Foundering Federalism?

07/12/17

Good Morning! In this a.m.’s eBlog, we consider the seemingly increasing likelihood of chapter 9 bankruptcy for Connecticut’s capital city, Hartford, before veering south to consider the ongoing fiscal storms in the U.S. Territory of Puerto Rico.

Moody Blues. In the latest blow from the capital markets to Connecticut’s capital city, Standard & Poor’s Global Ratings late Tuesday lowered Hartford’s general obligation ratings to junk bond status—with the action coming less than a week after we had reported the city had hired a firm to help it explore options for chapter 9 or other steps involving severe fiscal distress. Moody’s Investors Service had already downgraded Hartford’s bonds to a speculative-grade (Ba2), and it has placed the city on review for yet another downgrade.  S&P’s action appeared to reflect an increased likelihood Connecticut’s capital could default on its debt or seek to renegotiate its obligations to its bondholders, with S&P credit analyst Victor Medeiros noting: “The downgrade to BB reflects our opinion of very weak diminished liquidity, including uncertain access to external liquidity and very weak management conditions as multiple city officials have publicly indicated they are actively considering [municipal] bankruptcy.” The ratings actions occurred as the city continues to seek more state aid and concessions from the city’s unions—even as the state remains enmired in its own efforts to adopt its budget. Mayor Luke Bronin, in an interview yesterday, confirmed the possibility of bond restructuring negotiations. This is all occurring at a key time, with the Governor and legislators still negotiating the state’s budget—on which negotiations for the fiscal year which began at the beginning of this month, remain unresolved. In a statement yesterday, Mayor Bronin noted:  “I have said for months that we cannot and will not take any option off the table, because our goal is to get Hartford on the path to sustainability and strength.” He added that any long-term fiscal solution would “will require every stakeholder—from the State of Connecticut to our unions to our bondholders—to play a significant role,” adding: “Today’s downgrade should send a clear message to our legislature, to labor, and to our bondholders that this is the time to come together to support a true, far-sighted restructuring.”

A key fiscal dilemma for the city is that approximately 51 percent of the property in the city is tax-exempt. While the state provides a payment in lieu of local property taxes (PILOT) for property owned and used by the State of Connecticut (such payment is equal to a percentage of the amount of taxes that would be paid if the property were not exempt from taxation, including 100% for facilities used as a correctional facility, 100% for the Mashantucket Pequot Tribal land taken into trust by federal government on or after June 8, 1999, 100% for any town in which more than 50% of all property in the town is state-owned real property, 65% for the Connecticut Valley Hospital facility, and 45% for all other property; such state payments are made only for real property.  

Unretiring Debt. U.S. Federal Judge Laura Taylor Swain gave the government of Puerto Rico and the Employees Retirement Systems (ERS) bondholders until yesterday to settle their dispute over these creditors’ petition for adequate protection—warning that if a deal was not reached, she would issue her own ruling on the matter—a ruling which could mean setting aside at least $18 million every month in a separate account, albeit Judge Swain noted she was not ready at this time to say whether that would entail adequate protection. Her statement came even as Puerto Rico Governor Ricard Rossello Nevares yesterday stated that, contrary to complaints made by the Chapter of Retirees and Pensioners of the Federation of Teachers, the House Joint Resolution does not represent a “threat,” but rather comes to ensure pension payments to public workers who once served the U.S. Territory, adding, however, that the retirement system as it was known no longer exists, stating it “is over,” in the absence of resources that can ensure long-term pension payments: What we have done is that we have changed from a system where it was a fund to a pay system where what implies is that now the government under the General Fund assumes responsibility for the payment of the pension…That is, the retired do not have to fear, quite the opposite. The measure that we are going to do saves and guarantees the System. If we had not implemented this in the fiscal plan…the retirement system would run out of money in the next few months.” Describing it as a “positive measure for pensioners,” because, absent the action, it was “guaranteed to run out of money,” the Governor spoke in the wake of a demonstration, in front of La Fortaleza, where spokesmen of the Chapter of Retirees and Pensioners of the Federation of Teachers denounced the measure—a measure approved by both legislative bodies and sent to the Executive last month as a substitute retirement system for teachers.

Unsurprisingly, the Puerto Rico government and representatives of labor unions and retirees opposed the ERS bondholders’ request to lift the stay under PROMESA’s Title III. In response to Judge Swain’s query to the bondholders: “If I were to enter a sequestration in the manner you stipulated…What would that do for you?” Jones Day attorney Bruce Bennett responded; “Not enough,” as the ERS bondholders argued they needed adequate protection, because Puerto Rico has not made the requisite employer contributions to the ERS, which guarantee payments of their bonds. In contrast, opponents argued the resolution authorizing the issuance of these bonds was an obligation of Puerto Rico’s retirement system‒not the Commonwealth, and creditors were going beyond contractual rights in forcing the government to make appropriations from the general fund and remit them as employer contributions. An attorney representing the retirement system argued the ERS security interest filings were defective in reference to claims by bondholders that they have a right to receive employer contributions; however, an attorney representing the PROMESA Board countered that just because the collateral to their municipal bonds has been reduced, those bondholders are not entitled to such protection, testifying: “What is the claim worth when you have the GOs saying ‘we get all the money because we are in default.’”

