Detroit Gets Ready for Trial; & How to Avoid Future Detroit’s

August 29, 2014

Visit the project blog: The Municipal Sustainability Project 

Getting Ready to Rumble in the Motor City. With Detroit’s trial on whether the federal bankruptcy court will sign off on the Motor City’s sixth version of its proposed plan of adjustment to address its nearly $18 billion in debt scheduled to open bright and early next Tuesday, U.S. Bankruptcy Judge Steven Rhodes yesterday rejected Detroit bond insurer Syncora’s blistering “personal attack” on Detroit’s chief bankruptcy mediator and ordered the creditor’s attorneys to prove why they not have sanctions imposed upon them, and Judge Rhodes struck from Detroit’s bankruptcy record Syncora Guarantee Inc.’s objection from earlier this month in which Syncora accused Chief District Judge Gerald Rosen and mediator-attorney Eugene Driker of demonstrating “naked favoritism” toward retirees—rejecting Syncora’s claims outright and ordering its objection struck from the public record, writing in his order: “Syncora’s highly personal attack on Chief Judge Rosen in the objection was legally and factually unwarranted, unprofessional and unjust…Justice requires the court to strike the attack from its record,” giving Syncora’s attorneys two weeks in which to respond in writing with evidence as to why sanctions should not be imposed. Calling Syncora’s allegations false, Judge Rhodes stated that Judge Rosen and Mr. Driker carried out their responsibilities in trying to offer potential resolutions to address the Motor City’s pension problems, writing: “They were in no position to ‘collude’ with anyone, to ‘orchestrate’ or ‘engineer’ anything, to ‘execute a transaction,’ or to ‘pick winners and losers.’ Nevertheless, the court did not act on the city’s request that Syncora be required to publicly apologize to Judge Rosen and Mr.Driker, with Judge Rhodes writing: “The court concludes that a coerced and therefore insincere apology is not a true apology at all; it is not an acknowledgment of a mistake or an expression of regret.” Judge Rhodes’ 22-page decision was issued yesterday as Syncora and another holdout bond insurer, Financial Guaranty Insurance Co. (FGIC), were reported to be in mediation talks with Emergency Manager Kevyn Orr’s team.

Getting Ready for Tomorrow. Meanwhile, Detroit, mayhap already looking beyond the outcome of its confirmation trial set to commence next week, yesterday secured up to $275 million in financing — funds critical to support the city emergence from municipal bankruptcy—if and when the U.S. bankruptcy court determines its proposed plan of adjustment is approved. The Motor City is hoping to use the funds to help finance the city’s restructuring and pay off debts, disclosing the agreement with Barclay’s Capital yesterday to Judge Rhodes. The funds will allow the city to pay off its $120 million loan from Barclays that financed “quality of life” improvements to city services, $45 million toward a settlement of a troubled pension-related debt with two banks, and potentially $55 million toward limited-tax general obligation bondholders. The loan also denotes a mark of confidence that a municipality—even in bankruptcy—can secure financing after filing for bankruptcy. In this instance, once again, the arrangement also appears to demonstrate the importance of the State of Michigan’s enhanced role in the Motor City’s successful efforts to emerge from bankruptcy: the arrangement involves the Michigan Finance Authority issuing bonds if Detroit successfully emerges from bankruptcy court. A trial over the city’s debt-cutting plan starts Tuesday in bankruptcy court. Indeed, Emergency Manager Kevyn Orr indicated that several firms had expressed interest in lending money, noting: “Detroit continues to make steady progress in returning to firm financial footing and becoming an attractive place to invest once again…We look forward to deploying these funds in our ongoing effort to make Detroit a viable and strong American city once again.” Yesterday’s agreement also demonstrates a turnaround: two earlier such borrowing efforts by the city had been rejected by Judge Rhodes, because the earlier efforts involved the city proposing to use the proceeds to pay off a troubled pension-related debt. The Barclay’s loan is backed by Detroit’s income tax revenue and up to $10 million in collateral from the sale or “monetization” of unspecified city assets, but it “expressly excludes” any city-owned art at the Detroit Institute of Arts—with the proceeds intended to go toward upgrading Detroit’s computer systems and buying new equipment for the police, fire, and emergency medical services departments. Barclays is charging the city a base interest rate of 3.5 percent plus a market-based flexible rate that would cap total interest payments at 6.5 percent, according to Mr. Orr’s office, with the term of the loan scheduled to expire co-terminously with the term of the quality-of-life loan on the date Detroit exits bankruptcy—after which Detroit would have to secure “bridge financing” to service the new debt or earmark certain revenues for repayment of the balance.

What about Your City? The former Governor of Wyoming late yesterday sent me an article, “How 21st-Century Cities Can Avoid the Fate of 20th-Century Detroit,” (How 21st-Century Cities Can Avoid the Fate of 20th-Century Detroit) from Scientific American by Carl Benedikt Frey, who is a research fellow of the Oxford Martin School at the University of Oxford and the Department of Economic History at Lund University—and who also serves as a specialist advisor to the Select Committee on Digital Skills at the House of Lords, U.K. Parliament. How could one resist an opportunity to benefit from a scientific perspective about how U.S. state and local leaders might want to think about the future of cities in this country—and what lessons there might be to be learned from Detroit? Mr. Frey writes that “Cities that invest in the creation of an adaptable labor force will remain resilient to technological change,” noting that “[M]anufacturing cities such as Manchester and Detroit did not decline because of a slowdown in technology adoption. On the contrary, they consistently embraced new technologies and increased the efficiency and output of their industries. Yet they declined. Why?

“The reason is that they failed to produce new employment opportunities to replace those that are being eroded by technological change. Instead of taking advantage of technological opportunities to create new occupations and industries, they adopted technologies to increase productivity by automating their factories and displacing labor.

“The fate of manufacturing cities such as Manchester and Detroit illustrates an important point: long-run economic growth is not simply about increasing productivity or output—it is about incorporating technologies into new work. Having nearly filed for bankruptcy in 1975, New York City has become a prime case of how to adapt to technological change. Whereas average wages in Detroit were still slightly higher than in New York in 1977, they are now less than 60 percent of the latter’s incomes. At a time when Detroit successfully adopted computers and industrial robots to substitute for labor, New York adapted by creating new employment opportunities in professional services, computer programming and software engineering.”

