We have a thorough process that had led us to construct diversified portfolios with issuers that we believe are generally well prepared for a recession. Of course, the speed at which this situation came upon us and the unprecedented nature of it has created a high degree of uncertainty.
Huge portions of the country are in some degree of lockdown and these lockdowns are likely to grow. This is impacting revenues across many municipal sectors and to be frank, we expect there to be ratings downgrades in the certain sectors at this point. However, we also want to be aware of the structural strengths of municipal issuers that should support bond repayment and stave off distress scenarios in all but the most dire of escalations of this crisis.
Up until essentially last month, we had been in a slow and steady economic expansion for more than a decade. That allowed many issuers to take important steps to prepare for the next recession. Another important thing to note is there has been, and will likely continue to be, an aggressive policy response from both the Federal Government and the Federal Reserve. The policy response may be a multi-step one and will likely result in significant monies flowing downstream to municipal issuers, as well as ensuring strong access to credit.
One aspect of the policy response we find particularly interesting is the temporary expansion of the authority for the Federal Reserve to buy long term municipal bonds. Previously, the Fed was only authorized to purchase short term municipals, with maturities up to six months. Given the Fed has already stepped to support the short-term muni market, further support is not out of the question. However, we would note that the Fed purchasing municipal bonds is a very complicated task, with nuanced political and market considerations. Just because the Fed received this authority, does not necessarily mean they will follow through with purchases.
In terms of local governments and transportation, this is one of the times where we are going to be happy to have a local government sector underpinned by stable property tax revenues. However, each local government is going to have its own unique challenges from the COVID-19 crisis either through drops in tax revenues, or increased costs associated with responding to the crisis.
Our immediate concerns are going to be those credits reliant on more economically sensitive revenues, like sales taxes, those with weaker fiscal conditions, and those in states that will be less likely to be able to provide that important support for their local governments. However, as noted before, that the long steady economic recovery has helped many locals build up reserves in recent years.
Below we highlight some transportation sectors:
Airports: There has been a significant drop in flight volume, and there may end up being a total shutdown of domestic air traffic for a period of time. There are a few mitigating factors here to consider. Airports are set to receive bailout money directly from this stimulus bill and benefit from the bailout of the domestic airline companies. They also tend to carry high levels of liquidity that have historically helped them weather prior periods of stress.
Mass Transit: The same concerns that apply here, drastic declines in ridership. However, one important distinguishing feature of mass transit systems is that they are often funded through a wide variety of revenues. For example, the MTA is funded through farebox revenues, but also city, state, and regional taxes, as well as support from the federal government for its capital spending. Many other mass transit systems have diverse revenue sources and indeed many of them bring municipal bonds that are backed by taxes, rather than by the operations of the transit system.
Toll Roads: We focus on well-established toll roads for our portfolios, rather than any speculative projects that might not be able to absorb an unexpected demand shock. While traffic volume is going to fall meaningfully in the coming months, toll roads tend to carry high levels of liquidity and have relatively low operating expense levels, particularly since most toll roads have moved past human toll collection for most or all of their tolls.
A bright spot – GARVEE Bonds: This is the one bright spot for the transportation sector right now. If you are not familiar with a GARVEE bond, these bonds are payable from Federal Grant Revenues, which are funded from the highway trust fund. That gets its revenues from the federal gas tax and is often supplemented by appropriations from congress. This is a reauthorization year for the trust fund, but we expect support for renewal to be much higher than in any other year as the government is looking for ways to keep the economy going. Sidelining construction projects is not what the political winds call for. Therefore, we find GARVEES to be a bright spot in the transportation sector.