Due to Puerto Rico’s perilous fiscal condition, it currently is making pension payments, for the most part, on a pay-as-you-go basis: public corporations and municipalities are making their employer contributions; however, those contributions are going into a segregated account; in addition, the fiscal plan contemplates making public corporations and municipalities similarly transform to a pay-go pension system—with the Territory supporting its position before Judge Swain by its police power authority.

The State of Puerto Rico’s Municipalities. The Puerto Rico Center for Integrity and Public Policy has reported that Puerto Rico’s municipal government finances deteriorated in FY2016 after improving in the prior two fiscal years. Arnaldo Cruz, a co-founder of the Center, said the cause of the deterioration was likely related to the election year, based on the collection of data and responses from 68 of the territory’s 78 municipios. Mr. Cruz added that the ten non-responders happened to be ones which had received D’s and F’s in past years. The updated study found that 30 municipalities nearly have the muncipios received more than 40% of their general fund revenue from the central government—mayhap presaging fiscal mayhem under the PROMESA Board’s intentions to eliminate such state aid to local governments over the next two fiscal years—i.e,: a cut of some $428 million. Such severe cuts would come even as the study found that more than half the muncipios realized a decrease their net assets last year, and half realized a decrease in their general fund balance—even as 27 municipios allocated more than 15% of their general fund income to debt repayment.

According to the March fiscal plan, Puerto Rico’s municipalities have:

  • $556 million in outstanding bond debt;
  • $1.1 billion in loans to private entities; and
  • Owe $2 billion to Puerto Rico government entities, primarily the Government Development Bank for Puerto Rico.

Mr. Cruz notes a potentially greater fiscal risk is related to Government Development Bank loans, which Puerto Rico’s municipalities continued to receive last year: last month, however, the Puerto Rico Senate approved a bill to allow the municipalities to declare an emergency and declare a moratorium on the payment of their debt. The fate of the effort, however, is uncertain, because the legislation died when the legislature adjourned before House action—mayhap to be taken up next month when they reconvene.

Fiscal Challenges Key to Municipalities’ Futures

eBlog, 04/26/17

Good Morning! In this a.m.’s eBlog, we consider the kinds of fiscal challenges key to a municipality’s future—focusing on the windy city of Chicago, before examining the complex federalism issues conflicting the U.S. Territory of Puerto Rico’s efforts to return to solvency—and deal with a Congressionally-imposed oversight board.

What Is Key to the Windy City’s Future? Chicago, the third most populous city in the U.S. with 2.7 million residents, is one which, when Mayor Rahm Emanuel was first elected, was what some termed a “time bomb:” He took office to find a $635 million operating deficit. However, he did take office as the city’s demographics were recovering from the previous decade—a decade which witnessed an exodus of 200,000, and the loss of 7.1% of its jobs—creating an exceptional fiscal challenge. At his inception as Mayor, the city confronted a debt level of $63,525 per capita—so deep that one expert noted that if one included the debt per capita with the unfunded liability per capita, the city would be a prime “candidate for fiscal distress.” Chicago then had an unemployment rate of 11.3%. The then newly-elected Mayor was confronted by a Moody’s downgrade of  Chicago’s $8.2 billion of general obligation and sales tax backed bonds with a three-level downgrade—and a bleak warning that the Windy City could face further adverse ratings actions absent progress in confronting growing unfunded pension liabilities, adding that the city’s $36 billion retirement-fund deficit and “unrelenting public safety demands” on the budget would, absent significant growth in the city’s operating revenues, increasingly strain the city’s operating budget, as pension outlays competed with other spending priorities, including “debt service and public safety.” Thus at a session last week moderated by former Crain’s Chicago Business Publisher David Snyder, a key focus was: what makes a city attractive to a corporation looking to relocate? Mr. Snyder provided some background and context for that discussion, noting how the makeup of the corporate community in Chicago has changed since the 1980s, when Chicago’s economy was driven by large public corporations. He said that the era of the large corporation is over: today healthcare and logistics firms lead the way, with private or family-held middle-market businesses driving growth in the Chicago region and an entrepreneurial culture experiencing a renaissance; while John Lothian, the Executive Chairman of John J. Lothian & Co., provided an overview of the extraordinary technology changes which he believes fundamentally altered how the financial sector in Chicago operates. He noted that today, getting hired in the Windy City more often than not requires a degree in science, technology, engineering, or mathematics—a change which has closed off jobs from young people, who used to join the sector as runners, gaining experience and contacts. He also noted that Chicago, a world-class city, is now not just competing with New York City, but also in a global competition with other cities around the globe. The stock yards of old—cattle—have been transformed into shares of corporations. Providing some scope to this urban transformation, Dr. Caralynn Nowinski Collens, Chief Executive Officer of UI Labs, a tech accelerator for digital manufacturing, noted that a decade and a half ago, there was virtually no tech scene, funding, or support: students graduating from Illinois schools with technology degrees had to leave the state to pursue their careers. In contrast, she noted, today there are over 100 incubators and accelerators and 300 corporate R&D centers in Chicago; there are 275 digital startups every year. No sector of the city’s economy is growing more rapidly; indeed, today Chicago has the third fastest growing tech sector in the nation. Dr. Collens said that Chicago’s economic diversity and legacy of industry make it an excellent place for the technology industry to flourish as its legendary older industries have become among the world’s most sophisticated, noting, however, that there are many challenges which could put a snag in the Windy City’s aspirations to become the digital industrial center of the world—specifically noting that the importance of getting young Windy Cityites to focus on the threat of the displacement of jobs by automation, in order to enable the city to become a global leader in technological innovation and, thereby, economic growth.

