CHICAGO — The state with the highest number of Chapter 9 cases in the U.S. also happens to be the state with the lowest ratio of state debt per capita: Nebraska.
The Cornhusker State has seen 62 Chapter 9 filings since 1980. That's more than any other state in the union. California comes in second, with 45 bankruptcies, and Texas third, with 38, according to James Spiotto, bankruptcy expert and managing director of Chapman Strategic Advisors.
Nebraska has continued to log the highest number of Chapter 9s in recent years, and since 1980, every case has been a sanitary improvement district.
Chapter 9 is used so often in Nebraska largely because the deals are small and the debtors are special taxing districts. The bankruptcies are relatively fast and efficient, unlike the messy and costly cases in California and Detroit.
Bankruptcy is an option in 28 of the 50 states, with efforts under way to allow entities in Illinois and the territory of Puerto Rico to file for protection. Any similarity between a Chapter 9 for a small Nebraska SID and a tarnished and a debt-heavy credit like a Puerto Rico authority or Chicago Public Schools would be in name only, experts said.
"Chapter 9 can be used as an effective mechanism, and generally it's with small municipal utilities or special tax districts that don't have a significant amount of debt," Spiotto said. "It gets more complicated the larger the municipality the most diverse and the larger the amount of debt outstanding."
Nebraska, which carries AA and AA-minus ratings, does not issue general obligation bonds. Its state debt per capita, $21, is the lowest among all the states. It is also tied with Wyoming for having the lowest percentage of debt service to government spending, at 0.1%.
In Nebraska, the SIDs have been a popular method to finance development outside of cities like Omaha. There are hundreds of SIDs in Douglas and Sarpy Counties.
The districts are initially financed with five-year warrants, and that debt is later financed into 20-year bonds if the development has value. Most deals are under $10 million in size, unrated, and seldom trade until they are later refinanced as long-term debt backed by property taxes in the district.
The original warrant issuance finances infrastructure improvements for subdivisions, and is paid off with special assessments and property taxes levied against new homes.
Under Nebraska law, warrant holders are paid back in order of registration, meaning that the first warrant holder is paid first and the last one last.
In most cases, bankruptcy plans stretch out repayment terms on the warrants, often up to 15 or 20 years from the original five years. It lowers the interest rates and sometimes also modifies interest terms to simple from compounded interest.
The Chapter 9 process has mostly worked, Spiotto said.
"It's sort of the means of a graceful death," he said. "The deals are small and this is probably the most effective way to deal with a utility that's lost its service area or isn't as successful as it should be."
Bondholders, or a local bank that holds the debt, might feel the cost of court fight isn't worth it, considering the small amount of debt involved, said Richard Lehman, president of Florida-based Income Securities Advisor and writer of a monthly newsletter on distressed muni debt.
"You don't want to make a big case out of it because the dollar amounts are so small," said Lehman. "This is one of the problems of buying in one of the small bonds — there's not enough value to pay a lawyer to go fight these things."
He wrote in his June 2015 Distressed Municipal Debt newsletter: "This is clearly something that should be addressed legislatively at the state level given the hundreds of similar defaults which will be upcoming and for which the cumulative expense to the districts to through this song and dance is clearly wasteful."
Nebraska's special districts have a long history of defaulting, and the state's agricultural district bonds were "featured prominently" in the George Hempel study of municipal defaults during the Great Depression, according to Lehman.
Unlike other Depression-era issuers, who often ended up paying creditors, the Nebraska SIDs did not, he said.
"I warn people against buying these things; if you buy a piece of it you're going to be out there alone," he said. "Sanitary districts have been a thorn in the side of the muni market for decades."