financial and management challenges for U.S. governments to incorporate into future budget cycles' reserve and liquidity targets, as well as other planning. To the extent that future federal aid is reduced or slowed, states might need to continually adapt their programs accordingly.

While we believe that states have the capability to absorb some of these costs, over the long term local governments might rely more on state assistance programs, such as additional support to hold communities harmless in response to permanent declines in school enrollment or resident displacement. Local governments could also pursue other avenues of disaster recovery, such as debt issuance or exploring more comprehensive insurance coverage policies to close potential gaps in recovery funding, including debris removal, rebuilding public infrastructure, and providing other emergency assistance such as temporary shelters for individuals displaced from their homes.

Chart 3

Potential FEMA Changes Underscore Policy Uncertainty That Could Shape Ratings

We will continue to monitor changes in federal policy in areas such as disaster declarations, cost-sharing for disaster recovery, and ultimately the role FEMA will play in disaster recovery. For municipalities and states with more significant exposure to disasters and limited ability to absorb financial and economic costs, we could see material credit weakening in the absence of federal support for disaster recovery.

Examples of issuers affected by disasters

Calcasieu Parish School Board (A-/Stable).  After Hurricanes Laura and Delta in 2020, the school board suffered approximately $250 million in building damage and saw more than 4,000 students leave the school district. The school board currently expects all but $25 million of rebuilding expenditures, or 90%, to be reimbursed by FEMA. If potential policy changes were to shift greater responsibility for funding disaster recovery to the state and local levels, local entities like Calcasieu Parish might need to rely on other sources of funding for future disaster recovery, such as hurricane relief bonds or the State of Louisiana. To the extent such changes would result in additional expenditures or debt at the state and/or local level without corresponding revenue, they could pressure state and local credit quality.

Terrebonne Parish (AA/Stable).  Without hazard mitigation grants, some municipalities might need to take actions similar to Terrebonne Parish, such as issuing locally secured sales tax bonds to fund hazard mitigation. While the project, known as Morganza to the Gulf, is a collaboration between multiple parishes and does include some federal funding, local municipalities in the region like Terrebonne have taken their own revenue-raising actions to fund hazard mitigation.

How U.S. Governments Receive Funding From FEMA

Spending for disaster recovery is highly intertwined in the U.S. Authorization for disaster recovery funding takes multiple steps and includes officials from all levels of governments.

Chart 4

Chart 5

FEMA has developed a seven-phase public assistance delivery model for states, territories, local governments, and eligible non-profit organizations, with a goal of improving accuracy, efficiency, simplicity, and timely access of public assistance (see chart 6). States have emergency management staff, planning, and procedures in place to engage with FEMA and assist local governments and non-profit organizations during the response and recovery phases following a natural disaster. While chart 6 details FEMA's median timing of each phase (with the median timeline from the initial request for public assistance to obligation of funding totaling 267 days, based on 2023 FEMA data), the timing of processing projects and obligating funding for disaster recovery can vary, and potentially take significantly longer, depending on the scale of damage, the complexity of projects, and level of funding requested.

In our view, prolonged delays in public assistance delivery could place higher demand on state and local government liquidity and reserves or necessitate cash flow borrowing. There could also be second-order effects on a state or locality's economic activity and revenue generation, which, over time, could weaken credit quality. To the extent that alternations to FEMA programs and/or staffing levels materially extend timelines for receiving federal aid, we believe states and local governments might need to bolster their budgets and reserves to cope with lengthier reimbursement periods following disasters.

Chart 6