Unemployment insurance (UI) claim filings were eye-popping this week, but not surprising.  A full stop of virtually all non-essential activities in most states also puts a full-stop on revenues from those activities.  The quickest way to conserve cash for companies in that situation is to lay off personnel.  Claims show up sooner than the job loss figures, which lag by a month.  The table below shows job categories where we believe a full stop, or near full-stop has taken place.  The job total in these categories is 29 million, so we guesstimate that we are roughly one-third of the way to total unemployment claims before they peak. Government assistance may arrive before all of these jobs turn into layoffs and aid is geared to retaining employees, so some companies may revisit their decision-making.

This being the beginning of the month when rents are due, it is really no surprise that the UI claims are so high and it shouldn’t be a surprise when they go higher in the coming weeks.

A full stop is considerably different than what we experienced in the Great Recession.  There, subprime mortgages had different origination dates or “vintages”.  Variable rate mortgages reset their rates at different times.  Defaults were rolling but not all at the same moment.  Structured finance, such as RMBS (Residential Mortgage Backed Securities), had layers of protection and over-collateralization, so it took time for borrower defaults to eat through these layers.

Today, the key issue going forward is liquidity (and recovery which we discuss below).  Will companies and government entities that receive cash flow from these activities survive a drought of four months or more and then live on lower cash flow as the economy begins to get back on its feet? Will government aid be enough to bridge the gap?

Force Majeure: Check your contracts and bond indentures

A number of companies have chosen to declare “force majeure” events, which gives them the right to break contract provisions.  Back in February, Reuters offered an “explainer” but many law firms also offer discussions of contract wording, which is critical to enforcement of the contract clause. (Just Google “Force Majeure”.)  CEVA Logistics, a Marseille based air freight, ocean freight, ground freight, rail, customs brokerage and contract logistics company did so. DHL Global Forwarding declared as well.

For those government officers that write and award contracts, it is important to check the documents.  For municipal bond analysts as well, check documents, particularly for projects that were financed and begun before the virus spread.  This will be more relevant for revenue-based financings, although general governments that contract out for services could be affected as well.

What We Worry About

We share our list of hot spots:

  • At the front of the line: Convention centers, stadia, museums, theaters, casinos. (See previous post.) In jeopardy are revenues and  taxes on event tickets as well as auxiliary activities, bond-financed stadia and other entertainment, wagering taxes from casino activities.  Standard and Poor’s has already placed many of these issuers on negative credit watch.
  • States and some local governments that collect fuel tax revenue. (Taxing gas per gallon was controversial in the era of high gas prices but looks good at today’s lower prices.) While most of the bonds secured with fuel taxes are at the state level, Florida, Alabama and others have secured bonds at the local level with this cash flow.  The American Association of State Highway and Transportation Officials (AASHTO) expect a 30% drop in fuel tax receipts.
  • Any Sector Dependent on Revenues from Mobility:
    • travel destinations
    • travel services
    • toll roads
    • transit systems
    • fuel taxes
    • anything people spend their money on when they travel from one place to another; restaurants, bars, hotels, experiences, taxicabs…
    • Standard and Poor’s has placed the transportation on negative credit watch
    • But help is on the way: the CARES Act, passed on March 25 will be sending money to strapped transit and transportation systems. AASHTO’s analysis presented here.
  • Mortgage servicers. Politico reported here.  In the rush to get aid to individuals as quickly as possible, the plight of servicers was overlooked.  They have to pay whether or not underlying borrowers have made their payments.  Ginnie Mae expects to help with liquidity issues within the next two weeks.
  • Privatized College and University Housing – with schools shuttered and forbearance on rent payments, these facilities and their private managers may also hit the liquidity wall. Colleges and universities counting on residual revenues are not likely to not see any.
  • Private Colleges and Universities – Some schools have already experienced group protests for tuition refunds. MIT and NYU along with others evicted their students from campus at the beginning of March.  Art School students are protesting  that schools are holding fast on tuition levels, despite lack of student access to specialized tools of the trade.
  • Sales taxes: While sales tax collections were healthy before the virus spread, we expect a significant drop in the next round of (lagged) statistics. Bright spots include online and mail order retailers, grocery and other food vendors and all the ancillary services that make these businesses operational. Sale of laptops and broadband are also brisk.
  • Oil–based: On top of dealing with the virus, cities like Houston are likely to see shortfalls in revenue tied to oil-based activities.  Although there was a “rally” on the news that Russia and Saudi Arabia may reduce production – this came via presidential Tweet.  Bloomberg.com suggests that the president has requested about one third of the reduction that would be required to stabilize prices.

Recovery

When our leaders issue an “all clear” signal, it will still take some time for people to feel confident in resuming their previous activities.  An “all clear” message that comes too quickly and is followed by a new set of virus cases, will shatter confidence.  There’s no specific date when the pandemic will end, which is causing broad-based uncertainty and forecasters have a limited line-of-sight.  Since testing has been paltry and random in the U.S. (and we’ve been told not to request a test unless breathing has already become difficult) it becomes impossible to know who might be carrying and sharing the virus even though they are asymptomatic.

Some activities may permanently be changed.  If more people continue to work from home, what happens to commercial real estate? Physical shopping is likely to take a hit as well, particularly as online retail ramps up and smooths out its fulfillment operations.  When will people be comfortable pawing over sizes and colors of clothing, accessories and shoes in a physical store again? (Virtual reality, anyone?) Hopefully, states and local governments have set up their “post-Wayfair” systems to collect sales taxes from remote sellers. But this too is controversial, especially for small businesses that find the complexity of record management and remittances too much to follow.

Disrupted supply chains will become more visible when production resumes.  Whether U.S. tariffs have pushed a re-alignment of relationships remains to be seen. Some forecasters also envision that people will move to less dense, more rural locations and away from cities.  Cities that have built their reputations around good food, drink, music, sports and so on could take a hit.