After 18 months of pandemic, we believe the municipal market has fully recovered. Though the market’s reopening and reflation have been dominant themes to date, federal policy changes, particularly regarding taxation, and infrastructure spending will now more likely command market attention—and advance normalization.
The Fed and U.S. Treasury have continued to provide support, with monetary stimulus and low rates boosting economic activity and benefiting municipals. The vital nature of municipal projects also has been a stabilizing factor.
Macro trends unquestionably are positive. But fundamental analysis will remain vital in evaluating specific credits. Here is our current take on several key situations, from California to Puerto Rico, and two key sectors: higher education and senior living.
California Water Utilities: Managing Drought
Though drought now grips much of California, wide-scale water-system defaults are not expected, as these systems provide an essential, monopoly service. However, downgrades could occur to systems not prepared for significant drought impacts.
Specific effects depend on system location, mix of water supplies, storage options, and size and sophistication in managing revenue disruptions from reduced consumption.
California law requires large water suppliers to plan responses to both a multiyear drought and a single year cutback of up to 50% in supplies. Some systems have even turned to emerging technologies such as desalination to offset shortages.
Clearly, the longer severe drought persists, the greater the potential for fiscal stress. But water utilities have entered the current crisis on strong fiscal footing with solid debt service coverage and liquidity—providing critical financial flexibility against unforeseen events and potential rate increases.
Illinois/Chicago General Obligation Debt: Fiscal Stimulus Provides Boost
We cannot overstate the American Rescue Plan’s importance for municipal credit quality. With Federal funds allocated to municipalities, schools, transportation facilities and other recipients over the next 18 months to two years, the ARP and the economy’s reopening and V-shaped revenue recovery have created strong catalysts for upgrades.
Lower-rated general obligation (GO) debt is already reaping benefits. Illinois has been the muni bond market’s highest performing area year-to-date. Both Moody’s and S&P have upgraded the state’s GO credit, moving the state further away from high yield. This has contributed to substantial credit spread narrowing for state GOs, and the city of Chicago, the Met Pier & Exposition Center, the Board of Education and other lower-rated names.
Puerto Rico: Fiscal Surplus Anticipated
Recent Covid-relief funding for Puerto Rico follows $83.5 billion in federal disaster relief related to the 2017 hurricanes, most of it still being deployed. Unprecedented federal aid and the recent uptick in economic activity have benefited government revenues.
The 2021 fiscal plan projects a $6.7 billion surplus from 2022 to 2026. But longer term, Puerto Rico’s Financial Management and Oversight board still projects a deficit absent structural reforms.