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October 10, 2017

The Impact of Recent Hurricanes on Municipal Bond Credits

Within a three week period, three major hurricanes touched down in the United States. Two of the most important economic regions in the country, southeastern Texas and the state of Florida, as well as the U.S. island territory of Puerto Rico were all ravaged with hurricane force winds and flooding. In Texas, Hurricane Harvey landed a one-two punch with not only category 4 hurricane winds but also unprecedented flooding in downtown Houston, its surrounding suburbs and other heavily populated areas in the region. The entire state of Florida and the U.S. island territories in the Caribbean were then crushed with Hurricane Irma only a few days later. Although that storm was downgraded before landfall in Florida, several areas around the state of Florida - most notably the Florida Keys, the southwestern coast and the Jacksonville area were all negatively affected by this vast natural disaster. Soon after that, Puerto Rico was devastated by Hurricane Maria. This island was already in an economic crisis due to a $74 billion debt load it cannot repay, years of economic weakness, persistently high unemployment and a population fleeing the island to seek jobs on the U.S. mainland. The entire island was affected and it is anticipated that recovery will take years.

The financial impact on the two U.S. mainland areas - Texas and Florida - will most likely be a short-term economic slowdown that may not last long due to the economic vibrancy of both areas. Each state was rated highly by all the ratings agencies at the time these unprecedented weather events hit. Texas is rated AAA by all three ratings agencies and Florida is rated Aa1 by Moody's and AAA by both Fitch and S&P. Of note is that both states do not have an income tax and rely primarily on the sales tax to generate revenue in each state. We anticipate a near-term reduction in sales tax collections followed by a rebound as these areas return to normal operations. The financial impact on Puerto Rico is enormous and federal aid will help but won't be enough to rebuild the entire island.

Within our holdings, we do own some credits that are located in the affected areas. Most were very highly rated (AA or AAA underlying rating) before the hurricanes. The source of revenue to pay principal and interest on the majority of our holdings comes from sales tax receipts, large toll road fees or utility payments (revenue bonds) or are backed by property taxes (general obligation bonds) in areas that should have the ability to raise property taxes if necessary to cover the cost of rebuilding infrastructure, such as schools.

In Texas, we have minimal exposure to bonds issued for municipalities or revenue projects in and around Houston. Many of the general obligation bonds in client portfolios were issued with an extra layer protection unique to Texas school districts called the Permanent School Fund (PSF). These bonds are all AAA rated and had a $37 billion fund balance as of August 31, 2016. We anticipate that the revenue bonds will not be adversely affected by the storm.

In Florida, we own several bond issues located around the state of Florida but none in the heavily damaged Monroe County, where the Florida Keys are located. We do own some credits in the southwestern portion of the state. That area is generally very affluent and is anchored by a large snowbird population. This area should be able to rebuild over time and we anticipate a full recovery. In the Jacksonville area, one of our largest holdings is Jacksonville Electric Authority. These bonds are rated AA2/AA- underlying rating and are stable by both Moody's and S&P. We also own JEA FL Water & Sewer that are rated AA2 / AAA underlying rating and are stable by both. Prices on these bonds have not changed materially since the hurricane.

We do not own any Puerto Rico or U.S. Virgin Island bonds as both of those underlying credits have been deteriorating steadily for many years. It is worth noting that uninsured Puerto Rico G.O. bonds dropped demonstrably in price after Hurricane Maria.

At Beacon Trust we have a conservative philosophy when investing in the municipal bond market. As such, we seek to purchase high quality, stable credits in areas that are doing well economically. Because of our "preservation of principal" philosophy, our credits were highly rated before the hurricanes and we do not anticipate that there will be credit downgrades or non-payment issues with the bonds now. Most of our holdings are essential revenue or general obligation bonds. These are among the most creditworthy bonds in the municipal market. We will continue to monitor all the credits in our portfolios that are located in the affected regions for any credit deterioration and will assess each situation as more information becomes available.

By Susan Hayes 

Managing Director, Fixed Income Portfolio Manager