Even if spreads hold steady, such highs encourage active investors to find value by letting research—not fear—lead their decisions. Fear sparks expectations that are almost always dislocated from reality. Active muni investors look beyond perception and at the underlying fundamentals of each credit.
Fundamentals Healthier for Mid-Grade Credits
Many mid-grade issuers are well positioned to weather the pandemic. Even so, a selective, research-driven approach is more important than ever, as fear lingers in some regions and sectors, while normalcy emerges in others.
We’re finding mid-grade opportunities in airports, toll roads and hospitals. These sectors fell out of favor recently, but still have underlying strengths, such as healthy cash reserves and federal support.
Los Angeles International Airport, for example, has nearly 500 days of available funds to use. Many toll roads—like Texas’s Harris County Toll Road Authority—have several years of cash to last them. Some goes to debt service, but the rest creates a big buffer to cover expenses while air and road travel ramps up to normal.
Hospitals, which received substantial Coronavirus, Aid, Relief, and Economic Security (CARES) Act aid, currently can cover 60% to 70% of cost spikes from COVID-19 patients. But elective surgeries—hospitals’ largest revenue generator—have also bounced back faster than expected, with some at 80% of volume compared to this time last year.
Municipal Issuers Are Resilient
The coronavirus panic spawned multiple challenges for most states and local municipalities. But municipal issuers have been resilient in stressful times due to inherent qualities like reliable revenue streams, low debt and the fact that they provide essential services.
Resiliency also comes from their authority, including the power to raise taxes and cut costs to address crises. And most states and municipalities are much better financially prepared to navigate the COVID-19 environment than they were before the 2008 financial crisis.
These and other truths are why municipal bond defaults have been remarkably low over the years. Since 1970, the cumulative default rate for all municipal bonds is just 0.1%.
Potential Mid-Grade Snapback Ahead
Time after time, rallies have followed downturns. Why would today be different? We’re optimistic that it won’t be. Mid-grade and high-yield muni credits have rallied significantly after sharp sell-offs during the 2008 financial crisis, the 2010 drop, the 2013 taper tantrum and the 2016 election (Display).