Hurricane Sandy inflicted significant damage on the East Coast of the United States as it flooded wide swaths of New York, New Jersey, and Connecticut, destroyed entire communities, and left millions of people without power for prolonged periods of time. Now, municipalities must face cleanup and rebuilding costs from a storm that had an estimated economic impact of approximately $40 billion, or 1.3% of gross regional product (GRP) in the New York tri-state region. By comparison, Hurricane Katrina, which hit the Gulf Coast in 2005, cost $120 billion, or 9.6% of GRP in the Gulf Coast region.¹

State and local governments in New York and New Jersey have both been hit with unbudgeted costs for storm preparation, cleanup, flood mitigation, evacuee management, and infrastructure reconstruction. In the most severe cases, state and local governments face liquidity strains as cleanup costs exceed their cash availability as they wait for the processing of federal reimbursements. Despite the extensive storm damage, state and local governments should be able to maintain the region's historically strong resiliency to severe natural disasters, while at the same time recover relatively quickly without harm to respective bondholders.

The most pressing concern for state and local governments is the need for short-term liquidity to pay for their cleanup efforts, while they wait for funds from the federal government. Historically, insurance proceeds, Federal Emergency Management Agency (FEMA) reimbursement, and state aid have mitigated the cash expenses. In extreme cases, New York, New Jersey, Connecticut, and affected counties and municipalities could access the capital markets for short-term financing.

President Obama has already authorized emergency funding for states affected by Hurricane Sandy. This authorization makes these states eligible for reimbursement from FEMA, which pays at least 75% or more for cleanup, rehabilitation, and hazard mitigation. There is a risk that the reimbursement could take months, possibly even a year, to arrive, long after storm-related costs were incurred. Immediate costs in excess of budgeted contingencies will force municipalities to use reserves, reduce other expenditures, or issue debt. This could place short-term stress on state and municipalities with little liquidity or reserves.

The storm, however, is not expected to be detrimental to the long-term credit quality of the majority of issuers. Property owners are likely to rebuild or replace damaged structures with reimbursed funds from insurance policies or FEMA. There also is even the ironic possibility that replacement properties could be of higher value than the destroyed structures. Furthermore, unless properties are condemned and purchased using eminent domain by the government (that is, the power to seize private property for public use), property owners will still have to pay their property taxes, which are used to support general obligation bonds. While short-term economic disruptions will cause revenue loss, it would take more than a year before assessed value appeals potentially reduce the tax rolls and result in a loss of revenue.

In addition to providing disaster-related reimbursement, disaster-stricken states have, historically, found avenues to provide cash to local governments to meet immediate needs. Following Hurricane Katrina, for example, the State of Louisiana provided bridge loans in the form of revenue anticipation notes. More important, proceeds from these notes were used to fund both storm cleanup and payments to bondholders in the event that revenues were not otherwise available. In the case of Hurricane Irene, Vermont accelerated local aid and permitted the Municipal Bond Bank to make short-term loans to municipalities to fund cleanup costs. Similarly, local governments in New Jersey are likely to receive financial assistance from the state's Division of the Local Government Services, which provides oversight of local governments within the state.

In summary, Hurricane Sandy caused significant economic disruption and loss of revenue for state and local governments from sales, utility, mortgage-transfer taxes, and other economically sensitive revenue streams, which will cause these issuers to miss their monthly revenue budgets in October and November. Notably, the State of New Jersey budgeted 8.0% and 4.7% growth, respectively, in income taxes and sales taxes. Yet, these projections were optimistic, and were already falling short prior to the storm.² However, economic activity during the recovery phase will be greater than budgeted, causing revenues during the balance of the fiscal year to likely exceed budgeted levels.

—Seth Klempner, Lord Abbett Research Analyst of Municipal Bonds