7.16.14

What Does Municipal Bankruptcy Mean to the People? U.S. Bankruptcy Judge Steven Rhodes yesterday heard testimony from a number of the 600 individuals who have filed objections to the Motor City’s proposed plan of adjustment, inviting approximately 80 to have their day in court, granting each five minutes, with the city’s attorneys given 30 minutes to respond. For the judicial musician, who has demonstrated a profound interest in trying to understand the implications of the city’s downfall and proposed exit plans, these hearings have served an important role to help the judge reflect on the implications of the emergency manager’s proposals from a very different perspective―after all, when Kevyn Orr and his staff and consultants leave next October, it is these people, the citizens of Detroit, who could be left behind. This is not an unusual move for Rhodes who set aside court dates prior to the eligibility hearing into Detroit’s bankruptcy last fall to hear from residents and other individual stakeholders. Rhodes appeared moved by their stories and referenced them in subsequent hearings. As the Detroit Free Press reported live from the testimony, one witness, Gisele Caver, a retired police sergeant, who is now disabled, fears losing her health care insurance, telling Judge Rhodes: “There is no cure for my disease.” In tears, she begged Judge Rhodes to make sure the city does take away her pension and insurance as she seeks to be comfortable in her remaining years. Similarly, another retiree, who was diagnosed with cancer last year, expressed apprehension about the implications of her annuity clawback.  Retiree Jo Ann Cooper, who worked for the municipal library for 30 years, said there is a lot of blight in her Detroit neighborhood, but she does not want to the leave city: “I do not believe the city of Detroit is broke, but I have no proof of it…I should not have to worry about a handout. At the rate this state is going, it could easily become a welfare state.” “I know that some sacrifices have to be made, but I never thought I would be struggling to get health care,” Jesse Florence, a retired city bus driver, told U.S. Bankruptcy Judge Steven Rhodes today in federal court in Detroit. Florence’s health-care premiums jumped from $152 a month to $1,026, he told Rhodes. “This is devastating.” In response, the city’s attorney said: “That effect cannot be minimized…Our plan isn’t perfect. It’s certainly not all we wish it could be. But it does reflect the fiscal reality we have today.”

Tapping. One outcome of the morning’s hearing was a request from Judge Rhodes that the city provide a representative to testify yesterday afternoon with regard to questions and apprehensions he had heard about the Detroit Water and Sewerage Department’s program of shutting off water to delinquent customers, which critics say has cut off water to thousands of the city’s poorest residents. Although the Judge stated he was uncertain whether the issue was actually under his jurisdiction, he decided to bring it up after a couple of retirees had expressed apprehension about it in their testimonies: “It’s a problem that’s affecting this bankruptcy.” Since its recent inception this spring, Detroit has stopped water service to more than 15,000 households in the city, leading the Judge to state the Motor City was “getting a reputation not only in this country but around the world” for the shut-offs — causing “a lot of anger” and hardship among residents. In late June, three United Nations experts said Detroit’s shut-off policy may violate international human rights. So, yesterday afternoon, Deputy water director Darryl Latimer was in hot water before the Judge to explain the Department’s new policy of shutting off water to customers more than 60 days late or $150 behind in their bills, testifying that the average residential delinquency is $540, while the average monthly household bill is about $75: “We’re trying to control the rates in the city of Detroit for all of our customers,” Mr. Latimer testified. “For those with affordability issues, we’re asking them to come forward so we can assist them,” adding that the department has restored water to thousands of delinquent customers within 48 hours after paying overdue bills or enrolling in a payment plan. (Detroit residents behind on their water bills can choose a plan that typically involves paying 30 percent of the outstanding bill and then the remainder — while keeping current on the present bill — over as long as 36 months.) In addition, he told Judge Rhodes that, this month, the department announced a Detroit Residential Water Assistance Program with $1 million in funding to help customers who cannot afford water―financed by a voluntary 50-cent surcharge the department has collected for several years. To which Judge Rhodes responded: “It sounds like to me the problem is informing and encouraging people what their options are to maintain their water services…If that’s what it is, that’s a solvable problem. I encourage you to work within your department to come up with a much more aggressive plan to solve that problem.” Judge Rhodes requested Mr. Latimer to return Monday with further options for those who cannot afford to pay their water bill.

Sync or Swim. The 6th U.S. Circuit Court of Appeals has set an accelerated schedule of two weeks to hear Detroit’s municipal bond insurer Syncora Guarantee Inc.’s appeal of Judge Rhodes’ decision last August that the Motor City’s casino tax revenues are part of the bankruptcy estate, and therefore subject to bankruptcy’s automatic stay, setting a hearing for two weeks from today to hear oral arguments, according to Syncora attorneys—the same date on which the appeals court is scheduled to entertain a series of appeals from labor groups to the U.S. bankruptcy court’s decision finding Detroit eligible for Chapter 9 protection. Syncora is appealing last Friday’s ruling by U.S. District Court Judge Bernard Friedman affirming Judge Rhodes’ decision that Syncora may not access the city’s casino tax revenue—revenue on which Syncora relies upon for collateral for interest-rate swaps it insures. Judge Friedman found that the casino tax revenues are not part of the bankruptcy estate, rejecting Syncora’s claims and affirming Judge Rhodes’ ruling that the automatic stay exemption cited by Syncora does not apply in the case, holding that the exemption statute “has no bearing on the use of the casino tax revenues to secure the City’s swap obligation payments,” writing that one of the main purposes of the exemption is to ensure the protection of a pledge of special revenues pledged to bonding and the city’s swap obligation was not a form of indebtedness issued to either the swap counterparties or Syncora.

