The Excruciating Choices of Municipal Bankruptcy

May 8, 2015
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Making Excruciating Choices. As San Bernardino races the clock to put together its proposed plan of debt adjustment by U.S. Bankruptcy Judge Meredith Jury’s fast approaching deadline three weeks from now, the city appears to have reached consensus to propose the elimination of retiree post-retirement health care benefits, according to an attorney involved in negotiations with city officials. The accelerated pace comes as the city is pressing to meet a deadline a week from yesterday to make public its proposed plan of debt adjustment. Steven Katzman, who represents a committee of retirees in talks with the bankrupt city, reported yesterday that a tentative agreement has been negotiated under which the city’s retirees would give up their benefits, but, as part of the agreement, receive a guarantee that San Bernardino will not reduce current pension benefits. Such an agreement would be consistent with the federally approved plans adopted by Stockton, but more generous than Detroit, where both pensions and post-retirement health care benefits were reduced. Under the potential consensus, the city would propose no reduction in its payments to its single largest creditor, the California Public Retirement System (CalPERS). The tentative agreement means retirees would move to a so-called “unblended” pool composed solely of retired workers, thereby realizing a significant increase in premiums they will owe. In addition, as part of the emerging agreement, the city would halt its current monthly subsidy of $112 San Bernardino currently provides its retirees to help with premiums, except that, under the provisional agreement, the city would continue to support a small number of older employees who are ineligible for Medicare.

The key negotiations represent a potentially significant breakthrough from negotiations behind closed doors with a committee of eight retirees, who are representing the city’s approximately 2,000 retirees. Notwithstanding the tentative agreement, these retirees, like all the city’s creditors, will be provided an opportunity to vote for or against San Bernardino’s proposed plan of debt adjustment prior to any final decision by Judge Jury. In describing the tentative agreement, Mr. Katzman noted: “The goal has been to reach a deal with the city, and the retiree committee’s recommendation is essentially to forsake health care benefits for protection of retirees’ pension benefits. The goal is to incorporate that agreement into a plan, and we are in active discussions with the city towards that objective.” Even as the tentative agreement could mark a significant milestone in San Bernardino’s goal of submitting its plan by the end of the month, other serious hurdles loom: negotiations with city firefighters, who are suing San Bernardino over contract issues, have broken down; the police union still has not signed off on parts of a potential bankruptcy agreement which would affect its affect its members, and some of the city’s municipal bondholders have sued San Bernardino over its decision to pay CalPERS in full, similar to the litigation in the wake of U.S. Judge Christopher Klein’s approval of Stockton’s plan of debt adjustment, under which Stockton chose to propose no reduction in its pension obligations to CalPERS, in effect forcing significant haircuts in its payments to bondholders—a decision consistent with San Bernardino’s position enunciated at the beginning of the year, when its city attorney told Reuters the city intends to cut its bondholder debt under the bankruptcy plan: San Bernardino has paid nothing to its bondholder creditors for nearly three years. Those bondholders include EEPK, the Luxembourg-based bank and holder of roughly $50 million in pension obligation bonds issued by San Bernardino in 2005, and Ambac Assurance Corp, which insures a portion of those bonds.

Here Come Da Judge. U.S. District Court Judge Otis D. Wright II yesterday rejected what he called “a trilogy of merit-less appeals” that the San Bernardino firefighters union had made seeking reversals of bankruptcy court decisions against them. In three opinions, Judge Wright affirmed rulings supporting the city’s position, with Judge Wright noting: “The city’s willingness to meet and compromise, and the union’s stubbornness, is quite apparent from the wealth of e-mail traffic between the parties…The union’s claim that the evidence regarding reasonable efforts is ‘scant’ is a misrepresentation of the evidence.” In harsh criticism of the union’s challenge, Judge Wright wrote that some of the union’s arguments in favor of appeal were: “vapid,” “surprisingly merit-less,” “befuddled,” and “legally unsupported and lazy.” Judge Wright’s first decision rejected the union’s appeal of Judge Meredith Jury’s decision last September to reject the city’s collective bargaining agreement with the union—a decision which paved the way for San Bernardino to impose a new contract reducing firefighter compensation; the second decision denied the fire union’s attempt to lift the stay which bars lawsuits against bankrupt entities―the union had sought to argue that the city had not complied with California state law in its negotiations. With regard to the third appeal, in which the union sought to appeal another of its motions for relief from a stay, arguing that the U.S. Bankruptcy court lacked the authority to “reinstate” a stay, Judge Wright opined the argument posed a hypothetical question which, Judge Wright noted, the court could not answer until it is determined that the automatic stay had, in fact, lapsed. Notwithstanding the trio of rejections, the San Bernardino City Professional Firefighters still have other suits pending, two filed last month alleging city officials are violating San Bernardino’s charter in an ongoing pay dispute. Indeed, with some 24 percent of San Bernardino’s general fund budget, some $28 million, currently devoted to its Fire Department, one can appreciate that the stakes for both sides are perhaps the fulcrum of any possibility for San Bernardino to either fashion a plan of debt adjustment—or to have a sustainable fiscal future. Unsurprisingly, the decisions came even as the city has continued behind closed doors this week to negotiate with three entities which could end up bidding to provide fire services for the city.

