The Challenges in Emerging from Municipal Bankruptcy


December 19, 2014
Visit the project blog: The Municipal Sustainability Project

T’was the week before Christmas, and all through the year
The progress on municipal sustainability was something to cheer;
From the rhythm guitar of Judges Rosen and Rhodes,
The Motor City seems to be back on its roads;
Stockton, by Judge Klein, has experienced great Deis,
Its sustainable future now could go any which ways.

Credit where credit’s due in the Motor City? Despite Detroit’s successful emergence from the largest municipal bankruptcy in U.S. history, credit rating agency Moody’s yesterday assigned the Motor City a B3 rating (a level six levels below an investment grade rating)—its first post municipal bankruptcy rating—and one that is, as the Bond Buyer notes, at junk bond levels. Moody’s did assign Detroit a stable outlook. Moody’s wrote: “The B3 issuer rating reflects Detroit’s improved credit profile and lower risk of near-term default now that it has emerged from its historic Chapter 9 bankruptcy filing…The improvements include a reduction in long-term liabilities and stronger near-term cash flow, as well as significant management and operational changes that are poised to enhance service delivery and stem population decline.” Nevertheless, the less than rave post-bankruptcy rating reflected the challenges Detroit confronts, including a persistently weak economy, diminished population, and fixed costs related to debt service retiree benefit costs, which are projected to consume a substantial portion of the city’s post-bankruptcy revenues, or as analyst Genevieve Nolan wrote: “Further, the city may face difficulties if it experiences even modest declines in the key revenue streams that support general operations.” Nevertheless, the stable outlook reflects the agency’s expectation that the Motown can resume paying its outstanding debt on time and in full ― and that its plan of adjustment, if fully implemented, will improve the city’s overall cash position and put it on a path of fiscal sustainability. Moody’s opined Detroit could be assigned an upgrade if it experiences economic improvements, material operating surpluses and cash balances, and reduces fixed costs under strong management oversight. In contrast, Moody’s moodily warned it could downgrade the city should its tax base decline, key revenue sources falter, debt levels rise significantly as a percentage of the operating budget, or the city experiences a trend of operating deficits. The ratings were issued just a week after the city successfully emerged from bankruptcy―issuing some $1.28 billion of new debt—debt which its financial advisors noted required novel financing structures to both comply with Michigan municipal law and the strict confines of Chapter 9 creditor settlements.

Schooling a Motor City Recovery? Ingrid Jacques, of the great Detroit News, yesterday noted that pressure is mounting for Detroit Mayor Mike Duggan to assume responsibility for Detroit’s school system, even though, as she noted, Mayor Mike Duggan unsurprisingly says: “I’ve got enough on the my plate right now.” But Ms. Jacques wrote: “Duggan has his hands full. Yet the mayor understands how integral schools are to Detroit’s turnaround. A strong K-12 network of schools is essential to rebuilding a middle class in the city. Without that, Detroit’s future is grim. While the mayor remains cool to the idea of taking on another major challenge, others in his administration have faith in him.” Nonetheless, a top city hall aide told her: “He doesn’t want to take over the schools, but he’ll have to do it…You can’t fix the city without fixing the schools.” But he might not be alone, as Gov. Rick Snyder has also begun to focus on the Motor City’s schools—especially with the term of his third emergency manager set to expire—with little to show for the long state takeover, even, as Ms. Jacques notes that the Governor has “made it clear that he’s not a fan of the Detroit school board regaining more control. But he’s also admitted emergency managers for the district haven’t been as effective as he’d like”—or, as she quotes the Gov.: “‘How do we do a better job of educating kids in Detroit?’” Whilst the Gov. has not directly proposed that Mayor Duggan assume greater oversight of city schools, she writes that he definitely thinks Mayor Duggan should take part in the developing conversation about schools. And, she adds, “[Gov.] Snyder wants the next blueprint for improving schools to come from the community — not him: ‘I want the community to be actively involved in this process.’”

Taking Stock in Stockton. At a hearing yesterday, U.S. Bankruptcy Judge Christopher Klein denied a request from the city’s holdout creditor, Franklin Advisors, to increase the amount Stockton would be required to pay the firm on its claim. Judge Klein’s ruling, which came in the wake of Franklin’s appeal to Judge Klein’s confirmation of Stockton’s plan of debt adjustment and stay on the city’s authority to exit municipal bankruptcy, deferred a final decision until, as the Judge said, he hears arguments on Franklin’s bid for a stay when the city’s plan becomes effective. Franklin continues to challenge the city’s exit plan on the grounds that it took steep cuts while the city’s plan of debt adjustment included no cuts at all in the city’s obligations to the California Public Employees’ Retirement System or CalPERS. The firm had been grouped in a class of creditors with city retirees who are set to receive a similar recovery rate. (Stockton’s plan of debt adjustment approved by Judge Klein did eliminate future health benefits for retirees, for an estimated savings of $545 million for the city.) Franklin argued said that if the retiree health benefits claim were discounted to present day value, the true savings would double; however, Judge Klein said he was not required to discount the claim and denied Franklin’s request. Stockton’s attorneys yesterday said the city’s plan of debt adjustment would go into effect within three weeks.

Yuletide Appeal. The National Association of Bond Lawyers yesterday filed an amicus brief with the 11th U.S. Circuit Court of Appeals in support of Jefferson County’s request that the court take an interlocutory appeal from a ruling of the District Court in Jefferson County v. Bennett, et al. Certain Jefferson County water and sewer ratepayers brought a case in the District Court to appeal the plan of adjustment confirmed by the intrepid U.S. Bankruptcy Judge Thomas Bennett in Jefferson County’s bankruptcy case—an effort which the County sought to have the District Court dismiss as moot, because the bankruptcy confirmation order had been substantially consummated when the county sold $1.8 billion of warrants on December 3, 2013. Although the doctrine of equitable mootness has been established in other chapters of the Bankruptcy Code, this is a case of first impression with respect to Chapter 9. The District Court denied Jefferson County’s motion to dismiss, but did certify the question for an interlocutory appeal to the U.S. 11th Circuit  Court of Appeals. The bond lawyers support the 11th Circuit taking the interlocutory appeal, because, they write, doing so would materially advance the disposition of the case and provide needed guidance to the municipal bond market regarding the finality of substantially consummated Chapter 9 plans of adjustment.


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