That is, Mr. Frey notes, state and local leaders need to manage the transition into new work—a leadership effort that will require an understanding of the direction of technological change, noting especially that technology is already beginning to impact many municipal jobs—where humans increasingly can be more cheaply replaced by computers and technology—replacing low income, low skill jobs in municipalities—so that future leaders will need to think and focus on “jobs that are not susceptible to computerization,” adding: “The reason why Bloom Energy, Tesla Motors, eBay and Facebook all recently emerged in (or moved to) Silicon Valley is straightforward: the presence of adaptable skilled workers that are willing to relocate to the companies with the most promising innovations. Importantly, local universities, such as Stanford and U.C. Berkeley, have incubated ideas, educated workers and fostered technologies breakthroughs for decades. Since Frederick Terman, the dean of Stanford’s School of Engineering, encouraged two of his students, William Hewlett and David Packard, to found Hewlett–Packard in 1938, Stanford alumni have created 39,900 companies and about 5.4 million jobs.” This seems to reflect some of the fine insights of my colleague Jack Belcher, Arlington’s Chief of Technology—who has been doing some of the hardest thinking about how to transform municipalities into the 21st Century. As Mr. Frey writes: “It is thus not surprising that we find San Jose, Santa Fe, San Francisco, and Washington, D.C., among the places that have most successfully adapted to the digital revolution.”

Detroit Preps for Historic Trial, Puerto Rico opts for power over bondholders, and Pennsylvania’s capitol city watches its purse.

             August 28, 2014

Visit the project blog: The Municipal Sustainability Project 

Drip. Yesterday’s Michigan Finance Authority sale of some $1.8 billion in municipal revenue bonds on behalf of the Detroit Water and Sewerage Department to finance the purchase of debt from investors attracted orders from about 64 institutional buyers, including many who participated in the department’s tender offer program, according to the Detroit Water & Sewerage Department (DWSD), netting the Motor City an estimated $249 million of interest rate savings over the life of the bonds. DSWD officials credited the favorable outcome to bond rating upgrades, investor outreach, and U.S. Bankruptcy Judge Steven Rhodes approval Monday of the voluntary tender offer and refinancing, noting that despite the city of Detroit’s municipal bankruptcy status, its outreach and strategic and financial plan, combined with updates on the Detroit economy by community leaders, and a tour of the sewage treatment plant appear to have contributed to the successful sale of the $855 million of senior and second lien water bonds and $937 million of senior and second lien sewage bonds. Bond documents warn several times that Detroit is at risk of filing for Chapter 9 bankruptcy again—in which case, according to the documents―the water and sewer bonds are subject to extraordinary optional redemption at par. Detroit will amend its plan of debt adjustment and treat all of the water and sewer debt as unimpaired once the sale closes and the tendered bonds are purchased, with the untendered bonds continuing to get the scheduled principal and interest payments. DWSD’s bond portfolio totals $5.2 billion.

The Unfine Art of Municipal Bankruptcy.  Art Capital Group has offered to loan the Motor City as much as $4 billion, but only on the condition that the City would, in effect, broach the so-called Grand Bargain and instead pledge the Detroit Institute of Arts and its collection as collateral to secure the loan, in effect handing over rights to the city-owned museum’s internationally acclaimed collection—and, likely, forcing the city to sell some of the Institute’s artwork to help finance the loan. But the deal would require the city to pledge the Detroit Institute of Arts and its collection as collateral to secure the loan — a process that would be highly unlikely considering it would require a legal battle over rights to the city-owned museum’s prized collection. The pre-trial move by Art Capital Group LLC is supported by Financial Guaranty Insurance Co. (FGIC) and implicitly supported by Syncora Guarantee Inc., two holdout creditors of the city—with Art Capitol purporting that it has made the offer in an effort to provide “the city, and the entire community, $3 billion to $4 billion.” The New York-based Art Capital wrote in a prepared statement. “Our goal is to do everything we can to keep the DIA’s art collection in the city and intact. We’ll work with the city to structure the loan with the flexibility needed so it does not become an unreasonable burden.” FGIC called the Art Capital offer “a game changer,” adding: “It represents a real and viable solution that could enhance recoveries for all creditors by billions of dollars and catalyze the revitalization of the City — while also keeping the DIA collection in Detroit. Choosing to proceed with the inferior ‘Grand Bargain’ would be opting to disregard common sense at the expense of all parties…The city cannot ignore the fact that the Art Capital proposal is a game changer…It represents a real and viable solution that could enhance recoveries for all creditors by billions of dollars and catalyze the revitalization of the city – while also keeping the DIA collection in Detroit. It is an extremely attractive option for all stakeholders and a win for all sides. Choosing to proceed with the inferior ‘grand bargain’ would be opting to disregard common sense at the expense of all parties.” The offer, nearly double what the group offered last April, would reduce the city’s indebtedness by nearly 25 percent if accepted—but leave one of its most critical assets for its economic future at risk.  Emergency manager Kevyn Orr’s office yesterday responded that Detroit rejects the offer and stands behind the so-called Grand Bargain that would retain the DIA as an independent entity, and leverage $815 million in combined state aid and non-profit contributions to ensure no city retiree falls below the federal poverty level and that the prized art collection will remain a jewel of the city—with spokesperson Bill Nowling stating: “The city will not sell or leverage the art. This latest proposal is nothing but a thinly veiled attempt by our remaining hold-out creditors to improve their recovery at the expense of the city’s pensioners and its cultural assets,” asserting that acceptance of the proposal would force drastic, double-digit pension cuts to the city’s retirees and undercut the unprecedented state intervention package or grand bargain. FGIC supports the Art Capital offer, noting: “It represents a real and viable solution that could enhance recoveries for all creditors by more than $2 billion and catalyze the revitalization of the city, while also keeping the DIA collection in Detroit.” Detroit’s rejection of the offer also came in the wake of its requested assessment of the offer by ArtVest Partners co-founder Michael Plummer, who Mr. Orr hired to evaluate the value of the world-class Institute. Mr. Plummer determined in his assessment for the city that the Art Capital deal was “not economically viable.” Moreover, Mr. Orr’s office has also questioned whether the DIA’s property legally can be sold: DIA leaders have vowed a legal battle if the city were to pursue a sale or a collateralized loan.

