The widespread economic fallout from the COVID-19 crisis dealt a formidable challenge to many municipal bond issuers’ ability to maintain and improve their credit quality. Given the need for state-level lockdowns and the subsequent realization that a return to pre-pandemic activity would take much longer than anticipated, the outlook as of mid-2020 pointed to an extremely trying period for the municipal bond market.
However, a combination of factors came together over the course of the year that led to more benign conditions than initially feared and set the stage for many better-than-expected credit outcomes. While some municipal credits have been downgraded since the pandemic began, most have held up relatively well, while cases of severe credit distress have been rare.
I believe the overall resilience of municipal credit quality reflects:
- Strong starting positions: Broadly speaking, the strong balance sheets of hospitals, airports, colleges and universities, and state/local governments heading into the pandemic provided a cushion that enabled many of these municipal issuers to absorb the “COVID blow” to their revenues.
- Massive, targeted fiscal stimulus: Substantial economy-wide support from the federal government and direct aid to hospitals, airports, transit systems, states, school districts, and higher education instilled confidence that cash levels would remain sufficient and incomes would fare better than hoped.
- Better-than-projected tax receipts: State income tax receipts have come in better than originally projected amid steady higher-wage employment, while states that rely more on capital gains tax receipts have benefited from robust equity market returns, as have public pension plans.
- Stable housing values: Unlike the 2008 global financial crisis, housing values have been somewhat of a bright spot during this crisis, staying stable in most geographic areas and increasing in others — a much-needed buffer for the vast majority of local governments and school districts.
- Expenditure adjustments: Specifically, there have been significant state- and local-government job reductions since the onset of the pandemic. State and local employment is down about 7% since peaking in February 2020 (Figure 1).
- The federal government is likely to pass additional fiscal stimulus. The figure currently being proposed for direct state and local government aid is more than what is needed to get through this fiscal year and, if passed, would deliver enough funds to help close budget gaps into next fiscal year.
- While not an ”all clear” from a credit standpoint, many of the hardest-hit municipal sectors have been given adequate time to adapt their operations and avoid material credit deterioration, helping to mitigate potential downsides.
- As credit-related concerns have become less pressing, the municipal market has begun to consider the longer-term impacts of the pandemic, many of which could take years to sort out:
- What will be the long-term implications, if any, for future US population growth?
- Who would the winners and losers be in a more permanent work-from-home environment?
- Will airports be forced to navigate a “new normal” with regard to business travel?
- Will there be lasting changes in how hospitals and universities operate going forward?
- Will people be less willing to enter continuing care retirement communities (CCRCs)?
- How will public pensions meet their return targets as interest rates likely stay lower for longer?