Harrisburg, PA next?

Bankruptcy for Harrisburg finally?

The fiscal troubles plaguing Harrisburg, Pennsylvania have been well telegraphed in muniland. Reuters detailed the problems earlier this month:

Pennsylvania’s state capital, a city of 50,000 about 100 miles west of Philadelphia, has been flirting with bankruptcy as it struggles to pay off $300 million in debt incurred through a financing scheme used to fund a revamp of its trash-burning plant.

In July, the city council rejected a rescue plan put forward by a state-appointed advisor that called on the city to sell the incinerator, renegotiate labor deals, cut jobs, and sell or lease its parking garage.

Bloomberg reports today that Harrisburg is likely to miss a municipal bond payment on September 15. When a bond issuer misses a payment, rating agencies give them 30 days to cure the missed payment; if they are unable to do so, the rater declares them in default. Municipalities are not required to file a Chapter 9 bankruptcy because of this, but generally that is the sequence of events. So if Harrisburg misses the bond payment, it is likely they are headeded to the federal bankruptcy courthouse. Bloomberg reports:

Harrisburg may miss $3.3 million in general-obligation bond payments due Sept. 15, said Robert Philbin, a spokesman for Mayor Linda Thompson, in a phone call today.

Does a downgrade cost anything?

The debt of the United States was downgraded by Standard & Poor’s several weeks ago, but the price of U.S. Treasuries have skyrocketed since then. This confuses many people because a baseline relationship in the fixed-income markets is that lower-rated, less-creditworthy bonds will be relatively cheap and investors will demand higher interest rates to compensate for additional risk.

To see this bond market truism, it’s much more instructive to look at the downgrade of the debt of New Jersey. Fitch lowered the state’s credit rating Wednesday citing heavy debt and benefit obligations. This followed downgrades by Moody’s and S&P earlier in the year. Municipal bond and credit default swap markets didn’t like this third downgrade and did what you would expect them to do: they required more yield in the case of cash bonds and more payment in the case of credit default swaps.

The graph above charts muni CDS prices for New Jersey (data supplied by Markit). You can see the move up in CDS prices began in June when Governor Christie and the state legislature made the final run to their agreement on the fiscal 2011 budget, which began on July 1. The uncertainty and contentiousness of the process must have spooked investors and dealers.

New leadership for muniland’s regulator

New chair for muniland’s regulator

New leadership has been announced at the Municipal Securities Rulemaking Board, muniland’s primary regulator. Alan Polsky of Dougherty & Co., the incoming MSRB chairman, has spent much of his career working towards increased transparency in the muni secondary market where bonds trade after issuance. This is great news. From the Bond Buyer:

Alan D. Polsky, senior vice president of Minneapolis-based Dougherty & Co. LLC and former chair of the National Federation of Municipal Analysts, will be the next chairman of the Municipal Securities Rulemaking Board beginning Oct. 1, according to market sources.

Polsky spent a great deal of time trying to improve secondary market disclosure when he chaired the NFMA in 2001. During that year, the NFMA issued several “best practice” disclosure documents recommending how issuers, borrowers, and other market participants could improve disclosure in various sectors of the market. Polsky also was a member of the Muni Council, a group of about 20 muni market group representatives dedicated to improving secondary market disclosure. The group was responsible for the creation of the Central Post Office facility which temporarily served as a one-stop place for issuers to file their disclosure documents.

Smooth sailing in muniland

Lately a lot of big waves have washed over muniland. The national economy has slowed; the 2009 federal stimulus program to the states has ended; there have been loud headlines about bankruptcy cases in Jefferson County, Alabama and Central Falls, Rhode Island; and Standard & Poor’s downgraded the debt of the United States with potential effects on the borrowing ability of states and municipalities. It’s a laundry list of woes.

Considering all the strong forces facing muniland it’s interesting that the municipal bond market is still in such good shape and that interest rates on municipal bonds have remained low. There are two big reasons for this performance.

The first and biggest reason for smooth sailing is that muniland’s sister market, the U.S. Treasuries market, is having a tremendous rally as investors sail into the safe harbor of owning U.S. debt. Even though Standard & Poor’s downgraded U.S. debt to AA+ two weeks ago the U.S. Treasury market is both liquid and deep; it provides investors with security and a place to park assets. There has been so much demand for U.S. Treasuries that their yield (which moves in the opposite direction of the bond price) is nearing the ultra low yields of Japanese government debt. Bloomberg reports:

Why the little guys can be on top

Here is a brilliant map from the Tax Foundation (via The percentages on the map indicate the amount of each state’s annual budget that goes to pay off interest on their debt. Massachusetts leads the pack in this statistic with 9.58% of their budget going towards interest payments, much higher than the average. It’s important to note that this is not a map of relative ranking of debt loads as that would look quite a bit different and have California in the lead.

After seeing this map, S&P’s announcement that cities and states can keep their AAA rating despite the U.S.’s downgrade makes more sense. The National League of Cities said the following in response to Standard & Poors’ statement:

Standard & Poor’s announcement that cities and states may keep their AAA bond ratings despite the recent downgrade of the U.S. federal government demonstrates the difference between U.S. federal debt and the municipal bond market.

