MuniLand

A municipal bankruptcy does not ruin a state

Cate Long

Jan 17, 2012 12:48 EST

Chart source: Bonddesk

State politicians in Alabama, Pennsylvania and Rhode Island have lambasted municipalities within their borders that have either declared, or attempted to declare, bankruptcy. The politicians gripe that when a municipality in their state goes into Chapter 9 bankruptcy, it affects the cost of borrowing for the state and other issuers located there. But this rests on the false assumption that markets do not discriminate between different borrowers. Municipal bond issuers, like public companies, are looked at individually because every entity has its own story. After all, when American Airlines went bankrupt, it was not as if all airlines suffered.

Alabama Governor Robert Bentley explicitly used the increased cost of borrowing for other Alabama towns as a bludgeon against Jefferson County officials who declared bankruptcy last November. The Birmingham News wrote:

He [Governor Robert Bentley] said the county’s situation already has affected borrowing throughout the state and he expects the bankruptcy to increase the cost of borrowing even more. “The credit rating of Jefferson County is terrible already so it can’t get much worse, but certainly filing bankruptcy does not help,” he said. “I know they were frustrated but at some point, you have to step up and have to be a leader and have to be a statesman and you have to do what’s right. Bankruptcy is not right.”

I remember thinking at the time that the governor seemed to be exaggerating the effect Jefferson County’s bankruptcy filing would have on the state. In discussions with Chris Shayne, the senior market strategist at Bonddesk, the leading alternative trading platform, I asked if it would be possible to compare the yields of a bankrupt municipality with those of  its state. Chris and his team were able to pull six years of trade data and construct the chart above. Some amount of Jefferson County bonds and warrants are floating rate, so they have been excluded from the analysis. But you can still see that yields for the bankrupt county spiked way over the state’s borrowing cost. In his analysis Bonddesk’s Shayne said:

The main reason that the JeffCo bankruptcy was a non-event outside of Alabama is that it was not a surprise. The county has had well-documented financial troubles going back to the Great Recession of 2008. They were afflicted with a combination of serious problems, including heavy exposure to derivatives, fraudulent city officials, and difficulty raising new taxes. By the time they finally filed for bankruptcy protection last month, most observers were expecting the announcement. (It is also worth pointing out that neither JeffCo nor Harrisburg is large enough to roil the markets by themselves.)

The chart [above] shows that JeffCo yields increased substantially as soon as the trouble began to leak into the market. You can also see that prior to the distress in 2008 Jefferson County actually had lower bond yields than both the national median and the statewide median. Following the first sign of trouble, however, yields crossed over and remained elevated till they declared bankruptcy.

Can revenue bondholders relax now?

Cate Long

Jan 9, 2012 10:16 EST

Bond markets generally focus on who has rights to specific cash flows and control over assets. That was what Alabama federal bankruptcy court Judge Thomas Bennett was addressing when he issued an opinion Friday afternoon covering the insolvent Jefferson County sewer system.

To recap the situation in Jefferson County, re-read what I wrote in November:

Last year, amid the county’s fiscal and political meltdown, the Russell County Circuit Court appointed a water system professional, John Young, to take over the management and operation of the sewer system. This action came at the request of the bond indenture trustee, the Bank of New York, which wanted the bond payments protected. Now the county is fighting with the receiver and creditors for control of the sewer system in bankruptcy court.

The crux of Judge Bennett’s ruling related to whether the sewer receiver, John Young, could keep control of Jefferson County’s most important asset, the sewer system, while the county was trying to consolidate its assets in the bankruptcy process. Bank of New York and other bondholders argued that the federal bankruptcy proceeding could not trump judicial actions taken at the local level. In other words BoNY, representing bondholders, wanted to keep the control of the sewer system and its cash flows. Although revenue bondholders have a lien, or right, to the cash flows of the sewer system, they also wanted control of the asset.

Judge Bennett, in his ruling, confirmed the right of bondholders to receive the revenue payments they are due from the sewer system. This will make the municipal markets cheer because it confirms an important plank of the system. On the other hand, the judge also ruled that control of the sewer system must be returned to Jefferson County. Bondholders would have preferred to keep control of this asset, which was collateral for the bonds.

