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Fixed-Income Insights

What’s the likely impact of Harvey and Irma on municipal-bond investments? Here’s our view.

 

In Brief

  • In the aftermath of hurricanes Harvey and Irma, investors may be wondering about the storms’ effect on the municipal-bond market. It appears there has been minimal impact thus far.
  • Still, we believe it is useful to review how to approach these types of events from an analytical standpoint, especially their potential impact on specific types of bonds.
  • For revenue bonds issued by facility operators, it is important to follow status reports from affected issuers (e.g., flood-damage updates from hospitals in the Houston area during Harvey).
  • For revenue bonds funded by tax revenues, it is essential to gauge the longer-term economic impact on storm-hit areas. This especially is important for states and cities that depend on tourism.
  • Issuers of general obligation bonds should be watched carefully for adverse economic trends in the wake of damaging storms, which could cause credit-quality outlooks to turn negative. 
  • While storm damage to troubled muni-bond issuer Puerto Rico is still being assessed, there appears to be minimal damage to resort areas, an important source of tax revenue for the island.
  • The key takeaway: Although there are no guarantees as to how the market will behave in the future, key historical characteristics of the broader municipal bond market—high issuer credit quality and low default rates—have not been altered by the recent storms.

 

The damage and disruption from hurricanes Harvey and Irma in recent days has been widely covered by general news outlets. For its part, the financial media have focused upon the impact to key business sectors and financial markets. However, the municipal bond market has not received much attention. 

From Puerto Rico to Florida to the Gulf region, many municipal bond investments were affected by the powerful storms. While the final implications of the one-two punch of Harvey and Irma are not yet known, it is clear that municipal bonds from the affected areas have held up well. Still, it is difficult to assess the extent of damage in the immediate aftermath of these natural events, and much analysis will be needed to sort out the impact for certain muni-bond issuers. Here, we examine some important areas to consider.

As a reminder, the municipal bond market can be separated into revenue and general obligation bonds.  Revenue bonds are backed by a dedicated source of funding, such as hospitals, airports, universities, or specific taxes. General obligation bonds are backed by the full faith and credit of issuing governments, whether they are states, counties, or cities. This means that the bonds are backed by a wide range of possible sources of cash for repayment. In analyzing the regions affected by the storms, we need to look at a variety of indicators to assess the implications for varying investments.

Revenue Bonds
For revenue bonds backed by a specific entity, investors need to gather specific information, such as whether the facilities have been damaged or evacuated. If a hospital or senior living facility has been closed, for example, then assessments are needed regarding how long it might take for them to be reopened. On the positive side, during Hurricane Harvey, some issuers such as Buckingham Senior Living in Houston, for example, distributed disclosures that they had minor flooding and had to move some people around their facility, but that on the whole operations were normal and that they did not need to evacuate. Since most of the information from similar issuers in the Houston area was positive, investors quickly were reassured that there weren’t any major problems.

With hospitals, many Texas systems distributed condition updates. For example, Houston-based Texas Children’s Hospital stated that it had activated flood doors to protect its facilities. The pediatric hospital was continuing inpatient procedures, but suspending those for outpatients, while closing some clinics. It became apparent that the facility had a clear and detailed plan for such an emergency. During Hurricane Irma, some Florida hospitals provided information that they were open, without water issues, during the storms, in order to make it clear that they were functioning. According to a Washington Post article on September 11, Tampa General Hospital reported no flooding or power outages.1 Lee Health in Fort Myers reported that not only had it kept patients that couldn’t be moved out of its facilities but also that for certain patients in the maternity ward the facilities also took in their caretakers.

During these types of situations, it is important for investors to stay current on disclosures from affected issuers, along with the local news, while continually reassessing the revenue impact of potential problems.  It also is necessary to review some bond-deal prospectuses to determine whether there are any potential concerns regarding bond structures. One negative example is that some deals allow issuers to call bonds if facilities become unusable. This may seem benign, but it can be a negative for investors if bonds currently have premium market prices, because the call price could be at par, leading to significant losses.

