The Many Interlocking Parts Critical to a Sustainable Fiscal Future

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May 22, 2015
Visit the project blog: The Municipal Sustainability Project

The Many Interlocking Parts Critical to a Sustainable Fiscal Future. The Wayne County Board last evening unanimously approved County Executive Warren Evans’ reorganization plan—a plan which will now give the green light to consolidate county departments and reduce the county’s structural debt by about 5 percent—a savings Mr. Evans believes vital to averting a potential state takeover if the county—which surrounds Detroit—is unable to make major changes. Thus these changes, adopted last night as a first step and abrupt change in fiscal direction, have critical implications for Detroit’s fiscal sustainability and recovery, as well as Wayne’s. Wayne’s structural debt is a toxic fiscal product of its underfunded pension system and a $100 million drop in annual property tax revenues since 2008. At the time Mr. Evans took office, Wayne County was on course to be insolvent by August of next year, according to an Ernst & Young audit: Wayne has, for years, run a structural deficit now estimated at $50 to $70 million. It has an accumulated deficit of roughly $161 million and a pension plan with a funded status that’s fallen to 45% from 95% ten years ago. Thus, the county’s elected leaders confront a hard fiscal road to sustainability ahead—and Detroit has, very much, a stake in that endeavor. The reorganization plan approved Thursday is part of a larger, structural recovery plan which Mr. Evans had unveiled in April. That plan proposes to eliminate the structural deficit by eliminating retiree health care, increasing employees’ retirement age, and making various pension changes. Under the plan adopted yesterday, the county would eliminate various departments and consolidate others as it begins its efforts to face down its $52 million structural general fund deficit. As County Executive Evans put it yesterday: “My team and I invested a great deal of time and thought into how the county should best serve our residents and businesses…It represents the ‘new Wayne County’ — how we need to work to provide services more efficiently and effectively.” Indeed, as Commissioner Tim Killeen (D-Detroit) said immediately prior to the vote: “This is the third reorganization that I’ve been here for, and I very much appreciate the negotiations, the coming together of minds (with the administration) on this…I think there was a lot more depth to this reorganization plan than I’ve seen in previous ones…I think overall it bodes well as the commission and the executive branch are trying to…get the county on a better path.” For his part, Mr. Evans notes: “(The plan) represents the ‘new Wayne County’ — how we need to work to provide services more efficiently and effectively for residents and businesses to live and grow.” Under the plan, the county will combine its Children and Family Services, Health and Human Services, and Veterans Services departments into a new department of Health, Veterans and Community Wellness. In addition, the plan also calls for shifting the Department of Economic Development Growth Engine’s functions to the Wayne County Economic Development Corp., a quasi-public agency—a move projected to eliminate 50 jobs. Nevertheless, getting there was not easy. Just as in San Bernardino, charter provisions hampered efforts: for instance, after county commissioners raised questions earlier this month about what they believed were potential violations of the county charter in the plan, Mr. Evans yesterday informed them that he and his staff had made some changes to address commissioners’ concerns: for example, the Senior Services Department was to be combined into the same department as Children and Family Services, Health and Human Services and Veterans Services, but, instead, the plan was revised so that senior services is to be reorganized into a separate department overseen by the director of the new health and community wellness department. Reversing fiscal directions and constructing a long term fiscal sustainability plan may be one of the greatest challenges of governance.

Indices of Municipal Recovery & The Challenge of Fiscal Sustainability

May 21, 2015
Visit the project blog: The Municipal Sustainability Project

Tapering Off? Detroit has one of the broadest tax bases of any city in the U.S.: its municipal income taxes constitute the city’s largest single source, contributing close to 21 percent of total revenue in 2012, or $323.5 million, the last year in which the city realized a general fund surplus. Thereafter, receipts declined each year through 2010, reflecting both a rate reduction mandated by the state and the recession. The declining revenues also reflected not just the significant population decline, but also the make-up of the decline: the census reported that one-third of current residents were under the poverty line and that the composition of businesses—unlike any other major city in the nation—was primarily made up of public organizations. Today, according to the Census, Detroit is still losing residents, but the exodus is tapering: Detroit’s population was 680,250 as of last summer, down an estimated 6,424 residents from the previous year—but a decline or outflow smaller than the previous year—when the drop was 10,072―and significantly lower than the annual average decline of 24,000 which Detroit experienced in the first decade of this century. Kurt Metzger, director emeritus of Data Driven Detroit, not only a demographer, but also the Mayor of Pleasant Ridge, notes that the influx is from young and older people moving in: Last year, Detroit issued 806 building permits for new construction, mostly for apartments, more than double the influx from the prior year. And, on the other side of the equation, the population outflow is slowing—or, as Mayor Metzger puts it: “There is just less housing available for those people who want to leave…If they haven’t left by now, they have decided to stay.” Detroit Mayor Mike Duggan sums it up: “It’s trending in the right direction…A number of people have decided to stay and see how things go…More people are staying in neighborhoods and more people are moving in.” Nevertheless, the Southeast Michigan Council of Governments has reported that the Motor City’s population is actually closer to 648,002 and the COG forecasts the population will continue to decline until 2030 when it would have about 610,000 residents.

Indeed, home sales in the four-county metro Detroit region inched up 1.4 percent year over year in April, while the median home sale prices climbed 18.9 percent, according to a report released this week. Farmington Hills-based Realcomp Ltd. II reported there were 4,004 home sales last month, compared to 3,947 in April of last year in Wayne, Oakland, Livingston and Macomb counties. Median sale prices rose from $121,900 in April 2014 to $145,000 last month. Oakland County had the greatest increase in home sales, rising 12.6 percent from 1,286 in April 2014 to 1,448, while Macomb had the second-highest increase of 7.3 percent, from 862 to 925 last month, according to Realcomp. Wayne County sales, however, fell 10.2 percent from 1,553 in April 2014 to 1,395 last month. In contrast, however, Wayne County sale prices rose 42.7 percent from $70,000 to $99,900.

