Municipal

Blog September 6, 2017

Municipal Credit Implications of Hurricane Harvey

Between August 24 and 29, Hurricane Harvey dropped well over three feet of rain across most of the Houston metro region. Harvey is widely believed to be the wettest storm in recorded history for the continental United States. According to the Houston Chronicle, more than 90,000 residential properties in the area have been damaged.

Despite its unprecedented scale, Harvey is unlikely to have a significant impact on the Gulf Coast region’s long-term credit fundamentals. Although natural disasters tend to weaken the near-term liquidity of impacted municipalities, they infrequently degrade long-term municipal credit quality and only in unusual cases do they tip issuers into insolvency. Reserves, credit facilities, emergency loans, insurance payouts, federal and state aid, and charitable donations are typically sufficient to buoy local issuers and economies as they recover from severe weather.

Incoming data suggests that Harvey’s credit recovery will be no different. Notably, liquidity fundamentals for key entities in Texas are very strong. The state of Texas holds over $10 billion in available reserves, and several vital revenue issuers in the Houston area reported holding over 1,000 days cash on hand at the end of FY16. This includes the Fort Bend County Toll Road Authority, Harris County Toll Road Authority, Houston Airport, and the ports of Corpus Christi and Port Arthur.

It’s also becoming clear that Harvey’s losses are likely to be a smaller percentage of Houston-area GDP than those of its closest peer storm: Hurricane Katrina. As the table below illustrates, estimated losses from Harvey are equal to 21 percent of the Houston region’s gross product; losses exceeded 200 percent of metro New Orleans’ GDP, post-Katrina, in 2005.

In fact, we anticipate that most local economies in the Gulf Coast will grow more quickly post-Harvey as areas are reconstituted and renovated. This is a traditional pattern for local economies after they experience a natural disaster, and the growth often flows through to sales tax revenue and sometimes to property values as homes and commercial buildings are reconstructed with superior materials and upgrades.

None of the above, of course, is to downplay the likelihood of a few notable ratings downgrades. Credits along the Texas Gulf Coast that entered the storm with limited reserves and modest tax bases may recover more slowly than those in a large metropolitan area like Houston, which has a fast-growing and diverse economy. Just by the law of averages, a few downgrades seem probable. S&P Global Ratings rates over 1,000 entities in the 54 counties that have been declared disaster areas. Moody’s Investors Service rates 475 entities.

Looking forward

It’s also true that federal priorities are changing, and Harvey’s experience may not reflect credit conditions that may exist after future disasters. Federal deficits are projected to rise, and Congressional scrutiny of disaster relief programs seems likely to increase. Notably, a Congress characterized by partisanship passed the Biggert-Waters Flood Insurance Reform Act in 2012 by a 402-18 vote, and lawmakers are likely to consider additional changes as it is scheduled to expire on September 30. In addition, President Donald Trump’s FY18 budget reduces appropriations for the Federal Emergency Management Agency (FEMA).

Reduced support for the National Flood Insurance Program (NFIP) and FEMA would significantly increase the correlation between credit risk and natural disasters. As such, investors increasingly need to take stock of resiliency and climate change planning when they purchase credits in disaster-exposed geographic areas (also see: A Federal Environmental Pullback and Municipal Credit, which considers the municipal impact of reduced federal support for environmental issues). Consider: Houston’s lax zoning standards and willingness to pave over areas that once had natural drainage may have contributed to the intensity of Harvey’s flooding, and most climate change models predict rising sea levels and more frequent, powerful storms of Harvey’s ilk. As of this writing, Hurricane Irma, rated Category 5, is set to make imminent landfall in Puerto Rico and Florida has declared a state of emergency. These are trenchant examples of the importance of municipal readiness for natural disasters, and these issues should be considered for diligent municipal credit review.

 

DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are subject to change without notice. Any estimates, targets, and projections are based on Breckinridge research, analysis and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.

Nothing contained herein should be construed or relied upon as financial, legal or tax advice. All investments involve risks, including the loss of principal. An investor should consult with their financial professional before making any investment decisions.

Some information has been taken directly from unaffiliated third party sources. Breckinridge believes such information is reliable, but does not guarantee its accuracy or completeness.

Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.