Post Chapter 9: Returning to the Municipal Market & Avoiding a State Takeover

In this morning’s eBlog, we consider the critical, first effort by the City of Detroit to issue full faith and credit municipal debt–an effort complicated by the  still unsettled fiscal  situation of Detroit’s public school system, and we examine Atlantic City’s efforts to—once again—avoid a state takeover.

To Market, to market…& the Ties that Bind. In the wake of last month’s unanimous approval by the Detroit City Council of the issuance of up to $660 million of refunding bonds to save an estimated $37 million and help pave the Motor City’s return to the municipal bond market after emerging from the largest municipal bankruptcy in American history (a successful sale is projected to generate savings of about $40 million that the city would use to provide budgetary and property tax relief)—and the Council’s further actions to put aside $30 million from a budget surplus to deal with a possible public pension funding shortfall of nearly $500 million; the city is set to issue full faith and credit municipal bonds today to refund up to $275 million of unlimited tax general obligation (utgo) bonds sold in 2014 and up to $385 million of limited tax GO bonds sold in 2010 and 2012—municipal bonds backed by state revenue earmarked for Detroit, which are to be issued through the Michigan Finance Authority (MFA) in an agreement led by underwriter Barclays—marking Detroit’s first GO bond issuance in the market since it exited the largest municipal bankruptcy in the nation’s history two and a half years ago. The $615 million refunding, which is expected to price as early as today, will test not only the implicit benefit of the value of the MFA authority, but, at the same time, the uncertainty created by the ongoing disruption to the security of similarly structured Detroit Public Schools (DPS) state-aid backed or so-called DSA (distributable state aid bonds) municipal bonds due in the wake of the DPS state takeover as it became insolvent—indeed, as our respected friends at Municipal Market Analytics (MMA) warned, these Motor City municipal bonds may incur “a larger-than-anticipated” penalty, even as Detroit CFO John Naglick attempted to make clear the significant distinctions between Detroit and DPS with regard to governing structures—and the fact that the city’s DSA bonds were protected during the city’s historic municipal bankruptcy. Moody’s and S&P affirmed the single-A to double-A ratings on Detroit DSA-backed bonds sold under the MFA’s local government loan program: S&P noted: “Given the double-barrel pledge, we rate the bonds to the stronger of the two pledges, which is the DSA revenue stream.” Nevertheless, MMA has noted that Detroit’s short-term progress since emerging from its historic municipal bankruptcy is insufficient to offset longer-term municipal investor risks, with fabulous Matt Fabian of MMA noting: “It’s clear that the state can’t be trusted with respect to its willingness to pay municipal bond holders, especially when it comes to (municipal) bonds held by Detroit…Remember that the city’s economic and financial future remains far from secure, and Detroit is at serious risk of relapsing into bankruptcy within the next 10 years: Buyers of the new bond series are thus betting directly that the state will change its tack and develop a willingness to pay city of Detroit bondholders in the future…[but] this is not an unreasonable speculation by risk-aggressive managers who have clearly communicated their plans to their own investors. However, this bond series should not be the province of traditional retail.” Ergo, the state aid statutory lien is central to the investment-grade ratings on the $615 million proposed sale—one which will unroll in four series:

  • a $247 million of taxable first lien limited tax GOs in a mix of term and serial maturities;
  • a $125 million taxable third-lien limited tax GO in a mix of serials and terms;
  • a $225 million fourth-lien tax-exempt unlimited tax GOs tranche with serial maturities; and
  • a final $18.1 million taxable fourth lien unlimited tax GO tranche in serial maturities.

Nevertheless, the sale is beset by apprehension with regard to the complex and unresolved fiscal status of the Detroit Public Schools (DPS) restructuring and the fate of the school systems’ municipal bonds—bonds secured by a state pledge, but under which the state funds now will go to a newly created district free of debt, even as the old DPS remains intact to continue collecting tax revenues to retire its debts. Indeed, S&P, in a quasi—scholarly action, recently downgraded DPS’s state aid bonds from 2011 and 2012 issuances, noting apprehensions about the potential fiscal impacts with regard to the new state legislation and potential disruptions of pledged state aid. Restructuring could disrupt pledged aid. (The MFA recently approved a $235 million financing to restructure the bonds.) , but final details have not been made available. Mr. Fabian notes it is clear the MFA will take action to restructure the bonds, adding, however, that absent more specifics, municipal bondholders holding the DPS bonds “are being presented with more anxiety than they probably bargained for when they bought those.” For his part, CFO John Naglick does not agree there is a correlation between Detroit’s refunding and the outstanding DPS bonds: “The distributable state aid pledged by the city is appropriated to the city under a different statute from the one under which state aid is appropriated to and pledged by school districts…Additionally, a significant portion of the DSA is allocated to the city by the Michigan constitution, not by [a state] statute. The bonds of the city and DPS are also issued under different statutes. Finally, in its [municipal] bankruptcy proceedings, the city did not impair, did not attempt to impair, and throughout that process treated as secured its DSA-backed debt.” Nevertheless, in its offering, the proposed sale lists nearly four pages of “risk factors” municipal bond investors might be advised to consider, including the warning that were Detroit to file again in the future for municipal bankruptcy protection, such a filing could have “significant adverse consequences affecting bondholders,” including “immediately delaying for an indefinite period of time payment on the bonds, modifying the maturity date, interest and payment terms and conceivably modifying the security for the principal amount.” Nevertheless, Moody’s and S&P last week affirmed the single-A to double-A ratings on Detroit municipal bonds backed by distributable state aid and sold under the MFA’s local government loan program; in addition, Detroit’s distributable state aid includes a portion of the 6% retail sales tax revenues collected across the state—of which the constitutional component is mandated by the Michigan state constitution and distributed on a per capita basis to townships, cities, and villages: it is not subject to reduction by the state legislature; in contrast, the statutory component of state aid is authorized by legislative action and distribution is subject to annual state appropriation by the state legislature.

