NEW YORK - In response to recent filings for municipal bankruptcy, Moody's Investors Service has provided an overview of how bankruptcies affect credit, and how bondholders are likely to fare in potential bankruptcy reorganizations.
"Municipal bankruptcy poses a number of risks for general obligation bondholders, including the possibility of a missed payment and a loss of their right to recover their principal in full," said Moody's Vice President-Senior Analyst Gregory Lipitz, author of the report. "For special revenue bondholders, in contrast, bankruptcy provides certain protections against default and extinguishment of the revenue pledge."
Alabama's Jefferson County is the latest and largest of a small group of municipal Chapter 9 filings -- the section of bankruptcy law that specifically applies to local governments -- in the last 12 months that included Central Falls, R.I., and Harrisburg, Pa., which was dismissed by the court. Detroit could emerge as the next large municipality to declare bankruptcy as the state of Michigan is reviewing the city's finances as a possible prelude to declaring a financial emergency.
Unlike corporate bankruptcy filings under Chapters 7 and 11 of the U.S.bankruptcy code, with many examples to learn from, says Moody's, municipal bankruptcies under Chapter 9 for issuers of rated debt are rare.
"The overwhelming majority of local governments that Moody's rates are sound investment-grade credits, and their risk of a bankruptcy or default is remote," said Lipitz. "When a local government does experience severe financial distress, however, the possible implications of a bankruptcy filing become an explicit part of our credit evaluation."
Also, bankruptcy and default are not synonymous for local governments, says the Moody's report. A bankruptcy filing does not always result in a default on indebtedness, and a payment default can occur independent of bankruptcy.
"Our ratings on debt of municipalities in bankruptcy will depend on the prospects for default and loss, and not on the bankruptcy filing," said Lipitz. "We consider the possible effect of a filing on the timely payment of debt service and on the ultimate recovery to bondholders."
He said the rating agency may also make rating distinctions among different classes of debt based on their likely treatment in bankruptcy.