Electric Municipal Bond Jolts. Hedge funds have been negotiating with Puerto Rico’s public power authority (PREPA) over a possible restructuring of more than $8 billion in municipal bonds in the wake of a forbearance agreement the authority entered into two weeks ago, which includes a list of all the bondholders, who represent some 60 percent of PREPA’s $8.3 billion in outstanding municipal revenue bonds. While Puerto Rico’s municipal bonds have traditionally been held by municipal bond mutual funds, the territory’s deteriorating fiscal condition and inability to file for federal bankruptcy protection has led to financial contortions as a means of averting insolvency. The list includes 15 creditors, of which three of those were already known to have been a part of the forbearance agreement—and which three filed suit against Puerto Rico earlier this year to annul a new law that allows public corporations such as PREPA to restructure their debt. A key issue is that PREPA’s forbearance arrangements with creditors reinforce banks’ claims of priority over bondholders in receiving repayment—a situation which makes it more difficult for the territory’s municipal bondholders to force increases in PREPA rates. PREPA has about $8.3 billion in bonds outstanding; the utility has indicated it will restructure its debt next March. Under the first agreement, the bondholders gave up their rights to sue PREPA for at least several months and signed non-disclosure agreements. With insufficient resources to both continue operations and make interest payments to its municipal bondholders, the utility has been paying its operational expenses in order to ensure continuity in its operations—before making its interest payments to its municipal bondholders—almost as if it were in a chapter 9 municipal bankruptcy—even though, because it is not a municipality, it cannot legally seek federal authority to do so. According to PREPA’s forbearance agreements with the bondholders and the banks, PREPA has $8.3 billion in outstanding revenue bonds and owes $696 million to Citibank, Scotiabank de Puerto Rico, Banco Popular de Puerto Rico, Oriental Bank, and Firstbank Puerto Rico. Two weeks ago, PREPA made changes to its bond-governing agreement which would make it more difficult for its municipal bondholders during the forbearance period to initiate a legal process to force rate increases. That jolt likely electrified bondholders, because the pre-existing  1974 agreement with its bondholders provided that the utility would adjust its rates so that revenues, at a minimum, would be equal to at least PREPA’s current expenses plus a level covering at least 120% of aggregate principal and interest payments to its bondholders—and that, if PREPA failed to follow said agreement, and if 10% of the bondholders requested the bond trustee to take action, then the trustee was directed to sue PREPA to force it to increase its rates. However, under a critical portion of the forbearance portion of the agreement, triggering an adjustment would require 50 percent of the bondholders to initiate such a suit—an outcome considered unlikely, thereby putting off any potential electric confrontation until the current agreement expires next March, when the utility intends to introduce a restructuring plan. Moreover, the utility claims that if it were to file for the protection of the Public Corporations Debt Enforcement and Recovery Act for restructuring during the forbearance period, the forbearance agreement itself would be voided.

Harried in Harrisburg. Harrisburg, Pa. Mayor Eric Papenfuse, in the wake of charges by the Dauphin County DA that the capitol city’s Treasurer, John Campbell, had stolen from a nonprofit, Tuesday said there was no threat to the city: “All accounts are in order and the city treasury continues to function in the midst of this dilemma.” The clarification came hours after Dauphin County District Attorney Ed Marsico charged Mr. Campbell with writing 10 checks to himself totaling about $8,400 from the account of Historic Harrisburg Association while he was its executive director. Mayor Papenfuse Tuesday named former City Treasurer Paul Wambach to oversee the office in Campbell’s absence, with the municipality’s solicitor stating: “As chief executive officer of the city, the mayor has an obligation to protect the city’s assets…Under that, he can take whatever steps he deems necessary as long as it’s not contrary to state law or the Constitution.” The County is charging him with theft by failure to make required disposition of funds received and a charitable organizations act violation. The financial charges against Mr. Campbell come in the wake of Harrisburg’s so far successful efforts to recover from the brink of municipal bankruptcy. (Unrated Harrisburg late last year began implementing a financial recovery plan that erased $600 million of debt, largely through the sale of the city incinerator and a long-term lease of parking assets. The plan includes four years of balanced city budgets and other measures designed to repair Harrisburg’s reputation in the capital markets. Incinerator and parking bond sales both closed in late December.) The Mayor indicated he fully expected Mr. Campbell to resign, warning that if he did not, the city would go to court “to settle this matter once and for all…We have cut off Mr. Campbell’s Internet access and he will not be welcome here on the premises.” In addition, the Mayor made clear that the treasurer and city controller must sign off on all city checks—adding that the issue came to light (no pun) after the Historic Harrisburg Association noticed the money missing several weeks ago, when it intended to reimburse the city toward $24,000 it had pledged under its Lighten Up Harrisburg program to help fix street lights. The Mayor noted that the city has yet to receive any reimbursement.


