Mapping The Mounting Muni Meltdown
Many local governments across the US face steep budget deficits as they struggle to pay off debts accumulated over years. Increasingly, as a last resort, some have filed for bankruptcy. There have been 26 municipal bankruptcy filings since 2010 and the pace is clustering, as Governing.com is keeping track. As Citi's George Friedlander noted (and we discussed here), technicals (net flows) are still dominant and dragging yields lower and spreads tighter; in spite of contagion fears from cities with clear economic problems (specifically those in CA with severe housing price collapses) and also general fund debt that is not secured by a G.O. pledge. However, with the August 'cliff' in redemptions clearly not priced in yet - as fear has driven momentum into bonds recently - we fear more than a few will be wrong-footed when the net flow shifts.
Municipal Bankruptcies Map
The map below shows all municipalities filing for Chapter 9 bankruptcy protection since 2010, along with local governments voting to approve a bankruptcy filing. Cities, towns and counties are shown in red. Utility authorities and other municipalities are displayed in gray.
This week, the city of Compton, CA (population approx 92K) reported a budgetary squeeze that could lead to bankruptcy. Officials announced during a city council meeting that Compton could run out of funds by Sept. 1, 2012. Compton currently has a deficit of $43 million and has depleted a $22 million reserve. While allegations of fraud and improper use of public monies loom over city officials, the fact that the city has witnessed a sharp decline in property taxes (and foreclosures) in recent times has only exacerbated its budgetary crises. As for impact on the yield levels on other credits within the state, there appear to be two types of "contagion," and little impact elsewhere:
- Bonds issued by cities with clear economic problems and, in particular, a severe housing price collapse are trading less well than before. This includes, in particular, communities in the "Inland Empire" that were at the far edges of growth when the housing bubble began to burst, including those that have been in the headlines recently: Stockton, San Bernardino, Fresno, and the smaller community of Mammoth Lakes.
- Debt that is unlikely to be affected by a Chapter 9 filing but is secured by a city with severe budgetary pressures is being pulled down to a degree that may, in many cases, is disproportionate to the actual risk. We stress that the debt most at risk in most cases is general fund debt that is not secured by a general obligation pledge, including leases and certificates of participation. Bonds secured by what are considered to be “special revenues" under the bankruptcy code are likely to be outside the scope of the bankruptcy. Nevertheless, this type of debt suffers from "guilt by association," but also from the possibility that ratings could be cut substantially while the bankruptcy of a given city is worked through. The bottom line is that there are likely to be some attractive offerings among issues that are subject to this type of contagion, but are likely to be dollar good. Trading in this type of paper tends to be thin and erratic, however, and attractive offerings may be difficult to find.
It is important to stress that aside from bond issues suffering from these two types of contagion (as well as redevelopment agencies, which have another set of problems entirely), local debt in California continues to elicit strong demand and trade at reasonable yield spreads to the triple-A market.
And Yet, Spreads Continue to Tighten
The state of New York is on track to beat California for the largest issuer’s title for the second year in a row (Figure 5), an event which has occurred only twice before since 1991 (1998 and 2011).
As we mentioned even last week, despite the recent negative developments for these local California credits, yields on Cal GO paper have yet to reflect any impact from these events . Spreads vs. AAA MMD for 10YR and 20YR Cal GOs have actually tightened 7bp on an average over the ten business days.
Thus, we do believe that technical factors remain the predominant factor, and we expect Cal paper will remain well bid in the face of a lack of new issue supply.
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