With the COVID-19 outbreak having spread to 40 countries around the world including the U.S., S&P Global Ratings has updated its narrative on the economic and credit implications (see "COVID-19’s Darkening Shadow"). Given that update, in this report we provide insight on what we will be watching in regard to credit conditions in U.S. public finance. (Also see "U.S. Public Finance 2020 Sector Outlooks Published," published Jan. 16, 2020 on RatingsDirect.)
- The growth forecast for the U.S. economy has been reduced as a result of the spread of the virus across the globe and we have seen record volatility in the equity markets. These are not welcome developments for U.S. public finance issuers.
- The economic fallout from the coronavirus has become more acute and there are sector-specific issues that could weigh on credit quality.
- The spread and timing in the U.S. and how it is managed will ultimately determine the credit implications across U.S. public finance.
S&P Global Economics has provided an updated forecast for the U.S. economy ("Coronavirus Update: A Bigger Hit To First-Half U.S. Growth," published March 3, 2020 on RatingsDirect) to capture the spread of COVID-19, the recent equity market volatility, and the Federal Reserve's rate cut. We believe that this forecast reduction has broad implications across U.S. public finance that bear watching. Here are highlights of the update:
- We now think that COVID-19 will be a material headwind to growth in the near term. We estimate 1% average sequential (seasonally adjusted annualized) GDP growth in the first two quarters of 2020 versus 2% pre-virus.
- The economy should rebound in the second half of the year as consumers release pent-up demand and firms rush to fill back orders and restock inventories.
- Still, there will be some economic activity such as people's discretionary spending and suppliers' capacity to meet demand lost permanently. On a full-year basis, we would see 0.3 percentage point trimmed from our published full-year growth forecast of 1.9% (pre-virus), with risks tilted to the downside.
The Federal Reserve cut policy rates by 50 basis points to 1.0%-1.25% in view of evolving downside risks to growth. This is a clear signal that the Fed will not wait on the sidelines for long and let runaway selling on Wall Street continue given the effects on confidence as well as wealth. If the rout in the equity markets continues, more rate cuts are likely to follow in the upcoming March policy meeting, and beyond if required. Credit-market specific liquidity tools will also be considered if credit markets stumble more severely.
Generally, the health risks of outbreaks and epidemics--and the fear and panic that accompany them--map to various economic risks. Beyond the costs (and capacity strains) to the health care system directly, the effects in the U.S. are primarily through five main channels amplified by tightening financial market conditions:
- Interruptions to travel and tourism,
- Reduced spending by households and firms,
- Weaker demand from China and the rest of the world,
- Disruptions to supply chains, and
- Lower commodity prices.
State and local governments
State and local governments (including school districts) are at the front line of containment efforts currently. Government readiness and planning as well as the costs associated with containment strategies will be the near term credit focus. While there is federal legislation under consideration that could provide emergency assistance, passage is uncertain. We believe that most state and local governments have reserves to address unexpected costs in the short term but the duration of the virus will ultimately determine the magnitude of any budget stress. (See "U.S. Local Government 2020 Sector Outlook: A Precarious Balance Of Stability And Uncertainty," published Jan. 7, 2020.)
The weaker economic forecast due to the spread of coronavirus does not bode well for revenue performance in the first two quarters of 2020. Most states and many local governments rely on sales tax revenue and consumer spending weakness related to COVID-19 will likely become apparent swiftly. The timing presents a particular challenge for governments that have a June 30 fiscal year end and have to end the year with a balanced budget. In addition to a forecasted reduction in economic activity weighing on consumer spending we believe that the equity market volatility could also weigh on consumer spending. We will be watching income tax collections based on slower forecasted economic growth and the current equity market volatility. Persistent market volatility and decline will pressure revenues and pension fund returns which could create longer term spending challenges. We will likely see regional variations in economic performance and the spread of the coronavirus but across our rated universe we view proactive management as a key to credit stability.
Given the still low number of patients with COVID-19 in the U.S., we have seen some, but minimal operational disruption or challenge as it relates to our rated health care and senior living providers to date; however, the situation is evolving. While in the past, these illnesses have largely been seasonal and managed with minimal operating disruption and credit rating changes, a widespread outbreak could further challenge credits which are already operating under revenue and expense pressures. And while balance sheets have generally been healthy for many of our providers and have helped to support credits and our stable outlook for the sector, economic or recessionary pressures could affect some of our credits.
Specifically, areas that we are watching that could exacerbate operating challenges if the COVID-19 illness becomes more persistent and widespread include:
- Health care providers' ability to manage the demand and their capacity to treat these patients as well as having the appropriate resources to manage overall care in a potentially more stressed delivery system.
- Some hospitals, particularly those providing tertiary and quaternary care, are already operating at high occupancies, and a more severe outbreak would naturally put operating pressure on high occupancy hospitals and could also crowd out or potentially disrupt other health care needs.
- Staff and labor quarantines, should they be needed, would pressure salaries and wage expenses given the already tight labor market.
- The supply chain could also be affected, not just for supplies needed to treat COVID-19 patients but also to the extent that there is more global disruption for general health care supplies, drugs, and devices.
- The cost of preparedness and care and who is helping to shoulder uncompensated costs, should the disease become more widespread, is also another consideration for hospitals. Although the federal government is considering legislation which could support some of these costs, passage is uncertain.
