05.28.14

eGnus. Severe municipal distress and the task of sorting roles of governance are hardly unique to the U.S. Two years ago, a report in South Africa listed at least 64 municipalities on the financial distress list: “From evidence to date, it is clear that much of local government is indeed in distress, and that this state of affairs has become deeply rooted within our system of governance.” The assessment, carried out in all nine of the nation’s provinces, found that there was an overall vacancy rate of 12% for senior managers in local government. The assessments were designed to ascertain the root causes of distress in many of the country’s 283 municipalities in order to inform a national turn-around strategy for local government. Insufficient municipal capacity due to lack of scarce skills was one of the department’s main challenges, along with poor financial management, corruption, and service delivery delays. The report found that skills scarcity was deepened by the decline of municipal professional associations and poor linkages between local government and the tertiary education sector: “Functional overreach and complexity are forcing many municipalities into distress mode, exacerbated by the poor leadership and support from other spheres and stakeholders.” The report found that the distressed municipalities lacked financial and human resources to deliver on their mandate and citizens’ expectations. On our very first day in Johannesburg, the news reported: “Most people are not entirely clear about what the officials in this amorphous government department do all day long beyond, presumably, going to a great many meetings with various levels of government, chiefs and tribal councils, listening attentively, nodding sympathetically, and then going home to watch TV…but while the man in the potholed street might not be clear about the purpose and day-to-day functioning of cooperative governance…the minister of finance would have been acutely aware of the need to sort out local and provincial government where mayors and MEC’s buy themselves fancy 4X4’s from the public purse (even the provincial ambulance budget, if that’s what it takes), because their administrations either can’t or can’t be  bothered to fix their roads….The job of cooperative governance minister might be less glamorous than divvying up the public sector kitty and deciding who gets taxed how much, but it is, in every sense, a real job, just one that hasn’t been done terribly well until now….”

More Time to take Stock in Stockton. Last week, U.S. Bankruptcy Judge Christopher Klein, on what had been anticipated to be the final day of Stockton’s municipal bankruptcy confirmation hearing, set another hearing for July 8, in order to get more clarity on collateral at stake. The announcement came in the wake of ongoing uncertainty about whether an exit plan for the city which imposes no reductions in the municipality’s pension obligations but proposes pennies on the dollar to Franklin Advisors, Inc., the only creditor with which Stockton has not reached an agreement, could meet the federal law’s test of being fair and equitable, with Franklin’s attorney arguing that if Stockton can continue meeting its pension obligations — which remain unimpaired under the plan — then it should be able to pay Franklin more than a penny on the dollar. Stockton’s attorney asked Judge Klein to approve Stockton’s plan of adjustment, nevertheless, noting that a city of Stockton’s size has never ended a contract with CalPERS—and that any expression of opinion on the pension issue would most certainly result in continued litigation. The city has been transfixed between the horns of the dilemma (please see above), telling the court that impairment of its CalPERS obligations would not only result in a massive termination fee of $1.6 billion, but would also make it very difficult to attract or retain public workers going forward: “The city leaders have to run a city in which people want to live.”

