What Happens if Municipal Bankruptcy Does Not Work?

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March 30, 2015
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The Prospect of Failure. As the federally imposed deadline for San Bernardino to submit its plan of debt adjustment or bankruptcy exit plan approaches, there is an increasing possibility the city’s auditor will not have all of the city’s financial statements audited. Notwithstanding that, U.S. Bankruptcy Judge Meredith Jury last week noted she would be “shocked” if the consultants the city brought in had not managed to have the city’s finances in order—the way every other city and county in a major municipal bankruptcy has, because reliable financial statements are critical to the kinds of negotiated settlements that characterized other municipal bankruptcies. Nevertheless, the seeming uncertainty with regard to who can really speak for the city—in addition to the lack of reliable financial information, means the risks of non-performance are increasing, albeit, San Bernardino City Attorney Paul Glassman advises the importance of keeping the “the audit in perspective,” noting that “[W]hile the city is working very hard to get its audit done…there is no legal requirement that audit be in place (to submit a Plan of Adjustment).” In fact, as Mr. Glassman has stated, Stockton had two years of unaudited financial statements when it filed its bankruptcy municipal plan of debt adjustment, putting it in a comparable position to San Bernardino if it missed both its audit targets, which he does not anticipate. He added that in the Vallejo and Detroit municipal bankruptcies, both were also behind. Ergo, Mr. Glassman believes there is little question but what the city will timely meet Judge Jury’s deadline. It is possible that the more serious problem relates to governance, or, as Counselor Glassman said before Judge Jury: “First of all, in mediation, I have gotten to know and worked with the mayor, city manager, city attorney―all smart, competent, well-intentioned people. And I say that without qualification…However, as a group, working with the City Council, we have a very ineffective form of governance and (lack of a) collective approach…We can’t say in depth what’s going on…and that’s part of the problem.”

Disparate Treatment. At the federal bankruptcy hearing, Mr. Glassman also provided further details with regard to an “interim agreement” between the city and the California Public Employees’ Retirement System (CalPERS), an agreement first announced last June, with greater details provided to the U.S. Bankruptcy Court last November with regard to the $13.5 million in payments the city owed to CalPERS in the wake of the city’s halt of pension payments for the first year of its bankruptcy. Under the agreement, the city first paid $1.5 million in last May, after which it agreed to make equal monthly payments of just over $600,000 per month for two years until the missed total and interest were repaid. Mr. Glassman told the court that under the city’s agreement with CalPERS, the state public pension agency had committed it would not pursue its challenge of the city’s eligibility for bankruptcy protection. Although, Mr. Glassman told Judge Jury, other creditors have characterized the city’s agreement with CalPERS as a “surrender” to CalPERS, he stated it was necessary to avoid having CalPERS reduce the benefits paid to current and future retirees and to avoid an “exodus” of employees that would leave the city unable to serve its residents.

Is There a Jewel in the Crown? What if the San Bernardino Fails to Meet Judge Jury’s Deadline? With the ongoing governance turbulence and uncertainty in San Bernardino with regard to whether the city can get its act together—and the very real apprehension that should it not, Judge Jury may not grant an extension: what will happen? Should the city fail and be denied an extension, the city’s federally granted protection from its creditors will expire—likely leading to a race to the courthouse by those creditors to secure default judgments against the municipality for failure to pay its obligations. The race will be serious, because all creditors understand the city has far fewer assets than claims against such assets. Moreover, the city’s former redevelopment assets are not part of the city budget, so they are already off limits: they have to be liquidated through other means with the bulk of the assets reverting to the state―some nearly $500 million dollars according to the State Treasurer’s Office. Virtually every other asset in the city is fully encumbered: San Bernardino City Hall is not only currently assessed at less than what is owed on the current notes, but it is sinking in additional debt: San Bernardino refinanced the edifice in the 1990’s, and then was confronted with mandated earthquake retrofits of nearly $20 million in additional debt: the architectural design for City Hall was banned in California in the wake of the 1972 Santa Ana Earthquake. The city does have two assets that would be on creditors’ hit lists: the Trash Department and the City’s Water Department: each could be worth in excess of $200 million if the perpetual water rights and potential operating profits were counted. There are estimates that the value of the city trash fleet is in the range of $25 to $35 million dollars, and that operation of the service could be exceptionally profitable if privatized. But the biggest jewel in the crown, as it were, would likely be the municipality’s water rights and water department. The city owns most of the water rights in the basin over which it is built: it is residents’ primary source of water—and with California in an ongoing drought situation, water is the city’s jewel in its crown: one creditor likened the value of the water service to be astronomical.

Gambling on Atlantic City’s Future. New Jersey State Senate President Stephen Sweeney (D-Gloucester), in the wake of state-appointed emergency manager Kevin Lavin’s report last week on Atlantic City, said the emergency financial managers were only making things worse, giving Wall Street a crisis of faith. Sen. Sweeney warned that any further ratings decline on Atlantic City’s debt “would make it even harder for the city to work its way out of its dire fiscal problems.” He complained that the Christie administration was warned months ago that decisive action was needed to stabilize Atlantic City’s finances and re-position the casino industry, adding: “They have held three summits and issued three reports, but they have done little to nothing to restore financial stability, protect local taxpayers, maintain public services, or to give the gaming industry the ability to rebuild its business opportunities: They seem to want to keep playing a losing hand.” Joseph Seneca, an economist at Rutgers University, noted that the reaction to the report from credit rating agencies should come as no surprise: “These are realistic assessments of the depth of the fiscal problems that has built over a period of time. The decline property tax base loss is just staggering…There’s fundamental erosion in the fiscal capacity of the city and that’s the reality…The fiscal realities here and now though are pretty dire: The drop of more than 50 percent drop in the tax base is stunning. It has to have deep and significant financial implications.” Perhaps the greatest concern is over time: Moody’s has warned that the state plan also relied on quick state legislative action, state aid, and timely property tax payments from already struggling casinos―an unlikely scenario as both the Revel and Trump Taj Mahal were delinquent on their property tax payments in 2014. As Moody’s succinctly put it: “Given the city’s cash flow projections and assuming pension and health benefit payments are delayed or deferred, the state legislature will have only three months to adopt the two bills before the city reaches a liquidity and debt service crisis…Debt service payments due on August 1 and December 15 may be at risk if the two bills are not adopted swiftly and the revenue infusion does not come in time.”

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