Muni Experts Don’t Expect Surge in Chap. 9 Filings

While local governments face cuts in state aid, declining revenue, and sometimes hefty retirement-benefit obligations, the market should not anticipate a boost in municipal bankruptcy filings, several muni-market professionals said Thursday during a SIFMA conference.

Historically, the number of individual or corporate bankruptcy filings under Chapter 11 of the U.S. Bankruptcy code far outweigh municipal bankruptcy filings under Chapter 9. Since 1937, 616 local governments have filed for bankruptcy protection, including two filings so far this year. By comparison, more than 11,000 businesses and individuals filed for Chapter 11 in 2009 alone, according to James Spiotto, partner at Chapman and Cutler LLP.

Spiotto and other industry professionals yesterday discussed the current fiscal challenges of states and local governments and their perspectives on Chapter 9 filings at the Securities Industry and Financial Markets Association’s Municipal Bankruptcy Protection and Bond Restructurings Conference in lower Manhattan.

One key issue for local governments is that a Chapter 9 filing could very likely diminish a municipality’s credit rating and lessen bondholders’ confidence in the credit, thereby limiting a municipality’s ability to raise capital for necessary infrastructure projects. Municipal bankruptcy filing might also deter corporations from opening up shop or expanding their businesses in a jurisdiction that has sought bankruptcy protection.

“Now major municipal bond issuers, as a number of people have said, are deathly afraid of Chapter 9 because of the stigma,” Spiotto said. “And how strong the stigma is today, how much it will be in the future, maybe that’s yet to be written. But the real question you face is, if you go in, can you come out, and when you come out who can you sell your bonds to?”

Along with potential borrowing limitations, bankruptcy protection is a time-consuming process, has no definite outcome, and forces local governments to spend money on attorneys and other bankruptcy costs instead of using those funds for essential services such as policing, sanitation, fire departments, and school systems. Many states also require city councils and state legislatures to weigh in.

In some situations, Chapter 9 has provided a last resort for cities, towns, and local governments that have run out of cash while facing daunting debt obligations.

“Clearly bankruptcy gives you a chance to restructure your long-term needs and commitments, particularly if you were put into those by a previous generation of leadership,” said Frank Shafroth, the Municipal Securities Rulemaking Board’s director of legislation and intergovernmental relations.

Muni utilities, special municipal districts, and health care borrowers are the most frequent types of Chapter 9 filings. Of the 245 municipal bankruptcy filings executed since 1980, only 45 have been filed by a city, village, or county, according to Spiotto.

Municipal borrowings that involve a business component — such as a retirement community, a sewer system, or a hospital — are more likely to default on their debt obligations, according to the panelists.

“Where there are enterprises that have competitive risks that are basically part of or connected to governments, those enterprises can bring down those state and local governments,” said Moody’s Investors Service analyst Robert Kurtter. “That’s where the real risk is, which is not to diminish the very serious problems and pressures that state and local general governments have in trying to deal with balancing these spending pressures with a very weak revenue system at this point.”

To avert Chapter 9 filings, many states try to step in and help municipalities using a state takeover or local government assistance programs. For many local borrowers, the potential difficulties triggered by filing Chapter 9 can encourage

troubled municipalities to make good on their debts and avoid costly legal ­proceedings.

“It’s there for what a judge once said in Texas — and this is really true with regard to the bond market and the stigma of bankruptcy and how do you get your funding — the judge said: 'We don’t hang people for stealing horses, we hang them so that horses won’t be stolen.’ And that’s sort of why people pay their bond debt,” Spiotto said.

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