Seeking Shelter from Physical & Fiscal Storms

January 14, 2020

Good Morning! In this morning’s eBlog, we consider the ongoing exceptional health, public safety, physical and fiscal challenges for the Michigan City of Flint and the U.S. Territory of Puerto Rico in the wake of a series of earthquakes—both physical and fiscal, as well as in a federal court in Boston.

Not in Like Flint. A new audit shows pension debt in Flint is in worse condition than what Detroit faced when it entered bankruptcy, but new Flint Mayor Sheldon Neeley said he is confident the cash-strapped city can right its financial course. Indeed, the fiscal challenges in a municipality is exceptional, given that its poverty rate among those who worked full-time for the past 12 months was 9.14%. Among those working part-time, it was 41.08%, and for those that did not work, the poverty rate was 44.07%.  The city has more than $370 million in pension legacy costs, which remain unfunded, or a 30% funding rate, which is worse than the 65% rate that a consultant for Detroit’s Chapter 9 municipal bankruptcy emergency manager calculated in 2013 for Detroit’s General Retirement employees. The Flint audit also uncovered a dozen material findings, significant errors, and financial risks—not to mention questionable accounting practices under former Mayor Karen Weaver’s administration that led to several errors, including miscalculated balances and a lack of internal controls over purchasing cards. On January second, the State of Michigan notified the city it had 30 days to submit a corrective fiscal action plan to address the audit problems and, the next day, advised the city that it was delinquent in submitting a separate report detailing its FY2019 funding levels for pension and retiree health care. 

Mayor Neeley, a former city Councilman and legislator who won his seat in October, plans to comply with the state’s requests and remains optimistic there is a way out of Flint’s financial malaise that avoids the specters of chapter 9 municipal bankruptcy or emergency management that have hung over Flint in recent years, noting; “We are changing the trajectory of the city as it relates to our finances and looking at pathways around those two options.” One of the most difficult challenges is likely to be Flint’s pension debt. Or, as Matt Fabian noted: “Pensions make the medium- and long-term budget situation worse…It complicates other issues that are almost always the cause for bankruptcy: ultimately, the pension is a long-term cost that needs to be covered and it’s going to consume tax increases and budget cuts and state aid.” 

While mismanagement has, no doubt, contributed to the city’s fiscal stress, the real challenge has been to try to stem the egress of those leaving the city—leaving behind those who cannot afford to leave, adversely affecting both income and property tax revenues—so that, after more than a decade of population loss, assessed taxable value decreases, and reductions in state revenue sharing, the fiscal and physical future appears grim.  The city, which was under state emergency management from late 2011 to 2015, when the state began the process of returning local control, emerged, as we have reported, one year ago last April—with the lead contamination in its water compounding the city’s fiscal plight and devastating assessed property values: Flint’s population, as state Senate Minority Leader Jim Ananich (D-Flint) noted, “only compounded Flint’s existing financial issues…The city’s population has declined, drastically shrinking its tax base, so there will continue to be some financial hurt until we have recovered from the crisis and the economy has adapted to the new environment.” Indeed, the city’s population shrank from 111,475 in 2010 to an estimate of nearly 96,000 in 2018, meaning Michigan state revenue sharing declined from $18.9 million in 2014 to $14.1 million in 2018, while taxable assessed values plummeted 40% from 2008 to 2012, according to data in “Michigan’s Great Disinvestment.”

Get the Lead Out! While Flint has received hundreds of millions of state and federal dollars since the lead contamination came to light, and the city is more than halfway through replacing its lead service lines, much of the state aid was limited to water infrastructure while the city’s budget struggled. After Mayor Neeley took office last November, his new hires included new advisers in finance, including economist Eric Scorsone, who came in as a member of Mayor Neeley’s transition team. Mr. Scorsone, the former Michigan Deputy Treasurer and Chief Economist for the state Senate, is an associate professor and Director of the Center for Local Government Finance and Policy at Michigan State University. Ergo, unsurprisingly, the Michigan Department of the Treasury volunteered to help as Mayor Neeley sought to assess and address the city’s dire pension situation—described by the audit manager of the Michigan Treasury Department as “underfunded,” but noting: “We’re aware of the city of Flint’s finances and underfunded retirement benefits: we plan to work with the city as they create their Corrective Action Plan.”

Nevertheless, if past is prologue, this promises to be a governance challenge—or, as Councilmember and Finance Chair Eric Mays told the Detroit News, his job was “to keep the state out” of Flint, referring to the state’s dismal past emergency management. Chair Mays noted he was “ecstatically excited” that Flint had ended its fiscal year with a $24 million fund balance, stating: “This mayor campaigned we were on the verge of bankruptcy…You give me $24 million, and me and my son and my grandkids, we are going to live good.”

