Municipal Bankruptcy & The Role of Intergovernmental Relations

August 18, 2015

Municipal Bankruptcy, Intergovernmental Relations, & Democracy. The San Bernardino City Council voted 4-2 late Monday to appropriate over half a million dollars to fund a new community center on the bankrupt city’s Westside—notwithstanding apprehensions the city might not be allowed to use the modular that will now be used for that purpose, much less concerns about how it might affect the city’s already difficult relations with the state. The center, once constructed, is intended to provide classes on aerobics, Zumba, nutrition, mental health, and English as a second language, in addition to partnering on other services. The financing is not to come from the bankrupt city’s general fund, but rather from the city’s CDBG grants. But it was only after a citizen at the session raised a question—after the first of the two votes needed to approve the center—that there appeared to be some recognition of a problem. The citizen asked how it was that that since the state had taken control of redevelopment how it was the Council could “wonder why the state is mad at you, you wonder why the state doesn’t want to help you? Maybe listen to yourselves, and wonder, ‘What am I doing?’” Indeed, City Manager Allen Parker responded to a follow-up question to staff that last year, when the city had requested the California Department of Finance to transfer redevelopment assets — items such as desks, computers, and this $158,000 modular, which the city-controlled agency had used until the statewide shut-down — to San Bernardino so the city could control them: the request had been rejected. The response triggered two Councilmembers to change their votes from aye to nay, with Councilmember Henry Nickel noting: “We have some very delicate negotiations going on with the state right now…The last thing I want to do is upset them. I want to be very clear on the legal ramifications of taking a $150,000-plus asset and using that for city use.” Notwithstanding, the rest kept their votes unchanged, demonstrating one of the many intergovernmental challenges that confront the city as it seeks to put together a plan of debt adjustment for the U.S. bankruptcy court’s approval, even as—in an election year—it must continue to govern the municipality. Indeed, community members have been asking for the community center since the city promised it before the state’s dissolution of the redevelopment agency.

As we have previously noted, the uneasy relationship between California cities and the state has played an important role in San Bernardino’s municipal bankruptcy, whether it be the suit filed by the state’s California retirement agency (CalPERS) for non-payment of the city’s prescribed contribution to the state’s public retirement system for its employees, or the—to this point—takeover and dissolution of local redevelopment agencies in 2012, a takeover at least in some part triggered by disagreement as to whether cities were consistently using the revenues from these redevelopment agencies as originally intended. More broadly, of course, the withdrawal of most California state direct financial aid to cities, which commenced some three decades ago in the wake of Proposition 13, has not only negatively impacted most cities in the state, but especially poorer cities such as San Bernardino—with fiscal insult added to injury via California’s redirection of some non-state revenues to specific programs including education and public safety, thereby shifting the expenditure burden from the state to its cities. State aid constitutes a very small percentage of revenue for cities in California—2% in the case of San Bernardino. This minute amount does little to even out disparities in fiscal capacity and need for cities such as San Bernardino. State actions in recent years—including changes in the motor vehicle license taxes and redevelopment agencies— have only served to exacerbate, rather than ameliorate San Bernardino’s fiscal problems.

