Nearing Municipal Precipices


March 17, 2015
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Nearing a Fiscal Precipice. With its federally imposed deadline to present U.S. Bankruptcy Judge Meredith Jury with a plan of adjustment just a little over two months away, San Bernardino’s Mayor and Council face an expensive deadline Monday to approve an amended agreement with the municipality’s auditors, who have just reported that the city will have to come up with just under $1 million to pay for the city’s audited financial statements for the past two years―nearly double the $490,000 of the firm’s (Macias, Gini and O’Connell, LLP) original estimate. With the Council facing a ratification vote Monday, there is anguished recognition that no plan of adjustment would be acceptable to the federal court absent those audited numbers―an audit, moreover, which has been repeatedly delayed, with the first of the two audits — for fiscal year 2012-13 —already a year late. The delays have already led to state reductions in financial aid for San Bernardino’s economic training agency, but reflect a trend: the prior 2011-2012 audit, for the year leading up to the city’s filing for federal bankruptcy protection, was submitted to the Council last June, some 15 months after the state deadline. Part of the fiscal disarray appears to reflect staff turmoil: San Bernardino’s finance manager, Scott Williams, has been placed on administrative leave, after just months on the job, and the city manager expects this week to be the finance manager’s last. The previous finance manager, David Cain, held the title for about 18 months before resigning; his predecessor, Jason Simpson, resigned in January 2013 after coming on about a year earlier and quickly helping prepare a report that municipal bankruptcy could be imminent. Indeed, constancy has been most inconstant in San Bernardino—or, as City Manager Allen Parker puts it: “If you take a look at it just from a management perspective — city managers, police chiefs (and department heads), we’ve had 24 turnovers in the last three years, I believe,” he said, with more departures below that level, adding: “There’s nothing unique going on in Finance that’s causing that.” Mr. Parker has indicated he cannot explain the specifics behind the auditing firm’s statement that it needs more man-hours and, therefore, such an enormous price hike: in a staff report, he said the audit firm can better assess how much staff time the job will take once the firm conducts its internal control testing, determines the number of major federal grant programs which require more detailed testing, and determines how much testing is required for accounting transactions; nevertheless, he has recognized the elected officials are between a rock and a hard place: the city simply cannot submit a plan of debt adjustment without the two years of audited financials. According to the city staff report for Council, the auditing firm commenced the city’s 2012-13 audit in November 2014. In the wake of the council’s approval of the city’s set of goals last July, San Bernardino intended to have its 2013-14 audit being completed in the first quarter of FY2015. Perhaps more discouraging than the repeated delays is the auditing firm’s warning that the audit situation is considerably more complicated than expected—certainly it imposes more than a wrinkle to the rapidly diminishing time in which the city has remaining to complete its proposal for Judge Jury to seek her approval for the city to exit bankruptcy. Nevertheless, City Manager Parker evinces some optimism, even in the face of some apprehensions with regard to the possibility the audits could conclude fund totals are different than expected, telling the San Bernardino Sun: “I don’t if know if ‘confident’ is the right word…Given the additional money and our commitment in terms of bringing additional people on board, I believe we will meet the deadline.”

Restructuring Municipal Debt. Three members of the Puerto Rico House of Representatives, Representatives Manuel Natal Albelo, Luis Vega Ramos, and Luis Raúl Torres Cruz, have proposed legislation which would permit the restructuring of the Commonwealth’s more than $70 billion of debt if voters were to adopt a referendum on a constitutional amendment allowing for the restructuring of the debt of the commonwealth and its public corporations. However, adoption of any of the restructuring proposals would likely lead to the largest municipal bond default in U.S. municipal history. The proposals would establish that payment of the debt should take into account the commonwealth government’s fiscal realities and that debt should not be considered superior to the priorities of cheaper electricity, lower water prices, strategic infrastructure investment, schools, effective special education programs, and better health programs for everyone, according to the proposed language. Another would set up a special independent commission for the government to restructure the debt. The legislation would allow the commonwealth to use the fiscal emergency legislation passed in late June to decree a moratorium on the payment of 78% of public debt service. The representatives have also proposed a bill to create a special commission to restructure the commonwealth’s debt. To become law, the proposals would require approval by 2/3ds majorities in the House and Senate of the referendum; such a public referendum would need a majority vote to pass. The proposal comes as Moody’s yesterday wrote that the Puerto Rico Electric Power Authority or PREPA is “most likely” to default, and that, because PREPA is the sole provider of an essential service to the Commonwealth, the credit ratings links between the utility and the government are linked. Thus, with little apparent action in Congress on pending legislation which would offer access to municipal bankruptcy for the Commonwealth, there is increasing apprehension of a default and insolvency. As Moody’s noted yesterday: “PREPA’s Caa3 rating has been closely related to the Commonwealth’s Caa1 rating because of PREPA’s reliance on the Puerto Rican economy and the close relationship between the two entities around governance, liquidity, and rate design.”


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