Don’t Start your Engines. Meanwhile, in the Motor City, similar delays seem in order. U.S. Bankruptcy Judge Stephen Rhodes has delayed the start date for hearings on Detroit’s plan of adjustment to August 14th—a trial expected to take at least four weeks. Judge Rhodes attributed his decision to delays in producing documents for objecting creditors and what he termed “unreasonable” document demands with a bond insurer. Some creditors had sought to delay the trial to September, but Judge Rhodes denied that request. The delay came even as the deadline for retirees and other creditors to vote on the plan remains tomorrow—and it comes as Judge Rhodes has scheduled a trial date for later this month to examine several legal issues in the Motor City’s municipal bankruptcy case, including whether the city’s proposed treatment of its bondholders is legal, with Judge Rhodes outlining 14 legal issues related to the city’s plan of confirmation to exit bankruptcy, including whether Kevyn Orr’s proposed offer to Detroit’s unlimited-tax general obligation (so-called ULTGO’s) bondholders violates Michigan’s Unlimited Tax Election Act, the 1979 state law that authorized local governments to attach unlimited tax pledges to their bonds.  The proposed settlement with the three insurers who wrap the ULTGOs calls for a 74% recovery with the rest of the 26% portion of the property tax levy going toward pensioners. With respect to limited general obligation municipal bonds, Judge Rhodes asked the sides to prepare arguments on whether the “failure of the plan to treat LTGO claims as senior unsecured claims violates the bankruptcy code, Michigan law, or a contract right that is enforceable in bankruptcy.” Detroit, as yet, has not settled with the LTGO holders, and has proposed repaying them roughly 10 cents on the dollar, among the lowest of all of the city’s unsecured creditors—a proposal which Ambac Assurance Corp., which insures some of the debt, is challenging. Judge Rhodes also wants the attorneys to address the status and issues raised with regard to Detroit’s water and sewer bonds—on which Mr. Orr’s plan calls for the full repayment of principal, but Detroit Emergency Manager Kevyn Orr has proposed to restructure the debt by lowering the interest rate, eliminating call protections, and possibly pushing debt service below other payments―leading Judge Rhodes to ask whether the part of the plan “relating to the interest-rate modification and call protection modifications of certain debt secured by special revenues violates the provisions of the bankruptcy code relating to such debts.” The judge also requested that the attorneys opine whether the counties of Macomb, Oakland, and Wayne have standing to object to the plan, as they have, and whether the plan’s assumed pension investment return rate of 6.75% and discount rate restrictions violate state law. In addition, on his bucket list, Judge Rhodes requested opinions on whether the municipal bankruptcy code requires the city to sell “non-core” assets to meet creditor obligations—a request which some believe refers to the Detroit Institute of Arts. Judge Rhodes set a deadline of next Tuesday for responses—scheduling a hearing for June 24th.

Grand Bargaining.  Following up the Michigan Senate’s overwhelming passage of the so-called “Grand Bargain” legislation last week ― a $195 million cash payment from the state’s its rainy day fund and set of oversight reforms, marking Michigan’s most aggressive intervention since Detroit declared bankruptcy last July―and creating an oversight board to monitor the post-bankrupt city with the power to review all nearly all financial transactions and enacts a host of other provisions, including future labor contracts, retirement benefits, and duties of the chief financial officer; the Motor City’s hometown automakers have added a pledge of $26 million towards the Detroit Institute of Arts’ $100 million contribution—with the DIA announcing the pledges from Chrysler Group LLC, Ford Motor Company, General Motors, and the General Motors Foundation at a news conference yesterday attended by Gov. Rick Snyder, who called the contributions another step forward. With the “Grand Bargain” now at $816 million, the funds will go toward the city’s pension obligations—intended to ensure that no public pensioner fall below the federal poverty level, in exchange for transferring the DIA’s collection out of the ownership of the City of Detroit to a charitable trust. Ford will contribute $10 million, General Motors will give $5 million, General Motors Foundation will provide $5 million, and Chrysler will provide $6 million. The announcement yesterday comes on the heels of the Detroit City Council’s unanimous approval last week of a resolution as part of the overall grand bargain to transfer the art collection at the DIA to an independent trust that will protect it from the city’s bankruptcy and any post-bankruptcy fiscal woes.

Is Detroit Contagious? Notwithstanding the seeming progress in the Motor City, as the unerring Matt Posner of Municipal Market Advisors notes: “[T]he high visibility of Detroit’s struggles is outshining the otherwise improving credit and trading fundamentals in the municipal issuer community.” He notes this from two different perspectives: 1) if you read back on the commentary from South Africa above, the sense that federal tax-reformers seeking to attack state and local tax-exempt authority, might, increasingly, regard state and local bonds as a conspiracy involving “inept issuers, ill-intentioned bankers, and greedy investors.” But Mr. Posner also notes (2) that the developments in the Motor City have—in addition—“undermined the perceived strength of the unlimited tax general obligation bond, limited tax general obligation bond, and nearly every other promise made by a municipality.”