The Painful Cost of Recovery. Notwithstanding some of the unique and fiscally creative partnerships engineered as part of the resolution of the Motor City’s record municipal bankruptcy recovery, Detroit will find that getting back on its four wheels will come at a high price: the city is expected to have to pay interest rates close to 5 percent in its maiden return to the municipal bond market on its sale set for tomorrow of some $245 million in bonds—the city’s first sale since emerging from municipal bankruptcy. The sale, which will be done through the Michigan Finance Authority, will provide that bondholders will have the first claim on Detroit’s income tax revenues, so as to ensure investors in the recovering city are repaid. Ergo, the 14-year bonds are being marketed at an initial yield of 4.75 percent, according to persons familiar with the sale, some 2.1 percentage points more than top-rated municipal securities. The high cost to Detroit’s taxpayers and the city’s budget is a reflection of the significant cuts the city’s g.o. bondholders received as part of the court-approved plan of debt adjustment, nearly a 60 percent reduction. Nevertheless, for the city—in stark contrast to virtual bankruptcy in state-local fiscal relations in California (please see above)—this is a key factor in the likely successful sale tomorrow: Michigan Gov. Rick Snyder, together the bipartisan leadership of the state leadership, enacted legislation to provide prospective Detroit municipal bondholders first claim to the Motor City’s income taxes—an innovative step to help in the city’s recovery—and one which earned an A rating for tomorrow’s sale from S&P–nine levels higher than its grade on Detroit’s general obligations. Moody’s, in mayhap a surprisingly upbeat mode, noted that Detroit’s employment has risen 3 percent over the past four years; more generously, the rating agency wrote that the Motor City’s income tax revenue rose 18 percent from 2010 to 2015. The proceeds from this week’s sale are intended to be devoted to repayment of a loan from Barclays plc that was a key to the city’s emergence from bankruptcy, as well as to help finance city projects, including upgrades for the fire department’s fleet. S&P wrote that Detroit’s income tax collections are strong enough to cover the bonds.

Arriba! The Puerto Rico Treasury Department reports that last month’s General Fund tax revenues for the U.S. territory of Puerto Rico came in 3.5% higher than budgeted, with sales and use tax collections coming in at a rate more than ten times (35.7%) greater than those for a year ago. The increased revenues included $21.1 million more than projected for the island’s General Fund. But the most significant increase came from individual income taxes: some $7.2 million more than projected, as well as foreign corporation excise taxes ($4.6 million ahead), and alcoholic beverage taxes ($4.5 million above projections). The biggest shortfall was for motor vehicle taxes, at $2.7 million. No doubt, the increase in the territory’s sales and use tax revenues was due in no small part to the rate rise from 7 to 11.5% which went into effect last July 1st; nevertheless, the Treasury reported the increased rate only contributed about $8 million directly to the sales and use tax revenue increase of $40.6 million in July compared to one year earlier—moreover, as Puerto Rico Treasury Secretary Juan Zaragoza Gómez noted, the sales and use tax realized revenue increases might have been spurred by a rush-to-beat-the rate increase which went into effect July 1st. But Sec. Zaragoza Gómez also noted that Puerto Rico’s completion last May of the last phase of an Integrated Merchant Portal collection of sales and use taxes at ports also likely contributed to the improvement in these tax collections. Finally, the Secretary also noted the government had reached settlements for back sales and use taxes owed with several large retailers last month—adding: “These collection efforts will continue during the coming months.” The rising revenues from traditional tax sources came as a Puerto Rican study group has recommended going ahead with converting Puerto Rico’s sales and use tax to a value added tax effective April Fools’ Day next year.

