12.3.13

B-Day in Motown. U.S. Bankruptcy Judge Steven Rhodes will issue his oral decision with regard to the City of Detroit’s eligibility for chapter 9 municipal bankruptcy protection this morning at 10:00 a.m. He is expected to issue his written opinion later today. The decision, coming after a nine-day trial—whatever it is—is certain to produce legal challenges, but also clear a lesser hurdle before the main event: fashioning a recovery plan that has the support of a majority of the Motor City’s 100,000-plus creditors. Judge Rhodes’ decision could also address the conflict between the Michigan constitution’s protections for pensions versus federal law. If, as many anticipate, Judge Rhodes determines the city is eligible, Emergency Manager Kevyn Orr would proceed with plans to propose a massive restructuring plan, or Plan of Adjustment. If Judge Rhodes determines the city is not eligible, Detroit would likely appeal—in addition to going back to creditors for another round of even more difficult negotiations; nevertheless, failure would almost certainly provoke a host of new law suits against the city from creditors that have not been paid in recent months―likely leading to Detroit refiling for federal bankruptcy.

In the event Judge Rhodes’ ruling gives the green light this morning for Kevyn Orr to commence what will be – by far – the more critical challenge of unspooling the largest municipal bankruptcy in American history, achieving consensus on a recovery plan; the process of negotiating such a plan with 100,000 plus creditors would be an exceptional challenge. But, in this case, it is almost less achieving a compromise on a plan to gain the support of a majority of the city’s creditors; rather it is fashioning a plan that will actually provide for a viable economic future for Detroit.  Moreover, because what happens in Detroit is likely to have ramifications for any city or county in the United States confronting severe fiscal distress, the next stages for the Motor City are expected to set national precedents for lenders, bondholders, unions, and pension funds. That is, this next stage poses a far more complex and critical challenge than any confronting Congress. Detroit would not have expended millions of its taxpayer dollars getting to this point were it easy to work out a compromise—thus there is little likelihood of achieving widespread consensus on any recovery plan. A restructuring or adjustment plan, after all, is intended to adjust — not eliminate — Detroit’s debts, so that none of the parties who have fought so hard against the bankruptcy can emerge from the process with everything it wants―and all the parties are far poorer than when the process began because of the enormous drain on resources already extracted to date. The real challenge will be not to simply patch over a broken fiscal process, but rather to fashion a plan that actually creates a viable fiscal and economic future for the city—a critical distinction from simply achieving a balanced budget.

 

Exiting Chapter 9. Jefferson County, Ala., home to the second-biggest municipal bankruptcy case in U.S. history, is expecting to close on the sale of $1.7 billion of new sewer warrants today—setting the stage to implement its Plan of Adjustment and exit from municipal bankruptcy. The county will use the proceeds to pay off prior sewer system creditors holding $3.2 billion in defaulted warrants, which will be retired. Once that occurs, the County’s plan of adjustment will be implemented, according to a market notice, ending a two-year process that cost the county $25 million in fees to lawyers and other advisors. Although several days remain on a two-week appeal period that began once the court confirmed the County’s Plan of Adjustment, today’s closing on the warrants will moot any appeals, according to Jefferson County Commission President David Carrington. When the county filed for Chapter 9 reorganization two years ago, attorneys projected that the complex case, at the time the largest municipal bankruptcy in the country with $4.1 billion in debt, could take three or four years and cost around $25 million to adjudicate (the case has already involved more than 75 attorneys who filed more than 2,000 briefs with the court). Moody’s noted that Jefferson County’s plan of adjustment “will test the county’s ability to manage its own operations and pay debt without the protection of bankruptcy proceedings…In particular, [the] county will need to implement sewer rate increases over the next 40 years, address sizeable unfunded sewer capital needs, and comply with a new debt service schedule that starts out moderate but spikes sharply upward in 11 years.” (With the sale of new warrants and better capital planning for the sewer system, which has been under a federal consent decree for decades, the county’s adjustment plan funds capital expenses for the first 10 years. After that a shortfall of $1.2 billion for capital needs was projected.) Commission President notes that despite its overcoming exceptional challenges, the county now must focus on restoring its financial credit in the market, and shed the “dark cloud of bankruptcy caused by past actions of county commissioners,” referring to previous commissioners and others who went to jail for corruption that enveloped the sewer system over the past decade. He noted Jefferson County must implement its new financial plan for the future, and publish audits on time: “We’re well positioned to grow so what we do now is take all of our energy getting our financial house in order and refocus on economic growth and job creation….I’m pretty optimistic now that this cloud is lifted, and excited about our future.”

When It Rains, It Pours. Michigan Governor Rick Snyder yesterday named financial review teams to examine the finances of two Detroit metro area governments – Royal Oak Township and Highland Park. The announcements could be a prelude to a state takeover, and comes in the wake of preliminary reviews launched last September by the Local Emergency Financial Assistance Loan Board, which had determined that “probable financial stress” exists in each community. The review itself was triggered by a preliminary analysis by the Michigan Department of the Treasury, as required under the state’s Local Fiscal Stability and Choice Act: the loan board reached its conclusions last month that fiscal conditions warranted moving on to next stage of review, after finding that Highland Park had violated state requirements of the Uniform Budgeting and Accounting Act. In addition, the report determined Highland Park was in breach of its approved deficit elimination plan filed in 2009. Its fiscal 2012 deficit elimination plan was not approved, because it would not result in eliminating the city’s shortfall within five years. The city’s water and sewer funds have experienced operating losses since 2008, reducing cash flows and hampering its ability to pay bills. In the case of Royal Oak Township, the Department of Treasury’s preliminary found numerous conditions warranted the deeper review including violations of Uniform Budgeting and Accounting Act provisions. The township recorded $205,000 in unbudgeted expenditures and borrowed $300,000 without either authority to do so or approval from the Department of Treasury. Royal Oak has operated with deficits in several funds over the past five years and it had submitted a deficit elimination plan deemed unacceptable by the state Department of Treasury. (Highland Park, which is located in Wayne County, has been under state control before and the Highland Park School District is already under emergency management. Royal Oak Township is located in triple-A rated Oakland County. The review teams must report back to Snyder within 60 days of their appointment as to whether specific statutory conditions exist or are likely to occur, and must determine whether a financial emergency exists in the local government. A review team can request a 30-day extension. If it is determined that a financial emergency exists, local officials have four options: a consent agreement with the state; an emergency manager; a neutral evaluator; or Chapter 9 bankruptcy, with Snyder’s approval.

 

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