Given recent headlines out of California, municipal bond investors would likely be surprised to learn that municipal bankruptcies in 2012 are actually below those of 2011, both in number and dollar amount, and that 2011’s filings were in turn lower than those in 2010. Overall municipal defaults and bankruptcies remain exceedingly low. However, with developments in California in recent weeks, a municipal investor could be forgiven for presuming that a tectonic shift in municipal credit quality was underway. Over a period of several weeks, Stockton and Mammoth Lakes filed for bankruptcy and San Bernardino and Compton are now actively exploring the possibility. While troubling in that they occurred so close together, these cities (specifically Stockton, San Bernardino and Compton) represent very troubled credits, both economically and fiscally, pushed to the edge by the housing bust and/or by poor or negligent management.

We believe that a municipal bankruptcy continues to carry significant costs, in terms of expense, political backlash and most important, access to market capital when it is needed most. As such, we disagree with those who now believe the stigma of bankruptcy is wearing off and that we are facing an onslaught of new filings. For the vast majority of municipalities, we expect a bankruptcy filing will remain a last ditch effort, once all other fiscal options have been exhausted.

While we do not dismiss the recent California bankruptcies as being non-events, we do not feel they represent a pervasive problem in the national municipal market, or even in the state of California. There will be additional bankruptcies of similarly distressed cities with below average socio-economic profiles that were impacted disproportionately by the housing boom and subsequent bust, but we believe the number will remain low relative to the overall market. Municipal entities are overseen by elected officials and, as a result, an element of political assessment is necessary when evaluating credit strength. An underlying credit positive is the potential political cover and leverage these recent bankruptcies may provide elected officials of other struggling credits to push through politically difficult, but necessary, fiscal reforms and budget reductions.

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