Reports from Bloomberg were that Pennsylvania Governor Tom Corbett and the Harrisburg City Council are in a standoff resulting from Harrisburg’s filing of Chapter 9 bankruptcy last week. The governor is looking to overrule the city council’s action and have the Commonwealth of Pennsylvania take over the finances of the city.
The story – often reported by our friends at Cumberland Advisors – is that of an incinerator that was not needed, but built as a boondoggle. After failing to attract enough business, the city decided to spend much more money retrofitting the incinerator, putting the city’s pledge behind the bonds used to finance and retrofit. This turned into a disaster. The city stopped making payments on the incinerator debt last year. With much consternation and discussion, they have continued to pay debt service on their general-obligation bonds.
Last week the city council voted to declare Chapter 9 bankruptcy for Harrisburg, even though the Mayor of Harrisburg was against it and the Commonwealth of Pennsylvania itself had passed a law declaring that it would be illegal for Harrisburg to declare bankruptcy.
There is now a court-mandated delay of a month to sort this out. On Monday, a judge for the US Bankruptcy Court in Pennsylvania set a November 23 court date to settle the legality of the bankruptcy declaration by the council.
Why is the state moving as if the matter has already been settled in its favor? It’s not just the politics, it’s the state not wanting Harrisburg’s woes to result in much higher borrowing costs for towns and cities in the rest of central Pennsylvania.
What do we see reflected in the municipal bond market, given the current state of affairs?
Most of the Harrisburg general-obligation debt is insured. Ratings on Harrisburg itself have been withdrawn by the rating agencies. Bonds backed by Assured Guaranty, the healthiest of the bond insurers (AA3 Moody’s and AA+ Standard and Poor’s) are trading at 5.5% to 6%. Bonds from downgraded insurer MBIA (now National RE), rated Baa1/BBB, are trading in the 6.25-6.50% range, and bonds with other insurers who are below investment-grade and have no rating are all over the lot, with trades in the 7%-plus range (levels courtesy of Oppenheimer). This is in a world where longer-maturity, high-grade Pennsylvania debt is trading in the 4.5% range.
The one thing we know for sure is that the bond insurers come down squarely of the opinion that Harrisburg has NOT taken the necessary steps to avoid bankruptcy: raising taxes, selling assets, and using their full faith and credit to pay their bonds.
So far, this has not carried over to the state’s own bonds, as far as any patina of higher yields associated with the problems of Harrisburg. The state sold bonds this week at their normal high-grade level.
Stay tuned as this develops.
Reprinted by permission from our friends at Cumberland Advisors