The effects of COVID-19 on the nation are far different than prior natural disasters in the recent history of the United States and continue to evolve with each day. We are still learning and reacting. The national impact is significant as evidenced by presidential approval of all fifty states’ declarations of emergency. Presently, the pandemic is affecting regions of the United States to different degrees. This calls for more nuanced and tailored responses than those employed in past calamities. We believe this approach applies to municipal credit analysis, as well (more on this later).
Past natural disasters caused severe infrastructure damage, relatively limited death tolls, and a fairly quick resumption of economic activity. This pandemic is different. Infrastructure is mostly unaffected while many people are unable to work with no definitive timeline on when they might safely return. Thus, while the immediate economic impact of the pandemic is similar to past disasters, the breadth and the uncertainty of its length make this one markedly different.
Additionally, the upward trajectory of any subsequent economic recovery may be much more uneven, halting and drawn out, particularly if the disease periodically resurfaces in the future after social distancing measures are relaxed. Thus – we wonder – if the pandemic and attendant economic effects may not be a single “blizzard” that only needs to be ridden out for a month or two but a “winter” that, absent a medical breakthrough, could persist to varying degrees until a safe and effective vaccine can be introduced to the population. Hopefully, the medical infrastructure and planning is now in place to manage any subsequent “storms” of new cases, while allowing the economy to return to some semblance of its prior state.
Clearly, certain revenues states and local governments rely on have been immediately impacted: sales taxes, permit and license revenues to name a few. Moreover, states and local governments will also have to navigate collection delays—and potentially eventual declines—of other tax revenues. For instance, states with income taxes have generally followed the federal government and delayed their filing deadlines to July 15th. The delay will impact near term collections particularly since the month of April historically records larger than average receipts of income taxes. Moreover, in states with progressive income tax structures coupled with a concentration of high net worth individuals —such as California, New York and New Jersey—the elevated reliance on top earners can cause severe revenue declines during economic downturns.
“…our focus remains on our Three Pillars of Credit Analysis: deal purpose, deal structure and the underlying credit quality of the issuer”
Many states, counties and municipal entities have also enacted temporary moratoriums on late payment penalties of property taxes as well as on penalties or shutoffs that water, sewer and electric utilities may enact for late payment of their monthly bills. Delays from a significant number of payers can strain liquidity.
Actions undertaken by the federal government in terms of direct stimulus payments will assist states and certain hard-hit areas; however, much of the currently enacted support is aimed at reimbursement for items such as healthcare costs or unemployment benefits rather than supplementing potential revenue losses. Importantly, a recently enacted Federal Reserve program will enable the Federal Reserve Bank to extend short-term loans of up to 24 months to state and local governments in the form tax and revenue anticipation notes to address delayed and reduced tax revenue. Currently, direct participation in the “Main Street Lending Facilities” program is limited to states, counties with over 2 million in population and cities with over 1 million in population. Less than 30 local governments nationally qualify given these restrictions. In our view, these arbitrary population thresholds are far too limiting leaving tens of thousands of local governments unable to access the program.
We have been actively urging the Fed to open the program to a wider group of local governments and are hopeful it will do so. The program has the potential to benefit a much wider range of deserving issuers and should be adjusted to accomplish this end goal. Moreover, the interest cost to the issuer remains undefined and access to the program may not be available for weeks. As a result, certain states have accessed the private market, choosing not to wait for the Federal Reserve. For instance, the state of Hawaii disclosed that on April 4th it had issued $600 million in taxable general obligation bond anticipation notes.
The dramatic impact of the pandemic and the attendant uncertainty places us in one of the most unique and challenging environments to implement our internal municipal credit analysis process. In light of impending revenue shortfalls, the underlying credit quality of a municipality entering the crisis and management’s ability and willingness to reduce certain expenses takes on significant importance. While continued federal government intervention will help alleviate the strains on state and local governments, our focus remains on our Three Pillars of Credit Analysis: deal purpose, deal structure and the underlying credit quality of the issuer (refer to “Process and Strategy” on our website for additional details).
A recently priced deal for the General Obligation Bonds (Alternate Revenue Source), Series 2020 of the city of LeRoy, Illinois exemplifies this process.
- PURPOSE– The Series 2020 bond proceeds are for needed capital projects for the city’s water and sewer systems, an essential service.
- UNDERLYING CREDIT QUALITY– The city’s reserves had been drawn down over the past few years, yet current levels provide a measure of flexibility to absorb increased costs or revenue declines. Management has taken steps to formulate a lean budget for the upcoming fiscal year ending 4/30/2021 and delayed final budget adoption until the end of April to better assess the impact of the pandemic and make any needed adjustments. Lastly, based on fiscal year 4/30/2019 performance, the city’s combined water and sewer systems covered debt service from operations with notable cash reserves within each system.
- STRUCTURE– Several different taxes and utility revenues are pledged to the Series 2020 bonds including net revenues of the water and sewer systems. The bonds are also secured by an unlimited property tax general obligation pledge and levy. Finally, the Series 2020 Bonds are also insured by Assured Guaranty Municipal and interest on bonds is capitalized from bond proceeds through December 1, 2022.
In this challenging environment, we remain focused on our core sectors of general obligation and essential service utility revenue bonds. Importantly we are making adjustments to our process of assessing credit quality within these sectors recognizing the unique credit strains due to the economic upheaval caused by the COVID-19 pandemic.
While the road forward remains challenging for state and local governments, and indeed almost any municipal issuer, there is a substantial degree of variance among issuers as to their ability to navigate this environment. Our commitment remains – rely on our credit analysis process to identify those best positioned to do so.
Thank you for continued confidence in our team. We will have additional commentaries on this topic in the coming weeks.
Director of Municipal Credit
April 20, 2020
 Based US Census Bureau July 1, 2018 estimates, the eligible participants would include the counties of Los Angeles CA, Cook IL, Harris TX, Maricopa AZ, San Diego CA, Orange CA, Miami-Dade FL, Dallas TX, Riverside CA, King WA, Clark NV, San Bernardino CA and Tarrant TX. Kings County and Queens County would also be eligible by population but functionally are part of New York City as the boroughs of Brooklyn and Queens.
 Based US Census Bureau July 1, 2018 estimates, the eligible participants would include the cities of New York City NY, Los Angeles CA, Chicago IL, Houston TX, Phoenix AZ, Philadelphia PA, San Antonio TX, San Diego CA, Dallas TX and San Jose CA.