As the COVID-19 pandemic evolved during the first quarter, the municipal bond market experienced one of its most volatile periods in years. Here, the Franklin Municipal Bond Department shares how they plan to navigate the market, which they think is likely to show signs of distress and elevated volatility for some time.

Since the second week of March, when a broad financial market selloff due to the global COVID-19 outbreak extended into the municipal market, many investors have asked for our outlook on the health of the overall muni market, as well as specific sectors and states.

In our view, the indiscriminate nature of the recent municipal market selloff has certainly created more attractive opportunities than at the start of the year. We also view recent actions by the Federal Reserve and Congress as favorable for the market.1

However, we also believe that the municipal market is still likely to show signs of distress and elevated volatility for some time. In addition, the longer the coronavirus weighs on economic activity, the more credit and default risk will come into play, albeit to varying degrees across different sectors and states.

While we would reiterate the view that it still too early to predict the full impact of the outbreak, it is abundantly clear to us that certain sectors and states are much more likely to be negatively impacted than others. Our research analysts have been intensely reviewing municipal-market sectors and subsectors based on assessments of impact and resiliency as it relates to the coronavirus, including hospital, transportation, education, and water and sewer. A summary of these views is outlined in the following sections.

Hospitals

Hospitals continue to be on the frontline of the COVID-19 pandemic. As expected, we continue to learn of significant impacts to revenue, liquidity and volume to hospitals across the nation.

Many hospitals have already secured and drawn on lines of credit to deal with short-term liquidity pressures. Over the next 9-12 months, we anticipate widespread technical defaults, with liquidity and debt service coverage issues beginning as early as this month. We also see more widespread violations picking up around the end of June, which will trigger ratings declines for many issuers in the sector.

While we recognize that the operating environment is more likely to get worse before it eventually gets better, we currently do not anticipate monetary payment defaults given significant federal, state and Federal Emergency Management Agency support and the return of high contribution margin elective and outpatient procedures once social distancing measures are relaxed.