Another speaker, Jerry Szatan, the founder of site selection consulting firm Szatan & Associates, came at the issue of municipal fiscal stability from a different perspective: he noted that risk and higher municipal taxes no longer are such key factors that can lead a company to flee a municipality. Instead, he said, the critical issue is talent: he noted that all corporate headquarters need highly skilled, educated, and creative professionals, and that there are only so many cities in the U.S. where such a wide talent pool exists. Unsurprisingly, Chicago, he noted, is one—stating that the diversity of the residents of Chicago is very important for corporations, particularly those with an international workforce; second, he noted that connectivity is crucial, citing the city’s international airport at O’Hare with being a critical asset, as well as the city’s dense downtown—which he noted facilitates interactions between coworkers and peers in other industries. Mr. Szatan balanced his enthusiasm with fiscal warnings: noting that corporations are risk averse, he warned against Chicago’s fiscal instability and the possibility of higher taxes. Mr. Szatan’s perspective was shared by Chicago Civic Federation Chairman Kent Swanson, who noted that Chicago has the infrastructure assets, educated workforce, and international appeal of a global city, but not at the steep price of a New York or a San Francisco. Thus, he said, office space costs are much more competitive, thereby more attractive to startups and smaller businesses. Ergo, he noted, he perceives the recent movement of headquarters to Chicago as a microcosm of what is happening across the world as people move from smaller cities to the cores of large cities. A third speaker, Chicago Planning and Development Commissioner David Reifman, noted that despite the fiscal challenges of the State of Illinois, there appears to be a commitment to address the state’s public pension crisis and improve the state’s dysfunctional funding and financial practices—and he extolled the city’s efforts to attract corporations, particularly via amenities in near proximity to downtown, such as an expanded O’Hare, new transit stations, and enhanced service on the Chicago Transit Authority, as well as programs to leverage high-density investments in the downtown area to generate funding for underdeveloped areas.

The Complexity of Federalism & Addressing Insolvency. The Justice Department has confirmed to D.C.-based Commissioner Jenniffer Gonzalez that it will review and send Puerto Rico’s Governor, Ricardo Rosselló, an assessment/evaluation of amendments to the U.S. territory’s pending amendments to the upcoming plebiscite on alternative status, with the confirmation coming as Puerto Rico’s main opposition party, the Popular Democratic Party, has voted to boycott the plebiscite scheduled for June 11th. The proposed plebiscite, the revised language of which the ruling New Progressive Party rejected last Sunday, appears to have exacerbated tensions between Puerto Rico House Minority Leader Rafael Hernández Montañez and three House Representatives. It comes as Gov. Ricardo Rosselló and the NPP legislators had approved a ballot that just had options for independence and statehood—and as Puerto Rico’s Secretary of Public Affairs, Ramón Rosario Cortés, yesterday warned of the possible elimination of the Christmas bonus and the reduction of the work week for Puerto Rico’s employees as still being a possibility if Puerto Rico is unable to cut spending as contemplated in the plan approved by the PROMESA Oversight Board–with the Board, when it approved the plan last month, warning that by July 1st’s commencement of the new fiscal year, there appeared to be a gap of $190 million to close: to cure said fiscal gap, the Board has proposed to reduce the work week of public employees and eliminate the Christmas bonus—an option the government rejected; nevertheless, it looms in the event Puerto Rico is unable to achieve the projected savings—leading Secretary  Rosario Cortés to say: “If we meet these metrics, there’ll be no reduction of the work week. But, if we fail, the (PROMESA) Board has established it can do it automatically. (That is), if we don’t get the savings, it’ll mean reduction of work week and full elimination of the Christmas bonus.” As part of the legislative package of measures submitted by the Executive, House Bill 938 would seek savings with a cutback on spending and efficiencies totaling $1.623 billion, with the proposal including savings of $434 million for mobility, a hiring freeze, and leveling of benefits; $439 million in “government transformation” via consolidations, public-private alliances and efficiencies; and $750 million in reduced subsidies. The Puerto Rican House of Representatives had been anticipated to consider the bill yesterday; however, the House leadership decided to allow for additional time to hear leaders from unions representing public employees, after the former marched to the Capitol in defense of the rights of their members.

