SOURCE: Breckinridge Capital Advisors

Breckinridge Capital Advisors

February 07, 2011 09:28 ET

Breckinridge Capital Advisors Challenges State-Level Bankruptcy

Leading Investment Advisor Calls for a Focus on Local Government Insolvency

BOSTON, MA--(Marketwire - February 7, 2011) - Breckinridge Capital Advisors, Inc., a Boston-based fixed income manager, today called for a focus on local government insolvency, in sharp contrast to Congressional interest in creating a state bankruptcy chapter. It also offered the top five reasons why states do not require bankruptcy protection and the top three insolvency law reforms that would most benefit the municipal bond market. 

"A federal bankruptcy chapter for states really isn't necessary," said Adam Stern, municipal bond analyst for Breckinridge Capital. "A more effective approach would engage state lawmakers who largely control the insolvency rules for their local governments. A few straightforward changes could help improve liquidity, reduce uncertainty, and ensure that low-cost capital is directed to the most creditworthy local governments."

This month, Congress will hold hearings to discuss how to alleviate state and local fiscal burdens. Among other things, lawmakers will explore whether states should have access to the bankruptcy courts. Breckinridge Capital thinks that reforms to existing municipal insolvency rules can help, but state reforms are unnecessary for the following five reasons:

1.) States' debts are manageable. State and local borrowing comprises 16 percent of gross domestic product, well within the post-1978 range of 12-18 percent. Principal and interest costs consume less than 10 percent of budget in most states, and states rarely rollover their debt with new bonds. 

2.) States' unfunded pension and retiree healthcare obligations are growing, but they remain a manageable medium- or long-term problem. In 2009, pension fund contributions comprised less than five percent of state revenues and pension plans held assets sufficient to finance 13 years of benefits.

3.) The threat of a bankruptcy filing is not required to spur renegotiation of employee-related obligations. Nearly every state enacted pension reforms in 2010.

4.) Labor unions are agreeing to pension reforms in the absence of state bankruptcy legislation because it is in their best interest. Unions are very unlikely to threaten a bond default or continued balance sheet deterioration. Access to the capital markets ensures fewer layoffs and givebacks for union members.

5.) Legal protections for pension and retiree healthcare obligations are more ambiguous than commonly thought. Some states construe pension benefits as mere property interests or gratuities, providing limited protection for public employees. Collective bargaining agreements and doctrines like state sovereign immunity complicate rules. In a fiscal emergency, states may have the ability to scale back benefits.

"States are in adequate financial condition, and the political process and existing laws are sufficient to resolve the pension and retiree healthcare obligations," noted Stern. "But at the local level, in some instances, we see more severe financial stress, and local politics and laws are not always conducive to settling employee-related debts. It is at the local level that reforms could prove beneficial. A few reforms could strengthen the municipal bond market and reward responsible local governments."

Municipal insolvency is a state-by-state process that sometimes involves the federal courts. Twenty-seven states authorize their local governments to file for federal bankruptcy protection, allowing local governments to restructure their debts through state distress laws or file for Chapter 9 of the federal bankruptcy code. In the remaining 23 states, municipal insolvency is governed by state law, often relying on control boards, receivers and low-cost loans to assist struggling municipalities.

Breckinridge Capital suggests three reforms that would immediately benefit municipalities, investors, and taxpayers:

1.) States should classify local general obligation bond obligations as "statutory liens" for the purposes of the federal bankruptcy code. This change would strongly insulate bondholders from impairment where pension or retiree healthcare obligations overwhelm local government. Under current rules, some states' local general obligation bonds are treated as unsecured creditors in a bankruptcy proceeding.

2.) States should reiterate that "intercept" clauses will be enforced if a local government seeks state or federal insolvency protection. Many states employ "intercepts" to ensure that weaker municipalities can access the bond markets, but investors are uncertain how these clauses will be treated if there is an uptick in default rates.

3.) States should bolster their municipal oversight procedures to ensure intervention before financial distress metastasizes. Sound monitoring of local governments' finances has been linked to lower borrowing costs.

"The current municipal insolvency rules lack clarity and inject uncertainty into the bond market," added Stern. "These reforms could help stabilize municipal finances immediately by reducing uncertainty, improving liquidity and ensuring that capital continues to flow to financially sound municipal borrowers. Better yet, they are all are achievable by state legislative action, alone."

About Breckinridge Capital Advisors, Inc.
Breckinridge Capital Advisors, Inc. is a Boston-based Registered Investment Advisor specializing in the management of customized fixed income portfolios. With over $13 billion under management, the firm works to help individuals and institutions invest in communities with taxable and tax-free municipal bonds. For more information, please visit

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