Fixed Income Investment Management
Based on Process and Discipline Behind the Process

Comments on COP Debt

COPs are debt issued by municipalities that circumvent the voter referendum process. If the "project" is being financed by the bond proceeds does not generate enough revenue to service the debt, the municipality has to ask its "legislature" to budget the debt service requirement. These projects can include building new schools, jails, museums, performing arts centers or the leaseback of government office buildings. COPs are considered to be a moral obligation of the issuer. Legally, the legislature can opt not to make the necessary debt service payments and not be in violation of any bond covenants. COP debt is normally rated either one or two notches below its G.O. debt rating. A strong argument can be made that if a municipality decided not to budget for this type of debt service, even though they are legally entitled to make this decision, the bond market would punish them rather severely. It is normal for a municipality to include COP debt service in their budgetary process in the current environment. Will "entitlement reform" at the state and local government change this budgetary practice? If the answer is "yes" and state and local governments opt not to budget for their COP debt service, I would expect the credit rating agencies to respond punitively with credit rating downgrades. The municipal bond market cannot tolerate a massive downgrade in perceived credit quality at this juncture of budget reform in the states. Have there been COP defaults in recent history? To the best of my knowledge, none that carried a rating of A or higher at the time of issuance. Even the Vallejo County California COPs have been current on their COP interest payments, according to a recent report published in Bond Buyer.  There are 5 school districts in Wisconsin arguing whether or not to continue their debt service payments on some COP debt. This is a small, but very important, test of the resolve and attention credit rating agencies will give COP debt under special situations.

March 25, 2011