10.25.13

Detroit on the Razor’s Edge: Day II. In the second day of hearings before U.S. Bankruptcy Judge Rhodes on the Motor city’s eligibility for chapter 9 municipal bankruptcy, Kenneth Buckfire, Detroit’s top outside financial adviser, testified the city was operating on a “razor’s edge” and had no options to avoid running out of cash and filing for municipal bankruptcy. He told the court that the city attempted to avoid filing last July by cutting expenses and looking at city assets that might be sold to raise cash, telling the court that Motown’s best source of revenue was its three casinos, which brought in about $180 million a year, or 20% of Detroit’s budget; but those funds have been off limits since the city pledged them as collateral to interest-rate swap contracts agreed to in 2009; and now the city hopes to use them as collateral on $350 million of debtor in possession financing to end the unfavorable swap deals: “I was very concerned about the default threat that, at any time, the swap parties could block the city’s access to gaming revenues which was, and still is, the highest quality revenue the city has…In January, that was our primary concern…The swap banks could deprive us of access to the casino revenue and cause the city incredible damage, and we would have had to make massive cutbacks to services.” He testified that in the effort to raise cash, the city considered selling everything from masterpieces at the Detroit Institute of Arts to city infrastructure; however, the city was unable to reach any sales agreements before the July 18 bankruptcy filing, noting, for instance, that the city’s Coleman Young Municipal Airport is “effectively worth nothing.” Mr. Buckfire testified the city cannot sell its portion of the Detroit-Windsor tunnel until at least 2020, and the works of the Detroit Institute of Arts are currently being appraised by Christie’s auction house. Mr. Buckfire also testified the city has been considering leasing the Detroit Water and Sewerage Department to a regional authority. Detroit Emergency Manager Kevyn Orr proposed the deal in June, and negotiations are ongoing. Several private equity firms were potentially interested in purchasing the department if they could charge higher water rates. Attorneys representing unions, retirees, and pension funds who claim the city is ineligible for bankruptcy will be able to question Mr. Buckfire, the third of five witnesses the city is expected to call, when the trial resumes this morning.

Pension & Post Retirement Benefits & Bondholder Creditors. Prior to Mr. Buckfire’s testimony, Gaurav Malhotra, a financial analyst who has advised the city since 2011, testified that Detroit could improve its cash flow only by restructuring its pension and health benefits, not by selling assets or deferring payments to its pension funds. Even if the city could sell some assets, he testified, the proceeds would do little to close the more than $18 billion in liabilities the city faces. Similarly, bond insurers wrapping Detroit’s debt fought the city’s restructuring proposal ahead of its historic July bankruptcy filing in part because they did not want to set a precedent for other cities: “They made it very clear to me they were not willing to consider any impairment of general obligation bonds,” Mr. Buckfire testified, noting that none of the city’s creditors, secured or unsecured, were happy with the restructuring plan unveiled by emergency manager Kevyn Orr on June 14th. The proposal treats the city’s unlimited-tax general obligation bondholders, as well as its pensioners, as unsecured, offering roughly a dime on the dollar in repayment: “Speaking with bondholders, nobody was willing to consider any compromise of their claims, whatsoever.” Bondholders of the city’s water and sewer bonds also pushed back against Mr. Orr’s restructuring plan. The city has nearly $6 billion of water and sewer bonds, which are considered among its most secured debt. Orr wants to spin off the department into a new regional authority and refinance the debt. Earlier yesterday, Charles Moore, a restructuring specialist from Conway MacKenzie, weighed in on one of the more controversial aspects of the city’s fiscal picture: the size of its unfunded pension liability. Mr. Orr, backed by a report from actuarial firm Milliman, contends the city’s two pension systems together have a $3.5 billion liability. The pension systems and unions say that figure is vastly inflated. Union attorneys have pushed to not allow the city’s estimate to be introduced. U.S. Bankruptcy Judge Steven Rhodes yesterday, however, said he would allow Mr. Moore to testify about the $3.5 billion figure, but only as it relates to the Emergency Manager’s efforts to negotiate in good faith, not as the true or final liability. The judge made the same decision about the forecasting documents that project the city’s revenue growth. Mr. Moore testified that after years of cuts, many city departments were “severely broken, unable to perform basic functions” such as sending out property tax bills. He said it would cost the city $500 million over the next six years to demolish blighted buildings and improve vacant properties and $250 million to fix city operations over the next 10 years. The figures come from Orr’s June restructuring proposal, which Moore played a key role in crafting.

Detroit emergency manager Kevyn Orr and Police Chief James Craig are expected to testify today or Monday, depending on the schedule. Union and retiree attorneys will call Gov. Rick Snyder and other top state officials to testify when the city rests. The trial will last at least through next week, and Judge Rhodes has set aside additional days in early November if needed.