Taking Stock in Stockton. Credit rating agency Moody’s has now opined [Stockton Bankruptcy Judge Raises Possibility of Pension Impairments in California: Mixed Impact on Bondholders] that were U.S. Bankruptcy Judge Christopher Klein to decide to permit Stockton, as part of its plan of adjustment, to reduce its pension liabilities, in contravention to California’s state constitution, but consistent with Judge Steven Rhodes’ decision that federal la (chapter 9) preempts a state’s constitution (an issue pending, currently, before both the 6th and 9th U.S. Circuit Courts of Appeal), such an outcome would be a positive development for municipal bondholders in ongoing municipal bankruptcies; however, the agency acknowledged that such a ruling could also act as an inducement for other California local governments to file for federal bankruptcy protection: “A ruling in favor of pension adjustments would incentivize some distressed California local governments to file under Chapter 9, but local governments would still have to fulfill the requirements of the bankruptcy code for becoming a Chapter 9 debtor…These requirements, combined with the high legal costs and protracted process of a bankruptcy filing, would still make additional filings rare.”  But the report also noted that if the authority of cities and counties in bankruptcy to treat pensions and post-retirement health care benefits in the same manner as other creditors, municipal employees could well be more amenable to concede enough on compensation and benefits to protect pensions and avoid bankruptcy altogether, noting: “Ultimately, this would be a positive development for bondholders if issuers are better able to target compensation expenses, rather than filing for bankruptcy and cutting debt principal.” The brief came in the wake of Judge Klein’s note that he could decide that the California Public Employees’ Retirement System (CalPERS) is a fiduciary, rather than a creditor—a decision that would bar the imposition of a lien on Stockton’s assets in the event of a pension payment delinquency or plan termination, or, as the analysis put it: “Such a ruling would provide Stockton with the opportunity to significantly reduce its pension liability and annual pension payments — an opportunity that it may still decline…Alternatively, Judge Klein could confirm the city’s proposed plan of adjustment as constituted, even if he decides that the city’s pension liabilities are vulnerable to adjustment in bankruptcy.” Under Stockton’s current plan of adjustment, its bondholders’ recoveries would be around 50%, on average, while the plan proposes no reductions in either pensions or post-retirement health care benefits.

Transfixed between a city and a state. Puerto Rico, a U.S. territory, is confronted by a year-long debt crisis—serious enough that last month Governor Alejandro García Padilla signed a new law establishing a de facto bankruptcy regime for state-owned enterprises—but with its Puerto Rico Electric Power Authority (PREPA), a cash-strapped utility, teetering on the brink of default, the new system may face its first test soon. Or, as William Glasgall, the State and Local program and editorial director at the Volcker Alliance in New York, wrote this week: “With federal debt relief or restructuring assistance to Puerto Rico unlikely in the immediate future, investors who eagerly bought its government corporations’ debt for years had better be prepared to hunker down for a long, anxious wait should defaults occur. In the future, lenders to high-risk states and territories ineligible for U.S. bankruptcy court protection may want to insist on the same kinds of formal default-resolution frameworks and independent monitoring that international banks and governments have imposed on riskier sovereign nations as a precondition for gaining access to their credit.” [“Puerto Rico’s Debt Mess May Spur Solutions for High-Risk Territories”]. From 1976-2006, businesses on the island were exempt from federal tax on their local profits. But once that carve-out expired, the economy fell into an eight-year recession. Thus, subsequent to Detroit bankruptcy filing last year, investors fled risky municipal bonds, which escalated Puerto Rico’s financing costs. Now the territory insists that it “cannot default”, because its constitution gives debt payments first priority; however, this only applies to its general-obligation and guaranteed bonds. The remaining public debt is backed by specific revenues like highway tolls or, in PREPA’s case, electric bills. Thus darkness is looming: the $800m of bank credit lines PREPA uses to buy fuel come due in August. Unless it can renegotiate quickly, it will either default or turn out the lights. No one knows what would happen then, because, as a governmental creature between a municipality and a state, Puerto Rican state agencies fall in a gap in America’s bankruptcy code: they are excluded from the bankruptcy protections provided to private and municipal corporations. Now, with looming, missed payments on the near-term horizon, one can anticipate a Caribbean hurricane of litigation—a risk so great the territory has sought to institute a new insolvency system for its companies, offering them nine months to negotiate a settlement acceptable to holders of 75% of their debt, after which, were the parties unable to reach resolution, local courts would impose a solution. But to holders of the territory’s municipal bonds, the signal received was that PREPA was set to restructure its $8.6 billion of liabilities; thus, the system’s two biggest creditors, the mutual-fund firms Franklin Templeton (which is a challenging creditor in Detroit’s municipal bankruptcy)  and Oppenheimer Funds, have challenged the law, arguing that the constitution gives Congress exclusive control over bankruptcy. But that challenge, as Mr. Glasgall writes, “is unlikely to provide immediate relief, as federal court challenges on the constitutionality of the legislation by mutual-fund managers Franklin Templeton Investments and Oppenheimer Funds Inc. will only complicate the territory’s quest to ease its unsustainable $73 billion public-debt burden and almost guarantee a legal quagmire that will take years to resolve. In that regard, both Arkansas and Argentina provide roadmaps to what may lie ahead.”

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