Court Rulings Shake Up Muni Markets

02/02/2012 8:00 am EST

Focus: BONDS

A handful of recent court cases will have significant impact on municipal bond markets across the country, writes Alex Anderson of Bond Smart Investor.

Big news broke in the municipal bond market over the New Year. California’s Supreme Court ruled to abolish Redevelopment Agencies (one of the biggest issuers of California municipal bonds) in order to redirect much needed funds towards the ailing state budget.

If you didn’t already know, redevelopment agencies are government bodies dedicated to urban renewal projects. The agencies issue bonds for local improvement projects and are typically funded through property taxes and project revenues.

The ruling by the Supreme Court will wind these programs down, prevent new issuance, and divert Redevelopment funds for state use. California has over 400 Redevelopment Agency issues, making up over $5 billion worth of municipal bonds.

For bondholders, the California Redevelopment ruling shows the power that a courtroom can have over municipal bond issues. Courts have the unique ability to change key components of bonds overnight with drastic consequences to investors.

Depending on which way the judgment goes, a municipal bondholder can be affected either positively or negatively. That’s why it’s important for you to size-up potential events affecting the credit quality of your bond portfolio.

Another instance of courtroom influence recently took place during the fall in Harrisburg, Pennsylvania. Harrisburg is the city that could not pay its $310 million in debt because of major cost overruns to a waste incinerator project. A judge dismissed Harrisburg’s bankruptcy filing, ruling that it was invalid under a state law.

This was a huge plus for bondholders, as bankruptcy filings are usually bad news because they can drag on for years and have too many unknowns. The ruling was also significant for the muni market in general; many worried that a large bankruptcy could have a domino effect into other areas of the municipal market.

The municipal insurer, Assured Guarantee, was also a co-beneficiary of this ruling. Without a bankruptcy, insurers are not on the hook to take over interest and principal payments.

Another widely anticipated court ruling is expected in the bankruptcy of Jefferson County, Alabama sewer system bonds. The city sewer has filed for Chapter 9 bankruptcy protection.

At issue is whether the filing should block the current sewer system revenues from flowing to debtholders as they normally would. Critics argue that with bankruptcy already filed, revenues should bypass the debtholders and go directly to the city receiver. The judge’s ruling will likely be used as a precedent in future bankruptcy cases.

The moral of these stories is that lawyers and judges can sometimes determine the health of certain municipal bonds. That said, it is important to keep up on bond news and understand any possible outcomes involving municipal issuers stuck in litigation.

If litigation looks like it can be detrimental, then sell your bonds. If keeping up on municipal litigation seems too complicated or time-consuming, hire a professional manager to do it for you.

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