April 3, 2012

Forget Meredith Whitney, as Muni Lawyer Predicts New Bankruptcy Wave

David Dubrow of Arent Fox points to underfunded cities with public works projects running over budget

Crippling debt for Harrisburg's $280 million incinerator has crushed the city's financing. (Photo: AP) Crippling debt for Harrisburg's $280 million incinerator has crushed the city's financing. (Photo: AP)

Predicting that the municipal bond market will soon see a new wave of Chapter 9 bankruptcy filings, a public finance attorney involved in multiple high-profile muni defaults expects to see a fresh round of implosions in the tax-exempt sector this year.

David Dubrow, a partner of Arent Fox LLP in New York who specializes in public and structured finance, is on the lookout for possible Chapter 9 bankruptcy filings by U.S. cities in 2012, especially in the states of Pennsylvania, California, Rhode Island, Michigan, Ohio and Indiana.

Financial analyst Meredith Whitney was taken to task last year by muni market participants after she predicted “significant” muni defaults and “hundreds of billions” in losses for investors. Now, Dubrow, who is closely involved in a series of such defaults, says he can see such a wave coming.

"A lot of medium-sized cities around the country remain under fiscal distress, whether from structural deficits, depressed local real estate markets, an inability to raise taxes, heavy debt loads and especially unfunded pension liabilities," said Dubrow, who heads Arent Fox's Tax Exempt Bond Recovery Group, in a statement.

The group represents major bond insurers such as AMBAC and Radian as well as bondholders and trustee clients in several high-profile muni defaults, including Stockton and Hercules City, Calif.; Harrisburg, Pa.; and Central Falls, Rhode Island.

Dubrow pointed to big-ticket public works, from sewer systems to waste disposal projects to new hospitals, that have ended up costing much more than projected, with less revenue available to cover their costs. The crippling debt for Harrisburg's $280 million incinerator, for example, has weighed on that beleaguered city for years, and last month the city’s court-appointed receiver resigned under a cloud.

"It's not that conditions are necessarily becoming more dire that will force a new crop of cities into bankruptcy," Dubrow said. "To the extent that some of the recent municipal bankruptcies can be successfully resolved in the view of the tax-exempt marketplace, that could represent a model of success that paves the way for other cities to follow suit with their own filings.”

Central Falls in Rhode Island could be the case to watch as a bellwether Chapter 9 in 2012, he says. Central Falls filed for bankruptcy last year and is now under state receivership.

Due to marked differences in state law, some cities fare better than others by declaring bankruptcy, according to Dubrow. In Rhode Island, where Providence, East Providence and Pawtucket are among the highest-risk cities, he notes, a law was passed in 2011 giving general obligation bondholders first-lien claims on all taxes and revenues, thus giving bondholders priority over local unions in getting paid in any restructuring.

Dubrow explains that Rhode Island recently created a statute giving a state-appointed receiver emergency powers to take over city finances and negotiate collective bargaining agreements and other contracts with municipal workers in the event of a default. Such authority, including the receiver's ability to file a Chapter 9 petition over objections of the city council or mayor, may be critical in maintaining public worker payroll and essential services for residents.

"Even though its cities are some of the most precarious in terms of financial health, Rhode Island has put a legal regime in place that could minimize the pain and stigma of a bankruptcy filing and actually facilitate a positive outcome for stakeholders," Dubrow says.

In contrast, he points to the lack of legal clarity in Alabama, where Jefferson County has struggled in the wake of its own Chapter 9 filing last November under the weight of a $3 billion sewer financing.

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