Failing Grade. S&P downgraded the Windy City’s Chicago Public Schools three notches, finding that its proposed budget would do little to address either its structural or liquidity woes. The rating agency also removed the credit from CreditWatch with negative implications and assigned a negative outlook, with analyst Jennifer Boyd scholastically writing: “The rating action reflects our view of the proposed fiscal 2016 budget, which includes what we view as the [school] Board’s continued structural imbalance and low liquidity with a reliance on external borrowing for cash flow needs.” The poor grades appear to reflect the system’s increased reliance in its proposed $6.4 billion FY2016 budget on more than $300 million from one-time revenues, not to mention an almost mythical assumption that the stalemated Governor and state legislature will provide CPS with $480 million in public pension funding assistance this year to close a $1.1 billion deficit—or, as CEO Forrest Claypool put it: “This budget reflects the reality of where we are today — facing a squeeze from both ends — in which CPS is receiving less state funding to pay our bills even as our pension obligations swell to nearly $700 million this year.” The hopes from CPS come as the stalemate in Springfield over passage of the state’s FY2016 budget has shown little to no progress—even as Chicago’s kids are already, no doubt, dreading the September 2nd return to the classrooms. CPS’s proposed budget assumes Illinois will help assume almost $200 million in CPS pension contributions—not unreasonable, as that would be in line with what the state contributes on behalf of other districts. The package could also be made up by shifting $170 million of the teachers’ contribution now paid by the district over to teachers, extending a payment amortization period, and possibly higher property taxes. Further, CPS last month announced some $200 million in cuts in the wake, last month, of its failed efforts to delay its FY2015 pension payment. The budget also relies on $250 million of debt relief primarily from $200 million in so-called scoop and toss refunding in which principal payments coming due are pushed off. CPS is proposing to draw down $75 million from reserves. Unsurprisingly, S&P does its math differently than CPS: the rating agency questions the school system’s arithmetic, wondering how it all adds up, especially because of CPS’ reliance on $480 million in, to date, unsecured state assistance for debt restructuring and reserves, both non-recurring revenue sources, adding: “The rating is also based on our view of the challenges the board faces in attempting to secure a sustainable long-term solution to its financial pressures, given the state’s own financial problems reflected in the current budget stalemate, and the board’s fiscal 2016 budget proposal that shows the continuation of a structural imbalance even if the board gets the assistance from the state.” The challenged fiscal math has already exacted a cost: CPS is paying a premium to borrow: its most recent issuance came at a yield of 5.63 percent on 25-year bonds—and that even with not only the system’s full faith and credit pledge, but also security via an alternate revenue pledge of state aid. The convoluted math, S&P totes up, is further jeopardized by next year’s expiration of the district’s teachers’ contract.

August 13, 2015

Municipal Bankruptcy & Public Safety. In California alone, 16 wildfires are burning 229,713 acres. So it is unsurprising that citizens and their elected leaders in San Bernardino have a significant stake in ensuring that any plan of debt adjustment approved by U.S. Bankruptcy Judge Meredith Jury ensures confidence, thereby guaranteeing there will be significant interest in the 28-page report (www.tinyurl.com/oraatpk) by fire consultant Citygate Associated the city released last night—a report recommending that the city’s fire department be annexed into the San Bernardino County Fire District. The report is consistent with the proposal recommended by San Bernardino City Manager Allen Parker; it is contrary to the position of the San Bernardino Fire Management Association. For both the city’s residents—and Judge Jury—the issue in bankruptcy is how to ensure the continuity of essential public services.  In its report to the city, Citygate evaluated the ability of three bidders — county fire, city fire, and Florida-based private firm Centerra — to meet certain key staffing standards. The report recommends San Bernardino County take over, under a plan which would include keeping 10 current city fire stations open, closing two, and adding the use of one additional county fire station, noting: “The best cost-to-services choice is County Fire’s Option C for 14 units and 41 firefighters (per shift) at $26,307,731 which includes sharing the use of a nearby County Fire station and Battalion Chief that can assist with covering part of the western City.” While the mere suggestion of privatizing or turning over control of a municipality’s fire department to another jurisdiction has traditionally been a sure fire road to unelection, it has actually become more prevalent in other parts of San Bernardino County and other areas in California. Indeed, San Bernardino Councilman Henry Nickel compared the modest opposition by constituents to the proposal to the outpouring of opposition when a community sent a robocall asking citizens to oppose privatizing the Fire Department, noting to the San Bernardino Sun yesterday: “My phone was literally on fire for two days…My voice mail filled up within about an hour of that robo call going out, and it took me two or three days to catch up. But since this article came out (outlining the report), I’ve received one phone call today regarding the county versus city debate…I think it’s very clear that Centerra is not something the public by and large supports, but — I hate to use the word resignation, but I think much of the public understands that the county medicine is probably the one we’ll have to take…It’s not something we want to do, but it’s something we might have to do.” City spokeswoman Monica Lagos posted a summary of the report and the city’s next steps here (www.tinyurl.com/pbogaxr). A special meeting, including a presentation of the report and a chance for resident comment, is scheduled for a week from Monday.

