Hurricanes, the Muni Market, and the Duct Tape Effect

 

October 23, 2018 [muni market, hurricane, damage, taxes, insurance]
Nicholos Venditti, CFA and Dominic Alto


Preparations ahead of a hurricane and rebuilding after it temporarily boost tax receipts in affected areas. But longer-term effects on muni markets are usually negligible.

Natural disasters may buffet municipal markets, but perhaps not in ways that some investors think. Rather than undercut a city or state’s ability to service its debt, tax receipts may actually rise short-term, though in the longer-run the devastation often just proves a wash, economically.

The recent destruction from Hurricane Michael is a reminder of Mother Nature’s awesome power. Some three-dozen people are assumed or confirmed dead, while reported damage estimates range from more than $10 billion in Florida to some $3 billion in Georgia and lesser amounts in the Carolinas, which, together with Virginia, are still mopping up following last month’s Hurricane Florence.

If much of the damage from Michael was from intense winds, Florence unleashed water—more than 10 trillion gallons of rainfall—causing massive flooding, and the reported $20 billion or so in related losses are largely either uninsured or covered by the National Flood Insurance Program (NFIP). Those from Michael are largely private, insured losses. Municipalities and infrastructure assets are usually not included in loss estimates and are generally very resilient financially.

A case in point is New Orleans, which suffered extensive destruction from Hurricane Katrina but never missed a debt payment. To be sure, the Big Easy, unlike most cities following a natural disaster, was impacted longer term, given huge out-migration and the loss of its position as the third-largest U.S. conference city behind Orlando and Las Vegas before that 2005 catastrophe. It’s now ranked 11th by Cvent.

Yet most coastal cities don’t normally suffer such long-term adverse impacts because in the preparation ahead of, and rebuilding efforts after, a violent storm, tax-receipts in the affected areas rise. We might call this the "duct-tape-effect." The repairs and rebuilding spur economic activity around the time of the event—demand for workers and materials increases—but are usually a wash in the long run because once the damaged assets are repaired or replaced, generally there’s no net increase in assets or productivity.

A greater financial risk would involve a lingering fall in the assessed values of ravaged real estate. Many segments of the muni market, such as school districts, are heavily dependent on property taxes. But state-led insurance programs, including NFIP and Florida’s Citizens Property Insurance Corp., help mitigate those risks, albeit at broader taxpayer expense.

Property and casualty insurers may raise premiums, depending on the scope of the damage and the degree to which they’re reinsured. More importantly, they are large owners of outstanding municipal bonds, among other financial assets—including equities—and may need to raise capital to help cover claims. In their relative value calculations on assets to sell, the reduction in tax rates following the Trump administration’s tax reform hasn’t necessarily left muni bonds more attractive on a tax-equivalent basis. We’ve noted some additional selling in the secondary market this year, but hardly a surge.

Back-to-back hurricanes certainly aren’t easy for insurers and their reinsurers to manage, not to speak of affected residents. And heavy losses from Hurricane Irma last year didn’t help. But muni markets tend to weather nature’s storms quite well.



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