Bonds: Unscathed by Katrina...So Far

Louisiana municipalities took a heavy hit, but the market isn't panicking. That could change as a clearer picture emerges

By Aaron Pressman

Almost a month after Hurricane Katrina came ashore, the $2 trillion municipal bond market is still waiting for the impact. Some bondholders initially feared their investments would be destroyed in the wake of the storm's far-reaching economic toll. So far, that hasn't happened, and federal aid could be on the way to prevent any major losses to investors.

Rating agencies and bond insurers have identified over $15 billion of outstanding bonds along the gulf coast in Alabama, Louisiana, and Mississippi that could be affected by Katrina's damage to local economies and infrastructure.


  Many bonds are backed by local sales-, property-, or income-tax revenues, and those collections have dropped dramatically as businesses shut down, homes were destroyed, and residents fled. Some bonds are also tied to specific facilities, such as hospitals, that may be knocked out for a year or longer.

Still, not a single notice of a missed payment or default has arrived yet, says Peter Schmitt, president of DPC Data, a firm authorized by the Securities & Exchange Commission to act as a repository of such notices. A handful of issuers have filed warnings that they may eventually be adversely affected by Katrina or that they might have to dip into "rainy day" reserve funds to make upcoming payments, he says.

Louisiana's treasurer posted on the Internet a searchable list of all bond issues in that state that could be affected. Investors can check the list to find contacts listed for more information about the status of upcoming payments.


  Surprisingly, for the most part, bond prices have held steady. The six mutual funds that invest solely in Louisiana bonds have dropped only 0.4% to 1% over the past four weeks, according to Morningstar data.

"Most bonds are holding up fine," says John Miller, a fund manager at Nuveen Investments in Chicago. "The market sees that much of the population will eventually return, and essential services provided by municipalities will continue to be provided." Shares of the major bond insurers have also suffered only modest losses. MBIA (MBI ) is down about 6% and Ambac (ABK ) is virtually unchanged from a month ago.

Some investors fear that the worst lies ahead. That's because many bonds in the affected areas aren't scheduled to make their next payment for weeks or even months. Some bonds issued to back the New Orleans Convention Center, for example, pay interest only twice a year, and the next payment isn't due until January. Still, while the hotel and tourism taxes backing the bonds are gone now, the issues are backed by insurance and visitors are expected to return to the Crescent City next year.


  If any problems do arise, the market expects that the federal government will step in. But with the financial picture so unsettled, it's not yet clear what, if anything, Congress might do to help bond issuers and investors.

"We really don't know what's going to be necessary yet," says fund manager Miller. "Some political response is likely, but it's a little early yet." One Wall Street official who's helping to organize a plea for aid said there was a sense of confusion in Washington over municipal bond matters.

But without waiting for a default, trade groups like the National Association of Bond Lawyers have already sent suggestions to Congress and the Treasury Dept. One idea almost certain to be approved is to create a special bond program to pay for rebuilding efforts as was done in New York after the September 11 terrorist attacks. But what kind of aid might be available to support prior bond issuers that run into trouble isn't clear.


  Suggestions range from federal lines of credit that localities could draw on temporarily to outright grants that would shift the financial burden onto Washington. "We're trying to pull together a wide variety of ideas that have been used in the past," says Walter St. Onge, a partner at the Boston law firm Palmer & Dodge and the president of the bond-lawyers group.

But at least for the municipal market, crisis has yet to arrive -- and there appears to be plenty of time for politicians to debate.

Pressman is a correspondent in BusinessWeek's Boston bureau

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