The uncontrollable nature of wildfires adds a combustible to the already complex challenge of elected leaders of a municipality in bankruptcy—with elections pending in November—creating a difficult balancing set of public as compared to campaign responsibilities. Unlike Donald Trump, the decision to file for bankruptcy for the city’s elected leaders is something no elected leader ever wants to do. And then the responsibility to approve a plan of debt adjustment to the federal bankruptcy court—even while contemplating a re-election campaign amidst the combustion of wildfires and politics is evidence of the extraordinary challenges and decisions ahead which will affect so many citizens—and their safety—not to mention the future of a city.

Jailhouse Rock. Wayne County’s elected leaders are scheduled to consider the proposed fiscal consent agreement between Michigan and the County today—an agreement intended to offer ways to improve Wayne County’s cash position, reduce underfunding in its pension system, and eliminate the county’s$52 million structural deficit—and be a governing alternative starkly different than in neighboring Detroit where the state preempted local authority through the appointment of an emergency manager. The consent agreement allows for the commission and Chairman Evans to “retain their respective authority.” The document has a number of highlighted sections on issues such as employee relations and changes that can be made to expired contracts, state financial management and technical assistance, and a prohibition against new debt unless approved by the State Treasurer. It also specifically mentions pension obligations and other employee contract commitments as at least a factor in the county’s financial troubles. But the major point of the agreement that will likely gain close scrutiny by many who work for the county is the authority it grants Chairman Evans to act as the sole agent of the county in collective bargaining with employees or representatives and approve any contract or agreement. The agreement will also address—and affect—the county’s jails, whose conditions have already been the subject of a court order this year, as Wayne County—and jail host Detroit—consider the future of the unfinished facility. In its review of Wayne County’s finances, the state noted the county’s unfinished jail and its $4.5 billion in long-term obligations as problems that need to be addressed, and mandated Wayne County to put together a plan to “adequately meet the county’s needs for adult detention facilities…” The County’s elected leaders, who are scheduled to discuss the agreement tomorrow, have just over three weeks in which to approve the document—an agreement which Wayne County Chairman Warren Evans very much hopes will be the key to resolving the county’s structural debt and unsustainable fiscal future: the proposed recovery plan lays out $230 million in cuts over four years.

Whether and how the plan will get the County and Detroit out from behind the fiscal bars will be a subset—but one with critical implications for the future relationship of the two jurisdictions, as well as for the county’s fiscal sustainability. The jail—in downtown Detroit on which Wayne County broke ground for construction four years ago—is an exceptional fiscal millstone: some two years after construction was halted because of ballooning expenses, the failed Wayne County jail project is still costing taxpayers more than $1 million a month. The plan was to build a $300-million state-of-the-art jail in downtown Motown four years ago—a plan which today features a costly pile of steel and concrete — fenced and guarded — with construction costs of $151 million, and an ever growing fiscal tab for county taxpayers of an average of $1.2 million every month. Thus, not only is the jail a sticking point between the two jurisdictions, but also a severe fiscal drain—or as the County described the situation last May: “Due to the county’s financial state, anything done on the Gratiot jail will just add to the deficit. Once the deficit has been solved, the county can move forward with options on whether to finish the Gratiot site or renovate the three existing jails. As the county makes progress on its recovery plan, it will better be able to solve the jail issue.” Worse, it appears that much of the debt issued by Wayne County for the jail’s construction has been diverted for other purposes—meaning Wayne County is spending as much as $1.2 million each month from its general fund. According to County officials, only $49 million remains from the $200 million in bonds Wayne County sold to finance the unfinished jail—a borrowing forcing the county to make interest payments on of $1.1 million monthly—even as it is spending nearly $55,000 each month on unfinished jail-related costs, including: security ($10,849), sump pump maintenance ($12,852), and electricity to the site ($4,000).

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