Has Sandy Hurt Senior Debt and Munis?

12/27/2012 7:00 am EST

Focus: BONDS

The superstorm that was Sandy wreaked havoc up and down the East Coast, but no has really talked about what it means to bondholders of companies and municipalities that have to dig out from this disaster in a slumping economy, notes Alex Anderson of Bond Smart Investor.

As we all know, the damage caused by Superstorm Sandy was immense. For those who own municipal bonds in some of the affected areas, this is a scary time.

Many issuers hit by the storm in New Jersey, New York, Connecticut, Massachusetts, Maryland, and Virginia are now under enormous financial strain. Bondholders wonder how their bonds from these issuers will be affected. Bond Smart Investor is here to help explain what is going on.

Financial Impact
Disasters can significantly impact every type of municipal bond. Revenue, general obligation, and appropriation-based bonds are all at risk.

Revenue bonds feel the most immediate impact. Toll roads are closed, water/sewer and electrical systems are destroyed, sales-tax collections are interrupted. You name it, it's affected.

More long-term are the effects on general obligation and appropriation debt. Property values decline with no foreseeable upswing. Foreclosures will surely increase.

Looking at past natural disasters, the impact can be seen in an issuer's financials. Expect to see weakened debt coverage ratios, reduction in fund balances, and shortening of days of cash on hand. All are clear signs of the financial strain due to storm costs and interruptions in revenue.

Don't panic. Although natural disasters inflict harm on muni issuers, much is reimbursed by insurers and the federal government (FEMA). This can be more than 75% of the total costs. The downside is that aid often takes too long to be disbursed and received by those in need.

Municipalities may also raise taxes and fares to deal with the added costs of recovery. For example, New Jersey has a 2% cap on property tax, but there's an exception that applies in disaster situations. New Jersey well may blow out the 2% property tax cap to pay for the recovery.

In the short run, municipalities must fend for themselves in the immediate aftermath of a natural disaster. Issuers may be forced to draw down their cash reserves. If additional funding is needed, issuers can access the muni market and issue more bonds. This is a fast and efficient way to get funding quickly.

In fact, during Sandy bond issuance has been so helpful for local governments that lawmakers in DC are taking note. Sandy demonstrated the importance of local governments' ability to access tax-exempt financing in disaster situations. This may promote even more opposition to recent proposals that threaten the municipal bond tax exemption.

One of the biggest issuers we're watching is New York Metropolitan Transportation Authority (MTA). The MTA is a good example of how issuers are dealing with the crisis in Sandy's aftermath.

The MTA recently announced that they will issue $4.8 billion in notes to cover damage from the storm. MTA will repay this new debt with reimbursement received from the Federal Emergency Management Agency and from insurance claims.

So far, the MTA estimates about $5 billion in total damages. Of that, MTA estimates they will have to cover just $950 million from their own cash reserves. As a result, to date there have been no changes to the MTA's credit rating.

What to Expect
Natural disasters surely cause investors anxiety. Nevertheless, history teaches that bonds are not likely to default.

Initially, expect the prices of affected municipal bonds to plummet as some investors run for the exits. Don't be among them. There's usually a rebound.

In many instances, rebuilding with insurance and federal aid has sparked economic mini booms after disasters. When this happens the value of bonds and the creditworthiness of an affected issuer may actually improve from pre-disaster levels. Though this may be the case, municipal investors should always consider the worst-case scenario, and minimize the vulnerability of their portfolios to disaster prone areas.

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