Prepping in the Motor City for Trial & Rechartering in San Bernardino

August 27, 2014

Visit the project blog: The Municipal Sustainability Project 

COPs and Sobbers.  U.S. District Court Chief Judge Gerald Rosen, the Detroit bankruptcy mediator appointed by U.S. Bankruptcy Judge Steven Rhodes, filed an order yesterday to require a mediation session today with the Certificates of Participation or COPs parties, as Judge Rosen seeks to resolve one of the last major obstacles to the Motor City’s potential exit from the nation’s largest municipal bankruptcy before the confirmation trial begins next Tuesday. The order went to the City of Detroit, Syncora Capital Assurance, Inc.; Syncora Guarantee, Inc.; Berkshire Hathaway Reinsurance Group; Wilmington Trust Company, National Association, as successor to U.S. Bank National Association, as Trustee and Contract Administrator Successors-in-interest to EEPK Bank and its affiliates, and the Ad Hoc COP Holders (Dexia Credit Local, Dexia Holdings, Inc., Norddeutsche Landesbank Covered Finance Bank, S.A.) (the “Hedge Funds”), and Financial Guaranty Insurance Co. to appear at the federal courthouse this morning at 10 a.m. in a last ditch effort to resolve the disputes between the city and the holders and insurers of $1.4 billion of pension certificates of participation—with the COP investors and insurers the critical, objecting creditors to the Motor City’s proposed plan of adjustment of its $18 billion in debts. The order notes that the “parties and counsel should be prepared to stay overnight in Detroit for a continuation of the mediation session on Thursday, August 28, 2014 in the event the mediators deem it necessary.” The issue involves Detroit’s suit, which seeks to invalidate the COPs, because, Detroit claims, the certificates were issued illegally in the original 2005 transaction; therefore, the city should have no obligation to repay. (Detroit defaulted on the debt a year ago last June and has offered holders pennies on the dollar.) Judge Rosen’s order follows Monday’s session before U.S. Bankruptcy Judge Rhodes, when Detroit sought to have the federal court strike a portion of Syncora’s objection to the city’s plan of adjustment and impose sanctions on the insurer in the wake of Syncora’s accusation that Judge Rosen conspired to protect pensioners and the Detroit Institute of Arts over bondholders.

Drip. As the Michigan Finance Authority yesterday began issuing about $1.8 billion of municipal revenue bonds on behalf of the Detroit Water and Sewerage Department to finance the purchase of debt from investors, S&P upped its rating on the bonds three levels up from junk bond territory—expressing greater confidence than either Fitch or Moody’s.  The sale includes a $121 million uninsured senior-lien portion maturing in July 2044, which is being offered at just under 5 percent, according to Bloomberg. The sale is another key piece in the puzzle of resolving the Motor City’s municipal bankruptcy—especially in the wake of the Motor City’s agreements with its general obligation bond holders and its retirees. If the refinancing proceeds as planned, investors and bond insurers would drop their objections to the water and sewer portions of Detroit’s debt-cutting plan, enhancing the prospects for Detroit to exit municipal bankruptcy. Thus, S&P’s investment grades (BBB+) denote that the bonds are at low risk of default. The issuance is important, because, according to DWSD CFO Nicolette Bateson, the refinancing could save $11.4 million annually over the first 19 years of the deal, and it could also raise $150 million for projects to improve the city’s sewage system. The refinancing transaction is expected to achieve debt service savings of at least $240 million, and it is intended as an alternative to the Motor City’s current bankruptcy plan for the revenue bonds, which calls for the impairment of nearly 50% of the debt by either stripping out call protection or replacing the current coupon with a lower interest rate. In the wake of the sale, Detroit intends to amend its plan of adjustment to treat all the debt as unimpaired, with the untendered bonds continuing to get the scheduled principal and interest payments. The bonds are secured by a lien on net revenues of each respective water and sewer system that include user fees, investments, and earnings. While the DWSD system’s funds and accounts are separate from the city with excess revenue invested by the bond trustee at the direction of the water and sewer department, investors have been warier. Indeed, the Detroit Water and Sewer Department provides service to some 43% of Michigan’s population, with over 70% of operating revenues coming from suburban customers. The sale includes a $121 million uninsured senior-lien portion maturing in July 2044—which was offered at a 4.85 percent yield, according to Bloomberg. Some bonds are backed by Assured Guaranty Municipal Corp. and National Public Finance Guarantee Corp., according to the people with knowledge of the deal. The refinancing transaction is expected to achieve debt service savings of at least $240 million.

Charting San Bernardino’s Future. Even as the City of San Bernardino continues its closed-door discussions with its creditors under the aegis of U.S. Bankruptcy Judge Meredith Jury, the city’s voters are preparing to weigh in themselves in the wake of the city council’s decision earlier this month (4-3) to put two ballot measures on the November ballot, which would determine how police and firefighter salaries are determined and repeal a longstanding formula used for determining those wages. The first measure, Measure Q, would repeal a section of the city charter establishing the criteria for police officer and firefighter salaries. (Under Section 186 of the city charter, salaries for police and firefighters are determined based on what police and firefighters are paid in 10 other cities of comparable size and population.) The other measure (Measure R) proposes to eliminate paying fired employees while they are appealing their terminations to the civil service commission until the commission makes a decision on whether or not to reinstate the employee. In addition, demoted employees appealing their demotions would be paid their adjusted wage until the civil service commission determined they should go back to what they were previously paid. Now the actual wording for the ballots arguing for and against changing the city charter have been resolved—with the arguments in favor of both proposed amendments signed by Cal State San Bernardino economics professor Thomas Pierce, who was on the citizen committee which recommended the two measures voters will see.  The opposition to Measure Q — which would set police and firefighter salaries by collective bargaining instead of the average of 10 like-sized cities — is signed by Amelia Sanchez-Lopez, community advocate; Vinson Gates Jr., retired fire captain; Ronald Coats, business owner and citizen; Jim Eble, community advocate; and Marie Negrete, community leader. In contrast, on the second measure, Measure R, no one filed an argument against the Measure in time, according to the city clerk’s office. The affirmative position voters will see states: “This simply doesn’t make sense. The City and its taxpayers should not be forced to pay an employee that lost his or her job due to disciplinary reasons simply because the employee is appealing the decision.” The text — the language on the ballot — would eliminate the existing language of Section 186, including its salary-setting formula, shift requirements, and the one mention of paramedics — saying the council “may authorize additional salary to be paid to local safety members of the Fire Department, assigned to duty as paramedics, during the period of such assignment.” In its place would be the following: “Salaries. The Safety of the people in the City is a highest priority of its government. Compensation of police, fire and emergency safety personnel shall be set by resolution of the Mayor and Common Council after collective bargaining as appropriate under applicable law, as it does for other City employees.”