Fire over Privatizing Essential Municipal Services. Despite the 6-1 affirmation by Mayor Davis and the City Council this week to contract out for fire and emergency response as part of San Bernardino’s proposed plan of debt adjustment—which is to be submitted to the U.S. Bankruptcy Court by Saturday, the proposal to do that is now drawing its own fire—not only from within the city, but also beyond its borders. The proposal, projected to save as much as $7―$10 million annually, depending on bids due in late yesterday and to be made public next week, has fired the head of Local Firefighters union 935 north to the state capitol in an effort to seek to preempt the proposal. Yet the proposed privatization has become a pivotal part of the city’s plan to successfully exit municipal bankruptcy—not only could it result in substantial operating and capital savings, but also the proposal could reduce some of its overbearing debt to the California Public Employees’ Retirement System, according to City Manager Parker—whose City Council endorsed plan for fiscal recovery and sustainability proposes that fire/emergency response and refuse services be the highest-priorities for outsourcing. With a demographic trend demonstrating that retirees are likely to live much longer than prior generations—but smaller municipal workforces in California municipalities, there is greater and greater awareness that California cities and counties are, increasingly, walking a fiscal tightrope where fiscal sustainability is increasingly at risk. That is not to say that contracting out will not create challenges: it would force recalibration of mutual aid decisions.

Moody Blues. Moody analysts Josellyn Yousef, David Strungis, Orlie Prince, and Naomi Richman this week reported that the sale of New Jersey state-enhanced municipal bonds for Atlantic City, would remove a “major short-term obstacle” for the fiscally distressed municipality, but warned the city still faces long-term risks due to “numerous financial challenges.” The warning came as the city was seeking to complete the sale of some $40.5 million in general obligation municipal bonds this week, a sale benefited under New Jersey’s Municipal Qualified Bond Act program (The state program, called the Municipal Qualified Bond Act program, gives Atlantic City bondholders protections similar to the distributable state aid bonds issued by Detroit, Michigan.) The proceeds of the sale are to be used to pay off a $40 million emergency state bridge loan due by the end of this week. In addition, Atlantic City is planning to issue $12 million of additional MQBA bonds by the beginning of August in order to make payments due on maturing bond anticipation notes. The sale, according to the dynamic Moody quartet should “should improve [Atlantic City’s] market access; however, the relatively narrow debt service coverage from state aid makes it unclear whether the city’s bonds would carry the MQBA program rating (A3 negative), or a somewhat lower rating.” Moreover, notwithstanding the relatively sunnier outlook, the quartet noted many financial and fiscal hurdles still confronting the city, including a $101 million budget gap for the fiscal year ending Dec. 30th, poor liquidity, and ongoing property tax appeals on casino properties. They also wrote that heavier municipal reliance on MQBA-enhanced debt could mark the beginning of some erosion in New Jersey state aid to help the city cover debt service, noting that since the state aid never reaches the city’s coffers, ‘the protection is similar to Detroit’s distributable state aid bonds that avoided payment interruption during its recent bankruptcy.’ Thus the credit rating agency warned that additional MQBA bond issuances by Atlantic City could actually undercut its debt service coverage levels: “If all of this debt is issued through the MQBA program, debt service coverage could decline to at or near one times qualified state aid depending on interest rates…The state Local Finance Board will only approve an MQBA bond issuance if revenues are at least sufficient to meet debt service.” With the city having acted last March on a short-term plan to address Atlantic City’s $101 structural deficit that included the potential of debt payment deferrals, Moody’s analysts noted that while some steps have already been taken, including $7 million in salary and wage savings from 195 layoffs; nevertheless, proposed bills to redirect $47.5 million of additional revenues from the Atlantic City Alliance Fund and Investment Alternative Tax remain stalled in the state legislature. As Mayor Don Guardian noted at our conference with the Volcker Alliance earlier this Spring at the New York Federal Reserve, the state action is critical: absent a significant liquidity infusion, debt service payments still remain highly susceptible to default in 2015—or, as the analysts put it this week: Atlantic City’s “future operations continue to face pressure from a large structural deficit.”

Unequal Odds. The Commonwealth of Puerto Rico has warned in its latest quarterly filing that it may place a moratorium on debt payments in FY2016 if the government is unable to enact a new tax plan and reduce its rate of spending growth to both balance the island’s budget and to begin to whittle away at its massive accumulated debt. Its combination of rising debt, sluggish economy, and falling population has lifted the yields on the Commonwealth’s debt above those of Greece amid growing uncertainty—and doubt—whether the Commonwealth can repay its debt on time and in full—and whether Congress will act to give the U.S. territory authority to renegotiate its debts in a U.S. bankruptcy court: because the island is not a state, there is no state to grant the territory—or its municipalities—authority to file for municipal bankruptcy and work out its debts through a plan of recovery under a federal court’s supervision. Thus, absent the kinds of legal and fiduciary protections available to all other Americans, the elected state and local leaders—and their citizens—increasingly confront a process likely to be far more uncertain and expensive: lawyers for all the different parties—bond holders, banks, bond insurance companies, and government entities—will probably have to rack up lots of billable hours as they seek the best outcome for their clients. Unsurprisingly, the territory’s many municipalities can hardly afford comparable legal representation, so that, absent Congressional action, there is a signal risk of municipal harm. In contrast, a group of 35 hedge funds have retained Morrison & Foerster, as well as Washington-based Robbins Russell Englert Orseck Untereiner & Sauber. That is, hedge funds and distressed-debt buyers, rather than the public, appear to have the upper hand. Indeed, for nearly two years, hedge funds and investors in riskier municipal debt have been purchasing Puerto Rico securities at distressed levels. There is no indication such purchases have anything to do with public purposes or the interests of the U.S. citizens. A group of 35 hedge funds, led by Fir Tree Partners and others, holds $4.5 billion of Puerto Rico debt: that is, these are businesses which purchased public debt at a discount, hoping to make a profit on Puerto Rico municipalities that can either avoid a default or that offer recover rates higher than what the hedge funds originally paid to own the bonds. Prices on Puerto Rico’s GO bonds maturing in July 2041 fell to as low at 55 cents on the dollar back in July 2014: now they are trading at about 66 cents, according to data compiled by Bloomberg.

