Atlantic City has struggled for years as the near-collapses of the gambling industry there has eroded its tax base. But recent events in America’s Playground, namely a super downgrade of its credit into junk status and the unwillingness of the state to take over its finances, have firmly pointed the city down a path that could end in bankruptcy.
This week, Standard & Poor’s credit ratings agency became the second to downgrade the former East Coast gambling mecca’s rating to junk status. It was what’s called a super downgrade, one that dropped the city a whopping four notches from BBB+ to BB, which is below investment grade. The downgrade came four days after Moody’s Investors Service downgraded the city six notches from Ba1, just below investment grade, to Caa1, which is deep into junk bond territory. The downgrades by two of the three major ratings agencies means it will cost Atlantic City even more to finance its debt.
A major downgrade doesn’t necessarily signify that the New Jersey city will go bankrupt. About 1 percent or so of all municipal credit ratings are in junk territory. Washington, D.C.'s bond rating reached junk status in the mid-1990s but Congress took over the city's finances for a period of time instead of letting the Capital city file for bankruptcy. Detroit plodded along for three years with a junk bond rating before resorting to filing for Chapter 9 status in 2013. But the event for Atlantic City is still a significant one as it indicates Wall Street’s lack of confidence in the direction the city is headed. And more importantly, the reason behind the downgrades are key: Both agencies said they were concerned about Gov. Chris Christie’s appointment of an emergency management team last week with ties to Detroit's bankruptcy. The governor has asked the team to consider the option of debt restructuring through bankruptcy.
The tactic by the state is “profoundly different,” said Frank Shafroth, director of the Center for State and Local Government Leadership at George Mason University. Up until last week, New Jersey had a solid record of fixing city problems on its own. In fact, no New Jersey city has entered bankruptcy or defaulted on General Obligation debt since 1970. (Camden filed for Chapter 9 in 1999 without state approval and withdrew its petition after the state agreed to give the city the needed aid.) As recently as last October, the state took over struggling Newark’s finances, a move that Moody’s cited at the time as a positive for that city.
“The state has heretofore come in and basically done whatever it takes to makes sure there’s no threat of default -- it has taken ownership,” said Shafroth, who is also a Governing contributor. “Here, it’s coming in with this weird posture. It appears to be sending the message, ‘We’ll put in someone who can help you file for municipal bankruptcy protection.’”
Previously, New Jersey was much more hands-on with Atlantic City. In December, the state gave the city a $40 million emergency loan after it was unable to obtain market access for a $140 million bond issue. The city also received $13 million of transitional aid, a form of emergency assistance. The state has also taken a number of actions over the past few years to try to bolster the city’s economy, and several pieces of aid legislation are currently pending in the state legislature. But, notes Moody’s, “it is unclear whether the governor will support any of these proposals now that the [emergency manager] is in place.”
The composition of the emergency management team is also a concern: Kevin Lavin, a corporate restructuring attorney, is the city manager appointed by Christie. Advising him is Kevyn Orr, another bankruptcy attorney who recently led Detroit through Chapter 9. “Default and/or Chapter 9 bankruptcy filing is not inevitable,” said Janney Montgomery Scott Analyst Tom Kozlik in a market note he published Thursday. “But one or the other or a combination is possible.”
If Atlantic City does file for bankruptcy, expert James Spiotto warned that a debt restructuring is not the same thing as a plan to re-energize a city that’s home to a dying industry. Despite several casinos closing in recent years, the gambling city remains highly dependent on them. Casinos make up three quarters of the city’s tax base, but casino revenues have declined 47 percent since 2006. Moreover, to cover tax appeals and settlements with casinos, Atlantic City has issued $345 million in bonds since 2010 and debt service now represents 15 percent of its budget. The extraordinary drop has forced the city to increase residential property taxes 50 percent over the last two years -- and more than 100 percent since 2008.
“People confuse debt adjustment with a recovery,” said Spiotto, managing director of the municipal consulting firm Chapman Strategic Advisors. “The real question is how do we provide appropriate services and stimulate an economy?”
The mayor and city council have been working on that problem actively for several years. Earlier this month, the council lent its support to Mayor Don Guardian’s plan calling for $40 million in cuts from its municipal budget over 10 years, with $15 million in cuts coming in 2015. The plan also includes layoffs and consolidation of city services across multiple departments and selling some city assets. But the appointment of an emergency manager and the super downgrades have dramatically changed the picture in the matter of a week, with increased concerns from the credit community about whether Atlantic City will be able to pay $12.8 million of notes due Tuesday.
“If you’re Atlantic City and you’re looking at two paths diverging in the woods,” said Shafroth, referring to Robert Frost’s poem, The Road Not Taken, “you’ve already taken some footsteps down the path of municipal bankruptcy.”