From Detroit to Havana: Challenges to Fiscal Futures

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December 9, 2015. Share on Twitter

The Motor City Road to Recovery. Detroit’s efforts on blight removal as part of its plan of debt adjustment and fiscal resiliency appears to be working: assessed property values in Detroit are beginning to increase in areas where blight has been removed, according to a new report by Rock Ventures and the Skillman Foundation released yesterday, which notes that demolitions have increased the value of surrounding homes within 500 feet by 4.2 percent, or an average of $1,106—an increase which, citywide, amounts to an increase in home values of more than $209 million—an increase which Mayor Mike Duggan yesterday described as “extraordinary,” adding that the city’s efforts to rid blight has allowed “good homes and good vacant homes” to increase in value. The report also suggests that, combined with other efforts by the city, including code enforcement and sales of public assets such as side lots, the value of homes nearby has increased by 13.8 percent, or an average of $3,634. Citywide, that amounts to an increased property value of about $410 million. From January 2014 until July of this year, 5,812 blighted structures in the city were demolished. The bad news is that the federal grant funding from the Treasury’s “Hardest Hit” program is running out: the federal grant program, which in 2010 provided grants of $7.6 billion available for foreclosure prevention in 18 states (Michigan received nearly $500 million, with 20 percent of its share going to Detroit for demolition of blighted residential structures and remediation.). Mayor Duggan plans to travel to Washington, D.C. soon to meet with White House officials in an effort to obtain a share of the next round of funding—a round dependent upon final Congressional action this week. The funding matters: Detroit has successfully used the funds so far to take on about 10 percent of its blight in the city.

Moody Blues: Lessons from recent Municipal Defaults and Chapter 9 Bankruptcies. Moody’s Investors Service yesterday noted that whilst municipal bankruptcies will remain rare, they will not be “unthinkable,” albeit the report added that “there is a waning taboo associated with municipal bankruptcy (please not story below on Hillview, Kentucky), so that its authors noted: “[W]e believe bankruptcy will increasingly be considered by extremely distressed entities as a tool to deleverage and reorganize liabilities, especially in the face of a pending service insolvency.” Indeed, in an uncharacteristically upbeat tone, the report added that Detroit’s “ability to enter and exit bankruptcy within 16 months with dramatically reduced liabilities and a path forward may be the template for future bankruptcies,” adding that the mere consideration of chapter 9 municipal bankruptcy by Detroit’s surrounding county, Wayne County, and Atlantic City, New Jersey appear to have triggered “state support and oversight” which have forestalled actual Chapter 9 filings, adding: Most recently, Hillview (please not item on Hillview below), Kentucky filed for municipal bankruptcy in order to avoid paying an $11.4 million legal judgment—a la the Town of Mammoth Lakes, Ca., Boise County, Idaho, and the Township of Westfall, Pennsylvania, which also cited legal judgments in their respective Chapter 9 filings. The report noted that “Of the recent bankruptcies, municipal bondholders have only came out ahead of pensioners in Central Falls, Rhode Island, adding that San Bernardino, which is currently holding the record for the longest period in municipal bankruptcy, “is seeking to substantially impair unsecured bondholder claims while leaving accrued pension liabilities untouched,” adding that “retiree healthcare benefits (also known as other post-employment benefits or OPEBs) essentially double what is at stake for retirees. They belong to the same creditor group as pensions, but have constituted separate legal claims within Chapter 9. As a result, they have emerged as an effective bargaining chip and have helped shield pension benefits by taking the biggest losses.”

The report warns that recovery rates for municipal bondholders will likely “be below historical levels…given the rise of preferential treatment for pensions: Detroit’s bondholders took deep losses during its bankruptcy. Holders of the city’s certificates of participation recovered a very low 12% and overall recovery was only 25%. In comparison, pension recovery was quite high at 82%”–and adding that “San Bernardino has recently proposed a 1% recovery for its pension certificate holders and an all-in recovery of 19%, while proposing no cuts to pensions. These rates are striking relative to the 64% historical average recovery on Moody’s-rated bonds.”