A Legacy for a City’s Future

San Bernardino Clears Path for Trial. On a 6-1 vote, Mayor Carey Davis and the San Bernardino Council yesterday voted in support of the city’s proposed plan of debt adjustment, clearing the way for the plan to be submitted to U.S. Bankruptcy Judge Meredith Jury, and opening the door for a trial which could take as long as a year to resolve the competing claims of thousands upon thousands of the city’s creditors, as well as for the city to try and convince the federal court it has a viable, sustainable plan for its fiscal future. Indeed, yesterday’s vote is not even necessarily the final say: with the city’s plan not due to Judge Jury until Saturday, yesterday’s adoption of the plan paves the way for intense negotiations among creditors with the city—as any further agreements could reduce the extraordinary costs to the city and its taxpayers of pending long and complex litigation in the federal courtroom. Nevertheless, San Bernardino County Supervisor Josie Gonzalez, whose district covers most of San Bernardino, yesterday, in city council chambers, said: “I, no different from the people in this room, value this moment as part of what will become your legacy in great history…Do not think of yourselves today. Think of 25 or 30 years in the future, and let it be said that on May 18, 2015, the leadership of San Bernardino was strong, and honest, and ready to introduce the future.” In contrast, one resident saw it from a very opposite extreme: “Today is the day the City Council committed suicide for San Bernardino.” The proposal in the adopted plan to outsource the city’s fire department drew the greatest opposition.

Creating a Sustainable Future

eBlog

May 18, 2015
Visit the project blog: The Municipal Sustainability Project

Architects of the Future. “We must be architects of a new beginning, and not slaves to the past,” San Bernardino Mayor Carey Davis stated Saturday in the wake of a presentation to the city’s strategic planning committee on the city’s current situation and possible future of the city’s proposed plan of debt adjustment—a plan which, unlike comparable plans in Detroit and Central Falls, Rhode Island, must be publicly approved before it can be submitted to the U.S. Bankruptcy Court next week. That is: there is a double approval process for a plan which is proposing significant changes in the way San Bernardino governs and which is proposing deep cuts and extensive restructuring. But it is also a plan, as in Detroit, Stockton, and Jefferson County, which is focused on the future. Nevertheless, the proposal received approval in advance of this afternoon’s vote by the City Council. Saturday’s session, at which representatives of business, education, religious and, other fields appointed by the Mayor to serve as a task force to decide upon a long-term strategic plan for the city, was a key step in trying to get broad community—in addition to Council, support. While the vote was advisory―another part of an effort to gather public input on the city’s plans―it appeared to demonstrate broad community report for the hard decisions and actions that lay ahead as the city proposes a plan to address its $20 million structural deficit and years of deferred maintenance that some project will cost some $200 million to address. The plan, which proposes extensive outsourcing, especially with regard to fire and refuse services—and a charter change, efforts to change that the city has previously, albeit unsuccessfully, provides an idea of how difficult a challenge lies ahead—even if the plan is approved by the City Council and, eventually, by the federal court. That is: it will be a plan of may complex provisions, changes in governance, new tax revenues—revenues counted on, but nevertheless dependent on the city’s voters—such as whether or not to renew the Measure Z sales tax in 2021―revenues the plan counts on to bring in $8.3 million annually.

Ojala! Puerto Rico’s leaders reached agreement Friday on a sweeping tax and spending plan that could result in a balanced budget for the U.S. Territory, albeit its implications, if this second such effort with the legislature were approved are uncertain. The agreement, framed by Gov. Alejandro García Padilla and legislators from his Popular Democratic Party, proposes more than a 50 percent increase in the territory’s sales and use tax, from the current 7 percent to 11.5 percent, out of which, about 90 percent of the revenues would go to the territory and just over 10 percent would go to the island’s municipalities—as a first step in a transformation of the Territory’s sales and use tax to a VAT or value added tax―a tax which would apply not just to goods, but also to services, except for health, education, prescription drugs, rent, mortgage payments, and utility payments. Junk credit-rated Puerto Rico faces a $191 million deficit in this year’s spending plan, and a nearing July 1 deadline by which to adopt its FY2016 budget. A planned sale of $2.9 billion of bonds backed by oil taxes hinges on achieving a balanced budget, a five-year financial framework and new revenue measures, according to its Government Development Bank: the Commonwealth and its agencies have $72 billion of debt. Lilliam Maldonado, a spokesperson for Puerto Rico House Representative Jesús Santa Rodriguez, said the revenue measures would bring in $1.5 billion per fiscal year. In addition, it appears there is growing consensus on other tax changes—plus some nearly $600 million in discretionary spending cuts. Despite the renewed effort between the Governor and key leaders in the legislature, the tentative, informal agreement faces a short time frame and any number of political obstacles—all pitted against a growing awareness that absent such extreme action, both the U.S. Territory and many, many of its cities could default. Thus, unsurprisingly, Senate President Eduardo Bhatia Thursday said: “May 14 will go down in history as the day that Puerto Rico began implementing a responsible budget.”

