Many of my most solid and otherwise down-to-earth friends and acquaintances in Harrisburg PA lately have been engaging in an activity that I can only call mind reading.
They’re not channeling Houdini or trying to talk to houseplants.
No, they’re trying to get in to the heads and read the minds of the one creditor in Harrisburg on which the future of the city, the livelihoods of tens of thousands, the deal to sell the incinerator, and ultimately billions of dollars in debt and investment now rests:
They are trying to read the minds of the managers of an obscure and heretofore little thought-of company called Assured Guaranty Municipal, or AGM.
AGM is the bond insurer of Harrisburg’s defaulted debt. The company is the city’s largest single creditor. AGM is also thought to be the last holdout against the city receiver’s plan to keep Pennsylvania’s capital city out of bankruptcy court.
For all the concessions of hundreds of city workers and small creditors, for all the hard work of the receiver’s office, for all the years of shouting and handwringing, it’s all coming down to a vote of one.
Simply put, there is not enough money to pay everyone, including AGM, what they say they are owed.
AGM, for its part, in its 2012 annual report, writes, “The Company has $154 million of net par exposure to The City of Harrisburg, Pennsylvania, of which $92 million is BIG (Below Investment Grade -editor). The Company has paid $13 million in net claims as of December 31, 2012, and expects a full recovery.”
But most seriously doubt that AGM will make a “full recovery” in Harrisburg. There’s simply not enough money to pay everyone 100 cents on the dollar. So will AGM accept a loss (called a ‘haircut’), or will it balk, and send Harrisburg into an uncertain future in bankruptcy court?
Divining the strategy of the company has grown to a fevered pitch in central Pennsylvania.
A bond insurer like AGM doesn’t own the bonds.
Rather, as AGM explains on its web page, bond insurance is “simply a guaranty that the holder of a municipal bond will receive scheduled interest and principal payments when due, even if the municipal issuer fails to make these payments. It is literally an insurance policy against an issuer’s payment default.”
When Harrisburg and the Harrisburg Authority defaulted on its incinerator bond payments several years ago, AGM (and Dauphin County, also a co-signer) made the bond payments, and so became a creditor.
As a result, the bond insurer has what amounts to a lien on the incinerator. AGM is a “subordinated creditor” of the incinerator, and has the right to approve any transaction that negatively impacts the face value of the bonds and back interest owed.
Or local interest, if AGM doesn’t sign off, the Lancaster County Solid Waste Management Authority (LCSWMA) can’t purchase the incinerator.
So, the guessing game goes, what will AGM now do? Will it take a deal, or will it risk sending the city into bankruptcy?
At its simplest, the mind reading parlor game concerning AGM goes something like this, and involves only two possible outcomes:
• AGM will agree to the Harrisburg receiver’s plan and take a haircut, since it risks more should the case proceed to federal bankruptcy court.
• AGM will not agree to the receiver’s plan, since dong so may only expose itself to litigation, perhaps from its own angry shareholders, guaranteers, or investors.
• Agreeing to take a loss may also send the wrong signal to other municipalities considering default.
However, some who have spent considerable time observing AGM say divining the firm’s intentions may not be so simple, for a variety of inherently complicated legal reasons.
That’s because, while everyone in central Pennsylvania has been watching AGM at Harrisburg’s bargaining table, AGM’s directors and lawyers have been looking far afield around the country at other municipal default cases involving the firm.
Most notably, AGM is a prominent creditor in at least three other high-profile municipal bond default cases: Jefferson County, Alabama; Stockton, California; and, most recently, Detroit, Michigan.
• Jefferson County, Alabama, which defaulted on both sewer and general obligation bond debt, owes AGM $464 million. Recent reports say the firm stands only to recover about 60 percent of its loss.
• In Stockton, California, AGM insured $125 million in pension bond obligations. Stockton made headlines in 2011 when it became the first municipality to attempt to use federal bankruptcy court to force bondholders and insurers to take less than what they are owed. AGM now faces a $100 million loss in Stockton’s bankruptcy case.
In 2008, when the Harrisburg Authority first defaulted on its incinerator bond debt and calls were heard to declare bankruptcy, municipal bond defaults were unheard of. Until that time, municipal bonds were considered extremely safe investments. There had never been a municipal bond default, and so there was little or no settled, or ‘developed,’ case law involving municipal defaults.
Part of AGM’s sphinx-like silence and strategy in Harrisburg in the last year or so almost certainly involved waiting to see what would happen with Jefferson County, Alabama, and Stockton California in bankruptcy court.
AGM in those cases certainly was attempting to “turn the law” to its favor, lawyers tell me, and perhaps hoped to prevent future municipal bankruptcy filings.
Then there’s what the lawyers call the “priority” problem.
Creditors in bankruptcy court are arranged in what’s called “tiers,” or the priority with which limited money must be repaid.
As a bond insurer in bankruptcy court, for example, AGM is a “subordinated creditor of the 3rd tier” behind the bondholders, who enjoy standing on the 2nd tier.
Part of AGM’s recent legal maneuvering in the other national municipal bankruptcy cases involved failed attempts to have the court elevate its standing to the 2nd tier of creditors.
Even more bad news awaited AGM in the Stockton, California, and bankruptcy case.
In April 2013, the judge presiding in the Stockton case ruled that AGM had negotiated in bad faith with the city before coming to bankruptcy court.
That ruling, legal observers say, has the potential to make AGM pay attention to good faith negotiations with Harrisburg’s receiver.
Even worse news for AGM, and perhaps Harrisburg, came with the threatened bankruptcy of Detroit, which now has a receiver. Detroit dwarfs all the other cases combined.
Detroit is nearly $15 billion in debt, and holds nearly $8.6 billion in bond debt, much of it insured, according to the trade publication The Bond Buyer.
AGM “insures $2.2 billion of the city’s debt, the bulk of which is water and sewer bonds, and $355 million of (general obligation) bonds,” The Bond Buyer reports.
The industry broadside also reported, “The collapse in the monoline bond insurance business since the 2008 financial crisis will play a role in the city’s (Detroit’s) negotiations and the ultimate impact on bondholders. The sector’s crisis left Assured Guaranty Ltd. as the only active insurer until the recent launch of Build America Mutual. Moody’s Investors Service in January downgraded Assured (AGM’s parent company) to A2 from Aa3, but noted that its capital adequacy remained strong.”
The upshot of this is that the Detroit case has the potential to make Harrisburg’s $370 million owed on the incinerator seem like small potatoes.
Will a looming Detroit bankruptcy only encourage AGM not to take a deal with Harrisburg’s receiver, in hopes of developing even more case law should the Motor City file a Chapter 9 bankruptcy petition?
For the near future we can only guess.
And attempt to read minds.