On the issue with regard to the role of states in the minority of states which permit municipalities to file for federal bankruptcy, Moody’s commented that “State aid intercept programs have thus far worked, but often depend on notification and well-functioning state governance: State aid intercept programs have thus far succeeded in preventing or curing a local government default,” but noted that state intercepts are “rare,” noting: “Intercept programs depend on strong underlying mechanics and the state’s commitment to ensure they work as intended. For example the State of Pennsylvania has not yet passed a budget for FY2016: The budget impasse has prevented state aid from being appropriated, which has called the reliability of that state’s intercept program into question and contributed to a downgrade of the program in November 2015.”

City on a Hill of Debt. In John Winthrop’s 1630 sermon on the good ship Arbella, he urged that the City of Boston be as a “city on a hill,” watched by the world. Fewer eyes are on a different city on a hill, Hillview, Kentucky, that is; nevertheless, it is a municipality that could change municipal bankruptcy, as that city seeks to use chapter 9 as a means to avoid making a full, court-ordered $15 million legal judgment payment to one of its creditors. Indeed, Hillview is utterly dissimilar to the municipalities we have covered; rather it is a growing municipality—a suburb of 8,000, which appears at little risk of insolvency, and is not claiming in its filing with the U.S. Bankruptcy Court an inability to pay its debt. Rather, as Moody analyst Nathan Phelps puts it: Hillview’s filing is “more evidence that municipalities increasingly consider Chapter 9 as a way to cure balance-sheet problems.” Thus it will be interesting to follow the court’s reactions as the trial commences this week in the wake of unproductive negotiations mediated by the ever electronically musical maestro of Detroit’s chapter 9 municipal bankruptcy, retired U.S. Bankruptcy Judge Steven Rhodes, the lead guitar for the Indubitable Equivalents. Unlike each of the other municipal bankruptcies we cover, Hillview’s issue relates to a decade-old dispute with Truck America Training LLC, which was awarded $11.4 million for business the company said it lost when Hillview took control of the land the company owned and from which it was evicted. Thus the issue is paying the award—something which Mayor Jim Eadens told the ever nimble Bloomberg reporter Tim Cook: “I don’t think they can shut us down as a city, and I don’t think they can put this burden on the taxpayers,” in an interview at Hillview City Hall. Indeed, Tammy Baker, Hillview’s city attorney, told Mr. Cook it was “financially irresponsible” not to file for municipal bankruptcy because of mounting interest costs—a filing made instead of any consideration of tax or fee increases, service cuts, or budget cuts. Nor does there appear to be any issue with regard to the municipality’s debt obligations. Jonathan Steiner, the Executive Director of the Kentucky League of Cities told Mr. Cook: “This is a unique situation…It’s not a city that spent itself into this situation or saw the collapse of an industry.” Unlike Detroit, which for decades endured an industrial collapse and a population exodus, Hillview’s population has grown more than 5 percent since 2010. The median household income, $48,000, exceeds the Kentucky average, and the percentage of people in poverty is less than half the state rate of 19 percent, according to U.S. Census data. From a fiscal perspective, Moody’s last summer noted that Hillview could issue municipal bonds to pay its court-levied debt and has “considerable ability to increase its two largest sources of operating revenue, occupational license taxes and property taxes.”

Hillview, however, begs to differ—or, as City Attorney Baker told Mr. Cook: “They think we can just go and raise taxes through the roof, and it won’t drive away business and it won’t hurt the citizens of Hillview…It would be possible to raise the occupational tax and the insurance premium tax to high amounts. That would be a heavy burden on our industry and a heavy burden on our citizens.” But as the ever prescient Dick Ravitch notes, Hillview could have a very tough day in federal bankruptcy court: “You have to prove you’re totally broke and can’t pay your debts.” Or as the greatest expert on municipal bankruptcy, Jim Spiotto told Mr. Cook, because of Chapter 9’s costs and unpredictability: “It’s going to be expensive, and that’s just the beginning…this will sound heretical, but there are better things to do than spending your money on lawyers.”