San Bernardino Prepares to Vote on a Plan of Debt Adjustment

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May 15, 2015
Visit the project blog: The Municipal Sustainability Project

Getting Ready to Rumble. San Bernardino yesterday made public its proposed plan of debt adjustment (San Bernardino Plan of Recovery) for consideration by the Mayor and Council to consider and vote upon Monday—a plan under which the city proposes to severely reduce post-retirement health care benefits, contract out for key municipal services, including fire and waste disposal, and cut by 99 percent what it will pay on its $50 million obligation to its pension obligation bondholders. Under the proposed plan, of the city’s ten classes of creditors, the draft plan proposes to make full payment to CalPERS and full payment where required by the state constitution. Notwithstanding the deep cuts in personnel already made, the draft plan proposes the elimination of an additional 250 positions, and continued deferral of $200 million in essential capital maintenance and replacement of fleet vehicles. Even then, the plan notes a structural deficit of more than $20 million would remain in the city’s general fund. According to the draft plan, about $51.7 million of the $357.9 million in potential labor savings for FY2015 through FY2034 have already been implemented through negotiations and mediation. The document reports that the city’s retirees have agreed to a settlement, under which they will pay more for retiree health care through moving to a separate healthcare plan—a move the document reports would save the city $370,000 annually beginning next year—and a change the president of the city’s retirees’ association told the San Bernardino Sun was worth it to ensure their pension benefits remained intact: “The immediate concern was the agreement that the city had with CalPERS…And the retiree association’s first priority was the preservation of our CalPERS benefits that have been earned by the retirees over the past several decades.” Under the draft plan, each of the eight groups of creditors proposed to be impaired would be entitled to vote to accept or reject the plan; nevertheless, the draft plan makes clear the city would seek to have U.S. Bankruptcy Judge Meredith Jury impose its proposed plan.
In his cover memorandum to the Mayor and Council, City Manager Allen Parker and City Attorney Gary Saenz wrote: “As the Recovery Plan makes clear, our first priority has to be the delivery of adequate municipal services…the pain will be shared among all stakeholders; employees, retirees, citizens (in the form of impaired service levels until the City can retain its footing) and capital market creditors. Only by undertaking the difficult process of refashioning the City into a modern municipal corporation can we be successful in creating a solvent future.”

The plan proposes to continue—or increase—the city’s pace of outsourcing some essential public services, to rewrite the city’s charter, as well as to continue to reduce the size of the city’s workforce, noting: “Contracting out of various services currently being provided ‘in house’ by the City is a keystone of this Plan…These include, but are not limited to, fire suppression, EMT services, and solid waste management collection/disposal.” Much of the outsourcing is proposed to begin this year, according to the draft 77-page recovery plan, including business license administration, fleet maintenance, and other services. With regard to the charter, the plan refers to the “interim charter agreement” under which city officials have already agreed to work, adding that the city expects the Council-appointed charter review committee to draft a proposed new charter and “place such proposed new Charter before the voters on the November 2016 ballot (or earlier if possible).” (In California, state law restricts proposed charter amendments to the November ballot in even-numbered years.) The forecast portion of the document forecasts that police and firefighters will continue to receive salary increases of 3 percent annually—an issue on which the city is mandated by its charter, in order to comply with the requirement to continue paying the average of what 10 like-sized cities pay for those positions. Salary compensation for non-safety employees is forecast to grow by 2 percent annually. Under the proposed plan, holders of $50 million in pension obligation bonds would receive an unsecured note and be paid based on a reduced principal of $500,000. Payments on that principal would begin in the sixth year after the Plan of Adjustment became effective. No payments would be made on bonds and certificates of participation issued in 1996 and 1999, respectively, for five years. Then, based on a new maturity date of 2035, only the interest would be paid for years six through 10, then interest and principal would be repaid through the term of the lease.

The City Council meets Monday to vote on the plan, which will be item six on its agenda: Resolution of the Mayor and Common Council of the City of San Bernardino Authorizing the Implementation of the City’s Fiscal Recovery Plan, the Filing of the Chapter 9 Plan of Adjustment and Disclosure Statement, and the Filing of Related Documents (#3853).
As San Bernardino City Attorney Gary Saenz earlier noted: “[The proposed plan] treats our citizens much better than our municipal bondholders…We expect our plan is going to provide for a substantial impairment of those (outside-the-city) groups, all for the purposes of increasing our service levels for our citizens. For each dollar we don’t pay our pension obligation bondholders, we will have a dollar to provide services.” Thus, Monday, San Bernardino elected leaders—much like their colleagues in Jefferson County, Alabama, and in Stockton—rather than a state-appointed emergency manager—will determine the fate of the proposed plan of debt adjustment—in an open and public forum―based upon a chaotic process of citizen and business impute, and strategic planning sessions by its elected leadership. There has been nothing pretty about municipal democracy, but a profound difference than preemption of local governance and accountability.

Governance Challenges. In the documents released by the city yesterday, one can appreciate the scope of the challenges—both in average per capita incomes, which mean the city has a significantly poorer tax base from which to meet mandates obligating it to pay salaries equivalent to those of its surrounding, higher per capita income jurisdictions. In addition, as the document notes, while the city’s new Charter created the position of city manager, an important step toward a council-manager form of government, the new Charter continued provisions which impede the city manager from exercising full responsibility and authority for effectively and efficiently delivering services throughout the entire city organization. Specifically, the new City Charter:

• Did not formally establish a council-manager form of government for the City of San Bernardino. Unlike many city charters, no form of government was specifically stated.

• Designated the Mayor as the chief executive officer of the City (strong Mayor), with responsibility for general supervision of the police chief and fire chief. While the city manager was designated to have day-to-day supervision of these functions, the new Charter did not achieve the objective of having a city manager position with full responsibility for managing the City.

• Maintained three separate departments under the administrative and operational direction of three advisory bodies (Component Boards) appointed by the Mayor and Common Council, not the city manager. The Mayor, however, lacks the authority to remove members from each of these boards. As a result, the water utility, library and civil service functions are not accountable to the municipal operation.

• Retained the authority of the Mayor and Common Council to appoint and remove department heads, division heads, and all unclassified City employees. Only classified employees within city manager-directed departments may be removed upon the recommendation of the city manager, without the additional required consent of the Mayor and Common Council. Due to contradictions within the Charter, it is unclear whether the city manager can remove department or division (classified employees) heads without the expressed consent of the Mayor and Common Council.

