05.09.14

Taking Stock in Stockton. U.S. Bankruptcy Judge Christopher Klein will oversee a four-day confirmation hearing, beginning on Monday, in order to determine if he will grant approval of the California city’s plan of adjustment—the key to paving the way for the city to emerge from federal bankruptcy. The challenge will be for the city to convince Judge Klein that its recovery plan is not only fair and equitable, but also that it will provide for a sustainable future—and that the court will reject the objections of a major creditor, Franklin Advisors. It has been just short of two years since the northern California city filed for chapter 9, during which time Stockton has attained agreements with virtually all its creditors—except Franklin, which, under the city’s plan of adjustment, would receive a single payment of $94,000 for $35 million of Stockton Public Financing Authority lease revenue bonds the municipality issued in 2009. Franklin, in its filing, wrote that Stockton used the loan “to build and equip Fire Station No. 13, modernize and improve Fire Station No. 7, relocate and construct the Police Communications Center, acquire land for and construct seven City parks, and acquire, construct and install numerous paving, bridge, widening, lighting, landscaping and other street improvement projects throughout the City. Franklin’s funds were put to good civic use… [but that] the City made just four interest payments – with no repayment of principal – before defaulting on that thirty-year loan prior to bankruptcy. In the ensuing pre-bankruptcy ‘neutral evaluation’ process, the City offered to restructure and extend Franklin’s Bonds through a proposal that it claimed would enable Franklin to recover all scheduled principal and interest over the next forty years and ultimately obtain a net present value recovery of 54.5%….Now, however, the City seeks to cram down a plan of adjustment that essentially provides Franklin with no recovery whatsoever. By the Plan, the City asks the Court to permanently discharge Franklin’s claim through a one-time payment of less than $94,000 – a recovery of approximately one-quarter of one percent (.25%) of Franklin’s principal,” urging the federal court to determine Stockton has not made a reasonable effort to provide a reasonable recovery and that the city discriminates against Franklin by treating other creditors more favorably, claiming the city has made no meaningful response to those points.” In fact, Franklin did receive less favorable terms than other creditors of the city whose bonds were backed by leases on parking garages, an office building, and a sports arena. If the plan is approved, as Levinson and the city believe it will be, then Stockton will implement its plan, adhering to its agreements, paying claims, and meeting all of the conditions under its plan, and officially emerge from bankruptcy.

 

  • The Pensionary/Federalism Challenge. Another issue Judge Klein will confront in the hearing is the claim by Franklin that Stockton’s plan of adjustment would make no adjustment to the city’s pension obligations—unlike, for instance, its sister chapter 9 city, San Bernardino. Franklin will urge Judge Klein to reject the plan, arguing that it unfairly discriminates against its claim by classifying its bonds with a dissimilar retiree health benefit claim—urging the court to note the signal inequity in that the city’s plan would provide its retirees with a combined recovery of 70%, while proposing a 0.25 percent recovery for Franklin. Thus, Franklin will urge rejection of the plan, because it fails to provide it with a reasonable recovery due to Stockton’s refusal to confront its pension problem: “The city’s willingness to pay tens of millions of dollars every single year for the next thirty or more years to satisfy the pre-petition pension claim completely undercuts its assertion that it cannot make any future payments in any amount to Franklin.” Stockton responded by claiming it had already acted to reduce its pension obligations; further, Stockton wrote that its plan provides a path for the city to absorb short-term increases in its pension obligations, while maintaining its feasibility, and that its retirees bore their share of the pain because of the elimination of their once-generous health benefits. In addition, the city noted that any impairment of its California Public Employees’ Retirement System (Calpers) pension obligations would trigger a massive termination fee of $1.6 billion, and would significantly impair its ability to attract or retain public workers in the future. The federalism issue of whether pension obligations can be impaired—already pending before the 6th and 9th U.S. Courts of Appeal, is an issue on which Judge Klein has indicated he is prepared to rule—after, in the past, rejecting a contract impairment argument, noting that the constitutional prohibition against contract impairment does not apply in the bankruptcy arena.
  • The Trend Gap. Judge Klein has, according to the Bond Buyer, seen reports on the City of Vallejo’s uncertain recovery from municipal bankruptcy, so that he is acutely focused on determining whether Stockton’s plan – because it does not address its pension obligations—will ensure a sustainable future, or as the Chapter 9 Wizard of Chicago, Jim Spiotto puts it: “The important thing is, you want a permanent fix, not a temporary fix. If pension payments are not affordable and sustainable in the long run and you don’t address them now, that obviously will be a problem later.” According to Mr. Spiotto, Stockton will have to demonstrate to the federal court that its pension obligations will not be a problem in the future and that it takes care of them under the recovery plan: “The best interest to creditors is a long-term success and growing of the community so that there are more taxpayers and revenues…And it is not in the best interest of creditors not to address systemic problems that exist today.”

 

Looking for the Checkered Flag.Detroit’s first budget under bankruptcy has the city spending less than $1 billion from its general fund in each of the next three years, according to the spending plan released Friday by emergency manager Kevyn Orr’s office.

The budget is consistent with a restructuring blueprint the city filed in U.S. Bankruptcy Court, a spokesman for Orr said. So the city’s spending plan — typically worked out between the mayor and the City Council — will be subject to the outcome of the city’s bankruptcy case.