Unsurprisingly, the political dynamics of changing administrations in the nation’s capital have added to the fiscal challenges—mayhap best illustrated by a Trump administration Deputy U.S. Attorney General writing the ballot options are unfair, and that he would not recommend the U.S. Congress release federal money allotted for the plebiscite with the planned ballot choices—triggering a response from Puerto Rico legislators, who voted to revise the language to add a third option: remaining a “territory.” However, unsurprisingly, Puerto Rico’s PDP party has argued that Puerto Rico is more than a territory of the United States, thus it has objected to this ballot language. Members of the party wanted to have part of the current name of Puerto Rico, “Estado Libre Asociado,” be the option rather than “territory.” (The former can be translated as “Free Associated State,” though it is usually translated as “commonwealth.”). Thus, over the weekend, the PDP’s Governing Board, General Council, and General Assembly voted against participating in the plebiscite because of the use of the term “territory” on the ballot. In addition, the Puerto Rico Independence Party has also said it would boycott the plebiscite. Nevertheless, notwithstanding that the review process may take a few weeks, Commissioner Gonzalez believes the federal government will end up confirming a status consultation, noting: “They are waiting to be sent documents related to the plebiscite that have not yet been delivered, according to the Commissioner in the wake of a conference call with interim federal Secretary of Justice, Jesse Panuccio. Governor Rosselló had requested a response by April 22nd, with the hope that that would leave time for the House Appropriations committees to authorize the $2.5 million disbursement allowed by federal law to hold the consultation for June 11; that delivery of the $ 2.5 million is conditional, however, on receipt of a formal opinion from the US Attorney General in order to determines that the electoral ballot, the educational campaign of the State Commission of Elections, and the materials related to the plebiscite comply with the constitutional, legal, and public policy norms of the federal government.

Meanwhile, Puerto Rico’s Treasury announced that March revenues exceeded budgeted projections for the month by 7.1%, noting that through the first nine months of the fiscal year, the territory’s General Fund revenues ran 4.1% ($250 million) above projections, with the key contributor being Puerto Rico’s corporate income tax, which added 86.8% more than budgeted, or $130.4 million. Similarly, a separate tax on non-Puerto Rico based corporations’ income (Act 154) continued to outperform last month, coming in 9.8% higher or $18 million more than projected. Last Friday the Bureau of Labor Statistics announced improved employment statistics for Puerto Rico from its household survey: according to the survey, the total number of Puerto Ricans employed increased in March by 0.7% from February and 0.4% from March 2016, while the island’s unemployment rate dipped 0.5% in March from February, with the March rate tying the statistic’s low point since June of 2008, when it was 11.4%. The BLS employment survey showed continued contractions, with total nonfarm employment down by 0.2% since February and 0.3% since March 2016. The employer survey indicated that Puerto Rico’s private sector employment in March was little changed from February, but has slipped 1% since a year ago March. (The discrepancy in the direction of the household and establishment surveys may be because the former includes agricultural and self-employed workers, while the latter does not.)

Death Comes to the Archbishop? Meanwhile, the Puerto Rico Commission for the Comprehensive Audit of the Public, which is charged with reviewing the legality of Puerto Rico’s debt died Wednesday; however, it appears on the road to recovery in the wake of Gov. Ricardo Rosselló’s signing a measure terminating the Puerto Rico Commission for the Comprehensive Audit of the Public Credit, after the measure was approved by the Puerto Rico Senate and House of Representatives. Governor Rosselló and legislators from his New Progressive Party said it should be up to the legal system to pass judgment on the validity of various bonds, and that the audit commission’s work was interfering with negotiations seeking to restructure Puerto Rico’s debt. Demonstrations outside Puerto Rico’s capitol building on Monday and Tuesday had apparently failed to sway Senators and Representatives inside as they debated and then voted against keeping it. (The commission was set up by the Puerto Rico legislature in July 2015 to examine the circumstances surrounding the issuance of the debt—especially to identify invalid debt.) Some members believed it was opening doors to municipal bondholder claims against those who prepared official statements or others involved with such bond issues. Since then, the group has released two “pre-audits” which raised questions with regard to the legality of much of Puerto Rico’s municipal debt.