Chapter 9 municipal bankruptcy cases are rare and market players closely watch the outcomes. The judge made a sound ruling today and the case will grind on. Jefferson County is not yet out of the woods but the path is becoming a little clearer.

Kind thanks to the Birmingham News for posting Judge Bennett’s order.

How Jefferson County trips up national reporters

Cate Long

Dec 27, 2011 17:42 EST

The New York Times really needs to improve the quality of its reporting on the municipal bond market. Mary Williams Walsh makes such a terrible hash of the situation in Jefferson County, Alabama, that she is bound to set off another muniland hysteria in the mold of Meredith Whitney.

In the opening paragraphs, Walsh contends that general obligation bonds (GO) issued by state and local governments and with the pledge of their “full faith and credit” may not be as creditworthy as always assumed. About half of the $3.7 trillion municipal bond market is general obligation bonds. She dramatically states that investors who own GO bonds might be in for a “surprise:”

People who own what is considered the safest type of municipal bond may be in for a surprise.

This safe debt, called a general-obligation bond, is said to be the next strongest thing to Treasuries because it is backed by a “full faith and credit” pledge. That means the government that issued it will pay it on time, no matter what.

But now Jefferson County, Ala., has stopped paying such debt, breaking with convention and setting up a fundamental test of what full faith and credit truly means.

What goes unmentioned is that the halted debt repayment is happening in the context of an insolvent county in bankruptcy. More importantly, general obligations bonds can be very high-quality from a strong issuer with top credit ratings, or they could be very low-quality from a near-insolvent municipality with the lowest possible credit ratings. The type of the bond is no assurance of ability to repay bondholders.

The point of a municipality seeking bankruptcy court protection is to halt the legal actions of creditors, including GO bondholders. This gives debtors time and a safe space to reorganize their finances. It’s not in any way “breaking with convention” to halt paying GO bondholders in bankruptcy.

The U.S. Federal Court system’s bankruptcy guide (page 49) describes Chapter 9 municipal bankruptcy:

The purpose of chapter 9 is to provide a financially-distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts. Reorganization of the debts of a municipality is typically accomplished either by extending debt maturities, reducing the amount of principal or interest, or refinancing the debt by obtaining a new loan.

Lessons from MF Global

Cate Long

Dec 16, 2011 10:25 EST

The October bankruptcy of MF Global has been the subject of several Congressional hearings recently. 38,000 MF Global clients lost $1.2 billion in the collapse, and numerous regulators, as well as the Department of Justice, have been trying to unravel hundreds of thousands of transactions to discover how this client money disappeared. Weeks later, it’s still unknown whether clients will have their funds returned or whether any laws were broken. What is certain, though, is that even after the passage of Dodd-Frank, our regulatory system has large supervisory gaps.

The derivatives and futures businesses in which MF Global operated are complex, and it’s easiest to understand the firm as a large transaction processor that served its futures clients by connecting them to exchanges around the world. MF Global was both a broker-dealer and a futures commission merchant, meaning it was regulated by the SEC as well as the CFTC. In addition, MF Global was overseen by the Financial Industry Regulatory Authority (FINRA) and the CME, two self-regulatory organizations empowered by the SEC.

The big problem with oversight of MF Global within the U.S. is that there were too many regulators with only a small window into the firm’s activities and none with the ability to see the full scope of risks and capital of the holding company. How can we fix this?

(more…)

The cost of kleptocracy

Cate Long

Nov 29, 2011 18:45 EST

Gary White, a former official of Jefferson County, Alabama, had his conviction on conspiracy and bribery charges affirmed by the U.S. 11th Circuit Court of Appeals today. White, a former county commissioner, is already serving a ten-year term in a South Carolina federal prison for his involvement in the sewer scandal that ended in the largest municipal bankruptcy ever. He’s just another piece of detritus from one of the largest cases of municipal corruption in recent American history. The Birmingham News reported the courts decision:

The opinion issued by the court, however, begins with stinging criticism of a period of corruption that included White and other Jefferson County commissioners.

