Can Municipal Insolvency Be Contagious?

eBlog, 10/24/16

Good Morning! In this a.m.’s eBlog, we consider the risks of fiscal contagion emanating from the historic city of Petersburg, Virginia, where the city’s virtual insolvency risks the solvency of the regional wastewater authority—and, therefore, the other participating municipalities. Next, with Election Day approaching, we travel to post-chapter 9 Stockton where the ballot issue of a sales tax increase on next month’s municipal ballot has divided the city’s candidates for Mayor and Council. Finally, we consider the exceptional challenges for the U.S. territory of Puerto Rico in the wake of the first PROMESA board meeting.

Can Municipal Insolvency Be Contagious? The South Central Wastewater Authority (SCWA), which provides wastewater treatment services to protect and enhance the environment for the City of Petersburg, the City of Colonial Heights, Chesterfield County, Dinwiddie County, and Prince George County, Virginia, may have to dip into its cash reserves and raise rates for its four other member municipalities if Petersburg fails to resume making its monthly payments very soon: to make up for the gap, each of the other four member jurisdictions would have to increase its monthly payments by approximately 61 percent. At a special meeting at the end of last week, the boards of the SCWA and the Appomattox River Water Authority were briefed on the outlook for SCWA’s finances due to Petersburg’s looming insolvency—with SCWA accounting manager Melissa B. Wilkins warning that unless the authority can tap some of its cash reserves, without Petersburg’s monthly payments, the Authority will be insolvent by the middle of next month—or, as she put it: “Right now, mid-October, we’re broke.” Indeed, forecasts provided to the directors, all municipal government officials from Petersburg, Chesterfield County, Colonial Heights, Dinwiddie County, and Prince George County, make clear that if SCWA does not begin to receive payments consistently by Petersburg and does not tap into its reserves, its operating cash will go into the red as early as next month: by the end of the fiscal year next June, the figures show the authority’s cash balance will be nearly $3 million in arrears. Ms. Wilkens advised that if Petersburg were to start making regular monthly payments beginning with the amount due for this month, and if SCWA were to shift about $996,000 in unused construction funds from a reserve account to the authority’s operating account, the authority would end the fiscal year with a positive cash balance of $35. Ms. Wilkin’s forecast assumes that SCWA will continue to operate under a “bare bones” budget—one which would not include any deposits into the authority’s reserves and puts a hold on any non-mandated construction projects. The key issue is that Petersburg imposes a disproportionate burden on the joint authority: the city accounts for approximately 55 percent of SCWA’s treatment load; ergo its share is of SCWA’s operating and maintenance costs. Its failure to do so means that to make up for the non-payment, each of the other four member municipalities would have to increase its monthly payments by about 61 percent.

The urgency and briefing come in the wake of the suit the authority filed against Petersburg last month, seeking the appointment of a receiver to oversee the city’s utility revenue and make sure the money collected from residents is used to pay SCWA and not for other purposes: the authority claims Petersburg owed it more than $1.5 million in overdue payments. Two weeks ago, Petersburg Circuit Court Judge Joseph M. Teefey Jr. opined that the suit contained “sufficient information that an emergency exists, and it is necessary that this court appoint a special receiver” to make sure residents’ wastewater payments are not used for other purposes, naming attorney Bruce Matson of the Richmond-based law firm LeClairRyan as the receiver. In addition, Judge Teefey, on his own initiative, ordered the city and the wastewater authority to meet with a mediator, McCammon Group of Richmond, because of “the special relationship of the parties to this action and the potential conflicts that are a consequence of these relationships.” In response, the City of Petersburg’s attorneys have filed a motion asking Judge Teefey to issue a stay of his order or to vacate it, because the appointment of a receiver automatically puts the city in technical default on more than $12 million in debt. The court has scheduled a hearing in the case for next Monday.)

For her part, Petersburg Interim City Manager Dironna Moore Belton, who represents the city on the SCWWA’s board, indicated she was hopeful the city would be able to resume making its monthly payments in the very near future, stating that the city is currently seeking a short-term loan to help that effort, advising the board Petersburg has identified a list of “key obligations” to be paid each month, which includes payments to regional authorities such as SCWWA, the Appomattox River Water Authority, and Riverside Regional Jail—albeit acknowledging that to keep current on those payments, that would “still not address some past-due payments.” Ms. Belton stated that city officials and their financial advisers “have a long-term package we are working on to address fiscal year 2016 past-due payments.”