An Ill Wind in the Windy City. Following in the wake of Tuesday’s credit rating downgrade of Chicago, Standard & Poor’s yesterday dropped the city two steps (from an A+ to an A-)—and warned of possible further downgrades, but seemingly not because of any actions or inactions by the city, but rather because of the adverse fiscal impact of Moody’s downgrade, which, S&P warned, could inflict liquidity pressures on the city, in part because, under some current agreements Chicago has with some of its banking institutions, those banks could call or demand some $2.2 billion in debt repayments. S&P credit analyst Helen Samuelson noted; “The rating action reflects our view that the city’s efforts are challenged by short-term interference that prevents a solid and credible approach at this time…That said, we recognize that the city has a diverse tax base and a management team that has good policies in place,” adding that: “These are an important foundation for any city that needs to address the challenges that this city is facing.” S&P reported it expects Mayor Emanuel’s administration to address the city’s liquidity pressures, either by means of full re-negotiations or through utilizing its own internal liquidity – but warned that: “If the city does need to access its own internal liquidity, at levels we feel compromise its overall liquidity strength, this could lead to further downgrades.” The issue is that the Tuesday downgrade by Moody’s opened the door in a way that permits the city’s banks which provide credit or serve as interest-rate swap counterparties to demand repayment of $600 million in short-term credit lines, $1.1 billion in floating-rate debt and swaps, and $500 million in sewer or water related floating-rate paper and swaps. Although no such demands have been made, Chicago leaders maintain the city has the requisite liquidity and reserves necessary to cover the costs. Chicago CFO Lois Scott yesterday noted: “The city of Chicago’s financial crisis is real, urgent, and has been decades in the making…The downgrade by Moody’s of the city’s credit – a decision they say was driven by the Illinois Supreme Court’s reversal of the state pension reform bill – has substantially magnified the city’s challenges and will add real costs to Chicago’s taxpayers…Standard & Poor’s noted today that their own downgrade is driven by the short-term pressures on the city’s fiscal position that were created by Moody’s actions earlier this week. However, unlike Moody’s, S&P recognizes the City’s efforts to not only address its legacy liabilities, but that it has the right tools in place to address the challenges it faces.”

Restructuring Municipal Debt: Is there a Lesson to be Learned from China?

May 14, 2015
Visit the project blog: The Municipal Sustainability Project

Getting Ready to Rumble. San Bernardino will release a proposed, sweeping plan of municipal debt adjustment this afternoon for the Mayor and Council to vote upon on Monday—a plan expected to propose sweeping changes which will affect the city’s businesses and residents, employees, and creditors for years to come—albeit, those changes, which will affect not just the different classes of the city’s creditors, but also its citizens, will not all be the same. City Attorney Gary Saenz yesterday noted: “It treats our citizens much better than our municipal bondholders…We expect our plan is going to provide for a substantial impairment of those (outside-the-city) groups, all for the purposes of increasing our service levels for our citizens. For each dollar we don’t pay our pension obligation bondholders, we will have a dollar to provide services.” Mr. Saenz, emphasized that the city had already made clear its intent to fully meet its public pension obligations to the California Public Employees’ Retirement System―in order, he noted, to retain employees―bit which, he noted, had already led to litigation against the city from its pension obligation bondholders. Without directly addressing the specific changes to cuts in basic city services, Mr. Saenz did state there would be “increased efficiencies” in municipal services, as well as other, unspecified “tough choices,” adding: “We are committed to it as a city…If we fail to implement in a significant way… Judge Jury (U.S. Bankruptcy Judge Meredith Jury) will have jurisdiction to call the city on that and require that we implement.” Dissimilar to the processes of finalizing plans of debt adjustment in Central Falls, Rhode Island and in Detroit; San Bernardino’s plan has been put together after seeking considerable citizen and business impute, strategic planning sessions by its elected leadership—or, as Mr. Saenz put it yesterday: “It was very much our intention, through the strategic plan and otherwise, to get input from the entire community — both the business community, the education community, and of course the everyday citizens — with regard to the city they want in the future…It was our intention to incorporate that into the Plan of Adjustment. We believe we have been successful in doing that, and we believe that the core team will concur that to the degree that we could, that we have been successful in doing that.” In fact, the city’s “core team” of 17 community representatives, as well as any other interested community members, will meet Saturday morning for a lengthy session to discuss the proposed plan of adjustment and other aspects of the city’s long-term future—a key session in advance of Monday’s vote. With Mr. Saenz warning, in advance, that the plan will involve some pain for many groups: “I believe that one of the primary purposes of Chapter 9 bankruptcy law is that a city that needs the protecting and the assistance of the bankruptcy court to readjust itself in order to continue providing services is going to need to do a number of things…That includes, unfortunately, impairment not only of a number of our creditors but of employee groups as well, and even to some extent impairment of our citizens who are going to have reduced service levels.” Nevertheless, he added, like castor oil, such a plan could be a keystone to a better and more sustainable fiscal future: “That’s the essence of it, a plan that essentially incorporates what the council will adopt as our recovery plan,” he said. “And that, of course, is going to describe for the court and all our creditors and, most importantly, for our citizens, how our city is going to recover and how we’re going to reestablish service solvency — which in my mind is the most important objective.”

