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Get ready. Your city or county could soon be declaring bankruptcy.Throughout 2011, U.S. municipal bondholders have been oddly confident that they would somehow be able to dodge the coming storm of municipal distress.
Nevertheless, the reality is becoming clear: bondholder losses are inevitable in municipal distress situations.
State legislatures have expressed considerable trepidation that the chapter 9 bankruptcy filing of certain municipalities could severely limit the ability of other municipalities to access the debt markets.
The Rhode Island legislature even went so far as to codify the politically untenable position that bondholder claims would be recognised as senior to all other liabilities.
Pennsylvania’s legislature last month adopted an amendment barring Harrisburg from filing bankruptcy for at least a year.
The tragedy of this ill-thought legislative meddling is that the underlying logic is both flawed and irrelevant. The central flaw that exists is that debt markets for corporate borrowers have adjusted to the risk of corporate bankruptcy by rationally pricing risk, not ignoring it. Worse, it is irrelevant because even if municipal bankruptcies would inhibit borrowing, they are inevitable. The municipal bond market is large enough to embrace reality: municipal debtors, like corporate debtors, are susceptible to financial distress (and frankly, are currently experiencing stress en masse) and yields should be adjusted accordingly.
Harrisburg, PA has been illustrative of the type of slow-motion unfolding disaster that we can expect in troubled municipal situations. With a looming choice between making a $3.3 million bond payment or covering operating expenses, Harrisburg has hit the wall. City Councilman Brad Koplinski provided an invaluable window into the thinking of local government officials facing distress when he observed that Jefferson County, AL has managed to negotiate a $1 billion haircut with bondholders, and Harrisburg should seek similar concessions. Forced to exist in a netherworld of de facto insolvency but restricted from exercising the remedies of a de jure recognition of the fact, Harrisburg has forcibly had the negotiating leverage of a bankruptcy filing removed from it. Removing leverage from a debtor is the absolute antithesis of sound restructuring strategy.
Municipal bondholders be warned, the haircut on the table for Jefferson County bondholders will be the starting point for negotiations in upcoming municipal distressed situations.
About the Author:
Margaret Bogenrief is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, investment, restructuring and turnaround services to companies and municipalities. She can be reached at [email protected].