Motor City’s Future. Even as U.S. Bankruptcy Judge Steven Rhodes is overseeing Detroit’s future in his courtroom, Detroit’s citizens are looking to the future in the ballot box—so it was that this week, in the second of three mayoral debates, which took place a mere four blocks from the U.S. court chambers, mayoral candidates Mike Duggan and Benny Napoleon offered the Detroit Economic Club very different visions of what they want for the Motor City’s future. Mr. Dugan, the former CEO of Detroit Medical Center: “If I’m elected mayor, the politics of division will be behind us,” promising the city would be open for business, open to constructive relations with City Council, open to black, white and brown, open to Christians, Jews and Muslims, open to gay and straight. Mr. Napolean, Wayne County’s sheriff, pushed his plan for reviving the city’s beleaguered neighborhoods, saying, “We have to change the city, but we have to do it where people live.” As Detroit News Daniel Howes writes: “How Detroit’s bankruptcy is resolved, assuming Rhodes determines the city eligible to proceed, will have dramatic implications for distressed municipalities, their ability to shed obligations through Chapter 9, and the defenses unions and pension funds can muster to protect their people….Because the city is insolvent, for one. That’s an inescapable reality facing a reckoning all its own, no matter who is elected mayor in an election shaped by forces neither contender can control.”

Post Municipal Bankruptcy. The city of Vallejo is planning to sell $19 million of water revenue refunding bonds next week—the city’s first bond sale since its emergence from municipal bankruptcy two years ago. The issue is to arrest the cost of rising interest rates—in part, of course, created by Congressional brinksmanship on the U.S. debt ceiling and near federal bankruptcy earlier this month. Vallejo intends to use the proceeds of the water bonds to defease and refund the city’s variable rate demand water revenue bonds secured by a direct-pay letter of credit from JPMorgan Chase Bank that expires this coming Pearl Harbor Day. JP Morgan does not intend to extend the expiration date, and Vallejo has been unable to find another bank to provide a letter of credit, which is why it is refunding the bonds next week, according to Vallejo’s finance director, Deborah Lauchner: “We can’t continue with the variable rate bonds and, as you can imagine, they had a very low interest rate…We’re going to be going into a fixed rate and it’s going to cost us more money.”

Harried in Harrisburg. Pennsylvania legislators this week advanced scaled-back versions of bills intended to protect taxpayers by restricting government borrowing, in large part reflecting apprehensions about the dire fiscal straits of the state’s capitol city, Harrisburg. The bill, Senate Bill 903, proposes tighter regulations on municipal finance tools, such as swaps and guaranties—instruments used repeatedly to finance projects and generate cash payments for both Harrisburg and the Harrisburg Authority, and financial practices that were detailed in a forensic audit published in early 2012 and state Senate hearings later that year. Those exposures resulted in proposed reforms to the Local Government Unit Debt Act (LGUDA), including those outlined in Senate Bills 901 and 903. The intent is to mitigate taxpayer risk by increasing oversight of borrowing by municipalities, counties, and local authorities. Both bills were passed out of the state Local Government Committee, with an amendment to permit public guaranties of municipal authority debts if they are part of a recovery plan devised through the state’s Municipalities Financial Recovery Act. The LGUDA legislation package was introduced several months before Harrisburg’s state-appointed receiver and his team filed their Harrisburg Strong Plan. Senate Bill 901 amended also would allow guaranties in cases where they allow the borrower to obtain a lower interest rate; such bonds would also be permitted for financing sewer, stormwater, or water projects. The changes to Senate Bill 903 – increased regulations rather than banning swaps, mainly – resulted from feedback during committee hearings in September: officials from Philadelphia and Dauphin County stressed that the sophisticated financial instruments can be a beneficial tool, if properly managed. Former state Auditor General Jack Wagner and Bethlehem-Area Public School District officials, meanwhile, urged the state legislators to prohibit swaps.  The proposed bill suggests penalties and new procedures based on Harrisburg’s audit: hearings officials and their lawyers and financial advisers would face fines and jail time for filing false financial statements; Senate Bill 901 spells out penalties for knowingly submitting misleading information to the state Department of Community & Economic Development, or causing or helping a local government unit to act beyond the scope of its authority. Or, as one commentator wrote: “SB901 reads like a checklist of lessons learned from Harrisburg’s forensic audit and related hearings before the state Senate last fall.” The bill also prohibits public entities from providing guaranties (akin to cosigning) for authority debts unless:

• The debt is incurred in connection with a loan from the federal government or the Pennsylvania Infrastructure Investment Authority;

• The guaranty enables a better interest rate;

• The debt will pay for water, stormwater, and sewer projects; and

• The guaranty is included in a recovery plan devised through Pennsylvania’s Act 47 for distressed municipalities.

 

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