“Muniland a quiet backwater today”

Muniland was quiet today as market participants confined the bloodbath to the equity markets. Investors mainly sat on the sidelines and benchmark yields were unchanged. The Thomson Reuters Municipal Market Data 10-Year AAA Scale closed at 2.38%, unchanged from Friday. Reported volumes were light.

The worst muniland event of the day occurred when Moody’s announced that they had cut Puerto Rico’s general obligation debt rating to Baa1, a level close to the bottom of the investment grade scale. Because it is a territory, Puerto Rico has the unique distinction of enjoying national exemption from local and state taxes, so its debt is widely held across America. It is also among the cheapest municipal bonds available because the market believes it has some likelihood of default due to high levels of debt and unfunded pension liabilities.

The muniland non-story that commanded headlines was the expected downgrade of state and local bonds due to the Standard & Poor’s downgrade of the United States. Chris Mauro of RBC Capital Markets has some very good analysis about the arcana of this market and how the headlines are wildly overblown:

Muniland likely resilient to U.S. downgrade

It’s a little frustrating to hear commentators outside of muniland bash all municipal bonds as though they were a homogenous asset class. AOL’s Daily Finance ran a quote from the top regulator at the Municipal Securities Rulemaking Board, who is pushing back on this idea:

“It is important to remember that only four to six [defaults] make headlines, but 45,000 others are doing OK,” Lynnette Kelly Hotchkiss, executive director of the Municipal Securities Regulation Board, tells DailyFinance. “Remember that every issuer is unique and needs to be analyzed on its own merit.”

Reuters is running with the meme that the municipal bond market will likely be resilient in the face of Standard & Poor’s downgrade of the United States. Bloomberg is sailing in the opposite direction with a gloomy view of the prospect of downgrades for munis after S&P’s action. The Bond Buyer reports that low expected issuance should help buoy yields. And the Wall Street Journal details how muniland has passed a critical threshhold in the second quarter as municipalities were able to renew and renegotiate their bank backstop agreements:

Out of equities into bonds

As investors left the equity markets today, they moved into the fixed-income markets. The benchmark for bonds, the 10-year U.S. Treasury, had sharp gains and is now trading at 2.40 percent. The muniland equivalent benchmark, the 10-year AAA muni, ended at a slightly lower yield of 2.38 percent. (Remember the muni AAA has lovely tax advantages that push its yield much higher. Consult your accountant).

  Yield Market Change Dow - 4.31% S&P - 4.78 % Nasdaq - 5.08 % 2.40% 10-YR U.S. Treasury + 0.22 % 2.38% 10-YR AAA Muni + 0.07 %


Hospitals, higher ed and housing

Howard Cure, director of municipal research at Evercore Wealth Management, is asked in this Bloomberg video if Jefferson County, AL and Central Falls, RI are leading indicators of massive defaults in the municipal bond markets. He thinks not. After all, he says, these problems have been known for years.  For Cure, the real focus should be on what he calls the “three H’s:” hospitals, higher education and housing.  These entities are often heavily reliant on federal funds, which may be reduced in deficit negotiations. Muniland agrees and reminds everyone that there are vast differences in the fiscal and financial strengths of issuers.

Bondholders will win in trashed Rhode Island town

The Wall Street Journal is running a story on the Central Falls bankruptcy entitled “Bondholders Win in Rhode Island.” The story lauds how bondholders are ensured of receiving 100 cents on the dollar, although the bonds are currently valued at 62 cents on the dollar. Meanwhile retirees can expect their pensions to be cut by 34%.

Reading through the comments to a Providence Journal story on the threat to the state’s credit rating from the bankruptcy proceedings, I came across the following comment detailing the abject poverty of Central Falls, the community which is supposed to pay bondholders off at par. It’s shameful that a busted community would impose haircuts on all their creditors except bondholders.

Bondholders have cut the line

Something doesn’t seem right in Central Falls, the Rhode Island city that declared municipal bankruptcy yesterday. Now that the state receiver has filed Chapter 9, all the town’s dirty laundry has been hung out in public, and, like any bankruptcy, it’s not pretty. Overspending and declining tax revenues doomed this poor town, along with liberal doses of alleged corruption.

Here is what doesn’t seem right in Central Falls. The city is dead broke and those they owe money to are lined up at City Hall to collect. But for some odd reason, the city’s bondholders have pushed ahead of all the others in line to claim full repayment of their debts; those later in line must settle for 50 cents on the dollar. Retired police officers and firemen will have their pensions cut by 50%.

It wasn’t Central Falls’s decision to give preferential treatment to bondholders. Last year legislators in the state capitol passed a law making the claims of bondholders superior to all other claims in bankruptcy. The Rhode Island General Assembly’s action flies in the the face of common bond market practice, which is that bondholders get in line with everyone else and a judge overseeing bankruptcy proceedings gives a fair resolution to all the creditors.

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