The arguments for and against Measure Q’s change to Section 186 follow:

  • Pro: “In every other city in California, the salaries of public safety employees are determined by collective bargaining and City Council resolution,” Measure Q’s backers begin. “Only in the City of San Bernardino is this not the case. Our City Charter dictates that outside forces will determine the salaries of our public safety employees.” The statement also says that by mandating shift hours for firefighters, Section 186 “locks the City into mandatory overtime, which comes to approximately $7 million in FY 2014-2015.”
  • Con: The group arguing against the changes to Section 186 argues it would add more politics to the salary-setting process, “cause our best-qualified firefighters and police to leave — making San Bernardino even less safe for residents” and do nothing to help the city’s finances…It puts taxpayers at risk while doing nothing to solve San Bernardino’s serious financial problems…Measure Q would reduce city paramedic services and make San Bernardino less safe for residents.”

While the argument says the change “will result in the outsourcing of paramedic services” and “the City Manager has publicly confirmed that the main purpose behind Measure Q is to outsource city paramedic services to an out-of-town corporation,” there remains uncertainty with regard to whether the amendment would have that effect. City Manager Allen Parker has stated he would like to consider the possibility of making the company AMR responsible for at least some paramedic services.

The 10-day examination period for the arguments for and against the ballot changes ends Sept. 2.

Motor City Gets Ready for Confirmation Trial

Getting Ready to Run. The attorney for Detroit bond insurer Syncora sought to continue to attack the integrity and impartiality of federal mediators appointed by U.S. Bankruptcy Judge Steven Rhodes involved in crafting the so-called grand bargain — in a hearing yesterday before Judge Rhodes—with the attorney, Stephen Hackney, telling the federal court that the discussions and negotiations behind closed doors were tainted by hidden conflicts of interest—specifically that there exists a conflict because the wife of mediator Eugene Driker is a former member of the Detroit Institute of Arts board, accusing the city’s municipal bankruptcy mediators, U.S. District Judge Gerald Rosen and Mr. Driker of “naked favoritism.” The Motor City responded by filing a motion with the court to seek Judge Rhodes’ consideration of an order to the insurer’s attorneys to apologize formally or otherwise to impose sanctions. Judge Rhodes yesterday stated he would decide on the issue prior to the commencement of the confirmation trial scheduled to commence a week from today. In its allegations, Syncora claimed the mediators conspired to protect pensioners and the Detroit Institute of Arts at the expense of financial creditors. Citing Judge Rosen’s public statements — especially his remark that the deal is “about Detroit’s retirees who have given decades and decades of their lives devoted to Detroit.”

Drip. The Motor City is planning to sell, via the Michigan Finance Authority, $1.8 billion of water and sewer bonds today in a key transaction that will permit the city to finance the purchase of $1.5 billion of tendered bonds, including not only currently outstanding callable bonds, but also to raise revenues for wastewater projects, in the wake of the U.S. Bankruptcy’s court’s ok yesterday. Under Judge Rhodes’ approval, Detroit can exchange at least $1.67 billion of its water and sewer debt for new bonds, sufficient for the Motor City to buy back or pay off early about 92 percent of the water and sewer bonds it was targeting with a repurchase offer. Should Detroit succeed this week in selling bonds to finance the deal, a group of bond insurers and investors will drop their opposition to the plan when the trial opens a week from today on Sept. 2nd. If the sale fails, the Motor City can still proceed by borrowing money from a unit of Citigroup Inc., according to the Motor City’s attorney, Heather Lennox. Under the proposal, the water and sewer department would buy back or redeem $1.67 billion of about $5 billion in bonds, according to the city, and the municipal bonds not repurchased would be honored and repaid without any change. The entire deal should close by Sept. 4th if investors buy the new bonds. The city expects the sale will enhance the city’s accelerating efforts to exit municipal bankruptcy, because the Motor City projects it will gain debt service savings of at least $240 million―as well as remove a key class of creditors who objected to Detroit’s proposed plan of confirmation, thus removing the potential risk of the federal court ruling on the status of the water and sewer revenue pledge which could set a legal precedent: U.S. Bankruptcy Judge Steven Rhodes’ approval of the tender and refinancing overcame the final hurdle in the wake of yesterday’s testimony by Kevyn Orr, senior investment bankers, and water and sewer department officials, when Judge Rhodes overruled a bid by bond insurer Syncora Guarantee Inc. (please see above), which insures some non- water and sewer city bonds, to secure the right to object. However, some other municipal experts see it another way, questioning whether the tender and refinancing might, instead, represent a default. Since the bonds that are not tendered will continue to receive scheduled principal and interest payments, Fitch Ratings said it does not consider the tender offer a distressed debt exchange; whilst Municipal Market Advisors has called the tender in which some bondholders agreed to less than par prices a default. If the refinancing scheduled to lift off this a.m. is completed as planned, four insurers with exposure on the bonds and investors will drop their objection to the Motor City’s plan of adjustment. The sale of the bonds is also intended to help refund some callable bonds for traditional present value savings and include $190 million of new money sewer revenue bonds to raise at least $150 million for projects, according to information for investors attached to the offering statements, and it comes in the wake of last Friday’s vote by the Motor City’s Water and Sewerage Department commissioners to accept the tender results, as well as the approval by the Detroit City Council and the Michigan Finance Authority (which will serve as issuer for the bonds). The city hopes to achieve both significant savings for its customers of the water and sewer system as well as “an open market alternative to the impairment in the city of Detroit’s plan of adjustment.” Under the terms of today’s sale, Detroit expects to realize an estimated savings over the next 27 years of $107 million or 6.2% on the refunded bonds, the equivalent of $11.4 million annually over the first 19 years, and it expects Detroit will have future refunding opportunities as more than a $1 billion will become refundable within the next two years. The Motor City yesterday indicated that if the refinancing is completed and holders of the tendered bonds are paid off, Detroit will amend its plan of debt adjustment and treat all the debt as unimpaired, with the untendered bonds continuing to receive the scheduled principal and interest payments. In addition, the city warned prospective purchasers that the Motor City remains at risk of filing for federal bankruptcy protection again―in which case, the documents note that the water and sewer bonds are subject to extraordinary optional redemption at par. The transaction could have other benefits: bondholders also agreed that the Detroit Water and Sewer District can pay $24 million annually to Detroit’s general employee pension fund as part of its operation and management expenses, with the payment coming from a pension liability payment fund that will be funded after payments are made into the state revolving fund junior-lien bond and interest redemption fund, according to the documents. The bonds are secured by pledged assets which include net revenues that come various sources such as payer rates. Moody’s termed the tender program a credit positive and, like Fitch Ratings, said it does not consider the tender and refinancing a distressed debt exchange; rather, Moody’s wrote, “This transaction diminishes the risk of an economic loss to water debt bondholders in the near term, though the system’s rating is constrained by its ongoing linkage to Detroit as it remains a department of the city,” adding that its rating also reflects the system’s large and diverse service area that spans an eight-county region, along with an improved financial position bolstered by recently enacted operational efficiencies and new management and governance best practices—adding that Moody’s had a third central consideration: it expects the rating to increase as the city “pursues its existing capital plan and continues to undertake an in-depth assessment of its long term capital needs, some of which remain unknown at this point.” The refinancing transaction is expected to achieve debt service savings of at least $240 million.

