PHOENIX — Municipal issuers no longer consider bankruptcy to be taboo and distressed governments are increasingly likely to consider it an option, Moody's analysts said in a report Thursday.
Seven Moody's analysts examined recent municipal bankruptcies and concluded that the previously dirty word might become an increasingly popular, though still relatively rare, option for municipal issuers facing unworkable financial imbalances.
"The number of general government bankruptcies following the recession remains low, but is still remarkable compared to the long-term experience of the U.S. municipal market since World War II," Moody's said.
Four of the five largest municipal bankruptcy filings in U.S. history have been made in a little more than three years, a trend Moody's and other analysts have attributed to a slow recovery from the great recession along with changing attitudes about debt. In its latest report, Moody's said that the successful emergence from bankruptcy of cities like Detroit, and Central Falls, R.I. as well as the willingness of investors to come back to defaulting cities like Wenatchee, Wash., may further contribute to a cultural shift about default and bankruptcy.
In previous decades, municipal bankruptcies were generally staved off by interventions and loans from the state or even federal government in some cases, such as during the New York city financial crisis in the 1970s. That appears to be changing in recent years. In recent months, Puerto Rico leaders have increasingly spoken about bankruptcy as a good option, and are actively pushing for federal legislation to allow it.
"In the apparent absence of a severe or prolonged capital markets penalty, it is not surprising that various governors, mayors and other local government officials have come to consider bankruptcy as a potentially realistic and effective option for restructuring liabilities," Moody's said.
Part of the reason is the rise of growing pension liabilities. Most of Detroit's defaulted general government debt, for example, was for pension funding.
The report also notes that these bankruptcy proceedings have not been kind to bondholders.
Bankruptcies effectively pit all a municipality's creditors against one another, and pensioners have generally been getting the best of it in the limited case law available. In Stockton, for example, pensions were unimpaired while bondholders had to accept a 50% haircut. Jefferson County bondholders recovered 58%, while pensioners recovered 100%.
Municipal bankruptcy is extremely rare compared to bankruptcy in other sectors, and despite the cultural and financial shifts noted in the report, Moody's expects it to stay that way.
Less than 1.5% of Moody's municipal portfolio is speculative or "junk" grade, compared with the corporate sector where a speculative grade is Moody's median rating.
"A more frequent use of bankruptcy by distressed credits does not in and of itself alter our overall stable outlooks for the state and local government sectors, but it does underscore how the recent recession has resulted in significant pockets of pressure, ongoing challenges of balancing rising fixed costs against anti-tax sentiment and a tighter budgetary 'new normal' that is less resistant to new shocks," Moody's said.
"We expect that bankruptcy and default will remain infrequent among rated local governments and consequently expect no change to our broad distribution of municipal ratings," the agency concluded.