To the extent that this illness causes short and less severe outbreaks, we expect some, but not meaningful, disruption to operations and performance and likely minimal credit impact for most providers; however, a longer term situation could cause rating pressure to certain hospitals that may already be in a challenged operating situation or should the recessionary and economic pressures negatively affect providers' balance sheets.
For the U.S. higher education sector, we see the COVID-19 outbreak as a growing risk. On top of the ongoing pressures colleges and universities are facing from declining enrollments--domestic and international--if the virus is not brought under control, long-term travel restrictions and related disruptions could further challenge credits which are already operating under revenue and expense pressures. And while balance sheets have generally been healthy for many universities following strong market returns, economic or recessionary pressures could affect some of our credits. Colleges and universities in the U.S. have experienced little effect to date. However, areas that we are watching that could intensify operating challenges include long-term disruptions, including international campus and U.S. campus closures. Should this outbreak continue and travel restrictions and bans remain in place for longer than anticipated, we would consider it a major credit risk for schools reliant on international students for the upcoming fall 2020 semester. Historically, we have not taken negative rating actions associated with outbreaks since their impact was temporary and recovery relatively rapid. Most U.S colleges and universities are well-positioned to manage the operational and financial implications associated with short-term disruptions.
Study abroad: Given the recent spread of the virus and its anticipated impact on travel, a growing number of universities are cancelling or rerouting study abroad programs for spring, and in some cases, summer programs. In addition to ensuring faculty and students are safe and healthy, U.S. colleges and universities are trying to make it easier for students to continue their studies. For instance, several U.S. universities with Chinese branches swiftly moved their courses online in order to keep students on track. As the virus has spread into the U.S, colleges and universities have benefited from some advance warning to have contingency procedures in place to address potential disruptions to instruction. While most should be able to handle the operational and financial implications, some will face disproportionate challenges the longer the virus continues.
International recruitment: Many U.S. universities recruit heavily internationally--particularly in China--to benefit from global perspectives on campus as well as to offset slowdowns in domestic student demand. While international students account for varying percentages of total full-time enrollments for the colleges and universities in our rated portfolio, some rely on a high proportion of students from those countries currently most affected by the spread of COVID-19. A general slowdown in the economies affected by the coronavirus could affect international recruitment in the fall semester. At this stage we do not foresee a meaningful impact on international demand, but if, contrary to our expectations, the spread of the virus were not to recede by the summer, a longer term situation could cause rating pressure on institutions that are already be in a challenged operating situation.
We consider this latest health emergency an evolving one with broad effects across the transportation infrastructure sectors and travel industry value chain with particular exposures for airports and ports (see "U.S. Ports Face Headwinds," Feb. 19, 2020; "U.S. Airport Sector Well-Positioned While U.S. Ports Prepare For Volume Declines Under Our Baseline Coronavirus Scenario," Feb. 12). Historically, we have not taken negative rating actions associated with outbreaks (e.g. SARS in 2003) since their impact was temporary and recovery relatively rapid. Additionally, most transportation issuers have good-to-strong liquidity positions to address near-term pressures and favorable business terms with tenants including minimum annual guarantee revenues and cost-recovery financial structures. However, should the COVID-19 outbreak create a persistent, durable, and material drag on air travel demand or trade flows, we would consider it a major credit risk, potentially leading us to lower the ratings on some issuers. For the U.S. port sector, we see the outbreak as an additional risk--on top of weakness due to the ongoing trade and tariff dispute--if it becomes a drag on the overall Chinese economy, dampening GDP growth that, in turn, will cause lower-than-forecast levels of goods imported to or exported from China. On the aviation side, larger U.S. airports with international passenger exposure also have a significantly larger domestic passenger base likely to provide an operational cushion unless travel restrictions or consumer behavior changes follow from additional U.S. outbreaks. Longer-term, changes in supply chains and any economic softening or recessionary pressures would affect our view of ratings and sector outlooks.
Public power and electric cooperative utilities are 24/7 operations. To the extent that illness or efforts to avert contagion through quarantines preclude employees from performing their duties, operations critical to delivering electric service to customers might be impaired. Such a development could negatively affect utility revenue streams if the epidemic continues for an extended period. Although S&P Global Ratings projects some permanently lost economic activity due to the epidemic, we nevertheless project modest growth through the first two quarters, which should help mitigate the effects on utilities that rely meaningfully on revenues from industrial customers.
The SARS-CoV-2 virus that causes COVID-19 belongs to the same genetic family of viruses that caused the 2003 SARS and 2012 MERS outbreaks. Treatment professionals are confident that existing technology and methods are already extremely effective against known pathogens and will also eliminate SARS-Cov-2, based on its genetic similarities. Water and wastewater treatment typically includes not just solids separation but introducing chlorination and, commonly, ultraviolet disinfection at appropriate levels and for a sufficient length of time. The ability of utilities to staff 24/7 operations will also be a focus but should be manageable given the level of automation at most facilities.
This report does not constitute a rating action.
|Primary Credit Analysts:||Robin L Prunty, New York (1) 212-438-2081;|
|David N Bodek, New York (1) 212-438-7969;|
|Geoffrey E Buswick, Boston (1) 617-530-8311;|
|Theodore A Chapman, Farmers Branch (1) 214-871-1401;|
|Suzie R Desai, Chicago (1) 312-233-7046;|
|Kurt E Forsgren, Boston (1) 617-530-8308;|
|Jane H Ridley, Centennial (1) 303-721-4487;|
|Jessica L Wood, Chicago (1) 312-233-7004;|
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