Voting Rights in Municipal Bankruptcy.  Mr. Posner has, equally astutely, noted the complex issues related to voting rights in municipal bankruptcy cases. As currently set, the Motor City’s plan would provide for votes from both bond insurers and bondholders. Detroit’s bond insurers, however, have asked Judge Rhodes to allow them to have exclusive voting rights, which, Mr. Posner notes, were Judge Rhodes to allow, would “bring the voting process in line with market expectations: that insurers have the rights and remedies afforded bondholders to the extent that they are in compliance with their payment obligations under the insurance policy.” If both the insurer and the individual holder were allowed to vote, that “could undermine the insurers’ ability to protect against losses with possible negative consequences accruing, such as higher premiums and greater uncertainty as to recovery prospects in the face of bankruptcy.” To date, nearly all insurers have covered full principal and interest payments on the Motor City’s debt since the city stopped making payments last June—with the key exception being Financial Guaranty Insurance Corp., which insures the city’s pension certificates of participation (COP) and a portion of the city’s water and sewer bonds―on which FGIC has paid only 17 cents on the dollar on the COPs, according to MMA. The insurer, as part of rehabilitation, worked out a plan with all its clients that has it covering only a portion of its claims up front, with the balance paid off after the claim matures. That has led insurer Berkshire Hathaway, which wraps some of the FGIC-insured water and sewer debt, to seek the exclusive right to vote on that debt, according to Mr. Posner: “It would seem reasonable for the court to a different view with respect to FGIC, perhaps finding in Berkshire’s favor or maybe even splitting the vote so that each insurer has a say related to its share of likely coverage.”

General Revenue Sharing. The Michigan legislature yesterday agreed to a 7 percent increase in revenue-sharing payments for the next fiscal year, under a budget plan that won preliminary approval in the state Legislature, but was less than what Gov. Rick Snyder had originally proposed. Under the action, overall shared revenue for cities, counties, townships, and villages will go up about $84 million, or 7.4%, to roughly $1.2 billion — less than the 9.7% increase sought by Governor Snyder. The action marks a turnaround in the wake of the steep cuts imposed during the last decade and a half as sales tax collections lagged and legislators siphoned off money to deal with budget deficits—and, it carried a bonus, as local leaders were pleased with the elimination of strings that have been attached to getting some money in recent years — such as showing efforts to consolidate services and curb the cost of employee retirement plans and health care—or as Samantha Harkins of the MML noted: “That has been so administratively burdensome for our members…They were already doing what they had to cut costs because they had to, given the financial situation all these years.” Under the $50 billion-plus state budget starting in October — and expected to win final passage this week in the Republican-led House and Senate — cities, townships, and villages will share $758 million, 2.4 percent more than this year, in sales tax revenue that the state constitution requires be given to them and over which Gov. Snyder and legislators have no control. They will get another $249 million, or 5.5 percent more, in statutory payments — less than the Governor’s proposed 15 percent boost. In addition, the package will set aside an additional $8 million for “financially distressed” cities and townships. Legislators agreed with Gov. Snyder’s call to significantly boost payments to counties, giving 74 eligible counties their maximum funding instead of the 80 percent ceiling distributed this budget year. Rep. Earl Poleski, R-Jackson, who chairs the House general government budget subcommittee, said he was pleased to start moving to a population-based formula that will make about 100 more communities eligible for revenue sharing: “All in all, it builds a little more equity into what we had all viewed to be a really inequitable method of distributing revenue sharing. These are the larger townships, any over 7,500 (residents). Those are the sorts of units that provide urban-like services — police, fire, parks.” The statutory shared revenue is a nearly 16 percent bump from the first budget Snyder signed. But because he and lawmakers slashed more than $100 million, or one-third, in statutory revenue that year to address a projected deficit, it is roughly 22 percent below the last budget signed by Gov. Jennifer Granholm.

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