An Ill Fiscal Wind. Citing the unremitting burden of debt from the Illinois Supreme Court’s recent decision finding the state’s proposed public changes unconstitutional, Moody’s has reduced the City of Chicago’s debt rating to junk with a negative outlook, writing that the city’s options for reducing the growth of its public pension liabilities “have narrowed considerably.” The rating agency dropped the Windy City’s $8.9 billion of general obligation, sales tax, and motor fuel bonds to a speculative grade Ba1—an action which will exacerbate Chicago’s borrowing costs when it reoffers floating-rate debt in fixed-rate mode later this month, and which could trigger a series of fiscal tribulations relating to bank support on its short-term borrowing program and other credit contracts: “Based on the Illinois Supreme Court’s May 8 overturning of the statute that governs the State of Illinois’ pensions, we believe that the city’s options for curbing growth in its own unfunded pension liabilities have narrowed considerably…Whether or not the current statutes that govern Chicago’s pension plans stand, we expect the costs of servicing Chicago’s unfunded liabilities will grow, placing significant strain on the city’s financial operations absent commensurate growth in revenue and/or reductions in other expenditures…The magnitude of the budget adjustments that will be required of the city are significant. In response, Chicago described Moody’s action as not only premature, but also irresponsible—an action which the city decried as playing politics with Chicago’s financial future by pushing the city to increase taxes on its residents without reform. Chicago’s four pension plans, collectively, have more than $20 billion in unfunded liabilities—leaving the city as much as about half the assets necessary to meet its promises. In response, Mayor Rahm Emanuel said: “While Chicago’s financial crisis is very real and at our doorsteps, today’s irresponsible decision by Moody’s to downgrade the City’s credit by two steps goes far beyond that reality,” adding that the agency both failed to acknowledge the city’s growing economy or its progress in addressing its fiscal challenges. Though the Illinois Supreme Court decision does not directly implicate Chicago’s pensions, it raises the risk that the city’s own proposed pension reforms will be similarly held unconstitutional—leading Mayor Emanuel to call the rating agency “irresponsible” to base its decision on the overturning of a state pension bill that did not include the city’s changes. In its action, Moody’s also dropped its ratings on the city’s senior and second lien water bonds, dropping them to Baa1 and Baa2 from A2 and A3, respectively; Moody’s also downgraded senior and second lien sewer bonds to Baa2 and Baa3 from A3 and Baa1, respectively, affecting $3.8 billion of revenue debt. The outlook remains negative.

As of April 20, the city was carrying about $589 million on its short-term borrowing program that includes lines of credit and a commercial paper program with a total capacity of $900 million. A speculative grade rating triggers an event of default on the city’s banking agreements that support the short term program. All of the liquidity contracts expire over the next year. The city has reported ongoing negotiations with liquidity providers to extend the dates. Moody’s action appears in stark contrast with other rating agencies: S&P recently affirmed Chicago’s A-plus rating and negative outlook, and Kroll Bond Rating Agency affirmed its A-minus rating and stable outlook. Fitch Ratings rates the city A-minus with a negative outlook. The change makes Chicago the only major city, other than Detroit, to carry a junk bond rating from Moody’s. Howard Cure, director of municipal research at Evercore Wealth Management in New York, said his firm has been avoiding Chicago general-obligation bonds “for a while;” nevertheless, he said he was surprised Moody’s cut the city’s rating low enough to place it in junk territory. “It’s not as if the city’s economy is doing badly,” Mr. Cure said. “They’re actually gaining population and having growth downtown. They have some big-city problems, but it’s not a Detroit situation.”

Taxing Times. With a growing sense that Congress will not act to provide Puerto Rico with the authority that every state has to offer access to municipal bankruptcy for its 78 municipalities, Gov. Alejandro García Padilla is seeking to go back to the legislature with a revised tax and spending proposal to try to address the U.S. Territory’s looming insolvency. In the Gov. Padilla’s latest proposal, he proposes a 13.25% value added tax (VAT), which would replace Puerto Rico’s current 7% sales and use tax. The VAT would consist of 11.75% for the commonwealth government and 1.5% for the municipalities—instead of the current 7% sales and use tax, divvied up so that 5.5% goes to the commonwealth and 1% to the municipalities. The remainder 0.5% also is collected by COFINA until late in the year, after which those revenues, too, are directed to municipalities. Under Gov. Padilla’s new revenue proposal, of the 1.5% portion, a 1% sliver would go directly to the municipalities and 0.5% would go to a Corporation for Municipal Finance (COFIM), which would hold money for bonds for the municipalities. Governor Padilla and Puerto Rico Senate President Eduardo Bhatia apparently have also reached consensus that the tax increase would be combined with a $500 million cut in government spending. This week, Gov. Padilla met with Sen. President Bhatia and House of Representatives President Jaime Perelló to discuss the proposal, before the Governor presented it to members of his Popular Democratic Party in the Puerto Rico House and Senate. This new taxing effort comes in the wake of the legislature’s rejection, in April, of Gov. Padilla’s tax reform proposal to reduce income taxes and increase consumption taxes―he had proposed a value added tax or VAT tax of 16%–which, after it aroused a beehive of anger—he modified to 14%–still not enough for the legislature: the House voted 28-22 to reject the modified tax changes. The Governor is scheduled to meet with party leaders this morning in an effort to try to reach a consensus solution for the commonwealth’s fiscal year 2016 budget. The budget for the current fiscal year is for $9.56 billion in spending. The government has indicated that it needs to come up with more than $1 billion in spending cuts and/or revenue increases to achieve a balanced budget in fiscal year 2016.

Saving Motor City Homes. Detroit, before going into municipal bankruptcy, had 78,000 vacant structures and 60,000 vacant land parcels—vacancies which presented an ongoing public safety and public health concern, forcing the city, despite the signal loss of population, to provide and maintain services over its 139 square miles—and to be vulnerable to its 66,000 blighted and vacant lots which encouraged arson and other crimes. The vacancies did—and do—not stop at the city’s boundaries, but also crossed into adjacent and surrounding Wayne County, where, this week, County Treasurer Raymond Wojtowicz extended this week’s deadline for homeowners in the Detroit metropolitan area to make payment arrangements on overdue taxes to June 8th—marking the second extension of the previous March 31 deadline. The notice came in a year when foreclosure proceedings have been started on about 75,000 properties―most in Detroit. Taxpayers remitted their taxes on nearly 20,000; 24,000 others are on payment plans. Slightly over one third of the 30,000 properties still facing foreclosure are occupied. Detroit Mayor Mike Duggan called Mr. Wojtowicz’s efforts “vital to the stabilization and rebirth” of Detroit neighborhoods. Gov. Rick Snyder signed a bill this year that allows homeowners facing financial hardship to use a payment plan to pay off debts and avoid foreclosure.