Rethinking. Detroit is on the brink of eliminating seniority as the sole criteria for firefighter promotions, likely leading to the overhaul of its old and traditional promotion formula: Motor City officials proposed the change during ongoing contract negotiations with the fire department union, which represents some 1,200 firefighters as part of discussions as the union’s contract expired June 30th, with negotiations intensifying over the summer. Detroit leaders have pushed for work rule changes within the fire and police departments, claiming that modernizing promotion rules will result in more efficiencies because they can hire the most talented firefighters, with the city’s Financial Advisory Board having previously cited “strict seniority promotions” as an impediment to the department’s progress; Detroit’s Police Department has used testing as a requirement for promotions for nearly two decades. While U.S. Bankruptcy Judge Steven Rhodes has ordered negotiations to remain confidential, the union reports it is negotiating on major sticking points that “ensure the integrity of our work and livelihood, our safety, our pensions, and our health care.” (Under Michigan’s Public Act 436, Emergency Manager Kevyn Orr can impose the contract terms on the union.)

Key Step in San Bernardino; Puerto Rico beats its deadline

August 15, 2014

Visit the project blog: The Municipal Sustainability Project 

Progress in San Bernardino. The City of San Bernardino and the San Bernardino Police Officers Association (SBPOA) last evening announced to U.S. Bankruptcy Judge Meredith Jury that they have reached a tentative long-term agreement. The terms of the agreement are confidential and subject to the gag order imposed by Judge Jury, a development which Mayor Carey Davis. Chief of staff Michael McKinney noted “is an important step forward towards emerging from bankruptcy,” adding that it would bring “long-term stability for the San Bernardino Police Officers Association members and the city.” Ward 5 Councilman Henry Nickel said the police officers’ contract “is the biggest piece of the pie next to CalPERS (the California Public Employees’ Retirement System),” noting that San Bernardino’s bankruptcy emergence strategy has been to work on the “most complex aspects first.” Last night’s agreement is subject to approval by both the City Council and the police union’s members—with the city council set to consider it at a closed door session Monday.

Buying Tiempo. The Puerto Rico Electric Power Authority or PREPA reached an 11th hour agreement with its creditors prior to last midnight’s deadline, releasing a statement saying it’s reached an agreement with creditors to further extend its credit and that it has committed to appointing a chief restructuring officer by Sept. 8th. PREPA’s released statement said the agreements reached yesterday “provide PREPA with a consensual path forward to improve its operations and financial situation,” and will enable the authority to use some $280 million held in its construction fund for payment of current expenses and capital improvements. In addition, the Authority stated that insurers and bondholders controlling more than 60 percent of PREPA’s outstanding bonds have agreed to amend existing bond documents to provide PREPA with liquidity and time to “develop a plan to achieve a restructuring of its business:” the insurers and bondholders will not exercise remedies against PREPA during the term of these agreements, and PREPA will continue to make required debt service payments in full. Further, the authority reported that the banks that provide revolving lines of credit will extend until next March 31st agreements to not exercise remedies as a result of credit downgrades. PREPA will continue to delay certain payments that were due to these lenders in July and August. PREPA said it will file a notice today on the Electronic Municipal Market Access (EMMA) system outlining the key terms of its agreements with the creditor groups.

Detroit’s Confirmation Trial Set; San Bernardino makes progress

August 14, 2014
Visit the project blog: The Municipal Sustainability Project

Getting Ready to Rumble. In the wake of yesterday’s session with attorneys representing the Motor City and its creditors before U.S. Bankruptcy Judge Steven Rhodes, the Judge set deadlines and hearing dates for the confirmation trial to determine if Judge Rhodes will approve the city’s proposed plan of adjustment—allowing the city to emerge from the largest municipal bankruptcy in history by finding that that plan is fair and feasible; Judge Rhodes announced he would delay the trial by eight days, scheduling the historic proceeding to begin Aug. 29th—scheduling as many as 30 calendar days for hearings over the restructuring plan, to determine whether the city’s proposed plan of adjustment to eliminate more than $7 billion in liabilities and reinvest $1.4 billion over 10 years in services is fair and equitable. Judge Rhodes set hearings for: Aug. 29; Sept. 2-5, 8-12, 15-19, 22-24, and 29-30; and Oct. 1-3, 6-7, and 14-17—with the October dates falling after the deadline of October 1—when Mayor Duggan and the Detroit City Council have the authority to request Emergency Manager Kevyn Orr to depart. In the trial, the Motor City will seek to prove it has assembled a plan that will provide for fiscal sustainability and services solvency—and that its plan is equitable. Judge Rhodes said he would allow testimony from an Ernst & Young official at an Aug. 19th hearing to be included as part of the trial, and he said yesterday he would allow retirees who do not have lawyers to present their own evidence and call witnesses when the hearing begins. Attorneys for Detroit and its creditors will begin their opening statements Sept. 2nd. The nearly six weeks’ of hearings are expected to pit Detroit and its supporters—including the Official Committee of Retirees, the city’s two pension funds, several major unions, and (likely) water and sewer bondholders (Please see Motor City Savings on Tap below) against its two major bond insurers — Syncora and FGIC, as well as several hedge funds. Judge Rhodes has allocated 85 hours of trial time equally between supporters and opponents of Mr. Orr’s proposed plan of adjustment to present their cases.

