July 17, 2012

In The News

Muni Experts: California City Bankruptcies Not Start Of Massive Wave


July 12, 2012

By Yali N’Diaye (MarketNews)

     WASHINGTON (MNI) – While three cities filing for bankruptcy in less than two months within one state could look like the beginning of a wave, at least within the State of California where it is taking place, experts do not see it that way.

Stockton, followed by Mammoth Lakes and now San Bernardino all have chosen the bankruptcy route since the end of June.

While this raises the risk of contagion, and the risk of dissipating the stigma associated with bankruptcy, experts still don’t anticipate widespread defaults among municipalities across the country, or a default for the State of California, even if more troubles are expected.

The bankruptcy stigma clearly is still there, and the burden remains significant.

“I think the stigma is still there but many municipalities may no longer have a choice,” said Triet Nguyen, Managing Partner at Axios Advisors LLC, a research service specializing in municipal bonds. “In many cases, Chapter 9 is the only tool cities have to force a restructuring of their pension and post-retirement benefit expenses,” he told MNI.

“Also, in this low-interest rate environment, the potential ‘market penalty may not be very significant,” he continued.

However, “bankruptcy remains a rare event, and municipalities that file must meet many criteria to successfully petition the court for relief at the state and federal level,” Moody’s senior vice president Eric Hoffmann told MNI Thursday.

“This is a long, expensive process and many bankruptcies (like Harrisburg, Pennsylvania, and Boise County, Idaho) are thrown out of court along the way,” he continued, adding bankruptcy remains a last resort solution. Hoffmann pointed out that in a Chapter 9 filing — as San Bernardino voted in favor of — the judge has “much less authority to impose a solution on a municipality’s creditors than in a Chapter 7 or 11 filing.”

“We believe there is still generally a stigma for U.S. cities filing for bankruptcy and it remains rare overall,” agreed Fitch Ratings U.S. Public Finance Managing Director Amy Laskey. “However, we would not be surprised to see additional municipal bankruptcies in California or elsewhere, due to the well known pressures facing some local governments,” she told MNI.

Certainly, “Contagion is an increasing risk, and one we are watching closely, but it is a risk that currently remains relatively low,” Moody’s Hoffmann told MNI.

Even so, California is nowhere near defaulting. Fitch and Standard & Poor’s rate California’s general obligation bond A-, and Moody’s assigned it A1. “States are separate issuers from their municipalities,” commented Hoffmann.

Fitch’s Laskey agreed, noting that, “We do not believe there is a connection between cities’ bankruptcies and California’s probability of default.”

Some factors are troubling, however, such as “the suddenness of San Bernardino’s bankruptcy vote,” as pointed out in a written commentary by Richard Larkin, director of credit analysis at Herbert J. Sims & Co, an underwriter of tax-exempt bonds.

It is especially troubling considering other alternatives were possible, he said, expecting headline risks to possibly “threaten California municipal bond prices.” Still, while bankruptcies could rise in California and other states, “I don’t believe that this is the beginning of a tidal wave of city insolvency across the country,” Larkin said.

 Other experts agreed, noting the problems remain specific to each issuer and that even increasing defaults would continue to represent a small portion of the muni outstanding debt.

 “To the extent that many cities in California do face the same set of fiscal challenges, one would expect to see many more Stocktons and San Bernardinos over the next few months,” said Nguyen.

Other states vulnerable to high local default rates include Pennsylvania, New York and Illinois, he continued.

However, Fitch’s Laskey argued that “extreme fiscal stress in one location does not indicate the same for another location.”

“While cities in California generally share certain attributes, including flat to declining tax bases, increasing pension costs, labor pressures, and state actions to balance its budget that are sometimes to the detriment of local governments, the magnitude of the challenges and the manner in which each government manages through them is different,” she said. This is reflected in the wide range of ratings Fitch assigns to California’s cities.

Moody’s Hoffmann told MNI that “The time frame doesn’t make them isolated, but Stockton and San Bernardino had been having fiscal issues for several years.” “Moreover, both Stockton and San Bernardino appear to have falsely reported their financial status for a number of years — San Bernardino for perhaps as many as 13 of the last 16 years.”

He added that Mammoth Lake’s situation is “quite different as it filed because it lost a lawsuit that required it to pay significant monetary damages that it could not afford.”

And even as he warned of more defaults in four states in particular, Nguyen said that “As an asset class, municipals still remain one of the safest investments around.” He pointed out that states’ credits are “on the upswing again.”

 So overall, despite anticipation of a rise in local defaults, muni experts do not see a wave of catastrophes in the U.S. muni sector and generally maintain their outlooks.

While both states and local governments “continue to experience fiscal stress,” Hoffmann said, “most local government ratings have not changed and less than 30 local governments are rated below investment grade.” He added, “The average state rating is Aa1, our second highest.”

Larkin is also sticking to his forecast of low municipal bond defaults, which should not exceed $20 billion this year, representing 0.5% to 1% of all municipal bonds outstanding.


          ** MNI Washington Bureau: 202-371-2121 **

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About Triet M. Nguyen

Triet Nguyen is a veteran of the fixed-income markets and a high yield/distressed municipal bond expert. Over his 32 year career, Triet has designed, marketed and managed every type of buy side investment products, from mutual funds (open and closed-end) to managed accounts and hedge funds. He is currently the managing partner of Axios Advisors LLC, an independent municipal research and investment advisory boutique specializing in high income strategies. Triet is the author of “Investing In The High Yield Municipal Market”, to be published in July 2012 by John Wiley/Bloomberg Press. He also moderates the Municipal Credit Research Forum on LinkedIn. His Twitter handle is @HighYieldPro. Before rejoining Axios (which he founded in 2002), Mr. Nguyen was a Senior Vice President at B.C. Ziegler, where he traded tax-exempt high yield and taxable municipal bonds (including Build America Bonds). From January 2004 to January 2008, he was a Managing Director of Saybrook Capital, LLC, managing one of the first ever municipal hedge funds dedicated to a credit strategy. As Director of Information Services at ebondUSA.com between 2000 and 2001, Triet contributed to the development of a pioneering online muni bond evaluation system. Prior to 2000, he was a Vice President/Portfolio Manager of the John Hancock Funds and a Senior Portfolio Manager of the Putnam Funds. Triet received a B.A. in Economics and an M.B.A. in Finance and Accounting from the University of Chicago.