A $1 Billion Haircut: Jefferson County And The New maths of Municipal Distress

At my firm we have been beating the drum on the issue of municipal distress all year. 

This has been a year of strongly held opinions on municipal finance.  Scorn has been heaped on Meredith Whitney for her bearish call on the municipal bond market (though when Nouriel Roubini made a similarly bearish prediction with a more nuanced timetable, little of that scorn transferred over). 

Without reprising all that has been said in 2011 on the subject, I will say that the argument has boiled down to two groups looking at two different sets of numbers:

  • The first group, of which my firm is proudly a part, looks at the unrelenting budgetary stresses facing municipalities, combined with large debt, pension and healthcare obligations and concludes that restructurings on a large scale are inevitable. 
  • The second group, largely institutional fixed income investors, looks at the historically low municipal default rate and concludes that the fears of the first group are overblown. 

The case of Jefferson County, AL might finally be enough to wipe the looks of smug satisfaction off the faces of all those in the second group.  The WSJ reports that debt restructuring talks are progressing and both sides are close to an agreement.  The basic outline: bondholders will forgive $1 billion of $3.14 billion in sewer bonds, with rate increases being enacted to allow servicing of the remaining debt.  To be clear, the $1 billion “haircut” is apparently a settled issue.  Sewer bondholders would then be set to receive a 68.2 per cent recovery.  That is nothing to smirk about.

Too many in the investment community have assumed that the taxing authority of municipalities could be used indefinitely to cover all sins.  This has always been a lie, and Jefferson County merely highlights this fact.

Looking across the country we are beginning to see municipalities hit a wall.  They are frankly reaching the point that their obligations are too burdensome.  Municipal distress may take longer to play out as the fact that the music has stopped playing finally sinks in, the restructuring community adjusts to working with government entities and the taboo against municipal bankruptcies is broken, but this is a story that is inevitable.   

As we have been saying all year, government, at all levels, does not exist to fulfil obligations.  Government exists to provide services to citizens.  We have reached the point at which an increasing number of local (and arguably state) governments can no longer do both.  State and municipal bondholders should be under no illusion that this inflection point will result in losses.

About the author:

David Johnson is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services to companies and municipalities. He can be reached at 312-505-7238 or at [email protected].

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