It was a short two weeks ago that I wrote a commentary titled “Hurricane Harvey – Unprecedented Event?” Harvey ended up being two events, the hurricane and then extensive, protracted rain and flooding. And here I am now, writing about another unprecedented event: Hurricane Irma, which hit the Caribbean and most of Florida as a hurricane and Georgia as a tropical storm, then ventured into South Carolina, Alabama, Tennessee, and North Carolina, causing more wind damage and flooding.
Irma was terrifying and devastating to many in the Caribbean; and even as it was downgraded in severity as it moved on its path, it provoked fear and uncertainty and a vast exodus of people, especially from South and Central Florida. While preliminary cost estimates of Irma’s wrath are not as high as initially expected, the death and injury toll goes on rising as search and recovery efforts continue, and there are post-storm dangers such as continued flooding in some areas, downed live power lines, waste leaks from Superfund sites, and overwhelmed wastewater treatment plants. A recent Bloomberg news article: (http://bloomberg.com/news/articles/2017-09-13/cities-swimming-in-raw-sewage-as-hurricanes-overwhelm-systems) describes how Irma overwhelmed utilities across the State of Florida and points out that the US EPA estimates that wastewater utilities need $271 billion to maintain and upgrade pipes, treatment plants, and associated infrastructure.
The impacts of the storm are vast, and coming on the heels of Harvey, they will ripple throughout the economy and the insurance industry (http://www.cumber.com/looking-irma-in-the-eye-iii/). Unfortunately many people who were flooded did not have insurance to cover it. Repairs and rebuilding will help offset reduced economic activity due to the storms, but damage estimates are at high levels, and this week is just the midpoint of hurricane season. August and September are normally the peak of the season, and the season won’t be over until the end of November. Based in Sarasota as we are, Cumberland Advisors weathered the storm with the rest of Florida. Our thoughts and best wishes go out to those who lost homes and businesses, were injured, or lost loved ones.
As John Mousseau and Gabriel Hament wrote in their piece “US Hurricanes and the Bond Market” (http://cumber.com/us-hurricanes-and-the-bond-market/), Cumberland selectively sold holdings of some smaller coastal cities’ debt ahead of the storm with the expectation that lower-rated, uninsured bonds of smaller coastal areas are more vulnerable to headline risk than other credits that are larger or higher-rated.
At Cumberland we have a conservative investment philosophy and invest only in high quality municipal bonds. 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. Prior to Harvey and Irma we had been selectively selling A-rated credits because the decline in yield spreads was not compensating enough for the additional credit risk. However, most A-rated bonds are still good credits.
As I mentioned in my Harvey commentary, investors’ expectations of a bump in economic activity as the recovery progresses may be reflected in the lack of noticeable price changes for municipal bonds in affected states. The price stability may also reflect a flight to quality and lower Treasury bond yields. The combined effect of Irma on the heels of Harvey, affecting a significant portion of the US population, may yet produce a different outcome in the markets than occurred in previous disasters. However, such an outcome is not detected yet in municipal bond prices. 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 we might have reasonably expected.
Puerto Rico was damaged by Hurricane Irma, and the Commonwealth has requested additional federal aid. The rebuilding may boost economic activity on the struggling island. Our insured Puerto Rico strategy, which we discussed in 2Q 2017 Insured Puerto Rico commentary (http://www.cumber.com/2q2017-review-puerto-rico-insured/) is not affected by the storm, because in our opinion, the bond insurers have ample liquidity and claims-paying resources at this time.
The Florida Hurricane Catastrophe Fund (FHCF) is a large Florida issuer in the municipal bond market and could possibly issue post-catastrophe bonds to fund claims and preserve liquidity, which could pressure ratings. However, recent estimates of damage are lower than initially forecast. The FHCF’s bonds are rated Aa3 by Moody’s and AA by S&P. The FHCF is administered by the Florida State Board of Administration and all property and casualty insurers in the state are required to participate. The insurance companies pay the initial portion of claims, then the FHCF pays its layer of reinsurance and the insurers then pay the remaining portion of claims. The FHCF is limited in the amount it can pay out by statute. A major storm has not hit Florida since Wilma in 2005 and that has allowed the credit to build a deep pocket of reserves. If needed, FHCF can charge assessments on insurance policies throughout the state, giving the fund a huge, high quality base to collect from and resulting in high ratings.
The news has covered the massive response of electric utilities throughout the country, providing crews and equipment to restore power and to help with the clearing of debris, repairs and rebuilding. In a similar fashion, the members of the American Water Works Association (AWWA) are ready to help other members. As mentioned in their website, AWWA.org, following Hurricane Katrina in 2005, AWWA took the lead in the creation of the Water/Wastewater Agency Response Network, or WARN as it’s commonly known. WARN allows utilities to partner with other utilities in advance of an emergency to assure that they can provide immediate help during events like these. The Texas WARN system (TXWARN) was activated days before Hurricane Harvey arrived; and already, utilities are receiving assistance with critical items like pumps and generators. Florida has a similar system, but we have not yet seen any news items related to the WARN response.
Electric, water, and wastewater utilities are large issuers of municipal bonds. Municipal bonds also finance other infrastructure such as roads, bridges, airports, and ports. According to a Moody’s report dated Sept 11, 2017, airports, seaports, and toll roads in Florida remain closed or inaccessible, and the extent of damage to their assets, while believed to be moderate, is currently unknown. These transportation entities will be negatively affected by disruptions to operations and losses of revenue in the short run. However, these issuers will generally be able to sustain their long-term credit quality because of three important factors: strong liquidity, resilient revenue streams, and experience with previous storms that has improved readiness. Other compensation in the form of business interruption and property insurance proceeds, along with disaster relief assistance from the Federal Emergency Management Agency (FEMA), will provide additional resources to support recovery.
At Cumberland we like revenue bonds because they are generally monopolies with relatively autonomous rate-raising ability and are less subject to political budget wrangling and pension issues than general-obligation bond issuers. That said, general-obligation bond issuers may have unlimited tax-raising ability. For example, according to a DebtWire article, Houston has an emergency tax increase of 8.9% going to vote. This would raise $113 million, compared with $200 million in cleanup costs and the loss of 34 vehicles.
As always, at Cumberland we will continue to monitor credits and developments related to hurricane season and other events in order to manage risk and preserve client capital.
 DebtWire Article: “Houston mayor wants one-year tax hike to assist with Harvey costs,” |12 September 2017 | 08:54 EDT
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