Summit News

Ailing U.S. cities unlikely to go bankrupt

NEW YORK (Reuters) - Cities and local governments that are struggling with gaping budget holes are unlikely to resort to bankruptcy, but they may have to sit down with bondholders to restructure their debt, restructuring experts said on Wednesday.

The city of Vallejo in California and a toll road operator in South Carolina are among the few to file for bankruptcy under Chapter 9, the part of the bankruptcy code for government entities.

"You look at these budgets and it looks pretty daunting if you look at all their obligations, pensions plus other things," Steven Smith, the global head of restructuring for UBS AG UBS.NUBSN.VX, told the Reuters Restructuring Summit in New York.

Hit by falling tax revenue and added demand on services, some cities are turning to their states for help. Pennsylvania’s capital city, Harrisburg, asked last week to be put into a special state program for distressed cities.

Budget deficits and tapped out taxpayers probably mean painful adjustments, creating work for turnaround advisers.

Jay Goffman, who heads the restructuring practice at Skadden, Arps, Slate, Meagher & Flom, said that while some cities were likely considered “too big to fail” he thought the White House was probably politically unable to bail out local governments.

Instead, he expected cities to resort to out of court restructurings.

“You have to sit down with bondholders,” said Goffman, who has made a name for pioneering faster bankruptcies and restructurings.

The work would not be that different from overhauling a badly broken company, he said, with many of the same professionals and legal tactics.

Goffman and others thought the more drastic option of bankruptcy was less likely, although it would give cities and local governments the ability to break contracts and recast their debt.

“I just don’t think there is much appetite to see cities go bankrupt,” said Smith.

James Sprayregen, who heads the restructuring practice at law firm Kirkland & Ellis, said he saw several obstacles to small governments seeking relief from debts in court. “The problem is they have the power to tax.”

Filing for bankruptcy also is complicated for governments, and many states do not have the provisions in place to allow local governments to seek Chapter 9 protection, he said.

Still, many restructuring professionals have begun to pitch their services to hobbled cities and regional governments, particularly as work dries up for turning around companies. It is likely to be an area of active work for specialized consultants.

“There may be whole teams of people who will develop experience the average restructuring person is not well suited to do. Muni is a really different animal,” Smith told the Reuters summit.

One big obstacle is likely to be the cost.

Professional fees can run well over $800 per hour for top talent and Lehman Brothers’ tab for its bankruptcy will soon top $1 billion for its accountants, advisers and lawyers.

“You talk about the numbers in Lehman and the numbers can be staggering,” said Goffman, who said politics would make municipal restructuring very tough.

“There’s a high cost to this. That becomes a very tricky issue when you have to tell people who aren’t making much money they have to give up benefits and they have to cut costs.”

Reporting by Tom Hals; Additional reporting by Joan Gralla. Editing by Robert MacMillan, Bernard Orr