Another one bites the dust? Part 4, Climbing out of the hole

April 9, 2010 | Chapter 9, Cities, Harrisburg, Municipal finance, Pennsylvania, Sovereign bankruptcy, Speculation, US News

[Continued from yesterday’s Part 3 and the previous Part 1 and Part 2.]


By: David A. Smith


By now, it’s clear that the Fiscal Times‘s story of Harrisburg‘s bond problems is only the beginning of another lengthy and protracted tale, full of words and fury and signifying writedowns.  The city has two huge cards to play:


1. It legitimately cannot pay its debts, and will be defaulting later or sooner – probably sooner.

2. If the city enters Chapter 9, it can more or less compel its creditors to take the terms it dictates.


As I figure it, there are six partiers at interest in Harrisburg‘s insolvency, who’ll be taking these pre-bankruptcy positions.


[Twenty years ago, I wrote an article, When Bankruptcy is the Best Survival Strategy, that’s still decently relevant. – Ed.]



Got to decide which functions are essential, and which optional


1. The city. The city is the debtor.  In Chapter 9, as we saw yesterday, it will have very considerable leverage over the creditors, since it cannot dissolve, cannot be dispossessed of operating control, and cannot easily be forced to sell peripheral assets (like City Island or the National Civil War Museum). 


Still, before she can take the city into bankruptcy, Mayor Thompson has to establish a judicial record of good-faith negotiation.  That includes searching the municipal sofa cushions for any available resources:


Thompson also said that Harrisburg is tapping reserve funds to service the debt, but warned that “there is not a lot of money left” for payments this year — leaving the business community in Pennsylvania’s capital nervous about whether default is in the offing.


In the case of Dubai World, we saw that the default threat got people’s attention, and that having gained it, Dubai dodged default [At least until April – Ed.].  Presumably the Mayor will do something similar, although since her city cannot be dissolved, she has less motivation to defer default than a private debtor would.  From the Bond Buyer:


The Harrisburg Authority’s incinerator debt has enough funds in its debt-service reserve accounts to meet a March 1 payment to investors, according to Assured Guaranty Municipal Corp.


2. City taxpayers.  They have a known future.  The Mayor and city council will raise all taxes, but only so much that the cows do not revolt:



Note to Mayor: avoid signs like this


Doubling the property tax in Harrisburg in 2011 is an option consultants offer for helping to dig the city out of its financial hole.
Mayor Linda Thompson on Tuesday proposed a 2-mill increase in the tax among recommendations to the City Council for 2010. She hasn’t ruled out further increases in 2011 and beyond.


Thompson also proposed increasing water rates by 40% –


Which will almost certainly go through. 


3. City service recipients. Their future is also easy to predict. They will receive less, and pay more for it:



We want you, but not on overtime


– while cutting overtime for police and firefighters and for neighborhood services such as streets, traffic and storm maintenance.


The city has to take these steps to establish exhaustion of pre-insolvency remedies, and to establish a judicial record of good-faith negotiations – or at least, negotiations that can be colored as good faith:


Thompson said that she is negotiating with the bondholders to reduce the debt load –


Here’s where it will suddenly get very interesting.


4. The bond guarantor.  Evidently much of Harrisburg‘s bond debt is guaranteed by Assured Guaranty.  For decades, smaller municipal issuers have availed themselves of external credit enhancement via monoline insurers (as they are called) such as AMBAC, MBIA, and Assured Guaranty.  Two of them are now on the sidelines:


Main rivals Ambac Financial Group Inc. and MBIA Inc. have written virtually no new business in the past year after multiple rating agency downgrades as both struggle with growing mortgage-related losses. Berkshire Hathaway Inc. entered the market with its own municipal bond insurer over a year ago, but has been cautious about writing much new business.


For Harrisburg, AGM is the only game in town. 



What’s behind the name?


From the Bond Buyer:


AGM insures $195.5 million of outstanding Harrisburg Authority resource recovery facility revenue bonds.


Obviously these are secured bonds within the meaning if Chapter 9 (see Part 3), and as guarantors do, Assured in turn got a comprehensive indemnity from various government parties:


Of that amount, Harrisburg and Dauphin County together guarantee $104.7 million, while the city is the sole obligor on the remaining $90.9 million.


So the county’s on the hook too.  That means all those suburbanites who thought they were safe, aren’t.





The authority issued the debt insured by Financial Security Assurance Inc. and secured with Harrisburg‘s pledge. AGM’s parent, Assured Guaranty Ltd., finished its purchase of FSA on July 1.


Assured bought this problem.  If their due diligence was worth a hoot, they should have seen this coming, and reserved against it – which they did, booking $1.6 billion of premium discount.