Financing Post Municipal Bankruptcy City Services. Stockton residents in two weeks will have a say on whether to approve a quarter-cent restricted sales tax increase where the new revenues would be dedicated toward funding libraries, a recreation program, and other services in the city. The vote on Measure M is projected to generate $9 million a year and $144 million overall for library and recreation services, including after-school programs, homework centers, and children’s story times. It will be a heavy lift: Measure M requires approval of two-thirds of voters to pass. Since 1980, proponents argue, the city has underfunded its library and recreation services; they add that the city’s municipal bankruptcy and the recession “only compounded previously existing problems;” moreover, they argue that since 1980, the city’s population has doubled, but not a single new library has been built. The main goal for proponents of the tax is to get Stockton to go from an average spending per resident of $15 on public libraries and recreation to California’s median of $35 per capita. Last June, the City Council voted 5-2, with councilmen Michael Tubbs and Dan Wright opposing, to reopen the Fair Oaks Library; however, the facility is not expected to open for several months. The City’s Community Service Director John Alita, speaking as a private citizen, told the Stockton Record the city has had to close pools, has under maintained playing fields, and has reduced the average time libraries are open to less than 30 hours per week, noting: “The more that those things continue, then the less and less there is opportunity for our community members to actually benefit from these amenities that we made and created to provide for them…(The) combined benefit of restoring what would be a normal schedule to residents and then being able to enhance that in areas where there’s nothing right now, I think we see that as Measure M’s greatest benefit.” (Last year, the Stockton Unified School District had the lowest third-grade literacy rate in San Joaquin County at 16 percent, according to University of the Pacific’s annual San Joaquin Literacy Report Card.) All six of the city’s Council Members have endorsed Measure M, as have civil rights leader Dolores Huerta, San Joaquin County Superintendent of Schools James Mousalimas, the League of Women Voters, and the Greater Stockton Chamber of Commerce. As proposed, Measure M would essentially leave the sales tax unchanged, as a state sales tax increase approved by the passage of Proposition 30 in 2012 will expire this year.

Nonetheless, incumbent Mayor and candidate for re-election Anthony Silva, City Council candidate Steve Colangelo, and former Councilman Ralph Lee White have expressed apprehensions, testifying before the City Council last May they opposed approving a new tax when Measure A funds are not being used to fund library services. (Measure A, a three-quarter cent tax, was a tax increase approved by voters in 2014 with no restrictions, but with the city’s promise funds would be used to hire more police officers—a promise as yet unmet.) Mayor Silva, at a candidate’s forum last week, said: “I’m kind of caught in the middle on this one: All that money that we promised has not been spent exactly on what it was promised to you. So here comes another tax,” adding that Measure A had also promised to fund essential services, including opening libraries and pools; however, but none of those things were done…I love libraries…I love books, but the schools already have libraries.” Another opponent. Ned Leiba, a CPA, who closely monitors the Stockton’s finances, noting what he termed was poor management of Measure A funds and the city’s overall “problem with accounting and auditing,” stated: “You don’t want to give money to an entity that can’t be responsible.” Mr. Leiba, a member of the Measure A oversight committee, said that instead, Measure M proponents should pressure the city into using budgeted but unspent funds and not a new tax to open libraries. Stockton wants to “hold on to every shekel,” but there’s no basis for management’s claim that there’s no money, he added: “You want to exhaust all other remedies before you turn to taxes.” Were voters to adopt Measure M, a seven-member oversight committee would be appointed to do an annual review of how much money is generated and how funds are used. It appears that were the measure to pass, all dollars collected by the restricted sales tax would be placed in a separate city fund to be used for libraries and recreation services in Stockton.  

