A little more than a month after one rating agency issued a paper promising not to downgrade a municipality’s credit if its officials talk about bankruptcy, Fitch Ratings yesterday distributed a report saying just the opposite.
The Standard & Poor’s paper — “What Credit Concerns Does Talk of Municipal Bankruptcy Raise?” — argued that a public contemplation of bankruptcy could represent a healthy examination of alternatives a government will never actually pursue.
While in some cases discussions about bankruptcy might reveal downgrade-worthy concerns about cash positions or solvency, Standard & Poor’s said many times municipalities are just trying to understand bankruptcy better or even illuminate its drawbacks.
The discussion itself does not indicate credit deterioration, according to Standard & Poor’s.
Fitch took a different view.
In “The Perils of Considering Municipal Bankruptcy,” a team of analysts including Richard Raphael and Eric Friedland warned that a public mention of bankruptcy could trigger an inquiry from Fitch.
“If bankruptcy is being actively considered, Fitch will assess whether the entity’s current rating should be maintained,” the agency said. “Consideration of bankruptcy not only indicates severe financial stress but also a willingness to compromise the credit standing of bondholders through a bankruptcy filing.”
The more municipalities talk about filing for bankruptcy, the more they are likely to do it, according to Fitch. The “tarnish” of publicly mentioning the B-word would wear off with increasing usage, the rating agency said. Besides, it added, the mere mention of bankruptcy “calls into question the issuer’s willingness-to-pay commitment.”
Fitch also warned municipalities to be careful about brandishing bankruptcy threats to establish leverage in negotiations with unions.
Sometimes, it said, the unions might call the bluff.
Municipal bondholders have historically fared well. Rated municipalities have seldom defaulted, and when they have the bondholders have usually been compensated. But that could change, Fitch said.
The City Council of Vallejo, Calif., which is operating under Chapter 9 bankruptcy protection, approved a workout plan that cuts some debt service payments to bondholders.
Furthermore, Fitch said the bankruptcy judge’s earlier rulings formed a basis that all creditors share equally in losses — including bondholders.
If the workout plan is approved and holds up, Fitch said it could establish a precedent in which bondholders suffer losses along with other types of creditors in municipal bankruptcies.
