We read that the municipal bond investors continues to stretch for high returns by seeking out low rated and unrated bonds to get them. Well, the Covid-19 pandemic couldnâ€™t have arrived at a better time to accommodate these folks. Itâ€™s increasing supply by making high risk out of previously solvent bond projects. Its not just that the pandemic has made existing troubled bonds even higher yielding. No, it is also that it has made thousands of previously solvent bonds very high risk thereby greatly expanding the supply of such debt. It has also changed the economics of the municipal bond market by suddenly taking away the ability to refinance existing issues as a sure-fire way of rescheduling debt maturities and reducing their interest rate in the process.
On the supply side, we see the downgrading of numerous debt issues because their business models have been impacted by the pandemic related shutdowns. Nursing homes, hotels, resorts, airlines, stadiums, shopping malls, charter schools, school dormitories in the private sector have all seen their revenues drop and had to invade debt reserves or reach standstill agreements with their bondholders. We even see such agreements providing operating funds from bond reserves to prevent a total collapse. Local governments have also seen their sales and use tax revenues drop from the lockdowns and decline in tourism. Still ahead will be reduced assessed values of inner city properties leading to lower property taxes, or should we say higher assessment rates.
Looking ahead, these problems will not quickly go away just because a vaccine makes a return to normal possible. The new normal will likely see that people in urban areas with new work habits, cultural values and social outlets. The business environment will also be different as governments seek to overcome budget shortfalls with new taxes and fewer services. Also, the new government in Washington will seek to make its mark on a recovery by implementing higher tax, borrowing and spending policies which have a poor record for economic results.
The outlook for the municipal market, however, is quite promising. The demand for cheap financing of projects and activities with dubious prospects is a bread and butter function of this market, especially for entrepreneurs unwilling to risk their own money (when they have any to risk) or governments with a desire to kick the can down the road or are followers of the maxim that â€˜a crisis is a terrible thing to waste.â€™
We have been observing and writing about municipal bond defaults for thirty three years, so nothing on this topic would surprise us anymore. We do fear, however, that the capital needs of the next decade combined with the extraordinary lack of oversight, regulation and investor ignorance in this market will make the $270 billion of defaults we witnessed during our watch pale in significance. However, the bond investors who will suffer in the coming defaults can take solace in the fact that the average recovery in some 2,300 settled defaults was above 75 cents on the dollar. Much better than the losses they may suffer when the current stock market euphoria comes to ground.
Richard Lehmann is publisher of the Forbes/Lehmann Distressed Municipal Debt Report.
Im a former Forbes columnist, investment advisor and publisher of the Forbes/Lehmann Distressed Municipal Debt Report. As a lifetime investor in postage stamps, Ive
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