October 7, 2014
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Nearing the Final Lap. Key negotiators, overseen by Chief U.S. Judge Gerald Rosen, met behind closed doors yesterday in an effort to achieve consensus with the last major holdout creditor, Financial Guaranty Insurance Co. under increasing pressure from U.S. Bankruptcy Judge Steven Rhodes—with the secret talks involving not just emergency manager Kevyn Orr’s team and FGIC, but also the State of Michigan. According to sources reporting to the Detroit News, FGIC is seeking cash and real estate to settle $1.1 billion in claims the firm has with regard to a controversial pension arrangement under which former Mayor Kwame Kilpatrick was convicted. Indeed, in an interview yesterday with the News, Governor Rick Snyder said he was confident the city could be out of bankruptcy in 30-60 days. By yesterday afternoon, Judge Rhodes told one of Mr. Orr’s team members, Geoff Irwin, that he hopes the Motor City will file at least one more version of its proposed plan of debt adjustment with “more settlements” and “soon.” Yesterday’s stepped up negotiations took place nearly one month after fellow creditor and bond insurer Syncora Guarantee Inc. reached agreement with the city in an arrangement involving a parking garage, riverfront land, a longer lease of the Detroit-Windsor Tunnel, cash, and other considerations. However, that deal was reached before this month, when governance switched with the power and authority of the Mayor and Council restored; thus, any proposed agreement reached now must be approved not only by the federal bankruptcy court, but also by Mayor Mike Duggan and City Council.
Transitioning. Mayor Mike Duggan yesterday testified on the 19th day of the city’s bankruptcy trial before U.S. Bankruptcy Judge Steven Rhodes that he and other Detroit leaders are committed to following Mr. Orr’s proposed plan of debt adjustment, using it as a blueprint for the city to return to regular working order in the wake of the largest municipal bankruptcy in American history. Nevertheless, Mayor Duggan testified that the challenges that he believes will be most difficult are those beyond his control, with the key fears being another national recession, reductions in state revenue sharing to local governments, and potential new casinos in Michigan that could draw gamblers away from Detroit’s three casinos, thereby reducing municipal revenues from Detroit’s wagering tax. Nevertheless, Mayor Duggan told the court: “I support this plan, and I believe it is feasible…I can’t predict a national recession. I can’t predict a cut in state revenue sharing. I can’t predict other casinos being approved. Those are the risks I signed up for as the mayor. I believe within this plan are the resources we need to be successful.” With regard to the $1.4 billion in Kevyn Orr’s proposed plan of adjustment for reinvestment for a sustainable future, Mayor Duggan testified that a significant portion of those revenues will only materialize if his city becomes more efficient as a city government and that it collects tax and fee revenues, telling the court he reviewed the restructuring and reinvestment numbers with every department head in the city and came to the conclusion that the plan is feasible: “This is going to be tight, and it’s not without risk.” Mayor Duggan was asked about progress achieved to date, including the regional water authority agreement that will raise $50 million a year for 40 years for upgrades to the aging infrastructure, and he testified about the city’s herculean efforts through the Detroit Land Bank to get abandoned and neglected homes fixed up or auctioned off to new owners, as well as the significant progress the Motor City had achieved in replacing streetlights throughout the city—the Detroit Public Lighting Authority has already installed 20,000 new lights, restoring service to nearly half the city’s neighborhoods, Mayor Duggan told the court.