Restructuring Municipal Debt. Even as Congress has now voted expressly not to help municipalities at risk of insolvency in the U.S., China is launching a broad stimulus to help its municipalities restructure trillions of dollars’ worth of municipal debts by means of a debt-for-bond swap program under which the People’s Bank of China’s plan will allow commercial banks to purchase local government bailout bonds which could then be used as collateral for low-cost loans from the bank. The new stimulus effort comes as China’s cities, which have $1.1 trillion renminbi in outstanding municipal bonds, are confronted with unsupportable levels of municipal debt—even as their borrowing costs remain high. China’s State Council has recently instructed the country’s top economic agencies, including its Finance Ministry, central bank, and the China Banking Regulatory Commission to put together a plan to help the nation’s local governments address their mounting debts.

The Unique Roles of Mediators in Municipal Bankruptcy

Getting Ready to Rumble. With the San Bernardino City Council poised to be briefed and then vote tomorrow on the city’s proposed plan of debt adjustment, so that it may be submitted to U.S. Bankruptcy Judge Meredith Jury prior to her deadline of May 30th, Paul Glassman, an attorney for San Bernardino yesterday, in court, told Judge Jury San Bernardino “hopes it can reach an agreement by the plan filing deadline with the unions…The city also has begun negotiations with other non-safety unions — and hopes to reach agreements with whatever groups it can before the plan filing deadline.” Almost as if in a two-ring circus, even as the Mayor and Council are prepping for tomorrow’s vote, the outlines of the battle amongst the city’s creditors that Judge Jury will opine upon are already emerging. Indeed, Monday’s status hearing in the U.S. Bankruptcy court did not come out well for some of the owners of San Bernardino pension obligation bonds, who suffered a key defeat. In a reprise of the struggles between bondholders and public pensions which characterized critical issues in the Stockton and Detroit bankruptcies, Judge Jury ruled against their argument that the pension obligation bonds should be treated no differently than San Bernardino’s obligations to the California Public Employees’ Retirement System (CalPERS), which San Bernardino plans to honor. The hearing, to consider Erste Europaische Pfandbrief- und Kommunalkreditbank AG and Ambac Assurance Corporation’s complaint filed last January seeking equal treatment as creditors with CalPERS—a hearing where the pension bond attorneys pointed to a court validation ruling the city obtained prior to issuing the pension bonds in 2005, focused on the issue with regard to San Bernardino’s argument that the pension bonds represented simply a refinancing of its unfunded liability to CalPERS; as a result, they had argued, it was not new debt, so that it did not require voter approval. The bank’s lawyers argued that any payment of San Bernardino’s obligations to CalPERS required equivalent payment to the holders of the city’s pension obligation bonds: “The bondholder pension obligation portion and the CalPERS pension obligation portion are separate portions of a single indivisible pension obligation owed by the debtor under the retirement law and CalPERS contract.”

Judge Jury, however, demurred, responding that she does not think the bonds and payments to CalPERS are a single obligation which should be treated the same in municipal bankruptcy: “Although maybe it is a concept I don’t fully understand, it does seem the retirement law is a source granting the city the right to issue POBs.” Judge Jury said she was wrestling with the awareness that, if POBs were not treated on par with pensions and bondholders were to be treated differently (e.g. take a haircut), the city could confront greater barriers in the future issuing municipal bond debt for its public pension obligations: “The city wants the opportunity to protect against uncertain fluctuations with CalPERS by issuing bonds…Both sides wanted this transaction, so it could happen.” Nevertheless, Judge Jury said the central issue was whether San Bernardino’s pension payments and bond payments were a single obligation. She opined they are not: “It is important that the remedies (for curing default) are different…That is enough for the court to be satisfied that it can’t be considered the same obligation,” adding that she does understand the importance of her ruling and the impact on the municipal bond market in California. Nevertheless, Judge Jury granted the motion to dismiss without leave.

The issue with regard to whether pension obligation bonds issued by a municipality ought to have exactly the same status as the CalPERS UAAL is, as one colleague puts it: “ridiculous,” suggesting that if we were to ask anyone (creditor, rating agency, or debtor) whether a refinancing is a separate and different debt issue that stands on its own….they would each give the same answer. The bond insurer in this case tried to push that, mayhap forgetting the status and uniqueness of CalPERS. The insurer questioned whether CalPERS is truly a creditor in the first place…as opposed to a conduit…receiving funds, investing them, and then paying it out to the retirees: “They cannot lose money and they cannot make money. They are a product of state law. The real creditors are the retirees…” much as Judge Christopher Klein had written in his confirmation opinion with regard to Stockton.

The Unique Roles of Mediators in Municipal Bankruptcy. Perhaps because of his electrical rhythm, U.S. Bankruptcy Judge Steven Rhodes made an invaluable contribution to the annals of municipal bankruptcy through his appointment of U.S. District Judge Gerald E. Rosen to serve as a mediator in Detroit’s municipal bankruptcy. So too, U.S. Bankruptcy Judge Christopher Klein swore by the invaluable U.S. Bankruptcy Judge Gregg Zive, who served as a mediator for him—and has now accepted a similar position in San Bernardino, where Ron Olinor, who represents the San Bernardino police officers’ union, noted yesterday: “I like everything the city has done so far today,” noting that the mediation process headed by U.S. Bankruptcy Judge Gregg Zive is bearing fruit: “Judge Zive is very much involved…We have been on the phone with Judge Zive twice today. He will be reaching out to you at the appropriate time. It has been a long road. There are many reasons on the city’s part and sworn officers’ part to make a deal…We have a deadline, thank you for that — we will know where the city is at after the plan is filed.”