“The budget presented is balanced and modest,” Orr spokesman Bill Nowling said. “It allows the city to provide basic public services to its residents and to make additional investments where needed.”

Many city departments will face moderate to slight budget cuts under Orr’s plan.

But the mayor’s office would be getting a bump. The office spent about $2.9 million this year. It is projected to get about $7 million in each of the next three years. The City Council’s budget also is expected to increase, from about $5.5 million this year to more than $7 million a year.

Mayor Mike Duggan will not have to approve Orr’s budget, Duggan’s spokesman said. The mayor, however, is expected to testify in bankruptcy court during hearings this summer to approve Orr’s plan of adjustment.

Although Detroit filed for bankruptcy last year, seeking relief from about $18 billion in debts and projected long-term liabilities, the city is expected to generate about $959 million in general fund revenue in the current fiscal year, which ends June 30. The budget includes a $120-million loan approved last month in bankruptcy court to help pay for city services.

This current fiscal year’s general fund spending came in at $996 million. Over the next three years, Orr’s budget calls for $937 million, $922 million and $927 million, respectively, in general fund spending.

City Council President Pro Tem George Cushingberry Jr., chairman of the council’s budget committee, said he is pleased the mayor and the emergency manager are working together. Cushingberry said he will be comparing the spending plan to the city’s previous appropriations.

The mayor typically presents the budget publicly to the City Council, setting into motion an arduous process in which the council tweaks the mayor’s plan and creates an alternative budget before a final spending plan is approved. There was no public presentation to accompany Friday’s release of the budget.

Other highlights of Orr’s plan include:

■ General fund spending on workers’ pay remains generally flat, going from $341 million this year to about $351 million in 2016-17.

■ The police and fire departments’ general fund budgets will be drastically reduced. But Orr’s budget indicates their operations will be supplemented by the $120 million from the “quality of life loan.”

■ The Police Department’s general fund budget will be $262 million next year, compared with $359 million this year. The Fire Department spent about $176 million this year but will get about $112 in general fund dollars next year.

Late yesterday, Michigan House Speaker Jase Bolger introduced a package of 11 bills to address the state’s role in Detroit’s municipal bankruptcy. Under the provisions of the legislation, the state would appropriate $200 million to assist the Motor City as part of its plan of adjustment to emerge from municipal bankruptcy—in return for which the legislation would create a seven-member board to oversee Detroit’s pensions and finances for at least 20 years. The football team-sized package would address oversight of the city’s finances and pension systems as part of the state’s role in the so-called grand bargain, with Speaker Bolger stating: “There is concern about what is the right thing we do for (the) city of Detroit and for the residents of Michigan…And certainly there’s concern about the money, but also concern that this never happens again.” As introduced, the package includes proposed legislation to:

■ Create a Michigan Settlement Administration Authority to appropriate $194.8 million, taken from the state’s rainy day fund, to be paid back from the tobacco settlement over the next 20 years;

■ Require Detroit to hire a chief financial officer to handle the day-to-day operations of the city;

■ Create a seven-member oversight commission to oversee the financial operations of the city. The proposal is modeled after New York City’s oversight commission (the New York State Financial Control Board), created in 1975 to shepherd New York out of its severe fiscal distress. The committee would be created in lieu of a financial advisory board that would have been put in place after emergency manager Kevyn Orr leaves the city next fall and Judge Rhodes approves the city’s emergence from federal bankruptcy. Under the proposal, Gov. Rick Snyder would make two appointments, the state Treasurer would make two, and Senate Majority Leader Randy Richardville and House Speaker Bolger would each make one. Detroit Mayor Mike Duggan would have veto authority over contracts over $750,000, as well as collective bargaining agreements.

■ Prohibit the Detroit Institute of Arts from approving a new millage or renewing the existing millage that benefits the museum, reflecting the change in ownership of the museum from a quasi-public to a private entity.

■ Implement pension reforms that: prohibit the city from opting out of an 80/20 hard cap for employee health care premiums, transition new employees from a defined benefit to a defined contribution system, and create an investment committee that will recommend pension decisions to the funds’ boards of trustees.

■ Require that the commission ensures that binding arbitration with police and fire are consistent with the goals of the city’s long-term financial plan.

■ Require that benefits for new city employees are no greater than benefits received by state employees.

Speaker Bolger noted that the legislation is drafted so that it would apply to Michigan municipalities with populations in excess of 600,000 or more that file for chapter 9 municipal bankruptcy, while Governor Snyder said the legislation would help build a solid foundation for the Motor City’s revitalization while creating safeguards for taxpayers: “The legislation offered today reflects the commitment from our partners in the Legislature to work together to help Detroit pensioners and ultimately save taxpayers millions of dollars as momentum builds to solve problems that have dragged on for far too long…The city’s long-term viability is essential for its 700,000 residents, who already are seeing improvements in vital services and their quality of life. But all of Michigan benefits from a restored Detroit. Our largest city is known throughout the world. Detroit shouldn’t be known for its struggles, but its renewal — as the comeback city in the comeback state.” The House Committee on Detroit’s Recovery and Michigan’s Future, which includes a total of three Republicans and two Detroit Democrats, will begin meeting next week, perhaps as early as Tuesday, to consider the legislation.

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