In 2003, the City Council in Harrisburg, Pa., voted 6 to 1 for a $125 million loan to fix up its local incinerator, formally known as the Resource Recovery Facility.

Little did city officials know at the time, but the trash burner off of 19th Street would become the face of an investment gone bad.

Eight years later, that bond debt has ballooned to about $310 million, and Pennsylvania’s capital city finds itself in bankruptcy court and faces a possible state takeover.

Many bond analysts point to the incinerator as Exhibit A in the perils of so-called enterprise risk. Such public enterprise ventures are drawing greater scrutiny from the major credit rating agencies, who say the problem is deepening.

Troubled public enterprises “illustrate the risks that public enterprise operations impart to local governments,” Moody’s Investors Service said in a report. “One common thread among these troubled enterprises is that they all operate in sectors that have ample competition from non-public organizations.”

Moody’s also cited a real estate venture that left the borough of Collingswood, N.J., on the hook and triggered a six-notch ratings downgrade to junk level by the agency, and a nursing home that Moody’s said is straining the budget in Strafford County, N.H.

“Enterprise risk has been part of our analysis for a long time, but it’s been more topical lately because we have had these high-profile situations,” said Geordie Thompson, a vice president and senior credit officer at Moody’s.

Many investments seemed safe enough at the time. Others had problems that for a long time stayed under the radar.

“In Harrisburg, I wonder if the incinerator situation would have gotten this bad if the bonds were uninsured,” said Alan Schankel, a managing director at Janney Capital Markets in Philadelphia. “Then the rating agencies would have gotten involved sooner. Because Assured Guaranty was providing such good backup there wasn’t any real public disclosure, except for a couple of reports from Harrisburg.”

Assured Guaranty insured the bonds to rebuild the incinerator through the Harrisburg Authority, while the surrounding Dauphin County guaranteed them.

Mark Schwartz, the Philadelphia-area lawyer representing Harrisburg’s City Council in its bankruptcy filing, was an investment banker in the 1980s.

“Bond insurance was a great gig back then. You made a lot of money and there were never any payouts expected,” he said in an interview.

The economic downturn that began in 2008 worsened projects that may have been iffy in the first place.

“It’s the convergence of some municipal undertaking of some of these enterprises with a sharp reduction of municipal revenues,” Schankel said. “Harrisburg is stuck with incinerator debt, while the overall economy and their own wealth metrics are in decline.”

Former Harrisburg City Council member Eric Waters, who voted for the loan, said recently he would have changed his vote. Concerns at the time over the trash burner four miles from downtown were environmental and locational, not financial.

“We were assured the debt would be taken care of quickly and would be manageable. Looking at the state of the city, you wish you could reverse decisions. But in 2003 things were urgent and interest rates were perfect,” Waters told a Harrisburg television station.

The city’s mayor, Linda Thompson, voted for the loan in 2003 while serving on the council.

She said she and others on the council didn’t know there was no performance bond, which ensures payment by a winning bidder should a contractor fail to deliver on a contract.

The first contractor went bankrupt in mid-project, and Harrisburg was on the hook.

“That’s the only sticking point, that I wish I had known there was no performance bond,” Thompson said. “And if I had known there was no performance bond, I would have stayed at the table and made them have a performance bond.”

Harrisburg last month came dangerously close to missing its municipal payroll, and two general obligation bond payments worth a combined $3.3 million.

In mid-September, the city worked out an 11th-hour agreement to extend a lease agreement with the Harrisburg Parking Authority in exchange for an upfront payment.

To make the lease payment, the Parking Authority took out a $10 million bank loan through 2026 at an elevated interest rate of up to 10.75%.

The loan was a credit negative for the authority, according to a Moody’s report. The bank loan “saddles the authority with expensive debt that it will be required to service out of its own revenues,” analysts noted

The Harrisburg City Council last week filed for Chapter 9 protection in a case replete with financial, legal and political complexities.

Municipal-supported enterprises usually involve essential services such as sewer and water utilities, which are natural monopolies.

Less essential ventures, such as real estate, golf courses or water parks, are more risky.

“Retail investors and institutional investors have to look at each issue and be careful,” said 30-year bond industry veteran William Mason, executive vice president of fixed-income trading at David Lerner Associates Inc.

A real-estate related loan left New Jersey’s Collingswood on the hook. On Sept. 12 the borough, located seven miles outside Philadelphia with a population of 14,000, received a six-notch downgrade from Moody’s to Ba1, or junk status, from A1, affecting $27.8 million of outstanding rated debt.

The municipality, which has a population of around 14,000, is a guarantor for an $8.5 million redevelopment loan on the failing LumberYard condominium project.

Mayor James Maley and other municipal officials say Moody’s acted hastily, and in fact met with the agency two weeks ago seeking a revision after the town secured a 60-day extension to Dec. 7 of $8.5 million owed to the Thrift Institutions Community Investment Corp.

“This came out of the blue,” Maley said of the rating agency’s action.

But critics still question why the borough involved itself with the project in the first place.

“Most municipal entities are noncompetitive — water and sewer, for instance. But there are other kinds that local governments typically stay away from,” said Geordie Thompson of Moody’s. “These have some private sector or nonprofit presence and they’re more open to the competitive nature of the marketplace”

Some projects began, either conceptually or in earnest, before the recession. Maley, in fact, said the first 50 Lumber Yard units sold within six months, pre-2008.

“Over time, we have been way out front in investing in properties for the good of the town,” the mayor said in a video message to voters.

Maley cited conversions of school and gas station sites to rentals as success stories.

“I drive past the Collingswood development a lot because I live near there,” said Janney Capital’s Schankel. “If the real estate market hadn’t collapsed, the thing would have been a success and everyone would have been patting themselves on the back.”

A Moody’s report also cited a nursing home in Strafford County, as a “troubled enterprise,” although an official in the southeastern New Hampshire county denied that the Riverside Rest Home in Dover consumes two-fifths of the county’s operating budget.

George Maglaras, chairman of the county’s Board of Commissioners, said Moody’s misgauged an accounting system that caused confusion.

“It is what it is. There are no smoke and mirrors,” he said. “A $36 million deficit? That’s not accurate.”

According to Maglaras, Strafford has a $3.5 million operating deficit, all of which is covered by property tax receipts. The county’s operating budget, he said, is $52 million.

Raye Kanzenbach, a senior managing director for RBC Global Asset Management, said municipalities sometimes get too ambitious.

“Then the project doesn’t work as expected,” he said. “They encounter technical problems or the expense becomes much more difficult that it’s out of control and not self-supporting. The locality figures, 'If we put our guarantee on it, the price will go down a couple of hundred basis points.’ ”

“To me, if the project is too big to be absorbed by the municipality, then the risk is probably too big for municipalities and bond buyers,” Kanzenbach said.

“Both sides need to be fairly risk-averse. Municipalities should not take drastic risk and bond buyers should take reasonable risk in buying fixed-income securities.”

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.