Our thoughts go out to all those displaced or injured, those who had homes and businesses destroyed, and especially those who lost loved ones. Many of us have been glued to the TV, focused on the news surrounding the devastating damage that has occurred and is continuing to occur at the time of this writing. It is heartening to see the outpouring of support from around the country. It is also heartening to hear that lessons learned from past disasters have reduced what could have been an even more devastating disaster. Positive steps have included the early designation of a state of emergency, triggering early aid in money and other resources from the Federal Emergency Management Administration (FEMA); improved and more coordinated communication; the existence of disaster recovery plans at many institutions; and physical reinforcement of buildings including hospitals. Hopefully a formal request to Congress for disaster aid will be addressed and resolved quickly.
The estimates of damage continue to rise as the storm moves and stalls, moves and stalls, dropping record rainfall on Texas and now shifting to Louisiana and Mississippi. And there are predictions of more rain this week for already hard-hit areas. Early estimates of damages were in the range of $30 billion but have grown to $100 billion or more according to some news programs. Katrina cost estimates ranged from $105 to $118 billion. Another perspective is that the total cost of Hurricane Harvey and continued flooding is less than estimates of the cost of a standoff in Congress on the debt ceiling! See point 7 in David Kotok’s commentary “Debt Ceiling Part II,” dated 8/29/2017, available here: http://cumber.com/debt-ceiling-part-ii/. Hurricane season has months left, and we hope the remainder is benign.
The initial cost of a natural disaster can be great, and not all costs are covered by insurance and disaster recovery aid. However, usually after a natural disaster there is a surge in economic activity that continues for an extended period as people and communities rebuild and money and workers flow into the area – increasing income taxes, sales taxes, and fees. The City of Houston, Harris County, and environs is a large economic engine with important municipal and corporate assets. The Port of Houston moves not only oil but food and will reopen, although a date has not been set as of this writing.
Investors’ expectation of a bump in economic activity as the region recovers may be reflected in the lack of noticeable price changes for Texas municipal bonds – at least not yet. The price stability may also be a reflection of a flight to quality and lower Treasury bond yields. This protracted disaster may have different outcomes in the markets than previous disasters. Possibly, investors are becoming increasingly numb to such events. We have noted that geopolitical events here and abroad are not causing as much investment price volatility as one would think.
At Cumberland we have a conservative investment philosophy and invest only in high-quality municipal bonds. That applies to our Texas holdings as well. These are bonds issued by municipalities with strong and diverse economic bases, conservative financial management, and reasonable debt and pension obligations. They generally have reserves set aside to address changes in anticipated revenues and expenses as well as unanticipated events.
We invest in bonds guaranteed by Assured Guaranty Municipal (AGM), National Public Financial Guarantee (NPFG), and Build America Mutual (BAM). Please see our 2Q 2017 municipal credit commentary (http://cumber.com/2q-2017-municipal-credit/), which includes a discussion of the strength of the bond insurers. The bond insurers, also referred to as financial guarantors, have strong claims-paying resources. They insure a number of single-A and triple-B municipalities. These may be small entities or have a narrower economic base or thinner financial cushion than a double-A-rated credit. However, the overall municipal default rate is very low. According to Moody’s, the five-year average default rate for municipal bonds is 0.15%, compared with corporate bonds at 6.92%. Interestingly, the municipal triple-B 5-year default rate is 0.61%, lower than the single-A corporate default rate of 1.15%, while the triple-B corporate default rate is lower, too, at 0.97%. See more detail in http://cumber.com/2q-2017-municipal-credit/. The bond insurers’ exposure to Texas, a state with many highly rated municipalities, is 5% for AGM; 6.7% for NPFG, and 14.3% for BAM. The bond insurers can provide an important stopgap for smaller Texas municipalities that may be operationally challenged in this environment, by stepping in and making debt-service payments. This may not even be necessary, as trustee banks responsible for administering bond proceeds and payments to bondholders may have sufficient funds on hand to meet debt-service requirements.
We also invest in school district bonds guaranteed by the Texas Permanent School Fund (PSF). The use of the PSF guarantee results in less expensive access to the capital markets for the school districts because the bonds receive triple-A ratings. The strong rating of the PSF guarantee reflects substantial PSF assets compared with guarantee obligations, good credit quality of school districts and strong oversight. The Texas PSF was created by the Texas Legislature in 1854 with a $2 million appropriation, expressly for the benefit of the public schools of Texas; and at the end of 2016 the fund had $37 billion in assets.
Longer-term, with increasing weather variability and more-damaging storms, there may be changing trends to keep an eye on. Fewer people may want to live by the coast, while insurance coverage and federal relief funding may change to try to incentivize people to move to less-risk-prone areas. This being said, people so far seem to want to continue to live in areas that are prone to earthquake or flooding – and are intent on reinvesting in their communities and their heritage. However, more and more municipalities, companies, and investors are concerned with the resilience of infrastructure and business continuity.
Hurricane Harvey and its aftermath will provide yet another opportunity for us as a nation to hone our preparedness and to reflect upon addressing our infrastructure needs. At Cumberland we will continue to monitor developments and take action to increase opportunities and limit risk.
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