“‘Kleptocracy’ is a term used to describe “[a] government characterized by rampant greed and corruption,” the court’s opinion began, citing three dictionaries. ”To that definition dictionaries might add, as a helpful illustration: “See, for example, Alabama’s Jefferson County Commission in the period from 1998 to 2008.”

It’s well known in the municipal bond market that Jefferson County’s default and subsequent bankruptcy are exceptional cases. Munilass, one of muniland’s most indispensable bloggers, said this of Jefferson County:

Portraying Jefferson County as a typical municipal credit is akin to portraying Enron as a typical corporate credit. With Jefferson County, various financial firms – but primarily JP Morgan – exploited an existing culture of corruption and made taxpayers the victims of one of the largest frauds in the history of the financial markets.

Because the issues of fraud and corruption were so well known in the markets, I’ve been wondering about the statements that Robert Bentley, Alabama’s governor, made after the bankruptcy filing. From the November 9th Birmingham News:

“I believe you pay your debts,” he said. “That’s what I told them and I still believe that.”

He said the county’s situation already has affected borrowing throughout the state and he expects the bankruptcy to increase the cost of borrowing even more. “The credit rating of Jefferson County is terrible already so it can’t get much worse, but certainly filing bankruptcy does not help,” he said. “I know they were frustrated but at some point, you have to step up and have to be a leader and have to be a statesman and you have to do what’s right. “Bankruptcy is not right.”

Harrisburg back to square one

Cate Long

Nov 28, 2011 14:04 EST

Federal bankruptcy judge Mary France dismissed the Harrisburg City Council’s petition to file municipal bankruptcy last Thursday. According to Bloomberg her ruling stated:

“For Chapter 9 bankruptcy to work, all of the branches of the municipality must be on the same page,” France said. “Therefore I find that city council was not authorized to file the petition.”

Judge France has hit the nail on the head. The legislative and executive branches of Harrisburg’s government have been behaving like two sides of a family fighting over a deceased parent’s estate. The battle has been brutal and family members have talked past each other. Harrisburg mayor Linda Thompson seems to have little patience for others’ views, which is a tough way to govern.

So Harrisburg is cast into the arms of the soon-to-be-confirmed state receiver, who will have to return the city to fiscal solvency. But Harrisburg’s debts are just too high to pay off, and the incoming receiver has no authority to force bondholders and bond guarantors to take less than the face value of their paper. On Twitter Jim Warner, the CEO of the Lancaster County Solid Waste Management Authority, suggested that the leftover debt after the sale of the city’s main assets — its incinerator and parking garages —  would be about $55 million.

But this doesn’t take into account the other debt of the city. My rough calculations show the city will have a debt load of about $224 million.  And although it’s not consolidated, the city is also responsible for over $200 million of school debt.

This small city of 50,000 — where over 25 percent of residents live under the poverty line — is responsible for shouldering $425 million in debt. The new Harrisburg receiver needs to be Superman to bring this city back to fiscal solvency.

Harrisburg needs the bankruptcy option

Cate Long

Nov 18, 2011 17:57 EST

Pennsylvania Governor Tom Corbett took the next step in the process of pushing the bankrupt capital of his state towards fiscal recovery today. Bloomberg reports:

David Unkovic, chief lawyer for the Pennsylvania Community and Economic Development Department, is set to run the finances of Harrisburg after Governor Tom Corbett nominated him as the state’s first municipal receiver.

Once approved by a state court, the overseer may act without the consent of the bankrupt capital city’s elected officials. Unkovic’s appointment may be reviewed as soon as Nov. 28.

Unkovic has 30 plus years of experience as a bond counsel. The governor has also hired a Washington law firm to assist Unkovic on his fiscal restructuring efforts. Harrisburg has an impossible pile of debt to service, and much of it needs to be discharged to make the city’s finances sustainable.

Fortunately the legislation that the receiver is working under relegates Harrisburg’s mayor, Linda Thompson, to a sideline advisory role. I’m sure the new receiver will have a few team photos taken with her and then promptly relegate her to parade and ribbon-cutting duty.

