Where will the next major municipal bond default occur? While there are several definitions of default, Learn Bonds likes the one used by the major credit rating agencies. A default is when bondholders don’t receive their money (interest or principal) on time.
This year there have been several headline grabbing municipal bond defaults occurring Stockton, Harrisburg, and Jefferson County. Stockton, a city in California, in February 2012 decided to default on $2 Million in payments to bondholders. Harrisburg, Pennsylvania in March 2012 defaulted on $5 Million in payments to bondholders. Last but not least is Jefferson County, Alabama which defaulted on a $15 Million payment in April. What do these three defaults have in common? In terms of geography, nothing. Each default occurred in a separate part of the country: west coast, north east and south east. But is there an area of the country where we are more likely to see a default of a city, county or school district?
In order to find out, my first call was to the rating agencies. I contacted all three of the major agencies and asked them which state had the most municipal issuers rated below investment grade. Moody’s was able to quickly provide me an answer. New Jersey and Michigan currently have 4 municipal issuers rated below investment grade. As I am a New Yorker, my interest was peaked by New Jersey, the fictional home of Tony Soprano and the actual home of Governor Chris Christie. (It should be noted, that since my initial request Moody’s has upgraded Collingswood from non-investment grade to investment-grade. So technically, New Jersey is not the worst.)
I thought it would be interesting to examine the particular details of how a couple of these New Jersey municipalities got into trouble. Were there any overarching themes or was each its own unique story?
Moody’s Rating: Ba3 Outstanding GO Debt: $32 Million
In 2007, the City of Salem decided to revitalize its downtown by building a major office building known as the “Finlaw Project”. The city guaranteed the debt for this project taking on over $19 million in obligations, and tripling the cities potential debt liabilities in the process. Like every construction project, there were delays in completion, which forced the city to step in with support to pay interest payments. The project now seems to be able to support its bond payments without the city’s assistance. However, the city’s population is not in a great position to support its debt if there are more problems with the project. Salem has a small population of about 5,000, which makes less than 2/3rds the average per capita income in the United States.
Moody’s Rating: Ba2 Outstanding GO Debt: $24 Million
The biggest taxpayer in Harrison, or should I say the biggest non-taxpayer in Harrison, is the Red Bull Arena. The stadium which houses the professional soccer team the New York Red Bulls (owned by the high caffeine energy drink of the same name) owes the city $1.2 million in current and delinquent property tax payments. Although ordered by the courts to pay, the stadium has yet to send funds to the Town. I will bet that a lot of the city’s debt comes from providing incentives to the team so they will call Harrison home. Be careful what you wish for!
Moody’s Rating: Baa3 Outstanding GO Debt: $31 Million
Collingswood is a wealthy suburb of Philadelphia, with a tax base of $1.1 Billion. The almost 14,000 residents have an average per capita income 25% higher than the rest of America. However, the borough took on lots of debt obligations trying to spur economic development, including guaranteeing $4.5 Million of an $8.5 million condominium development project. The project did not work out as anticipated, and the borough was required to make a payment on May 1st, 2012. The borough was able to re-finance this obligation through the sale of a tax anticipation note. With this out of the way, Moody’s upgraded the borough’s rating.
What’s the common theme among all of these New Jersey stories? To spur local economic growth, the city, town and borough guaranteed loans or provided big incentives for real-estate development projects. While I am not saying avoid all municipalities that have big obligations from building an office building or stadium, I would be very careful.
For more information on municipal bonds, visit the municipal bonds section of Learn Bonds.