Motor City Savings on Tap? Detroit’s unique tender offer, for which it is seeking a go ahead from U.S. Bankruptcy Judge Steven Rhodes, for its $5.5 billion in water and sewer bonds, appears to be tapping into a potential a success. The offer, part of the city’s proposed restructuring of its DWSD bonds could prove a key step to alleviate a stalemate with the Department’s bondholders and, thereby, remove a difficult hurdle to the Motor City’s efforts to exit municipal bankruptcy. If the city is able to refinance the debt in a public offering, it projects interest rates would be at 5.75% or lower rate, even for uninsured bonds, according to documents filed in the federal bankruptcy court. In addition, Assured Guaranty has agreed to wrap at least some of the new bonds, which would feature a senior lien on the department’s revenues. The proposed refinancing includes the tender offer, a refunding of the tendered debt, a refunding of currently callable debt, and $190 million of new money bonds—with Emergency manager Kevyn Orr’s office warning that without the federal court’s approval, DWSD’s capital budget “will be perilously depleted beginning in October 2014.” That, in turn, could lead to federal EPA sanctions. The offer was cobbled together in the wake of mediation between the city and insurers Assured, Berkshire Hathaway Assurance Corp., Financial Guaranty Insurance Co., and National Public Finance Guarantee, as well as an ad hoc committee of water and sewer bondholders that includes Blackrock Financial Management Inc., Eaton Vance Management, Fidelity Management & Research Co., Franklin Advisors Inc., and Nuveen Asset Management, plus trustee US Bank NA. According to its filing with the court, “the tender would facilitate a consensual restructuring of DWSD’s capital structure, while rendering unimpaired all existing DWSD bond claims and resolving the DWSD bond objections to confirmation of the plan.” Under the proposal, each member of the ad hoc committee has agreed to tender a “significant portion” of its respective, impaired DWSD bonds—upon which Detroit would issue the new bonds either through a public offering, direct purchase, or a private placement—with the Motor City having sought Judge Rhodes’ affirmation that the pledge of DWSD net revenues would constitute a lien on “special revenues.” In the wake of payment to bondholders from the refinancing proceeds, the bondholders would be required to approve the city’s confirmation plan. In addition, under the agreement, the bondholders agreed the DWSD can pay $24 million annually to the Detroit’s general employee pension fund as part of its operation and management expenses—with the payment drawn from a pension liability payment fund that will be funded after payments are made into the state revolving fund junior-lien bond and interest redemption fund, according to the documents. The tender offer which began last week is scheduled to close a week from today—at which time the city will decide by Aug. 22 whether to tender the bonds. Detroit has asked the federal court to schedule a hearing on the motion on Aug. 25th—a motion which, if granted, would mean the bonds would go to market on or around Aug. 26, with a close scheduled for Sept. 4. The refinancing, if approved, would also let the city tap debt service reserve funds for current bonds that hold as much as $50 million, which it would use to reduce the size of the upcoming refunding.

A Taste of What’s to Come. Syncora Guarantee, a bond insurer and Motor City creditor bitterly opposed to the city’s proposed plan of adjustment, Tuesday filed an objection with Judge Rhodes challenging an $800 million settlement put together under the oversight of chief mediator, Gerald E. Rosen, Chief Judge of the United States District Court for the Eastern District of Michigan, whom Judge Rhodes had asked to serve during Detroit’s bankruptcy. Syncora charged that Judge Rosen had said repeatedly that he believed he ought to get the best outcome possible for a single group of creditors — the city’s retirees. Because, Syncora noted, the Motor City’s plan of adjustment was underpinned by the agreement worked out for the city’s retirees, the plan itself should be rejected as impermissibly tainted by the biases of its chief mediator, whose job it was to impartially negotiate out-of-court settlements of as many of the city’s debts as possible. While Syncora told the court it believed that Judge Rosen was acting out of good intentions, the federal court needed to assess whether that might unfairly bias against the requirement that similar creditors be treated equitably. Syncora is an unsecured creditor, as are Detroit’s retirees; but the insurer claims Detroit’s plan of adjustment – under which the city is seeking to repudiate the debt Syncora insured – is entirely inequitable, requesting that Judge Rhodes reject the plan immediately, calling the proposed settlement a “product of agenda-driven, conflicted mediators who colluded with certain interested parties to benefit select favored creditors to the gross detriment of disfavored creditors and, remarkably, the city itself.”