One of the biggest tasks that the soon-to-be-confirmed receiver has is to go down to the federal bankruptcy court on Walnut Street and withdraw the petitions that the mayor and state filed objecting to the city’s Chapter 9 bankruptcy filing. Bankruptcy should be the biggest tool in Unkovic’s toolkit to get Harrisburg to solvency.

The reason that Unkovic needs Chapter 9 is that as a state receiver he has no authority to “cram down” bondholders and bond guarantors. He has power to sell the assets of the city but it’s doubtful there will be enough to service the remaining debt even after a fire sale. It was always a little hard to figure this out because Mayor Linda Thompson had not presented a budget and there are no current financials for the city. It’s literally a fiscal mess.

Make Jefferson County’s receiver its salesman

Cate Long

Nov 18, 2011 10:50 EST

The story of Jefferson County, Alabama filing the largest municipal bankruptcy ever last week is well-known. The county went into hock for about $3 billion to build an EPA-mandated sewer system. On the way to completing the system, every local crook and corrupt politician piled onto the project to skim off some pork. Many of these players ended up in prison and left the taxpayers saddled with a sewer system they really can’t afford.

Last year, amid the county’s fiscal and political meltdown, the Russell County Circuit Court appointed a water system professional, John Young, to take over the management and operation of the sewer system. This action came at the request of the bond indenture trustee, the Bank of New York, which wanted the bond payments protected. Now the county is fighting with the receiver and creditors for control of the sewer system in bankruptcy court. My advice to Jefferson County Commissioners is to stop fighting John Young and change his role into a salesman for the system. The sewer system is an albatross, and it should be sold and creditors repaid with the sale proceeds.

The Russell County Circuit Court’s mandate covered raising sewer rates and lowering costs but did not grant Mr. Young a role in facilitating a settlement with sewer debt creditors. According to Young, he took on that responsibility “unofficially.” He claimed to have traveled many times to New York City to negotiate potential haircuts on the outstanding debt, meeting repeatedly with JP Morgan, the biggest creditor, and other Wall Street banks. Young had a lot of experience dealing with Wall Street as the former president of the publicly-held American Water Works Company.

There is a lot of animus towards John Young in Jefferson County because he has been paid over $1 million in the last year and is perceived to be representing Wall Street instead of taxpayers. The Jefferson County political elite, from U.S. Representative Spencer Bachus to the Jefferson County delegation to the state legislature (shown in the video above), want John Young out of the county’s affairs. The Commissioners of Jefferson County filed a motion in federal bankruptcy to remove Young as the sewer system receiver. That motion will be argued on Monday.

I attended a luncheon yesterday of the Municipal Analysts Group of New York where John Young talked about his role running the sewer system, his trips to New York to meet with creditors and his current fight to retain control of the system in bankruptcy. What was clear from his presentation was that the sewer utility that he found when he stepped into the receiver role was run as a comfortable, good-ol’-boy operation with few management controls. He said that no income statement, balance sheet or long-term business plan had been developed for the system. As someone coming from a shareholder-owned company he first set to work getting operational metrics and cost accounting in place. Imagine transforming an utility that had just spent billions on infrastructure with few controls into a cost-driven operation. It’s a mighty feat.

Harrisburg’s leadership shortage

Cate Long

Nov 14, 2011 18:58 EST

Harrisburg is a town that’s been crushed by debt and years of incompetent management. The city has been led by a mayor, Linda Thompson, who is unable to work with a majority of her city council and who will likely find her role greatly diminished as the state takes fiscal control of the insolvent city. I’m not sure that I’ve ever seen a politician who has so little control over the affairs of her city. Edith Honan and Kristina Cooke of Reuters did an outstanding backgrounder about the level of dysfunction among the Harrisburg’s political class:

Prayers notwithstanding, [Linda] Thompson and [Comptroller] Dan Miller, the city’s top financial official, refuse to speak to one another, even as the city they lead continues hemorrhaging money. Thompson characterized Miller as a “political opportunist who will stop at nothing to accomplish his self-centered ambitions.” Miller, who plans to challenge Thompson for mayor in 2013, said he considers Thompson “paranoid,” “not well educated” and “a phony.”

