The financial troubles for Atlantic City debt began with the financial meltdown of 2006, when Atlantic City casinos witnessed a decline of over 50% in revenues and the city’s property values were slashed by over 60%. Amid these financial uncertainties, S&P and other rating agencies downgraded the city’s debt below investment grade (junk status) and strongly indicated that Atlantic City is currently vulnerable to a non-payment on its debt obligations.

In this article, we’ll take a closer look at the financial stability of Atlantic City and if it’s on the path of becoming the next Stockton or Detroit.

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For any municipality, a financial deficit occurs when government expenditures exceed revenues for the given fiscal year. In the case of Atlantic City, New Jersey, expenditures have been staying the same or gradually increasing, but the city’s revenues have seen substantial declines. Atlantic City’s primary revenue source is property taxes levied on the properties within the municipality. These revenues – or the general fund – were projected to account for 85% of the total revenues for the city in 2015, and were the pledging source for Atlantic City’s debt. During 2010 to 2015, the city’s property values plummeted by over 60%, causing a devastating blow to the city’s finances and projected budget allocations based on the revenue assumptions. During fiscal year 2014-15 the city saw its property tax revenues decrease by over $130 million, with the deficit between revenues and expenditure growing each year thereafter.

Atlantic City’s casinos have also contributed significantly to the city’s financial troubles. The city had a huge concentration of its tax base in the casino industry. Usually, the casino industry flourishes on the discretionary income of its patrons – if discretionary income goes up, casinos see an uptick in their revenues, and if it goes down they see a decrease in revenues. During the financial crisis many people lost their jobs or had their wages slashed, causing lower footfall inside the city’s casinos. As a result by 2015 five of the twelve major casinos closed their doors, leading to over 8,000 job losses and costing the city over $90 million in tax revenues, which further contributed to the budget deficits for the city. In addition, some casinos have sued the city for overpayment of their tax share and asked for that money back, further straining the city’s budget by another $190 million.

The magnitude of this problem was recently demonstrated in April 2016, when the city owed over $8.5 million to its school districts and $3.5 million to the payroll system of Atlantic City while it only had about $8 million in available funds. The city had to postpone its $3.5 million for the payroll system to the end of the month.

On similar grounds, check what the Puerto Rico default meant for investors here.

Keep our glossary of municipal bond terminologies handy to familiarize with different concepts commonly used by municipal investors.

The main difference between Atlantic City, New Jersey, and other bankruptcy cases like Stockton, California, is that New Jersey is one of the states in the U.S. where the state government can financially intervene and implement changes if a municipality is facing potential bankruptcy. In 2010, New Jersey proposed a game plan that would take over Atlantic City’s financial operations and implement changes that would potentially close the city’s budget deficits. These changes include restructuring Atlantic City’s existing debt portfolio, deploying spending cuts, reducing the workforce and negotiating labor union contracts and other obligations.

Amid the state monitoring of Atlantic City’s finances, rating agencies have downgraded the general obligation debt of Atlantic City to below investment grade due to the projected deficit in Atlantic City’s property tax revenues and the closure of four casinos. The city’s total debt portfolio ($550 million) and its payments play a huge part in Atlantic City’s current and projected deficit.

There are three main options that emerge as potential solutions to the city’s financial downturn:

• As the overall economy has picked up and discretionary income levels have risen, the city can further increase property taxes to close the deficit gap. This can also be done in conjunction with slashing expenditures – like by reducing the city’s workforce, outsourcing services and cutting down programs like after school-programs funded by the city.

• Recently the State of New Jersey settled a deal with MGM Resorts, where MGM claimed they overpaid $100 million in taxes to to the city from 2009 to 2015. The negotiations saved the city $30 million. The State’s other efforts to bring positive developments to the city aren’t going unnoticed, either; for example, the Taj Mahal resort and casino will be converted to the Hard Rock brand, which will generate further tax revenues for the city.

• Another option that could add a lot of value is restructuring the city’s $550 million debt portfolio and receiving legal protection from its creditors under Chapter 9 – in other words, filing for bankruptcy.

As mentioned above, Atlantic City debt has been severely downgraded by all the ratings agencies and is now considered junk debt. This means that almost all the city debt is below the investment grade or BBB-.

Current investors in Atlantic City debt, or those considering investing, should rethink their options and consult their financial advisors. In a restructuring event, a city can default on all or some of its debt payments, which means that either bond insurance (if there is any) would kick in to make these debt service payments for the city or the investors will take the hit.

Find out the importance of bond insurance in avoiding bankruptcy headaches here.

In conclusion, Atlantic City has, so far, narrowly avoided defaulting on its debt obligations, but the concern is very much still looming. The city’s $550 million debt portfolio and its debt payments can further widen the deficit gap in the upcoming years.

Municipal debt investors must carefully analyze the city’s debt portfolio, the revenue streams backing that debt and the potential worst-case scenarios before making their investments.

Rising financial trouble at the municipality level is a cause of concern for investors. Be sure to check our take on due diligence for muni bonds before you make your investment decision.

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