May 6, 2010
John Mousseau is a portfolio manager and heads the tax-free Muni section of Cumberland. He is a member of the Management Committee of Cumberland Advisors. His bio is found at www.cumber.com. His email is John.Mousseau@cumber.com.
The Associated Press reported (Wednesday, May 4) satellite images which indicate that the oil slick in the Gulf of Mexico has reached the Mississippi delta and some islands off the coast of Louisiana. Our recent piece (“Oil Slickonomics”) laid out various economic/ecological scenarios – all of which are bad.
We have analyzed some of the impacts on municipal bonds. While the long-term impacts are uncertain and unknown, there are certainly concerns for total-return municipal portfolio managers.
The problem here is much more complex and troublesome than that presented by the disaster of the Exxon Valdez. In that spill there was a finite amount of oil which impacted Prince William Sound. In this one, we do not know when this oil flow of 5,000 barrels per day will be stopped. There are other estimates of this flow which are higher. There are some bold initiatives and new technologies right now being put into place to cap the ruptured well. This is a first-time effort to use them at this depth. Meanwhile the oil slick is growing and threatens five states. And the only thing heading to these states faster than the oil are the lawyers.
Fishing industries, which still have not recovered in the wake of Hurricane Katrina, will be devastated. Already there is a spike in seafood buying ahead of the slick. However, after the slick, the fishing industry will be handicapped for many months, if not years. The problem of course will be the consumer, who will rightfully ask, “Are the fish safe to eat?” For smaller communities along the Gulf that are fishing-dependent this will be a long-term problem and could be a lethal blow. Clearly, general-obligation bonds in this area are facing a possible developing risk.
Our biggest concern here is in Florida. Right now we’re focused on the entire west coast stretching from the Florida Panhandle to Naples. Note that the slick has NOT reached there yet but, for us, it is a concern. The effects on wildlife and fishing are deadly. Despoliation of white beaches and blue-green water can send tourism spiraling down. The multiplier effect here is huge, and most pronounced in Florida. Hotels, car rentals, airline bookings, restaurants, tolls from people driving on the turnpikes – all aspects of tourism take a large hit. Bonds backed by sales and usage taxes are clearly affected in an environment like this.
So far, calmer seas have slowed some of the expansion of the oil spill. And the device to act as a funnel may be successful. We hope that it is. But the nightmare scenario is the drift of the slick to the Florida Keys and then into the Gulf Stream. At that point, the east-coast beaches of Florida and further north are at risk and the economic impact is almost incalculable. The Palm Beach Post has reported that Palm Beach County emergency managers are already studying ways to block oil from the coast as well as the Intercoastal Waterway.
The wildlife and ecosystem damage to the areas is devastating. But just as large a concern is oil seeping into areas which by definition have very shallow water tables. Water and sewer bonds are considered among the most safe and reliable essential-service revenue bonds. We worry about the leaching effects of oil into water systems along the coastlines and estuaries and of course the Everglades. Some massive spending may be needed if systems become contaminated. Unhealthy local economies will certainly have a more difficult time sustaining higher water rates (to pay for decontamination) and maintaining a sound financial position.
While we see potential impacts all along the Gulf, from Texas to Florida, it is Florida that worries us the most. The other states have a mix of industry and commerce that Florida does not enjoy. The cumulative effects are so far difficult to estimate. At Cumberland, we have analyzed all bonds in portfolios within 100 miles of the Gulf coast. We have been selectively selling bonds in the Gulf area over the past week – not all bonds in the areas, but clearly ones we felt might be at risk AND where we felt that market prices were appropriate. The analogy we have is to Katrina, where we selectively sold bonds as the hurricane was hitting the shore but before the disastrous impact on New Orleans. But this analogy is imperfect at best. The environmental effects of this oil slick are impossible to measure, and the “rebuilding” is uncertain as to both time and cost. You can rebuild a building destroyed by a hurricane. Rebuilding ecosystems is much more problematic.
An example of a bond we sold is Clearwater Water and Sewer Revenue bonds, 5.25% due 12-1-39, callable in 2019. The bonds are rated AA3 by Moody’s and AA- by S&P. Clearwater is located just north of St. Petersburg Florida on the west coast of Florida. The bonds were sold at approximately a 4.70 yield (104). The fact that the bonds were mostly PURCHASED at a discount a little less than a year ago has NOTHING to do with the decision to sell. The bonds might be worth a point more on the offered side, but the key is that this is a market price that allows us to REDUCE risk. Right now Clearwater is fine. It is a VERY GOOD credit. But selling bonds at price levels where the funds can be redeployed to other areas of the country that do not have attendant risk, and that have similar yield levels, is the crux of total-return bond management. At best the Clearwater bonds will be unchanged as to credit risk. At worst they may be downgraded. Thus the risk is asymmetrical and growing.
There is some offset to the problems presented by the oil slick, including federal dollars, cleanup workers, and the concomitant revenues. But that is small compared to the projected forward economic impact. And while there will be federal money to help with the cleanup, already weakened state governments will be in a more-compromised financial position.
We hope and pray that this impending disaster will grow no larger and that the well will be capped and the slick contained and cleaned up. But a proactive approach to portfolio management dictates that one be forearmed.
We will keep readers apprised. Our clients know that we are proactive in lowering risk profiles wherever and whenever it makes sense.
John Mousseau, CFA, Managing Director and Portfolio Manager,