A recent wave of high profile Chapter 9 bankruptcy filings by municipalities in California and elsewhere has heightened the concern of many bondholders and other parties involved in municipal credit markets about the potential negative impact of such filings on an issuer’s municipal bond obligations. This year, the cities of Stockton and San Bernardino, Calif., have filed for bankruptcy, and several other large U.S. cities and counties are currently in bankruptcy or have recently emerged, including Jefferson County, Ala., and Vallejo, Calif. While a high level of municipal bond debt was a motivating factor in the bankruptcy filing by certain of these municipalities, a variety of other factors contributed to the financial woes of some, including a significant reduction in tax revenues, lower real estate values, underfunded pension plans, increased operating costs and fraud. Municipalities facing these problems routinely search for ways to restore financial stability, and Chapter 9 is increasingly being considered as a viable option. Whether it is the best option remains, in many cases, to be seen. For better or worse, however, the filing of bankruptcy by some very large cities and counties in the past few years may only help to embolden some municipalities to view the often significant political and public debt market implications of such a filing as risks they are willing to take.

Municipal bonds historically have been considered safe investments, but a municipality’s payment obligations to bondholders can (in certain cases) be altered under a Chapter 9 plan of adjustment, even over the bondholders’ dissent. The ability to reduce debt obligations or extend maturities is one reason why certain municipalities choose to seek relief under Chapter 9. Prior to filing, however, any prudent municipality will want to carefully consider all available alternatives and the potential ramifications of a filing, as bankruptcy will carry a stigma that can negatively impact the municipality and its surrounding communities even long after the entity emerges from Chapter 9.

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