Wherefore the Promise of PROMESA? The process of unravelling insolvency is slow and frustrating: it can be even more trying where it involves a quasi-state and there are issues of sovereignty. Ergo, despite two meetings, the federal control board has, to date, evidenced scant progress—likely awaiting the outcome of both U.S. and Puerto Rico elections. Moreover, despite the ongoing recovery from the Great Recession, our respected colleagues at Municipal Market Analytics note that the fifty-two year-to-date first time payment defaulters so far this year has broken above last year’s trend (forty-eight between January and October), noting that in order for this year to finish with fewer defaults than last year (a trend that has held every year since MMA began collecting this data in 2009), “there can be no more than six additional defaults in November and December. Those two months have together averaged 14 defaults since 2013, strongly suggesting that 2016 will see a break in the downtrend.” For its part, the representatives of the U.S. territory advised the PROMESA Board it lacked any fiscal ability to finance any of its debt service over the next decade absent changes in federal laws to address both the island’s economy—and those provisions which harm its ability to compete against other Caribbean nations, noting that Puerto Rico’s GDP has contracted for nine of the last ten years in real terms, driven by the expiration of incentives provided under §936 of the U.S. tax code and the U.S. financial crisis, both of which were exacerbated by out-migration and extraordinary austerity measures taken by the Commonwealth, measures including reducing government consumption by 12% in real terms from 2006 through 2015, cutting the public administration headcount by approximately a quarter; reducing or deferring critical capital expenditures; delaying tax refunds and vendor payments; implementing significant new revenue measures, including recent sales and petroleum products tax increases generating approximately $1.4 billion annually; depleting liquidity and undertaking extraordinary short-term borrowings from pension and insurance systems; reforming pensions, converting defined benefit plans to defined contribution plans—austerity measures which they said had been insufficient to eliminate deficits, thereby incurring significant deficit financing, a ballooning debt load, and persistent economic decline, as evidenced by driving emigration to the U.S. mainland: a loss of not just some 9% of the island’s population—but disproportionately a loss for the best-educated.

The statistics, part of a 100-page fiscal plan submitted to the PROMESA Board, sought to identify the resources available to support basic governmental services and promote growth; it promised to put together a specific debt restructuring proposal in the wake of receipt of input from the Oversight Board. The plan warns that if the U.S. territory were to take various steps to improve revenues, reduce spending, and improve economic growth, it would still face a $6 billion gap over the decade—leaving no resources to meet commonwealth-supported debt. The plan addressed neither the financial outlook for Puerto Rico’s public corporations or municipalities (which also owe roughly $17 billion of debt). The plan treats $50.2 billion of debt as being addressed by the fiscal plan and the remainder of Puerto Rico’s debt as independent of it, because it is supported by the public corporations, municipalities, and other public entities. For priorities, Puerto Rico’s first is for Congress to continue Affordable Care Act funding to the Commonwealth beyond its planned end in FY2018—a continuation which the territory projects this could mean an additional $16.1 billion in direct Puerto Rico government revenues and an additional $8.4 billion in indirect revenues due to improved economic performance. Gov. Padilla also asked for an indefinite extension of the Affordable Care Act and that Congress treat Puerto Rico similarly to the 50 states with regard to Medicaid spending—and the extension of the earned income tax credit program to Puerto Rico, noting that such changes would lead to an $18.9 billion surplus, which could be used for the payments. This would be out of a total scheduled debt service of $34.2 billion. In its plan, the Governor recommended seven principals critical to reducing the government financing gap and restoring economic growth: any austerity must be minimal; the government must introduce improved budgetary controls and financial transparency; Puerto Rico needs to improve tax enforcement, consolidate agencies, reduce workforce, and reform its tax policy to eliminate the revenue impact of the planned end of the Act 154 tax in fiscal 2018; change local labor regulations, simplify permitting in order to promote economic growth, and invest in strategic growth-promoting projects. Fifth, Puerto Rico’s government must continue to protect vulnerable members of the population, such as the elderly, young, disabled, and poor through government services. The territory must reduce its debt to a “sustainable” level. And, seventh, the federal government must be involved to help generate economic growth.

He identified other concerns, as well, including caution in balancing amongst the island’s creditors, noting a “contingent value right or growth bond that pays creditors in the event growth targets set in the plan are exceeded should therefore be considered as part of any debt restructuring,” and that, because local municipal bondholders are believed to hold $8 billion to $12 billion of Puerto Rico’s debt, according to an official with the Puerto Rico Fiscal Agency and Financial Authority, the plan says there must be consideration of the impact of debt restructuring on the local economy. Finally, Puerto Rico Secretary of the Treasury Juan Zaragoza advised the board that Puerto Rico currently owes $1.3 billion to $1.35 billion to suppliers.

 

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