The Elephant in the Room. As noted above, San Bernardino’s emerging plan of debt adjustment will pit pensions versus bondholders—in a state, like Michigan, where the state Constitution protects contracts—but in the wake of decisions by both U.S. Bankruptcy Judges Steven Rhodes in Detroit’s bankruptcy and Judge Klein in Stockton’s case that the federal municipal bankruptcy law, chapter 9, can preempt state constitutions. The stakes are significant, as one could learn from data released yesterday by Transparent California, based upon pension data from the San Bernardino County Employees’ Retirement Association (SBCERA), which also represents employees of other state and local agencies including the South Coast Air Quality Management District, San Bernardino Superior Court, and the California Association of Counties. Transparent claims the average pension for a retired San Bernardino County employee who put in 30 or more years was $88,000 in 2014, and three retirees pull in more than $300,000 a year in benefits. Transparent California is a government watchdog organization that tracks salary and other compensation data of public employees. The watchdog group, which notes the information reflects employees who retired after working 30 or more years at their respective employers, wrote that in neighboring San Bernardino County, three retirees receive pensions topping $300,000 annually. Former County Counsel Ruth Stringer, who retired in 2010 after 33 years working for the county, receives $327,717 annually. Former Sheriff Rod Hoops, who worked 34 years with the county before retiring in 2012, receives a pension of $319,459.68. And former Undersheriff Richard Beemer, who retired in January 2010, receives $301,853.64 annually. Transparent determined that the average $88,000 pension benefit in San Bernardino County is higher than the $73,700 benefit received by Riverside County employees in 2013, and vastly higher than the $67,026 average of Los Angeles County retirees in 2014. Why does this matter to the City of San Bernardino? Cities, counties, and states compete not just with the private sector for the best employees they can hire, but they also compete against each other. But such competition is hardly equal: there are significant disparities in per capita income amongst jurisdictions in metropolitan areas. The data would seem to go a long way in explaining the very significant burden San Bernardino confronts in seeking to figure out how—in municipal bankruptcy—it can afford to provide and finance the very best emergency fire and response protection for its citizens.

Puerto Rico: A Perfect Storm. Michelle Kaske of Bloomberg puts it succinctly: “Time is running out for Puerto Rico,” writing that the U.S. Territory’s government will have to commence unpaid furloughs of its workers if it is to make a July payment on its junk-rated bonds, according to the Chairman of the House’s Treasury Committee. With a $630 million payment on its general-obligation bonds due July 1st, it appears Puerto Rico will need to start furloughing its public workers, because Puerto Rico’s constitution stipulates that revenue must first be used to repay general-obligation debt—or, as Representative Rafael “Tatito” Hernandez told Ms. Kaske in an interview: “We don’t have money in the general funds and we don’t have the financing….So we have to work with the cash flow. We have to balance the expenditures and raise a little money, with certainty. No improvising.” That is, July 1st looms large: not only is that the bond debt deadline, but also, as with most states, it is the budget deadline for its new fiscal year. Even though Treasury Secretary Juan Zaragoza reports that Puerto Rico’s July obligations “are covered” and that “We expect the commonwealth to fully pay the G.O. debt service due on July 1, since 1/12 of the payment is deposited on a monthly basis in a trustee account held with a private bank.” Nevertheless, as in Stockton—and now as emerging in San Bernardino―a struggle between the Commonwealth’s municipal bondholders scattered throughout the 50 states and its employees and retirees is front and center. Increasingly, Puerto Rico is faced with fewer alternatives but to implement unpaid furloughs for non-essential government workers and, possibly, issuing IOUs for other public employees. Ms. Kaske notes that Puerto Rico and its state agencies owe $73 billion, more than all but two U.S. states. Its unemployment rate is 11.8 percent, more than double the national average. The Government Development Bank, which lends to the commonwealth and its localities, had $1.1 billion of net liquidity as of March 31, a precipitous decline from the $2 billion it had in October. Puerto Rico’s 20-year GO bonds’ are returning an average yield of 10.45 percent, according to data compiled by Bloomberg: those precipitous yields on its municipal debt soared to 10.74 percent on Mayday after its legislature rejected Governor Alejandro Garcia Padilla’s proposed tax package. With insolvency looming, the government may need to slash spending by as much as $1.5 billion in the coming fiscal year. Rep. Hernandez notes: “We are in the middle of a perfect storm: No finance, no budget, and no revenue. And people are starting to realize what this means.”

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