By Otis Casey, credit analyst at Markit
 |
| Otis Casey |
Last Tuesday, the city of Harrisburg, Pennsylvania announced that it intended to skip an upcoming payment of USD3.29 million on its general obligation debt that would make this the second largest municipal default of the year. Harrisburg was known to have some financial challenges, particularly around an incinerator project issued by Harrisburg Authority, a distinct municipal entity. Some municipal market observers had expected a possible default on the debt related to that project specifically. The default on the city's general obligation debt though suggests a deeper fiscal challenge. The payment is insured by Ambac Assurance, a subsidiary of Ambac Financial. Ambac confirmed that it would fulfill its obligations and make the payment scheduled for Sept. 15. That is reassuring for bondholders as the struggles facing the municipal bond insurers are well known. Five-year CDS on Ambac was trading at 72 points upfront last week, a half to a point higher on the news. That means that protection sellers are so concerned with a jump-to-default scenario that in order to sell protection from default on USD10 million worth of bonds, they require a USD7.2 million payment at the outset of the trade plus a running 500 basis points premium per annum.
Some market participants have noted that the fiscal challenges facing municipal issuers are not too much unlike the challenges facing the high beta sovereigns in the European market. In fact, CDS spreads on the small universe of municipal credits with traded CDS tend to widen out when the markets refocus on the sovereign debt problem. However, there is no liquid market traded for municipal CDS on Harrisburg, Pennsylvania and the impact of this default is expected to have a small impact on the municipal bond markets, at least for now. CDS on the Commonwealth of Pennsylvania did widen though by 13 basis points on Wednesday to 134 bps in reaction to news on the chance that the state may have other municipalities struggling with similar problems and may have to offer direct financial aid to Harrisburg. So far it has not done so.
The real impact of this default may not be felt broadly in the financial markets now, not even in the nascent municipal CDS market but the default does have some symbolic significance. Just maybe it sets a precedent for other issuers to follow suit. Granted, it seems unlikely that too many issuers would find losing access to the capital markets worth the temptation of letting their insurers fulfill their financial commitments. That is unless the economic recovery stalls completely and growth stays anemic for a lengthy time, in which case it will not just be a tale of one or two cities but something a bit more.
 |
