Does default equal bankruptcy?

March 15, 2012

Harrisburg, Detroit, Central Falls, Vallejo, Stockton, Jefferson County — all these municipal entities have made headlines recently as their coffers got closer to empty. But are they just unwilling or unable to make principal and interest payments, that is, defaulting, or are they bankrupt?

In the Encyclopedia of Municipal Bonds, muni sage Joe Mysak defines default as

the failure to make timely payment of principal and interest, or to comply otherwise with features of a bond’s indentures.

Now, the receiver of Harrisburg, David Unkovic, announced last Friday that the city would not make certain bond payments:

Pennsylvania’s distressed capital city, Harrisburg, will skip $5.3 million of debt payments due next week, the first time the city has defaulted on its general obligation bonds, to ensure there is enough cash to fund vital services.

The payments that will be skipped consist of: $2.735 million due on the city’s general obligation refunding bonds, Series D of 1997, and $2.53 million due on the city’s general obligation refunding notes, Series F of 1997, Unkovic said.

The Harrisburg receiver, who is in charge of the city’s fiscal decisions, will not “make timely payment of principal and interest” on this specific GO bond, the only one of the many that Harrisburg has outstanding that will be in default. As required by the rules of the Municipal Securities Rulemaking Board, Harrisburg filed a public notice of principal and interest payment delinquency on the EMMA website (EMMA is the authoritative place to find such information).

It is possible that the $5.3 million in payments that Harrisburg is skipping will be paid at a later date, or that a bond insurer will make the payment (if it is insured, that is). Even if the bond defaults, it remains a binding legal obligation between the issuer and those who own the securities.

Bankruptcy is the end of the plank for a fiscally weakened municipality (states cannot go bankrupt). Chapter 9, which is the federal framework for a municipal bankruptcy, requires a city or county to petition the federal bankruptcy court to dissolve or restructure its liabilities. These liabilities include its bonds, payments owed to creditors, other pension and employment benefits (OPEB), and union and other legal contracts. The municipality must meet certain conditions to be accepted into bankruptcy court, the most important of which is that the municipality must be specifically authorized to be a debtor by state law or by a governmental officer.

For example, Harrisburg’s petition for bankruptcy was denied because Pennsylvania passed a law requiring a one-year wait between the law’s passage and new municipal bankruptcy filings. Unkovic was appointed to oversee the city instead. Central Falls (Rhode Island), Vallejo (California), and Jefferson County (Alabama) were all accepted into bankruptcy court and had, or will have, various liabilities reduced. The bankruptcy judge asks the bankrupt entity to prepare a plan to extinguish necessary liabilities to become solvent again.

The important point for muniland is that a bankruptcy court cannot haircut revenue bonds, which are paid by dedicated revenue streams like sewer fees. The court will generally oversee the reduction in principal of general obligation bonds. This is a tremendously serious event and may end bond market access for the bankrupt issuer.

A bond default is big problem, but bankruptcy is a car crash. Municipalities work hard to avoid it.


Riski: Municipal bankruptcy

Orrick and The Bond Buyer Webinar on March 22 “Navigating the Municipal Bankruptcy Minefield”

Van Eck’s Muni Nation: The Dreaded “D” Word

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