The COVID-19 pandemic presented an international public health emergency, with economic and social challenges no one could have predicted—challenges that have impacted the municipal bond market. It would be fair to describe these circumstances as unprecedented. However, in recent history we have experienced other unprecedented events that presented significant market challenges. These have included: the financial crisis of 2007-08, the Great Recession, or more recent climate events, such as the fires experienced in our State’s metropolitan areas this past fall, or the extreme damage to the power grid inflicted by the extreme ice storm experienced earlier this year, which left over a million people in Oregon without electrical power (in some cases, measured in weeks).
Of course, these examples of market challenges are all unique in their own way. And while such events are often described as unprecedented, the municipal bond market has evolved over many decades to adapt to changing times, and incorporate protection into bond structures to support bond issuers and help provide forms of security to bondholders. In recent years, as yields have progressively dipped and credit spreads tightened, certain issuers have shed many of the conventional security features and covenants in favor of cost savings or fewer restrictions. This trend is not unique to municipal bonds, and is also a trend in the corporate bond market, referred to as covenant-lite or “cov-lite” in the bond community.
Prioritizing Credit Quality
Despite this trend, we continue to prioritize credit quality and place value on bond covenants, which in many cases, are currently priced at substantially lower premiums than we have ever seen. Knowing that the municipal bond market and our local economies may be impacted by such events is why we continue to value these features. One of the greatest casualties of the pandemic has been the Leisure and Hospitality sector. In Oregon, Leisure and Hospitality currently accounts for the bulk of Oregon’s jobs not recovered since early 2020. Although the sector has regained 62% of jobs lost early in the pandemic, the State currently has more than 42,000 jobs left to recover to reach the prior peak employment month of February 2020.1
A Disciplined Approach to Risk Management
Although preparing for the unprecedented may seem daunting, this is precisely why we prepare a detailed analysis of each holding in the Trust’s portfolio, and then follow-up on that analysis with ongoing credit surveillance. These reports highlight the credit features and deficiencies that inform our investment decisions during volatile times.
Security selection and sector exposure decisions are also determined as a result of our proprietary credit reports, which facilitate a more quantifiable determination of which risks are considered acceptable versus those without protection. This allows us to avoid the assumption of investment risk without the commensurate reward of additional yield.
We meet quarterly with our credit committee, which provides guidance on timely credit topics and is prepared to convene on an ad hoc basis. We also maintain an internal credit monitor that notes developing economic and credit matters of concern and issuers, or entire sectors, which may periodically struggle. Nevertheless, despite currently tight credit spreads, we continue to prioritize credit quality as we anticipate the unprecedented.
A Look at How Bond Structures May Help Protect Investors
Aquila Tax-Free Trust of Oregon currently holds (as of 9/30/21) Metro’s Dedicated Tax Revenue Bonds, which were originally issued in 2017 to finance the Oregon Convention Center Hotel. The bonds are secured by a pledge of two portions of Metro’s transient lodging taxes collected in Multnomah County. Transient lodging taxes consist of a tax imposed on all hotel and motel room rentals in Multnomah County. It should come as no surprise that, following the initial impact of the pandemic, Multnomah County hotels experienced historically low occupancy and revenue as a result of diminished convention, business, and tourism travel. In just the central city portion of the City of Portland, hotel occupancy plummeted from 68.6% in February of 2020 to 9.0% in April of 2020. Occupancy rates have since progressively recovered to 49.3% in June of 2021. Although hotel occupancy has improved significantly, relative to the beginning of the pandemic, most travel is currently leisure-related, and business and group travel remain low relative to pre-pandemic levels.
To protect investors from the recent lodging tax volatility, the bonds include a multi-layered security structure, which includes dedicated funds set aside in a debt service reserve account. The Visitor Development Fund, Inc. Board also took action to reduce and delay non-critical expenses in the then-current fiscal year and going forward. In addition, Visitor Facilities Reserves include three additional reserve funds held pursuant to an intergovernmental agreement between the City of Portland, Multnomah County, and Metro. While these reserves are not pledged to the payment of the Series 2017 bonds, they are available for payment of debt service on the bonds.
Fiscal year 2021, pledged revenues were 1.65 times debt service. Further, when including the amounts as discussed above, which are included in reserves that are not pledged to the Series 2017 bonds, but available to pay debt service, resources available exceed eight times debt service. A project that produces revenues at rate eight times debt service is impressive for just about any project, let alone the extreme conditions faced by lodging taxes during the pandemic. Without these additional reserves, investors would have been significantly more exposed to the revenue volatility experienced during the initial phases of the pandemic.
1Source: Oregon Employment Department
Mutual fund investing involves risk; loss of principal is possible. Investments in bonds may decline in value due to rising interest rates, a real or perceived decline in credit quality of the issuer, borrower, counterparty, or collateral, adverse tax or legislative changes, court decisions, market or economic conditions. Trust performance could be more volatile than that of funds with greater geographic diversification.
The Fund seeks to provide as high a level of income exempt from state and federal income tax as is consistent with capital preservation. For certain investors, some dividends may be subject to federal and state taxes, including the Alternative Minimum Tax. Consult a tax professional.
Information regarding holdings is subject to change and is not necessarily representative of the entire portfolio. It is for informational purposes only and not intended to represent a solicitation to buy or sell any particular security.
Before investing in the Fund, carefully read about and consider the investment objectives, risks, charges, expenses, and other information found in the Fund prospectus. The prospectus is available from your financial advisor, when you visit www.aquilafunds.com or call 800-437-1020.