Pub. 4 2014 Issue 4

25 FALL 2014 Timothy A. Stratton and Eric McGlothlin are partners in Gust Rosenfeld’s Public Law and Finance sections and can be reached at 602-257-7422. transactions, as well as the nature of the asset or project being financed. Some lenders only lend money for essential govern- ment projects under the theory that the municipality is less likely to default on an essential government service. Not all proposed uses are essential, though, and a careful analysis of the true nature of a project or proposed use should be made. Annually appropriated financings can be very beneficial to both borrower and bank but greater due diligence should be undertaken. RECENT BANKRUPTCY FILINGS BY MUNICIPALITIES In 2012, twenty municipalities filed for Chapter 9 bankruptcy protection, the highest number since 1991. Although only nine municipalities filed bankruptcy petitions in 2013, the largest municipal bankruptcy, Detroit's, was filed in July 2013. Most of these cases resulted from poor fiscal management, changing demographics and falling real estate values, which adversely affected revenue sources for municipalities. Munici- palities are sometimes unable to cut certain expenditures given that they are fixed by other governing bodies, union contracts, or pension obligations. A thorough review of rating agency reports, as well as knowledge of the political dynamics of the municipal borrower is a critical part of any credit decision process when dealing with would be municipal borrowers. MUNICIPAL LENDING CHALLENGES For those municipalities that are financially sound, the credit risk of lending for these purposes may be limited. How- ever, some municipalities are financially distressed, raising questions as to whether they are creditworthy. Municipal bankruptcy filings are a real possibility. Therefore, to pro- tect against financial loss and to mitigate risks, banks should implement a robust due diligence process and conduct ongoing monitoring to ensure the debt can be satisfied or, in a worst- case scenario, recovered. Consideration should be given to the municipality's willingness and ability to increase taxes or cut operational costs as well as past financial practices. A thorough review of state law must be undertaken so the lender has a full understanding of the type and strength of security securing the repayment of the bonds. Banks should also obtain and maintain current financial statements and other relevant documentation to assess the municipality's financial condition and its ability to repay its debt. It is also imperative to understand the lien position in a direct loan context of the creditors and the presence of any parity or senior lien bonds. Unlike the public capital markets, there is no requirement that municipal borrowers undertake to provide continuing disclosure of financial data, therefore it is important that any loan agreement or trust indenture provide a mechanism for the bank to obtain reasonable financial data on an ongoing basis over the life of the borrowing. Municipal bonds continue to be a safe and advantageous investment, but the changing landscape of municipal bank- ruptcy places greater emphasis on good due diligence and credit review which should be undertaken by investors and financial institutions. w Arizona Bankers Travel to D.C. To meet with Janet Yellen Curt Hansen, National Bank of Arizona; Geritt Van Huisstede, Regional President Wells Fargo Bank; Jerry Ernst , President of Horizon Community Bank.