Tempus Fugit. St. Francis, long ago, warned: “Time is round, and it rolls quickly.” So too for those gambling on Atlantic City’s future—and who cannot, like Donald Trump, simply declare bankruptcy and walk away from the famed boardwalk city—the time here with which to reckon is five days: that is, the city must come up with the means to meet a $3.4 million debt service payment by then or default—with the consequent urgency to reach agreement with the state on a bridge loan—a loan upon which the state last May agreed, as part of a recovery package to avoid an immediate default, but upon which the state has been characteristically slow to follow-up: it has only recently begun proposing terms to the city, according to Moody’s, where crack analyst Douglas Goldmacher noted a sign of how much Atlantic City need the loan occurred when the state had to step in to make an $8.5 million payment owed to the Atlantic City School District last week—a payment to be deducted from its final loan amount—with Mr. Goldmacher writing: “The city has requested, and the state has agreed, to a $74 million loan, but the terms have not been publicly announced and no formal agreement has been reached…The legislation did not outline the terms for the loan, leaving it to the state’s Division of Local Government Services to negotiate with Atlantic City management.” He added that negotiations with the state are underway, and, if the loan can be executed this week, it would help Atlantic City to avoid default next Monday and to make payments on an additional $18.6 million owed in municipal debt service for the rest of this year; he noted the funds could also help the city devise a five-year financial plan required by early November as part of the state rescue legislation, warning: “Absent any receipt of state support, we believe a default would likely set off a series of missed debt payments and revive the prospect of Atlantic City filing for municipal bankruptcy, or pursuing debt restructuring outside chapter 9 bankruptcy, which we would consider a distressed exchange.”

Mayor Don Guardian Tuesday evening noted the city is close to finalizing the loan, and City Council President Marty Small vowed Atlantic City will have a plan to close a $100 million shortfall in next year’s budget in time for a state-imposed Nov. 3rd deadline, albeit the city still may seek an extension. The state has said it will similarly step in and cover the city’s payroll or the pending $3.2 million bond payment, Atlantic City Mayor Don Guardian said on Tuesday. If Atlantic City fails to submit a plan by Nov. 3rd, or if the plan is rejected, the state can sell city assets, break union contracts and assume major decision-making powers from the city’s government for five years. Brian Murray, a spokesman for Governor Christie, said that there is nothing in the bill that would allow an extension. “The statute signed by the Governor is very clear that city officials had 150 days to develop a plan…There is nothing in the legislation or otherwise that provides for any waiting period regarding the city’s request for a bridge loan.” Similarly, a spokesman for Senate President Steve Sweeney also dismissed any notion of an extension: “It appears the government of Atlantic City is not concerned about its residents or its responsibility to govern…If the city was serious, they would have submitted a plan already. This financial crisis was well-known for years prior to the signing of the legislation. It’s time for action, not delays.”

Council President Small said the city will be ready with a plan within the state-imposed 150-day timeline, but blamed the state for a six-week delay in providing vital loan documents. She added Atlantic City did not receive bridge loan documents until two weeks ago, which hampered the process of working on the plan, noting: “The Governor signed the document of Memorial Day weekend…We’re just getting those documents.” Said documents relate to an agreement on a $74 million bridge loan which would allow Atlantic City to cover its expenses as it completes its plan to prevent the state takeover.

If the loan is not approved this week, the city could default on a $3.4 million debt service payment, according to a report by Moody’s Investors Service issued yesterday: “Absent any receipt of state support, we believe a default would likely set off a series of missed debt payments and revive the prospect of Atlantic City filing for bankruptcy, or pursuing debt restructuring outside bankruptcy, which we would consider a distressed exchange…A sign of how much the city needs the bridge loan came July 15th when the state stepped in to make an $8.5 million payment to the Atlantic City School District on behalf of the city. The payment will be deducted from the city’s final loan amount.”

Council President Small also expressed other frustrations with the state, noting that all of the ideas the city has come up with to balance the budget, such as adding a hotel room tax of $10 and a wage tax, have fallen on deaf ears in the state government: “The City of Atlantic City, as they say, is the golden goose…We’re responsible for a lot of projects and programs throughout the state…Well, the golden goose has a little paint chipping away. Now it’s time for them to help us out.” Nevertheless, and notwithstanding his frustrations, Councilman Small said that he is not giving up on the city that he was born and raised in: “Some people think that we’re wasting our time and that the state is going disapprove anything we give them…Well guess what, we’re going to die trying.”

In his assessment, Mr. Goldmacher also wrote that Atlantic City is also looking to tackle other municipal debt challenges including $228 million in bonds issued to cover tax appeal refunds incurred between 2010 and 2015, as well as an additional $165 million in refunds to Borgata Hotel Casino and MGM Mirage. Borgata and MGM Mirage have taken a combined $17 million credit against their 2016 year-to-date property taxes as partial payment for the owed refunds, according to Mr. Goldmacher, who notes: Atlantic City is responsible for any refunds owed on taxes paid to the city, the county and school district: Both the city and state are negotiating with the casinos to adjust future payments and make payment arrangements.” 

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