The Long, Hard Road to Recoveryfrom Municipal Bankruptcy

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eBlog, 6/23/16

In this morning’s eBlog, we explore the City of Detroit’s successful steps to return to the municipal bond market with its first-post municipal bankruptcy issuance; we consider the looming electoral and fiscal challenges in not-so-far away East Cleveland in the wake of an expensive recall election in a municipality adjacent to next month’s GOP nominating convention—a small municipality awaiting some determination whether it might merge with the City of Cleveland or file for chapter 9 municipal bankruptcy. Finally, with its own clock headed to overtime, we look at the looming debate in the U.S. Senate over the House-passed PROMESA legislation—with, as the Romans would have said—tempus fugit.

Steps on the Road to Recovery from Municipal Bankruptcy. The Detroit City Council yesterday unanimously approved the issuance of up to $660 million of municipal refunding bonds—an action which is projected to save the city some $37 million as well as mark a key step towards the Motor City’s successful return to the municipal bond market in the wake of the largest municipal bankruptcy in U.S. history. The city is hoping to benefit from record-low yields in the muni market to refund the bonds, saving $15 million for the next two city budgets and about $20 million for property tax bills. In its first post-bankruptcy public debt offering last August, the city restructured $245 million of variable-rate revenue bonds backed by city income taxes into a fixed-rate mode. The issuance here is to refund up to $275 million of unlimited tax general obligation bonds sold in 2014 and up to $385 million of limited tax GO (LTGO) bonds sold in 2010 and 2012. The debt was enhanced with a statutory lien and intercept feature on Detroit’s income taxes; now the proposed sale must gain final approval from the Detroit Financial Review Commission, which meets next Monday. In other action yesterday, the City Council also approved the set aside of $30 million from a city budget surplus in order to enable it to address a potential public pension shortfall of nearly $500 million. The shortfall, which Mayor Mike Duggan had disclosed earlier this year as part of a discussion of potential litigation by the city against consultants who had worked on the city’s plan of debt adjustment—especially with regard to projected future pension payments—appears to be because of the use of outdated mortality tables. (Last week, the Detroit City Council agreed to hire actuarial consultant Cheiron to work on a new pension funding model.) The refunding bonds, backed by state revenue earmarked for Detroit, would be issued through the Michigan Finance Authority later next month. The sale would mark Detroit’s first post-chapter 9 bankruptcy general obligation or GO bond issuance since its exit from the nation’s largest-ever municipal bankruptcy a year ago last December—or, as Detroit Finance Director John Naglick put it yesterday: “We hope this leads to a better general obligation bond rating, which would help us in the future.” The city’s current GO bond ratings are B3 with Moody’s Investors Service and B with Standard & Poor’s. Director Naglick advised the Council that savings on the LTGO bonds will benefit Detroit’s general fund budget by approximately $15 million, while savings on the UTGO bonds of $24 million will be used to lower the debt millage on the city’s property owners.

Democracy & Municipal Fiscal Distress. With the GOP convention scheduled to meet next door in Cleveland in just weeks, there was an election—a recall vote—in next-door East Cleveland yesterday in which the city’s voters—at a cost of $10,634—and for the second time in the last seven months rejected a recall of City Council President and Ward 3 councilman Thomas Wheeler. The vote—one which cost the nearly insolvent municipality some $10,634.77, came as Council President Wheeler is heading up the City Council’s efforts to try and merge with Cleveland—even as the city awaits a response from Ohio with regard to its proposal to file for chapter 9 municipal bankruptcy. In surviving his second recall effort in seven months, Councilmember Wheeler yesterday noted: “The people of East Cleveland know my history and what I represent…It (the cost of the recall election) is taking away money from the taxpayers that we could use for something else.” The turnout—under 7 percent—of 267 ballots marked a decline from last December’s earlier failed recall election. In gaining the uncertain vote of confidence, Councilmember Wheeler said his first priority is appointing commissioners for potential East Cleveland-Cleveland merger conversations: “I know people want to stay the course.”

Running Out of Time. U.S. Senate Majority Whip John Cornyn (R-Tex.) yesterday said he expects the Senate to begin consideration of the House-passed PROMESA legislation [H.R. 5278] next week, with his comments coming in the wake of Federal Reserve Board Chair Janet Yellen this week having testified before the Senate Banking, Housing and Urban Affairs Committee that Puerto Rico’s nearing insolvency is “is inherently a matter for Congress,” adding that the Federal Reserve’s authority “is extremely limited” and that “it wouldn’t be appropriate for us to give loans to Puerto Rico: We have very limited authority to buy municipal debt and the authority we have, if we were [able to] buy eligible debt, I don’t think it would be helpful to Puerto Rico…Beyond that, we have no ability to make emergency loans.” With a looming $2 billion payment by Puerto Rico falling due a week from tomorrow, the timeline for Congressional action has become complicated: the House has adjourned and is not scheduled to be in session next week; thus, were the Senate—where Senate Minority Leader Harry Reid (D-Nev.) has indicated there are “some serious concerns” on his side of the aisle about the House version—apprehensions which he said would require consideration of amendments—the Congressional calendar abruptly carries signal implications—non-action could leave the U.S. territory vulnerable to creditor lawsuits in the wake of an almost certain default on a $1.9 billion debt payment due July 1st. While the House-passed bill includes a provision to stay such a suit, that provision only carries weight if PROMESA is signed into law by President Obama. Thus a default by the U.S. Senate would run the risk of the Commonwealth’s future being determined in federal courtrooms, including one that hedge funds holding Puerto Rican general obligation municipal bonds filed Tuesday in New York in the wake of municipal debt restructuring talks breaking down.

As the Senate awaits consideration of the House-passed PROMESA, the National Taxpayers Union wrote yesterday to urge the Senate to concentrate on “maintaining the taxpayer safeguards in the existing legislation, and, if additional changes are proposed, focus on: 1) Ensuring Puerto Rico’s government respects debt-payment priorities; 2) Strengthening provisions to encourage federal tax reform for the Commonwealth; and 3) Limiting the influence of the union-dominated ‘audit commission’ that wants bloated government pension debts to go to the head of the line.” In its letter, the Union favorably noted that while the House-passed version provided “provided greater detail over how the new federal oversight entity would certify voluntary debt restructuring agreements, and would modify the selection and confirmation process for members of the body,” the entity would also be empowered to take certain actions relating to privatization and commercialization of government assets, deeming that “a welcome addition to the bill that must be a priority for the island’s economic well-being.” With regard to debt restructuring, NTU wrote that the pending legislation “has made important progress on respecting the balance of rights between creditors and debtors…and, as a result, taxpayers. H.R. 5278 helpfully prevents inter-debtor transfers, and now requires the court to consider in a restructuring proceeding whether remedies available under other laws might offer a better recovery for creditors than whatever was being initially proposed. For its part, the oversight entity must also ‘respect lawful priorities or lawful liens’ as outlined in Puerto Rico’s constitution,” adding it would oppose any amendments to reverse these gains, but would support distinct language clarifying that in any restructuring action resulting from PROMESA’s new authorities, pension debt is subordinate to constitutional obligations.”

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