But getting to “good” will be a challenge: the city has more than $620 million in unfunded pension and retiree health care costs.  At the end of 2018, 31% of the city’s promised pension was funded, a drop of nearly 20% from 2017, and the equivalent of $372.9 million in unfunded liability, according to the city’s most recent audit: Flint’s liability for retiree benefits such as health care, which is not pre-funded, amounts to $249.8 million, according to the audit report: Flint contributed $23.5 million to its pension plan in 2018, less than half the $50.9 million which was paid to retirees, according to the audit; the projected $17.9 million Flint had to pay in 2018-19 retiree health care costs “is nearly insurmountable for a city in the fragile financial state in which Flint finds itself.” That means Flint will need to increase its contributions to the retirement fund so it reaches funding levels acceptable to the state. (Michigan deems a pension system “underfunded” if it falls below 60% funded: At the end of 2018, Flint had 1,773 retirees and beneficiaries receiving benefits supported by 443 active employees working to earn their own benefits, according to the audit report.) According to Mr. Scorsone: “Because we have so many retirees to current employees, we know we’re going to have address some of the city’s contribution levels…We do expect some substantial increases in the city’s contribution levels going forward to try and make up the difference.”

The city also has a liability of $100 million in bonds for the Karegnondi Water System, which is offset by about $97 million of monthly credits through its water contract with the Detroit area’s Great Lakes Water Authority. 

Other Debts. The audit noted marginal increases in the City of Flint’s income tax revenue and property value: the city ended the 2018-19 fiscal year in late June with a positive balance of $720,000 after spending $52.5 million, according to the audit: Income tax revenue in FY2018-19 was $16 million, up from $15.5 million in 2017-18; Flint’s taxable value of property was $734 million in 2018 compared with $714 million in 2017, according to the audit. Nevertheless, the increase in tax revenue, according to Mr. Scorsone, remains well below where the city was a decade ago: “We should be very clear on this: the City of Flint, given its current cash position, would not be eligible for [chapter 9 municipal] bankruptcy. You pretty much have to be out of cash completely, as Detroit was, to even enter into a bankruptcy conversation.” The audit of Flint’s finances from July 1, 2018 through June 30, 2019 found 12 material conditions within the city, most zeroing in on a lack of financial controls within the city. Thus, understandably, Mayor Neeley noted: “I’m very concerned about the outcomes and what the audit revealed: We’re taking action currently trying to move us beyond the position we are in now.”

Equal Disaster Assistance for a U.S. Territory? Puerto Rico Gov. Wanda Vázquez Garced declared a state of emergency earlier this week in response to the quakes, as did several mayors of Puerto Rico’s 78 municipios. President Trump has since approved emergency federal assistance for the island. It’s unclear what new damage may have been caused by the latest earthquake, but reports from earlier in the week show hundreds of homes were destroyed, as well as a major power plant on the island was so severely damaged that two-thirds of customers, totaling millions, were left without electricity. In Washington, D.C., 56 Members of Congress have asked President Trump to declare Puerto Rico a disaster zone as soon as Governor Wanda Vasquez Garced files a formal request, as a result of the earthquakes that occurred earlier this week, writing: “The people of Puerto Rico need solid assistance in this hour of great need, and it is up to us to help in every possible way. We believe that granting a major disaster declaration for the island would help meet the needs of Puerto Ricans affected by these earthquakes,” said the group of federal lawmakers, led by Puerto Rican Democratic Congressman José Serrano (New York), one of the leaders of the Allocations Committee of the Federal House of Representatives. Lawmakers indicated that the disaster zone declaration would facilitate access to emergency assistance for individuals and the governments of the U.S. territory, warning, in their letter, of the serious damage caused by earthquakes in residences, schools, buildings, and public infrastructure—and noting that the federal government has yet to disburse billions of dollars in emergency assistance promised to Puerto Rico in the wake of the catastrophe caused by Hurricane Maria—writing: This is a time of great distress for the people of Puerto Rico: it is imperative that the federal government provide all the necessary resources to save lives, ensure public health and safety, and help thousands of people recover lost property and jobs,” adding that the terramotos or earthquakes haveaggravated existing problems as a result of hurricanes Irma and Maria…More than two years later, Puerto Rico residents are still recovering from the devastating impacts of these previous natural disasters. Federal assistance was slow at that time and most of the funds allocated by Congress have not yet been disbursed by the Administration. It is our obligation to ensure that this does not happen again and that solid assistance is provided to affected US citizens residing on the island.”

In the wake of the terramotos or earthquakes, which have struck the U.S. territory of Puerto Rico, Presidential candidate and Vermont U.S. Senator Bernie Sanders (I-Vt.), Rep. Nydia Velasquez, and Rep. Alexandria Ocasio-Cortez have demanded that President Trump expedite assistance to the island and declare a disaster in order to expedite FEMA assistance, especially for the electric system—and especially to address the damage wreaked—damage which has had an impact mainly in the south, with the trio noting: “The hurricane (Maria) destroyed the island and today, tens of thousands of people still live under canvas roofs. In recent days, earthquakes have cost millions of dollars in damage, destroyed hundreds of homes, caused massive blackouts and they have forced residents to sleep in homeless shelters due to fear of being buried in their own homes by another earthquake,” as they insisted the President release the funds authorized by Congress after Hurricane Maria and order FEMA to respond to the new emergency on the Island, adding: “Postponing the disbursement of this vital assistance for a longer time, given the humanitarian needs of Puerto Rico, is a scandal.” Concurrently. Puerto Ricans Daron Soto, Ocasio-Cortez and Jose Serrano, urged FEMA interim Administrator Peter Gaynor to assist the government of Puerto Rico to give stability to the electrical system: “It is time for President Trump and his administration to put an end to his personal vendetta against Puerto Rico and use all available resources to help rebuild the island,” with growing apprehension with regard to municipios still without power.

