Issuers See Less Shame in Default, Panelists Say

LAS VEGAS — Municipal bond issuers now may be more open to declaring bankruptcy and defaulting on loan payments, panelists said at the National Federation of Municipal Analysts annual meeting here Thursday.

“I get the feeling the market is a little more forgiving now. I’m not sure the stigma [attached to bankruptcies and defaults] is quite as bad” as it was, said Richard Larkin, director of credit analysis at Herbert J. Sims & Co.

“If there is less stigma, [issuers] are more willing to say, 'Let’s pull the trigger and get out of this [with bankruptcy],” added Larkin, one of three panelists at a morning session titled “The Big 3 — Man-Made Disasters That Changed Public Finance History.”

The panel also included Bennett Murphy, partner at law firm Dewey & LeBoeuf LLP, and Daniel Pope, history professor at the University of Oregon.

Discussion focused on three notable municipal financial meltdowns: the 1975 New York City fiscal crisis, the $2.25 billion default of the Washington Public Power Supply System in 1983, and the mid-1990s bankruptcy of Orange County, Calif.

Pope, who wrote the book “Nuclear Implosions: The Rise and Fall of the Washington Public Power Supply System,” said the WPPSS default set a precedent.

The agency was created to fund the construction of five nuclear power reactors, but ran into trouble from the start. In addition to inaccurate estimates of future power demand, the authority faced economic and regulatory challenges, “an amateur board of directors,” a “small and provincial managerial staff” and bad labor relations, Pope said.

WPPSS ended up building only one reactor and defaulted on payments for its Projects 4 and 5 bonds after the Washington Supreme Court relieved 88 utilities of their obligation to make payments on the $2.25 billion of debt. “To some extent, that made some issuers think, it’s not unthinkable that we default,” Pope said.

Larkin said another market change has made bankruptcies and defaults more acceptable — an increase in the number of sophisticated financial executives working in the municipal market. He said many of them have experience in the corporate sector, where bankruptcies are often viewed as effective and viable means of reorganization. Companies that emerge from bankruptcy are often stronger and owe less debt, Larkin said.

“We are getting more sophisticated financial people involved now, particularly in hedge funds, who bring the style and attitude of the corporate market to the bond market,” Larkin said, “In the corporate market, you can have an airline declare bankruptcy, and people are lining up to lend them money.”

Increased tolerance of defaults and bankruptcies means municipal analysts should be more vigilant, and may lead analysts to “look for higher yields because the chance of defaults is higher,” Larkin said.

The panelists added that the financial crises in New York, Washington State and Orange County have positively affected the industry.

Larkin said New York City’s crisis “started the first push for disclosure,” noting that before the crisis some official statements were only four pages long. In addition, New York’s financial collapse encouraged the Governmental Accounting Standards Board to begin creating standardized accounting practices. The crisis, he said, “highlighted the need for cash-flow analysis, to understand how cash comes in and goes out.”

In addition, Larkin said the Big Apple’s meltdown created the need for municipal analysts.

“The analysts in the NFMA can thank New York’s financial crisis for their career. The sins of New York provided the fodder that reshaped municipal credit analysis in the modern era,” he wrote in a document provided to conference attendees.

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