Gauging the Government Shutdown's Impact on the Tax-Free Bond Market

By Hal M. Bundrick

NEW YORK (MainStreet) ¿ The tax-free bond market has been bandaged and slowly mending since being battered by the Detroit bankruptcy, as well as rising interest rates. Now the U.S. government shutdown is another disorder to diagnose. But if the federal furlough is short-lived, it should have a minimal impact on the health of the municipal bond market, according to Fitch Ratings, the fixed-income research firm.

"If the stalemate carries over into inaction in lifting the debt ceiling mid-month, there could be broader disruptions in the financial markets and the pace of the economic recovery," Fitch says in an analysis. "These disruptions could negatively affect state and local governmental revenues and cause volatility in the valuations of public pension funds and endowments of not for profit entities, such as college and universities."

Considering specific credit segments, Fitch expects not-for-profit hospitals, and the healthcare sector in general, to experience little, if any, impact to operations and cash flow in the near-term.

"Funding under both the Medicare and Medicaid programs are mandatory and are not subject to annual appropriations," the report says. "If the shutdown is more prolonged, however, not-for-profit hospital and health care providers are adequately positioned to weather a more drawn out resolution due to their strong balance sheets."

State governments should remain mostly unaffected, as well. The largest federal aid program is Medicaid, whose funding is not expected to be curtailed. Local governments, generally receiving only about 4% of direct federal aid ¿ 9% for school districts -- will also likely feel little impact from the shutdown. However, government workers missing paychecks may ripple through some local economies, especially in the Washington D.C. region and other areas with sizable numbers of federal civilian workers, such as cities with large military bases.

Higher ed should see only minor burdens, unless the shutdown drags on, which could then impact federal research funding, as well as access to some financial aid programs.

The ratings firm expects no immediate problems for housing bonds. All Fitch rated Public Housing Capital Fund bonds and bonds backed by Section 8 contracts have debt service reserve funds in place with no disruption in bond payments expected.

"Under the Military Pay Protection Act, which was passed by the House and Senate, military pay will be exempt from the appropriations crisis," the Fitch report says. "The Basic Allowance for Housing (BAH), which serves as the primary revenue source for military housing transactions, is considered part of military pay and therefore should not be affected. Additionally, all Fitch rated military housing bonds have debt service reserve funds in place."

--Written by Hal M. Bundrick for MainStreet