Financial Armageddon. Wayne County, one of the nation’s largest counties, which surrounds Detroit, also confronts many of the same fiscal stresses which brought the Motor City into municipal bankruptcy: plummeting property taxes are putting its deficit on track to swell to $200 million by 2019, from $159.5 million in 2013, according to Fitch; Wayne County’s pension assets are $910 million less than promised payouts, and its post-retirement health care is underfunded by $1.3 billion—or, as one analyst put it: “When we look at Wayne County’s tax base, its budget, its balance sheet, it looks eerily similar to the city of Detroit’s problems.” Indeed, three months after Wayne County Executive Warren Evans warned of possible “financial Armageddon” in the face of the county’s looming budget deficit, Mr. Evans is proposing to reduce wages, end post-retirement health-care benefits for future retirees, and reductions in pension benefits. Moody’s has moodily reduced Wayne’s credit rating to junk status, and Fitch has noted that the county’s jail debt may be “particularly vulnerable,” as officials sort out its finances: should Wayne County file for municipal bankruptcy, its $200 million municipal bonds backing an unfinished, 2000-bed jail in downtown Detroit would likely go unpaid. Officials halted construction in 2013 amid cost overruns. For his part, Mr. Evans said in the County’s recovery plan released last month that if his recommendations are implemented, the county can plan a new jail. Whether finishing the partially built facility is the answer, however, remains an “open question,” according to his report. Mr. Evans has proposed changes to cut $53.4 million from spending; meanwhile the county’s efforts to negotiate wage and benefit reductions with unions are showing little signs of progress. The county’s largest union, AFSCME Council 25, reports its members have already taken pay cuts. Gary Woronchak, Chairman of the Wayne County Commission, states the county’s debt payments are safe: there is “no chance” of vendors or bondholders not being paid. Should the county’s fiscal conditions deteriorate, Chairman Woronchak believes the most likely outcome would be a consent agreement, in which county officials and the state would agree on measures to resolve the crisis, adding that, unlike in neighboring Detroit, even though Governor Snyder could appoint an emergency manager, that step would not be needed, because, he says, the financial challenges are manageable and municipal bankruptcy “is not in the realm of what’s going to happen.” Indeed, almost like Romulus and Remus, Detroit’s long-term recovery from municipal bankruptcy might irretrievably now be dependent upon Wayne County’s avoidance of going into municipal bankruptcy.

Going to School on Debt. After really trying to give Gary a chance, and less than a month after the city’s School Board fired its school district’s interim chief financial officer, the Indiana legislature—in a state which does not specifically authorize municipalities to file for municipal bankruptcy―is trying to finalize new state legislation which would allow the state to take over the city’s school system. It would, if the final details are worked out, mark the first use of an emergency manager to assume responsibility for a local entity. The statutory language authorizing a state takeover is expected to incorporate specifics with regard to the process for selecting an emergency manager, as well as the scope of authority such a manager would have—or, as Dennis Costerison, a lobbyist for the state’s public school system described it for the Bond Buyer: “It will be a first, and it will be very interesting…We’ve never had a district go this far before.” The bill authorizes the Distressed Unit Appeals Board or DUAB to oversee the new emergency management process. The DUAB was created in 2008 to help distressed local governments deal with property tax revenues losses, but, so far, has only managed a few units. Under the legislation, DUAB will hold a public hearing on the Gary district’s finances. The state board will then select three financial managers, and the Gary school board will choose one of them. The manager will have a year’s tenure. The legislation authorizes the DUAB authority to “delay or suspend” a school the district’s principal and interest payments on loans from the Indiana Common School Loan Fund and recommend to the state board of finance that it make an interest-free loan with a six-year maturity. Micah Vincent, chair of DUAB and general counsel and policy director for the Indiana Office of Budget and Management, said the board has yet to work out the fine print of the takeover. Mr. Vincent hopes to fine tune the plan over the next month; DUAB will hold the public hearing this summer.

Mr. Vincent noted the board will be looking at other states’ programs, including that of Michigan, which is considered to have a relatively strong emergency management program. An emergency manager will likely begin his or her tenure with a comprehensive audit of all areas of the school district from “bookkeeping to bill paying,” according to Mr. Vincent, who declined to comment on whether the process or the emergency manager would have the ability to restructure bond debt, but noted that the current law only allows for the restructuring of state loan debt. The school corporation has $30.5 million of direct debt. That includes $13.8 million of general obligation bonds, and $16.4 million of state loans. It has another $44.3 million of underlying debt from Gary Building Corp. mortgage bonds. Its debt service fund had a negative ending balance of $349,000 as of fiscal 2013, an improvement from the $669,000 deficit in 2012 but down from the $2.4 million positive balance in 2009, bond documents show.

Gary, a city of 78,000, just 25 miles from Chicago, is a municipality which has experienced severe fiscal problems related to its population decline and property tax caps—in addition to nearly a 50 percent reduction in state school aid over the last five years—indeed, today Gary has among the highest number of charter schools in the state, whilst the city’s public school system has experienced nearly a 40 percent decline—meaning that by this month, the system’s general fund balance had fallen to $6.6 million in the red by 2013, a severe reversal from the $9.3 million surplus the school system recorded in 2009. State property tax reform exacted a severe toll: when enacted in 2008, the school system’s general fund was barred from receiving any property tax revenues and forced to rely entirely upon state aid. And as if such fiscal misery was not enough of a challenge for municipal leaders, voters last week rejected a referendum that would have raised additional revenue. But the academic road map in Gary is likely to only become more challenging: the state’s newly adopted budget includes provisions to modify Indiana’s state school funding formula to make funding more closely follow students: that is a change that could have the effect of cutting state aid for lower income, urban school districts, but increasing fiscal assistance for suburban districts which are experiencing increased enrollment.