Speaking of Mediators….Key San Bernardino city officials and some of the city’s creditors met with their own court-appointed federal mediator, U.S. District Court Judge Gregg Zive, in Reno, Nevada—with discussions not including key creditor, the California Public Employees’ Retirement System, according to Michael McKinney, San Bernardino Mayor Carey Davis’ chief of staff. Likely CalPERS, the city’s largest creditor in its municipal bankruptcy, was not present, because the agency has forged an interim agreement with CalPERS in an effort to help form a plan for San Bernardino to exit bankruptcy protection—after the city withheld its employer portion of CalPERS pension payments from the time of its bankruptcy filing a year ago in July. CalPERS currently estimates San Bernardino’s debt to the agency at $16.5 million, plus interest—although in the outline of its pendency plan in 2012, the city had noted it intended to pay the full amount it owes CalPERS. Working toward a settlement between CalPERS and the city has been the centerpiece of mediation talks with, according to brief statements made in previous filings and court appearances—with the thinking being that once the largest piece of the city’s financial obligations was decided, the remaining parties would have certainty how much remained to adjust with the city’s other creditors.
Unchartering? San Bernardino’s Council could vote today on whether to put proposed amendments to the city charter up for a vote of the people. In our case study on San Bernardino, we noted that its city charter fragments decision-making authority over budgets, personnel, development, and other critical issues among the mayor, city manager, city council, and city attorney—not to mention several boards and commissions—constraints that we noted “Greatly reduce the ability and flexibility of the city to adapt to economic and fiscal conditions as they change over time.” Now, after consideration of five amendments put together by a citizen review committee and discussed at city council meetings, the Council has narrowed its focus to two possible changes which its elected leaders hope could save the city money. At its previous meeting, the council decided not to pursue other proposed changes—changes which would have added a potentially sweeping statement that if multiple interpretations of a provision are possible, the one enabling the city applies; eliminated language governing the school district, which the district does not use; and replacing the city’s policy for recalls and initiatives with state policy. The council has the option of putting either proposed change on the ballot, both on the ballot as one item, both separately, or taking no action. Of the two amendments approved:
• One would eliminate a provision (§186) that guarantees that police and firefighters be paid the average of what 10 other cities with 100,000 to 250,000 people pay. Instead, pay would be set by collective bargaining as it is for other city employees — long a flash point in the city and the focus of most citizens’ charter comments, pro and con, since before the review committee recommended it.
• The second would end the practice of paying any employee who has been terminated or demoted until that employee has the chance to appeal the city’s decision to the civil service board.
With regard to public safety compensation, Mayor Carey Davis said he understood the city cannot underpay its public safety personnel; “[h]owever, I support the committee’s suggestion that salaries should be determined by market forces and our ability to pay…The modifications to Section 186 do NOT represent an automatic pay decrease but it does provide some flexibility to the Council and our public safety personnel with regard to salary discussions which will still be subject to California Law.”

Getting Ready to Rumble in the Motor City

August 13, 2014

Visit the project blog: The Municipal Sustainability Project

Getting Ready to Rumble. Attorneys representing the Motor City and its creditors are due before U.S. Bankruptcy Judge Steven Rhodes this morning for discussions with regard to the confirmation process for Detroit’s debt restructuring in anticipation of the historic trial scheduled to commence a week from tomorrow. The anticipation is that Judge Rhodes will set deadlines and hearing dates for the trial, which is expected to last well into September, to determine if Judge Rhodes will approve the city’s proposed plan of adjustment—allowing the city to emerge from the largest municipal bankruptcy in history by finding that that plan is fair and feasible. On that same afternoon, farther west in Minneapolis at the National Conference of State Legislatures’ 2014 Legislative Summit, we will be moderating a session on Municipal Bankruptcy: “What are states to do when a locality heads south?” The panel features Richard Ravitch, who not only served as Lieutenant Governor in New York and played a critical role in New York City’s near default, but also served in a unique role as a consultant appointed by Judge Rhodes in the Detroit bankruptcy case; Kil Huh, who directs the Pew Center’s work on state and local fiscal health; and U.S. Bankruptcy Judge Thomas Bennett, who oversaw the largest municipal bankruptcy case in American history prior to Detroit’s case—Jefferson County, Alabama.
Homework. With next week’s historic trial set to focus on the disposition of some $18 billion in municipal bond debt, the National Association of Bond Lawyers yesterday released the General Obligation Bonds: State Law, Bankruptcy and Disclosure Considerations, a timely document to assist its own members and other state and local public finance participants better understand the labarynthian world of municipal bonds, especially focusing on general obligation or GO bonds, with a focus on the characteristics of general obligation bonds, state law remedies, municipal bankruptcy, and disclosure considerations. The release emphasizes that, lo and behold, not all general obligation municipal bonds issued by a state, local government, school board, or other public entity enjoy the same security or the same remedies for enforcement of the promise to pay. In addition, as we are likely to learn over the coming weeks as we focus on the trial in downtown Detroit, how a state or local government’s GO bonds are treated in a bankruptcy is uncertain. Although the disclosure for general obligation bonds provided in Official Statements must be tailored to each general obligation bond, the paper does discuss topics that should be considered in preparing an Official Statement for an offering of general obligation bonds. The paper is the brainchild of the organization’s current President, Allen Robertson, who originated the concept as he took office in Chicago last year—in no small part to help state and local leaders better appreciate and understand that while there has been a general assumption that all general obligation bonds are backed by a state or local government’s full faith and credit (e.g. said government has committed to raise taxes to ensure interest payments to all bondholders if necessary), NABL’s new paper tartly notes: “It has become apparent that all general obligations bonds do not enjoy the same security or the same remedies for enforcement of the promise to pay under state or local law…Further, the treatment of general obligation bonds in a Chapter 9 bankruptcy case is uncertain and will depend on the security provided by applicable state law,” adding that the characteristics of GO bonds are determined by state laws and local ordinances, so that the source and security for debt service payments on the bonds may vary from one issuer to another; moreover, NABL adds, some GO bonds are only supported by either a pledge or the issuing state or municipality’s full faith and credit or a pledge of the issuing state or local government’s taxing power, rather than by both. Further, the report finds that the characteristics of an issuer’s full faith and credit obligations vary from state to state. Moreover, for anyone not yet confused, the special report reminds us that there are three general kinds or types of GO bonds: unlimited tax, limited tax, and bonds payable from the issuing government’s general fund—and, even beyond that, the report reminds us that there are variations across state and local governments on exactly what these terms mean. The report examines options bondholders might have in the event of nonpayment of timely tax-exempt GO bond interest under respective state laws prior to a municipal bankruptcy filing—with such remedies dependent upon differing state constitutions and statutes, as well as whatever specific commitments a state or local issuer of GO debt promised to take to ensure payment—with the main remedy being to have a court issue a writ of mandamus, compelling a public official to pay the debt service―albeit, according to the paper, judges, as a rule, are limited in their authority to issue these types of writs if the duty to pay the debt service is mandatory and imposed by state law. Moreover, the paper adds, a state or local government may try to frustrate enforcement of the writ, and federal bankruptcy courts may be unwilling to issue writs when there is a need for governments to prioritize the provision of essential public services to their citizens.