“AGM does not expect to pay claims on the next debt-service payments, which are due March 1, 2010, as the relevant series currently have sufficient cash in their debt-service reserve funds to cover the March 1 payments,” according to the insurer.


Knowing that Assured got an indemnity from Harrisburg makes this statement more entertaining:


– and argued that the bondholders bear some responsibility for the city’s fiscal straits because they lent money to a locality that has long had financial problems.



Interesting argument …


In the same manner as a drunk driver who sues the bartender, or a gambler who successfully argues the casino’s extending of credit induced him to gamble, and therefore he should be relieved of his debts – a case that a developer I knew won – Mayor Thompson is busily laying the groundwork for a defense to the Assured indemnity, arguing that they should pay on the guarantee because they signed it, and she should not have to pay because her predecessor was bamboozled.


A spokeswoman for Assured Guaranty, a New York-based firm that is the ultimate insurer of the bonds, said the firm is “working with the folks in Harrisburg on finding a solution,” but insisted that its guarantee of the Harrisburg debt is firm.


Assured’s a large company – in late March its market cap was $4.0 billion – but its leverage is very large, judging by just one quarter’s new issues:


In the third quarter, Assured Guaranty insured $8.7 billion in U.S. municipal new issue debt, or about 9.6% of the total issued in the quarter.



Really, we’re managing it!


As a counterparty, it’s not without risk, having recently been downgraded:


The ratings outlook is negative … these rating actions reflect the effect of Assured’s capital restructuring.  Moody’s review of AGC’s and AG RE’s IFS ratings initiated on November 12, 2009 focused on the successful execution of Assured’s plans to bolster the weakened economic and regulatory capital position of AGC stemming from mortgage related losses.  … Since then, Assured has completed a $575 million common stock issuance and has indicated a portion of the proceeds have been downstreamed to AGC. 


The municipal subsidiary is fairly strong:

Of Assured Guaranty’s three main insurance businesses, Moody’s affirmed the rating on its municipal finance insurer Assured Guaranty Municipal Corp., but maintains a negative outlook. Moody’s downgraded Assured Guaranty Corp., to Aa3, from Aa2 and downgraded the reinsurance unit, Assured Guaranty Re, to A1, from Aa3 on the lack of business opportunities to reinsure other insurers. Both remain on review for an additional downgrade.


Obviously the guarantor is going to make a major payment on these bonds, but there will be a considerable tussle between guarantor and city – with the great Commonwealth of Pennsylvania looming large in the background, watching how the guarantor treats its miscreant municipality.


5. The state. A city that is also a state capitol is the ultimate illegitimate son, never out of the parent’s eye, but never fully in the parent’s confidence.  Always on the parent’s financial leash, but never able to tap the parent’s checkbook.



Now, Number 1, I have nothing to do with Harrisburg‘s finances


Understandably, the state is doing everything it can to avert its eyes from Harrisburg‘s problems:


For now, Ed Rendell, the governor of Pennsylvania, is keeping his distance from the fiscal crisis in the state’s capital –



City Hall’s that way


Because if he sticks up his hand, he’ll be expected to bail something out.


though he has met with the mayor and urged her to start slashing spending.


Brave Sir Robin!



When danger reader its ugly head

He bravely turned his tail and fled

Brave, brave, brave, brave Sir Robin!



Do what I say, not what I do!


6. The bondholders.  Now we come to the creditors.  We’ve seen already that Chapter 9 – if the city elects it – gives them nothing they cannot already have secured.  Of course, should there be a default, they will do everything they can to cut a new orifice in the guarantor … but most likely without success.



Just grin and bear it, fellas


As with the Dubai World creditors – for that matter, the creditors of the future George IV – the end result is likely to be a stretched-out repayment period.



Make your pennies go farther


A good bipedal negotiation walks on two legs: one leg of threats, one leg of concessions.  Mayor Thompson and Comptroller Miller are off to a good start – putting Chapter 9 squarely on the table, and making clear they will do it. 


I lack the information to figure out the right answer – that will appear in the fullness of time.  But structurally, here’s the solution:


Harrisburg‘s recapitalization


1. City sells all marketable assets, and privatizes management of the rest.

2. City raises taxes.

3. City cuts services. 

4. Assured Guaranty makes large payment (maybe 55%) on the guaranteed bonds.

5. Pennsylvania contributes new ongoing subsidy, possibly in the form of discreet governmental transfers.

6. Bondholders agree to an extended repayment schedule at favorable interest rates.

7. City, with a straight face, promises never to do it again.


And the City never files Chapter 9.


You read it here first J.



Know before your friends do!