Shocking Municipal Bondholders. Puerto Rico’s Electric Power Authority (PREPA) gained another week from its municipal bondholders—time to get insurance companies to sign onto an agreement to restructure the agency’s $8.2 billion of debt and for commonwealth lawmakers to approval the proposal: the new agreement extends termination dates on an earlier agreement between the Authority and investors owning about 35 percent of the agency’s bonds to the middle of next week, according to the utility, marking a third extension—as all parties await a call for an extraordinary session of the legislature, a prerequisite for consideration of legislation to authorize a restructuring of PREPA—a restructuring which would be the largest ever in the $3.7 trillion municipal-bond market. The additional time came just days after the U.S. Supreme Court agreed to hear an appeal by Puerto Rico to reinstate a local debt-restructuring law that would allow some island agencies, including PREPA, to ask its municipal bondholders to take losses: the disputed law would affect $22 billion of Puerto Rico’s $70 billion in debt, including $8.2 billion owed by PREPA. The issue involves the authority of the Puerto Rican government to fill what it asserts is a gap in federal bankruptcy law, which bars filings by Puerto Rico’s public utilities. (PREPA owes $196 million of interest to investors on New Year’s Day, but U.S. Bank, the bond trustee, has approximately $24 million in a reserve account, according to a Dec. 7 event filing on EMMA, and the utility had, as of Sept. 30th, $252 million in deposits at the Government Development Bank for its reserve account, construction fund and operating account, according to a Nov. 6th financial filing. PREPA’s restructuring support agreement with bondholders “contemplates that some or all of the January 1, 2016 interest payments would be paid with funding provided to the authority, but it remains premature to predict whether and to what extent that will occur,” according to the EMMA filing. “The trustee is currently not holding other funds in the sinking fund that will be available to pay interest on the bonds due on January 1, 2016.” Under the restructuring support agreement, investors would take losses of about 15 percent in a debt exchange. Bond insurance companies which guarantee repayment on $2.5 billion of PREPA’s municipal bonds have yet to agree to the plan.

Cuba. In Havana, Monday, I asked about the city’s fiscal condition, but the answer was that the city is such an integral part of Cuba that it does not really have a separate fiscal existence. What it does have is remarkable vibrancy and a seeming lack of fiscal disparities, while it does have the most remarkable stream of vintage and colorful antique U.S. automobiles. Our visit came amidst a time of significant change, with U.S. and Cuban officials meeting the very next day in Havana for their first round of talks on billions of dollars in competing financial claims, one of the most contentious challenges in the process of normalizing relations—negotiations which are part of a broader agenda of discussions aimed at normalizing relations between the two countries after 50 years of enmity: there are 5,913 U.S. individuals and companies with claims which have been certified by U.S. officials against the Cuban government for property confiscated after the 1959 revolution, claims originally valued at $1.9 billion, with the bulk coming from corporations. Cuba says it has about $121 billion in counterclaims for damages stemming from the U.S. economic embargo. The two sides were scheduled to discuss “a wide variety of claims,” including those certified by the U.S. Foreign Claims Settlement Commission, government claims, and claims related to unsatisfied U.S. court judgments against Cuba, according to the State Department—for talks likely to last beyond President Obama’s presidency. The two sides also have continued pre-existing talks that have been under way on migration issues. The discussions come in the wake of last December’s announcement by President Obama and Cuban President Raúl Castro that the U.S. and Cuba would begin to normalize relations after decades of frozen ties. While only Congress can fully lift the trade and travel embargoes, the White House has taken several steps on its own to loosen regulations. The U.S. removed Cuba from its state sponsor of terrorism list earlier this year, and Washington and Havana restored diplomatic relations and reopened embassies in both capitals this summer.

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