Motor City’s Future. Much of the Mayor’s time in federal court yesterday was with regard to his conviction that the signal challenge the city confronts will involve its efforts to make the city safer and more livable, so that it can halt the city’s decades-long population decline: “We’re probably at about 10% of where we need to be…We’re building in the right direction. It’s going to be a multi-year process,” he told the court before the city can boast the level of services expected of a big city. Detroit would fund about $1.4 billion in restructuring programs in part by eliminating debt. In 10 years, it plans to spend $440 million on blight remediation and $439 million on police and fire protection. The city is only about “10 percent” of where it needs to be in restoring services, the Mayor said, testifying he has hired top government officials from New York City, the Commonwealth of Massachusetts, and Louisville, Kentucky, to lead various Detroit departments, including planning, housing, and information technology. Some, like Mayor Duggan, have previous experience with both private and municipal corporations. The mayor described the city’s progress rebuilding services, testifying that one focus has been on persuading residents to begin repairing their own blighted neighborhoods. Citing lessons he learned restructuring Wayne County, Michigan, where he was a top executive, and as head of the Detroit Medical Center, Mayor Duggan testified: “We’re trying to build a culture in which you don’t always say, ‘What is city government going to do for me?’…One person doesn’t do a turnaround.” Mayor Duggan testified he is skeptical about the wisdom of borrowing another $50 million, as proposed by Emergency Manager Kevyn Orr, noting that would bring Detroit’s exit loan to $325 million. He testified he wants to make sure that any additional borrowing is necessary and that it would not be used to help pay $50 million in extra consultant fees—a level, he noted, by which the city’s hired “bankruptcy experts” had exceeded their budgets. Under questioning by the attorney for holdout creditor FGIC with regard to whether city officials can be counted on to meet the terms of Mr. Orr’s pending plan of debt adjustment and recovery and assertions that city employee morale has been adversely affected by pension cuts, as creditors have sought to undercut the city’s proposed plan of adjustment provisions which provide its retirees and with more favorable settlement terms compared to other creditors; the Mayor made clear that it matters, because it impacts morale of current city workers and, therefore, Detroit’s ability to wrest efficiency and productivity out of its workforce. After the Mayor completed his testimony, bondholders and the bond insurer FGIC began their challenge to Detroit’s proposed plan of debt adjustment by calling Cynthia Thomas, the executive director of Detroit’s retirement systems, to the stand. Ms. Thomas disputed the city’s estimate of how much the retirement system would earn from future investments. The system’s long-time consultant predicted the two retirement funds will earn about 7 percent to 8 percent annually, Ms.Thomas testified. Consultants hired by Mr. Orr predicted the systems will typically earn less than 7 percent a year. Using the lower number increased the size of the systems’ underfunding. FGIC has argued that the underfunding is smaller than the city claims in its debt-cutting plan. A smaller underfunding may leave more money for other creditors.
The Wisdom of Hindsight. Motor City Council President Brenda Jones also testified yesterday, telling the court she now believes Emergency Manager Kevyn Orr made the right call in filing for municipal bankruptcy, admitting a change of heart after her adamant opposition to Governor Rick Snyder’s appointment of Mr. Orr last year, telling Judge Rhodes: “There was a point when I felt the city was in crisis, we had bills, bankruptcy could’ve been done by the city themselves.” Yesterday, however, when asked by Judge Rhodes if she is committed to implementing Mr. Orr’s proposed plan of adjustment, Councilmember Jones responded: “Yes, I am.” Because Judge Rhodes must find that the pending plan of adjustment is feasible, he must assess not only the plan itself, but also the willingness and commitment of the city’s elected official to carry out what is, in effect, the city’s blueprint for its future. Nevertheless, during cross-examination, lawyers for Detroit’s holdout creditors pointed out that Councilmember Jones in the past opposed portions of Mr. Orr’s plans – including her votes against privatization of garbage collection and the lease of Belle Isle by the state. In addition, the attorneys pressed Councilmember Jones with regard to her in depth understanding of the pending plan—in response to which, the Council President admitted she had not fully reviewed the 10-year financial projections in the plan, nor did she participate in assisting Mr. Orr in determining what amounts to fund on the different initiatives, testifying that the $440 million in the plan to tackle blight was a good start, but not enough, but, nevertheless, making clear; “The City Council and the mayor will work to the best of their ability on the allocation of the money that is in” the restructuring plan: “We have a group of confident council members and we’re ready to do our part.” After yesterday’s session, Judge Rhodes recessed the trial until October 14th.