A Legal Appeal. Concurrently, the Puerto Rico Employees Retirement System bondholders have appealed a U.S. District court ruling against them to the U.S. 1st Circuit Court of Appeals in far away, but un-earthquake-hit Boston, after, last Tuesday, U.S. District Court Judge Laura Taylor Swain rejected the bondholders’ motion for her to appoint them as a trustee for the system. The First Circuit Court posted a case opening notice for the appeal, and the municipal bondholders filed a notice of the appeal in the District court. In the case, law firms Jones Day and Delgado & Fernández are representing Andalusian Global Designated Activity Company and about 20 other investment funds holding ERS bonds; and law firms White & Case and Sánchez Pirillo are representing AAA Portfolio Bond Fund and about 20 other investment funds holding ERS bonds. The PROMESA Puerto Rico Oversight Board, the Puerto Rico Fiscal Agency and Financial Advisory Authority, and the Official Committee of Retired Employees of Puerto Rico are the opposing parties. The effort to protect timely debt payments on special revenue bonds is projected to now shift to enacting new state laws in light of Monday’s U.S. Supreme Court announcement it will not consider an appeal of a Puerto Rico case—an announcement which was the first of two involving Puerto Rico expected this month from the busy Supreme Court: the Justices are expected to also release their ruling in a lawsuit begun by Aurelius Investment and other hedge funds which are arguing the court should invalidate all actions taken by the PROMESA Financial Oversight and Management Board for Puerto Rico.

If a majority determine that the Oversight Board created by Congress has a primarily federal role, it could do what the hedge funds want or at least what an appellate court ordered, which is to mandate U.S. Senate confirmation of a new board.  For its part, the PROMESA Board argues that Congress had the authority to establish the board as a primarily local body under Article IV of the U.S. Constitution, which empowers Congress to admit new states and administer the territories. The announcement relates to last March’s decision by the First Circuit Court of Appeals involving the Puerto Rico Highways and Transportation Authority’s special revenue bonds, wherein Assured Guaranty and two other municipal bond insurers petitioned the U.S. Supreme Court to accept an appeal. Bankruptcy attorney John Mudd in San Juan, who represents unsecured creditors in Puerto Rico’s quasi chapter 9 bankruptcy, said he was not surprised by the denial, because only a small fraction of cases are considered. The case law on the protected status of special revenue bonds is, he noted, different from last year’s First Circuit appellate court ruling and that ruling only applies to the appellate court jurisdiction in New England and Puerto Rico, he added. The decision, however, will only have wide implications if another appellate court issues a similar ruling, according to Mr. Mudd.

A Stimulus to Act? With new sessions of state legislatures commencing, the wizard or guru of chapter 9 municipal bankruptcy, Jim Spiotto, suggests this would be an ‘ideal time’ for the introduction of legislation in state legislatures to protect city and county borrowing risks, or, as he put it: “It’s important to have borrowing costs as low as possible because, there’s no justification to having higher borrowing costs,” as he estimated that last March’s ruling by the First Circuit of the U.S. Court of Appeals has increased borrowing costs 20%-25% over the duration of a long term municipal bond, noting: “The First Circuit didn’t take away the validity of the lien…What it did do, is raise the question of timely payment which will possibly lead to lower credit ratings or downgrades of existing bonds which will increase the borrowing costs.” He did note that the appellate court had recognized the authority of states to require payments on special revenue bonds in a bankruptcy, adding that he hopes the National League of Cities, the Government Finance Officers Association, and other groups will use Monday’s Supreme Court announcement as a signal to begin work with state legislatures to enact similar statutes.

The hope that the high court would accept the Puerto Rico case rested on the conflict it created with protections afforded to revenue bonds in other Chapter 9 municipal bankruptcy cases involving the cities of Detroit, Stockton, and San Bernardino, as well as Jefferson County. Mr. Mudd noted that state law can always be changed by federal law, suggesting that a federal law would be the better option than enacting model state statutes. Matthew Fabian, the superb Managing Director of Municipal Market Analytics, in an email at the beginning of this week wrote that although the Puerto Rico case “only directly impacts borrowers within the First Circuit,” the Supreme Court’s decision to not hear an appeal “has given revenue bond issuers nationwide a slightly better reason to file for chapter 9…Municipal investors are being compelled to think about any revenue bond’s connection to a government that might file for bankruptcy and to integrate GO [general obligation bonds] with revenue bond credit analytics: There could be some spread widening for revenue-structure-dependent credits, like Chicago’s STSC, O’Hares, or even the new COFINAs, but this is apt to be slight in the current market.”

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