Why These Bonds Will Stay Afloat
At least one commentator is forecasting a coming Armageddon in the municipal bond market in the wake of Katrina. No doubt about it, the fiscal systems of states and cities in the path of the deadly hurricane are in tatters along with much infrastructure bankrolled by muni finance. With the tax base of wide swaths of the Gulf Coast in ruins, defaults can't be far behind, can they? Not if Louisiana State Treasurer John N. Kennedy has anything to do with the matter.
Kennedy told BusinessWeek Louisiana has ready cash available, from its own resources, totaling $6 billion. That's more than three times the $1.8 billion the state owes, and an even larger multiple of its annual outlays to pay interest and redeem maturing bonds. Also, it has two "very substantial" lines of credit with banks and is negotiating a third. And he's dickering with Washington for favorable bond-financing terms of the type New York got after 9/11. Predictions of defaults are "nonsense on a stick," Kennedy said in a telephone interview. "The state is prepared to meet all of its current and future obligations."
Of course, bonds issued by cities are separate. And on the face of it, there's plenty to scare investors. "I'm not trying to sugar-coat this. Our economy has been disrupted," Kennedy said. Almost one-third of Louisiana's $125 billion of annual income is produced in New Orleans. The Crescent City has $513 million of outstanding bonds, and its water and sewer authority another $198 million, according to Moody's Investors Service (MCO ). Another half a billion dollars of bonds that funded the city's Ernest N. Morial Convention Center must be paid with sightseeing and hotel taxes that may be sharply down for many months. Market fears are palpable: On Sept. 7, the center's bonds traded nearly 5% down from the last trade two weeks before Katrina.
But if history is any guide, federal assistance will help smaller localities sidestep defaults, argues Kennedy. Besides, some cities may be up and running sooner than expected. New Orleans' French Quarter and Garden District avoided most flooding damage and electricity has been restored to the main business area, once under a few feet of water.
So how can Louisiana, with some of the lowest debt ratings among all the states, muster so many resources with tax revenues off-line? It has $387 million in its "rainy day" fund, another $3.5 billion in trust funds that can be tapped with the approval of state legislators, and a $2 billion agreement to borrow against its securities portfolio, Kennedy says. Talks with Congress and the Federal Reserve are underway to set up further backing for smaller issuers.
Federal aid to the disaster area could be modeled on the government's help to the New York region after September 11. As well as direct grants, aid was available to cover local bond payments until tax revenues recovered. Congress also set up an $8 billion Liberty Bond program that allowed commercial projects to issue tax-free municipal bonds. Typically, bonds financing such private activities can be used only to finance municipal structures like airports. Liberty Bonds allowed commercial and retail rebuilding projects to lower interest costs and tap a $2 trillion market. Another tactic used in New York that could be repeated would relax limits on local issuers refinancing their bonds to lower interest costs. Kennedy says he's investigating whether a hurricane recovery authority could be set up to issue bonds as well. "Throughout history, the United States has provided very large support to local governments not just for emergency response but also to rebuild and repair," says Robert Kurtter, senior vice-president at Moody's.
The Liberty Bond program caused some controversy over the use of its proceeds for projects seemingly unrelated to terrorist attacks, such as a power plant in Queens and a bank office in Brooklyn. The state and city of New York have also had a tough time allocating money. More than two years after the program was approved only $2.3 billion had been spent. But neither issue should pose much of a problem for the Gulf Coast, where the damage is far more widespread and the need more urgent.
Kennedy plans to be ready when assistance becomes available. He met with 75 bond underwriters, trustees, and attorneys on Sept. 6 to draw up a list of every bond payment for every issuer in the state due through the end of the year. The idea: Use the list to line up assistance before any payments are missed. Much of the debt is also backed by bond insurance companies like MBIA Inc. (MBI ) and Ambac Financial Group Inc. (ABK ), so payments will be covered even absent a federal program. Shares of MBIA have dropped 5% since the hurricane hit, while Ambac has lost less than 2%, reflecting investor confidence that the bond insurance industry has ample capital to pay any claims. "The insurance industry has proven its worth in the past in situations like this," says Rick Marrone, head of the municipal bond investment unit at Evergreen Investment Management Co.
And as the regional economy recovers, rebuilding can be paid for with new bonds. The municipal market can handle large borrowings, as issuers have churned out over $300 billion of total new debt during every year since 2001. For now, muni investors haven't panicked. In general, says Marrone, "[Katrina is] just not having much of an impact on bond prices." And if Kennedy gets the help he's seeking, the muni market could dodge a financial hurricane.
By Aaron Pressman in Boston