Setting Terms and Conditions. With one member of the City Council absent, San Bernardino Mayor Carey Davis broke a tie late last night to impose new terms and conditions of employment on the city’s firefighters—with the late vote serving to implements budget cuts the Council had approved 5-2 last June, including the closure of a fire station and the implementation of so-called constant staffing. In the wake of U.S. Bankruptcy Judge Meredith Jury’s ruling last month that San Bernardino could reject its existing contract with firefighters, but rejection of San Bernardino’s request to explicitly rule that they could therefore impose a contract of their choosing; last night’s vote is almost certain to trigger a new suit from the fire union—mayhap further muddying the city’s timing and ability to complete its plan of debt adjustment. San Bernardino fire union attorney Corey Glave had emailed the mayor and council prior to the session that the proposed terms violated Public Employees’ Retirement Law and the city charter. Councilmember John Valdivia warned his colleagues before the vote: “This is risking public safety, causing hysteria with our senior citizens, to pinch a few pennies.” Valdivia said, contrasting it with new hires and promotions approved Monday for about $560,000. Prior to the vote, the city manager told the Council his negotiations and the budget were accomplished as directed by the Council and that he was not the first city manager to make clear that police and fire needed to be cut: “I am at least the third city manager you’ve had, consecutively, say it’s mathematically impossible” to balance the budget without reductions to police and fire. The vote effectively implements Fire Department reductions from the 2014-15 budget that the Council adopted on a 5-2 vote last June, but which have not yet gone into effect. Under the provisions, the city “expressly and exclusively retain(s) its management rights,” including the right to contract out. The vote follows last summer’s rejection by U.S. Bankruptcy Judge Meredith Jury, at San Bernardino’s request, of the city’s previous bargaining agreement. The resolution adopted last night finds that passage is critical in order to keep the city’s budget spending balanced, noting: “The failure of the City and the (San Bernardino City Professional Firefighters) to reach agreement regarding the implementation of the 2014-2015 Fire Department budget reductions creates a substantial financial burden impeding the City’s ability to balance the General Fund budget…and continue to provide essential services to ensure the health, safety and welfare of its citizens thereby making it necessary to impose certain terms and conditions of employment.” The city has calculated its reductions for the department have reduced the city’s budget by $2 million from the budget, albeit staff have warned the elected leaders that the four month delay has significantly eroded those potential savings. The reductions include closing Fire Station 10, and removing one unit from the station on E Street north of Highland Avenue. Two planned layoffs have already been rescinded, but four demotions are still underway, although those four are being appealed to the city’s civil service board. The Fire Department did implement its plan to increase dispatcher staffing so that lower-priority calls can be given to the private ambulance company American Medical Response rather than firefighter/paramedics, lowering the total call volume. Pay will continue to be set by City Charter Section 186 as the average of what 10 cities of similar population pay for the same positions. That charter guarantee, which also applies to police, would be eliminated if San Bernardino voters approve Measure Q in November.
It ain’t over until it’s over. Moody’s analyst Christopher Coviello yesterday wrote that U.S District Judge Sharon Blackburn’s refusal to dismiss an appeal of Jefferson County’s municipal bankruptcy plan of debt adjustment approved nearly a year ago by U.S. Bankruptcy Judge Thomas Bennett was credit negative for sewer warrant holders, because it could jeopardize the Jefferson County’s ability to repay the debt. Judge Blackburn’s ruling that an appeal to Judge Bennett’s decision can go forward challenging the constitutionality of a security feature in the county’s plan of debt adjustment that permits the bond trustee to ask the bankruptcy court to compel the county to enforce the plan, if elected officials refuse to raise sewer rates necessary to service the debt, was key to paving the way for Jefferson County to close on $1.8 billion of 40-year refunding sewer warrants last December. Thus, Mr. Coviello yesterday wrote: “The court’s decision is credit negative for sewer warrant holders, because it raises the possibility that a successful appeal will undo the county’s aggressive rate increases, which are critical to its ability to pay the new debt service…If the court rules that the bankruptcy judge does not have the authority to enforce the approved rate increases, there is a significantly higher risk that future revenues would be less than what the county needs to cover debt service payments…Jefferson County’s ability to repay debt service is already precarious.” Even if Jefferson County did not issue any more parity debt, according to Moody’s, sewer revenue debt service coverage beyond 2024 would be relatively narrow at around 1.2 times. Comparing the current year’s net revenues with maximum annual debt service, which will occur in 2053, coverage is significantly lower at 0.4 times—an amount, according to Moody’s, that is well below the median of 1.62 times for all rated sewer systems in the country, and 1.58 times for the largest systems: “Because of its back-loaded debt structure, Jefferson County likely did not build in enough revenue capacity for future capital investments, even with the planned rate increases…Beyond regular system renewal and replacement, the sewer system will be hard pressed to fund significant investments to meet the stricter environmental standards that we expect will be in place by 2024.” To meet the escalating debt service requirements, and the first 10 years of capital and operating expenses, Jefferson County’s plan of adjustment included annual rate increases of 7.89% from 2014 to 2018, and 3.49% annually from October 2018 through maturity in 2053.