For the most part, 2011 has seen the municipal bond market return to a state of normalcy, from the Meredith Whitney-led meltdown of last winter.
The year has seen a decline in the number of municipal defaults versus last year. Also, municipal tax receipts – from income taxes as well as sales taxes – on the state level are about to print their sixth quarter in a row of RISING tax receipts-this after a decline of five quarters in a row, in the midst of the fiercest part of the recession. Local government taxes in general are still declining on an overall basis, as property taxes are now catching up with property values in many areas – although in general, local property taxes tend to be more stable than income and sales taxes at the state level. The overall picture for state and local governmental units is quite good and is almost back to the levels of early 2008, when declines first began.
There are, though, a handful of well-publicized municipal problems: Harrisburg, PA; Vallejo, CA; Central Falls, RI; and Jefferson County, AL.
Here is a brief update on these hotspots.
Harrisburg has been feeling the pain from building an incinerator that they did not fully need and which went way over budget. Bonds used to build the incinerator have been having interest paid by the bond insurer, Assured Guaranty, who is negotiating for payment from Harrisburg. Under Pennsylvania’s Act 47, Harrisburg has had its status declared as distressed. This means the state is now coordinating with the city to formulate a recovery plan. The state of Pennsylvania does not want to see Harrisburg declare bankruptcy, as this would affect other central Pennsylvania municipalities, as well as Dauphin County, which is owed $75mm from the city. The state is exploring budget cuts as well as tax increases to solve Harrisburg’s problems, which have been compounded by a city council that has been unable to agree on an approach and rejected the state’s plan. Some Harrisburg bonds have been trading in the 8% range, while some of their insured 10-year bonds have been trading in the 5% range, or more than 200 basis points over scale.
Jefferson County, AL
Jefferson County, AL is also looking to avert bankruptcy. Jefferson County, under a federal court order, rebuilt its sewer system, which was failing. Many of the bonds they issued (most of which were insured) were tied to derivatives. When most of the bond insurers’ ratings were downgraded during the financial crisis, Jefferson County’s interest-rate costs skyrocketed. Some local officials have been convicted of corruption charges, and some of the banks that constructed the bond structures have settled with the Securities and Exchange Commission, which investigated the situation. The state itself has stepped in and is looking to craft a solution. The county is negotiating with creditors who own approximately $3 billion of variable-rate warrants on which the county has been defaulting. An appointed receiver has proposed a large sewer fee increase but has encountered severe backlash from county residents. The uninsured bonds that exist are trading at roughly 3% over stated scales.
Central Falls, RI
Central Falls, RI, a very small community in Rhode Island, filed for Chapter 9 bankruptcy on August 1st. The city has been plagued by high pension costs, and though municipal taxes were raised, they were not enough to pay the city’s debts. The state has been in control of the city’s finances since last summer, when it stepped in and stripped the mayor of his authority; but that did not stop the Chapter 9 filing. The city has been negotiating with police and fire unions to get some voluntary concessions and to have retirees accept some voluntary reductions, but these talks have not produced meaningful results.
There have only been a small number of trades in Central Falls, RI bonds in the past few months, in the 7.5 to 8.5% range. Central Falls’ general obligation bonds continue to be paid as per a state order.
Vallejo declared bankruptcy in 2008, for similar reasons of unmanageable police and fire pensions, salaries, and benefits. After negotiations with unions and creditors, Vallejo is now seeking to emerge from that bankruptcy. Vallejo has been paying the debt service on their bonds, as mandated by a judge. Under the reorganization plan, a large owner of certificate of participation bonds is accepting a reduced amount and National Public Finance (formerly MBIA), an insurer of some of Vallejo’s bonds, is accepting a reduced interest rate, although insured bondholders are paid the original rate. This plan doesn’t alter securities tied to designated revenue sources such water revenue bonds – see our piece from May:
Some of Vallejo’s school-district and water bonds have been trading in the 7% range.
While clearly most municipalities and issuers are in much better financial shape than two years ago, these “hot spots” continue to be a source of concern in the Muni market. We will update as things continue to develop.