For bonds backed by specific taxes, investors will need to consistently review financial statements after the disaster, because it might take time for some areas to get back to full strength. (This was an issue in New Orleans after Hurricane Katrina.) Bonds backed by hotel or tourist taxes need to be monitored, even though they historically have provided very high-quality support for investors. There still are many outstanding questions. For example, will Miami Beach quickly return to full capacity? Will Houston’s visitor numbers pick up fast enough to support hotel taxes? How soon will Disney World return to normal—and how much revenue was lost during the days it was closed? 

While it appears that most if not all of these issues will be resolved positively, that has not always been the case. It is important to remember that when Hurricane Katrina damaged New Orleans, more than half of the new municipal bond issues at the time had bond insurance supporting them, which meant that if revenues did not rebound, bond insurers would make up the difference. Today, with fewer than 5% of new bonds coming with bond insurance, that support is unavailable. While these revenue bonds are quite unlikely to face default, negative trends could lead to downgrades, or at least negative outlooks, from credit ratings agencies, so active surveillance should remain an important part of the investment process. (Remember that the municipal market can be affected by adverse tax, legislative, or political changes, and by the financial condition of the issuers of municipal securities.)

General Obligation Bonds
With general obligation bonds, the security comes from a wider range of revenues, so there is a low probability of funding problems. Still, everything needs to be watched carefully for adverse trends that could cause credit-quality outlooks to turn negative. For example, Florida and Texas do not have state income taxes. Both states have high credit quality and diversified sources of revenue, but many of these revenue streams are consumption-based (both states depend heavily upon sales taxes). If their economies take a long time to return to normal, these revenues could trend downward.

Both states also rely on natural-resource industries. In Texas, it appears that affected energy facilities are restarting fast, so this might not be a problem. Still, the industry’s progress needs to be watched. Gasoline prices have moved up in anticipation of supply issues. Agriculture is a key industry for Florida, especially orange growers; according to some forecasts, half this year’s crop could be damaged, which means a lot of lost revenue. These and other indicators will have to be carefully monitored in the weeks and months to come.

On the other hand, there also could be some positives for general obligation bonds. With all the needed rebuilding, and the flow of government or insurance monies to areas that have been damaged, there likely will be many new houses built and many jobs created, at least temporarily. (Note that the affected areas will see significant levels of uninsured property losses as well.) This will bring an influx of workers to the locations being rebuilt, boosting local economies. Further, building supplies and other goods will have to be purchased to patch roofs and rebuild walls. These developments could lead to a short-term burst of economic growth for affected areas.

Puerto Rico
Puerto Rico, already closely watched by muni investors because of its economic problems, will receive extra scrutiny because of the damage caused by Irma. More than 60% of the island’s population lost power, and approximately 20% lost access to the water system. While recovery efforts may take a long time, Puerto Rico has been very hopeful, and is focused upon garnering more revenues from tourism to help its economy, so investors need to monitor the volume of vacation travel. (Since wide swaths of the Caribbean were affected by Irma, it will take some time to sort out the overall impact of the storms on the region.)

There were no indications of major damage to the island’s resorts, so that is a cause for optimism. That’s important, because hotel and sales taxes are key revenue streams for the Puerto Rican government. Another positive development is that it appears that the Trump administration has provided funds to Puerto Rico for recovery efforts. This actually could be positive for the commonwealth’s economy, which has not been received much assistance from the federal government in recent years.

Summing Up
After the recent hurricanes, there is much to watch on the municipal bond front, but so far, indications suggest that investments in storm-battered regions have held up well. Bond prices have not moved much in reaction to the uncertainties, and the rapid dissemination of updates from affected issuers appears to have eased market concerns. There are many types of municipal bond investments in these sections of the United States, reflecting the diverse nature of the broader muni market, and each requires unique analysis.  (Investors should note that certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole.) The municipal bond market historically has been characterized by issues of high credit quality with low default rates. The brutal strength of the recent storms has not changed these qualities.

 

1Amy Ellis Nutt, “Florida’s Hospitals Weather the Storm,” The Washington Post, September 11, 2017.

 

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