His words seem kind compared with those offered by four former Thompson aides. They told the local newspaper that the mayor isn’t fit to hold office.

As Harrisburg proceeds towards state receivership and Chapter 9 bankruptcy, the mayor rarely displays a full understanding of the financial condition of the city. I wrote previously about her lack of knowledge of the amount of “stranded debt” the city would have after selling its most valued assets. I’ve seen her resist numerous calls for the completion of a forensic audit of the city incinerator, which is where most of the debt has accumulated. This is important because it’s not clear that all the dealings around the project  were on the up-and-up. The mayor’s campaign manager served as chairman of the incinerator authority until March 2010, and some have suggested that she may be trying to protect incompetence, or perhaps worse. In addition, his law firm had substantial billings to the incinerator authority.

Mark Schwartz, the attorney for the majority of the Harrisburg City Council, released documents today that show he has petitioned the SEC and IRS to investigate if the bonds issued for the incinerator really meet the conditions of a tax-exempt debt. It’s an interesting strategy because it pushes the facts and conditions about the incinerator debt and derivatives out into the open. When institutions operate in the dark, one never knows what may be found. Schwartz also released a long list of law firms that have been involved in underwriting the incinerator’s debt between 1993 and 2003. Seemingly every law firm in Harrisburg has been involved in these deals at one point or another.

Pennsylvania has a long and sordid history of political corruption. The governor, Tom Corbett, will soon approach the Commonwealth Court to seek appointment of a receiver to take over the city. This receiver would benefit from endorsing the Chapter 9 bankruptcy filing, which a majority of the city council filed in October. Chapter 9 protects the city from creditor lawsuits, and, more importantly, puts the bond guarantors — Assured Guaranty, Dauphin County and Covanta —  in a subordinate position on their claims. Harrisburg is morphing from a minor debacle to a full-on money fight. The city and state need as much protection as they can get.

Further:

Jefferson County goes kaboom

Cate Long

Nov 10, 2011 17:18 EST

Crushed by sewer debt and stripped of 48 percent of its general fund revenues by a state court, Alabama’s Jefferson County filed the largest municipal bankruptcy in history yesterday. The filing brings three years of financial chaos to an end and represents the largest default of municipal bonds and derivatives ever.

It’s been a long road for the county. In 1996 a federal judge ordered it to upgrade its sewer and waste water systems. To comply with that mandate, Jefferson County has issued over $3 billion in sewer debt, some of which was done in a blatantly illegal manner. The former Birmingham mayor and county commission president are now serving prison terms for bribery. Twelve others were convicted of bribery and conspiracy, and over twenty people involved in construction of the project have served jail time. The lead underwriter of the sewer debt, JP Morgan, also made the largest derivatives-related settlement with the SEC for an illegal payments scheme, although the bank admitted no fraud.

Jefferson County has been the poster child for muniland corruption for years as its residents have born the cost of the illegalities. Sewer rates have been raised 329 percent in the past decade. 500 county employees have been terminated. The county’s reserve funds have been depleted. Because of the crushing cost of the fraud the county has nowhere to turn but to the protection of federal bankruptcy court. With this filing, the county brings all court cases it is facing to a standstill and can halt debt payments until its massive liabilities have been adjusted.

The county commission has been working intensely with its creditors since August when they postponed filing for bankruptcy at the last minute at the request of the governor. The governor promised to convene a special session of the legislature to give the county the right to raise taxes to cover its massive revenue shortfalls and create a state guarantee for new bonds issued by the county. The governor said recently though that he would not convene this special session until all creditors had agreed to the proposed terms. According to the bankruptcy petition, some of the sewer debt has been sold to new parties, which has complicated negotiations. Bloomberg reported:

The county’s bankruptcy attorney, Kenneth Klee, said the filing was necessary because talks with creditors and the receiver in charge of the sewer plant broke down.

“There was an impasse reached,” Klee said in an interview today. “None of the creditors — zero — signed up to the deal that we have been negotiating for six weeks.”

Alabama Governor Robert Bentley, is not happy with the county’s bankruptcy filing and said in a statement published by Reuters: