Emerging from or Entering Municipal Bankruptcy

December 1, 2015. Share on Twitter

Rebuilding Detroit. The Detroit Financial Review Commission, the nine-member commission created in the wake of the largest municipal bankruptcy in U.S. history, yesterday concluded that the Motor City, in its first post-bankruptcy year, has been in compliance with its plan of adjustment as approved by now retired U.S. Bankruptcy Judge Steven Rhodes. The good news came in the wake of the Commission’s review and in the wake of receipt of updated financial plans. In its first year, the Commission has reviewed and approved 237 city contracts and one collective bargaining agreement between the city’s transportation department and a transit union; but also a period during which Detroit has amended its budget and issued new debt with the review and consent of the Commission.

The Commission is made up of appointees by Governor Rick Snyder, Mayor Mike Duggan, and the City Council; it has authority to review and approve the city’s budget, major contracts, and labor agreements for a number of years to try to keep the city on a sound fiscal course. In its biannual report to Gov. Snyder, the commission found that the City of Detroit has been in compliance with the plan in its first year by providing commission members with updated financial plans—a period during which the Commission has reviewed and approved 237 city contracts and one collective bargaining agreement between the city’s transportation department and a transit union; but also a period during which Detroit has amended its budget and issued new debt with the review and consent of the Commission. Detroit Mayor Mike Duggan, yesterday, in an interview with the Detroit Free Press, described the relationship between his administration and the Financial Review Commission as a positive one, noting: “As long as we balance our budgets and pay our bills, we’re going to get along with the Financial Review Commission just fine,” adding that Detroit remains on track to post balanced budgets for FY16 as well as the current fiscal year. By early 2018, Mayor Duggan responded he anticipates that “We will be out of the control period,” effectively restoring full fiscal authority to the city from the oversight committee—absent some significant fiscal misstep.

According to the report, Detroit expects it will record a larger-than-expected surplus for the year ending June 30, 2015: based on first-quarter fiscal year 2016, which ended in September of this year, the city projected a $35-million budget surplus for the current year. Nevertheless, Detroit officials and their pension funds are still wrestling with looming public pension liabilities—liabilities that have recently grown, as the recovering city faces an upside down pyramid of retirees from a time when the city’s population and workforce was far larger than today—and retirees who are projected to live far longer than originally projected, based on new actuarial calculations based on updated mortality tables use to determine how long retirees are expected to live. Commission Executive Director Ronal Rose, in his biannual letter to Gov. Snyder, wrote that Detroit has formulated a strategy to address the pension balloon payments starting in 2024 by hiring a consultant to examine the numbers by the end of the year. Nevertheless, these financial forecasts could change, according to commission staff, or, as Mr. Rose put it: “It is important to understand that many changes in the projections will occur over the next few years and these changes may be positive or negative.” The key apprehension is long-term: Detroit faces a pension balloon payment in 2024 of $195 million for its two pension funds—or nearly 71 percent higher than the $114 million incorporated in its plan of adjustment. In his report, Mr. Rose did note that “in years after 2024, the annual amount payable decreases by about $2 million per year.”

Over the next six months, commission officials said they are looking for the city to make progress on a number of fronts, including:
• Major changes and consolidations in city departments to improve the effectiveness and efficiency of finance, human resources, information technology, planning, and housing;
• A new ability for Detroit tax filers to submit returns electronically after Michigan’s Treasury begins to process individual income tax returns for the city, commencing in January;
• The formal separation of the city’s water and sewerage department into two systems — one to manage the city and another to manage its suburbs — also expected in January; and,
• A new city planning system expected to launch by April to run municipal financial management and human resources.

Tempus Fugit. With time running out on debts due (please note Bloomberg’s chart below), Puerto Rico Gov. Alejandro García Padilla, joined by Pedro Pierluisi, Puerto Rico’s representative in Congress, will testify today before the Senate Judiciary Committee with regard to their most current fiscal sustainability issues and positions—including whether Puerto Rico might default—its first ever default—on a debt service payment. Today’s hearing is the same day on which Moody’s Investors Service is projecting Puerto Rico’s Government Development Bank (GDB) to default on debt service payments for $355 million of notes—of which two-thirds, or $273.3 million, is backed by Puerto’s Rico’s full faith and credit or general obligation guarantee.

Moody’s projects that Puerto Rico is more likely to default on the non-GO portion of the debt, adding, however, that given the U.S. territory’s severe liquidity challenges, Puerto Rico could default on the entire payment. Gov. Padilla, at a press conference yesterday, said he would decide either late yesterday or this morning whether the Commonwealth will make the GDB bond payment, noting: “There are creditors of the Government Development Bank that continue to negotiate with the bank today,” so that the timing of his decision would depend on the status of those negotiations.

This morning’s hearings, according to Chairman Charles Grassley (R-Iowa), are “to help committee members and the public identify and gain a better understanding of the root cause of Puerto Rico’s fiscal problems.” Mr. Pierluisi and Gov. Padilla have repeatedly urged Congress to amend the Chapter 9 municipal bankruptcy law to provide the same rights as other municipalities, as provided in pending bills offered by Mr. Pierluisi and Sens. Richard Blumenthal (D-Conn.), and Chuck Schumer (D-N.Y.)—bills which the Chairs of the respective House and Senate Judiciary Committees have made clear they have no intention of marking up. In addition to the two Puerto Rican elected leaders, former New York Lt. Governor Richard Ravitch, who is also not only a member of the a public finance veteran, but also the Detroit Financial Review Commission, and a former member of a Washington, D.C. fiscal oversight board, will also testify—on a panel with Carlos Colón de Armas, a professor of finance at the University of Puerto Rico; Alex Pollack, a resident fellow at the DC-based American Enterprise Institute; Stephen Spencer, managing director at Houlihan Lokey in Minneapolis; and Richard Carrión, executive chairman of Banco Popular in San Juan.

The chances of Senate constructive input is dim. Senate Finance Committee Chairman Orrin Hatch (R-Utah), yesterday said the Senate should be cautious about any municipal bankruptcy proposal and that Congress needs precise estimates of how much aid is needed before it can decide whether to help: “Right now, too many people are willing to throw out demands and vague proposals – with a price tag as high as thirty to forty billion dollars – accompanied by a lot of political rhetoric.” It is not clear to what the Senator is referring, of course, because, unlike the bankruptcies of General Motors and other financial institutions in the wake of the Great Recession, the federal government has made no payments to Detroit or any other municipality which has gone through chapter 9 municipal bankruptcy.

For his part, Chairman Grassley, whose panel oversees bankruptcy law, has expressed doubt about whether such a step alone would solve Puerto Rico’s financial strains, noting: “Restructuring debt and throwing taxpayer money at the island, without ensuring the creation and implementation of structural and fiscal reform, fails to resolve the underlying problems in Puerto Rico.” Again, Chairman Grassley seems to have a signal misperception of municipal bankruptcy. Nevertheless, Senate Republicans, including Chairman Hatch, have said they are working on a legislative proposal to address the concepts of a control board and bankruptcy, albeit, with Congress scheduled to adjourn in less than two weeks, the chances of affirmative action appear unlikely.

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