The Knife Edges of Municipal Bankruptcy


Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal pipeline to the recovery for the City of Flint, the outcome of a Pennsylvania grand jury investigation of the near municipally bankrupt Pennsylvania capital city of Harrisburg, before addressing the .growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico.

In Like Flint? The Michigan legislature has finally agreed to appropriate $20 million to make the requisite match in order for some $100 million in federal aid to go to the city, with the funds to be used to replace corroded pipes which leached lead into the city’s drinking water system, creating not just grave health repercussions, but also devastating the city’s assessed property values and public safety budgets. The city’s near insolvency, which had come in the wake of the decisions which lead to the water contamination by a gubernatorially appointed Emergency Manager, may mark one of the final chapters to the city’s physical and fiscal recovery.

A State Capital’s Near Bankruptcy. Pennsylvania’s capital city, Harrisburg, chartered as a city the year the Civil War commenced, which came close to filing for chapter 9 municipal bankruptcy, will, in its proposed budget for the upcoming fiscal year, follow a court-approved bankruptcy plan, with slightly more revenues than expenditures, except that the city does not expect to be able to hire police as fast as called for in its budget. At a workshop this week, the first of several planned before the City Council votes on the budget for FY2017-2018, the proposed plan proposes minimal increases in most departments, as total revenue is expected to climb to $119.86 million, an increase of about $7 million from last year. City Manager Mark Scott, in a memo to the Council prior to its consideration of the budget, wrote: “In developing our budget recommendations, it is obvious we do not have anywhere near the money we would like to have…Nor is that likely to change any time soon. We cannot expect to address our future by replicating our past. We will have different staffing than in the past and different service delivery expectation. Right now, we are budgeting to establish a solid base—meaning staff skill sets and new, efficient systems/processes.”

In the city, where taxpayers and residents, as well as city officials, consistently list public safety as a top priority, Harrisburg’s five-year plan to increase spending on police was a keystone of the city’s plan of debt adjustment, which was officially confirmed in February. Nevertheless, while the Police Department budget, at $72 million, meaning it is more than 60 percent of the total general fund budget, calls for a significant increase in hiring, and recruiting. City Manager Mark Scott, however, warned that the issue involves more than the budget: “We’re getting people into the academy as fast as we can,” as he advised he hopes the city to realize “a net increase of 18 officers by the end of the year.” Following a trend that began before the 2012 bankruptcy filing, the city again plans to have fewer employees than the year before. This year, however, that is primarily due to the new voter-approved city charter, which transfers sewer workers from the city to the independent Water Department: the new budget authorizes 746 positions, compared to 763 one year earlier.

Tropical Fiscal Typhoon. Puerto Rico, the insolvent U.S. territory, is trapped in a vicious fiscal and physical whirlpool where the austerity measures it has taken to meet its fiscal obligations to its creditors all across the U.S. have come at a steep fiscal and physical cost: some 30,000 public sector employees have lost their jobs, even as the nearly 75% increase in its sales and use tax has backfired: it has served to curtail shopping, adding to the vicious cycle of increasingly drastic fiscal steps in an effort to make payments to bondholders on the mainland—enough so that nearly 33% of the territory’s revenue is currently going to creditors and bondholders, even as its economy has shrunk 10% since 2006. Over this period, the poverty rate has grown to 45%, while the demographic imbalance has deteriorated with the exit of some 300,000 Puerto Ricans—mostly the young and better educated—leaving for Miami and New York. Puerto Rico and its public agencies owe $73 billion to its creditors, nearly five times greater than the nearly $18 billion in debts accumulated by Detroit when it filed for chapter 9 municipal bankruptcy four years ago in what was then the largest municipal bankruptcy in U.S. history. Now, with U.S. District Court Judge Laura Taylor Swain set to preside next Wednesday (Financial Oversight and Management Board of Puerto Rico, 17-cv-01578), we will witness a unique trial, comparable to those in Jefferson County, Detroit, Stockton, San Bernardino, etc.; however, here there will be differences compared to chapter 9, as there will be roles for both Puerto’s Rico, but also the PROMESA oversight board—with, presumably, both seeking a fiscal recovery, but unlikely to have comparable proposals with regard to the most appropriate and effective plan of debt adjustment. Perhaps the greatest challenge will be economic recovery: for Detroit, whose bankruptcy pales in comparison to Puerto Rico’s; Detroit was able to benefit from a constructive state role and an economy vastly boosted by the federal bailout of its gigantic auto industry. That contrasts with current federal laws discriminating against Puerto Rico’s economy vis-à-vis competitor Caribbean nations, and caught in a Twilight Zone between a state and municipality, with a stream of its young talent streaming to Miami and New York, leaving behind a demographic map of poverty, empty classrooms, and aging people—and dependent on sales taxes, but with sharp reductions in pensions almost certain to sharply and adversely affect sales tax revenues. Judge Taylor will require the wisdom and strength of Job.

The Different Roads out of Municipal Bankruptcy

eBlog, 1/25/17

Good Morning! In this a.m.’s eBlog, we consider yesterday’s guilty plea from the former Mayor of Pennsylvania’s capitol, Harrisburg, for actions he had taken as Mayor which plunged the city to the brink of chapter 9 bankruptcy; then we consider Detroit Mayor Mike Duggan’s announcement that a majority of Detroiters will see a reduction in their property tax obligations—a sign of the signal fiscal turnaround. Then we head into the icy blast of Winter in Pennsylvania, where the former Mayor of Harrisburg has pleaded guilty to stealing city-purchased artifacts, before veering south to note Puerto Rico Gov. Ricardo Rosselló has signed into law an extension of Act 154’s tax on foreign corporations.  

Public Mistrust. Former Harrisburg, Pa., Mayor Stephen Reed pleaded guilty Monday to 20 counts of theft  for stealing artifacts purchased by the city in Dauphin County court Monday, with the outcome coming in the wake of negotiations with the state Attorney General’s office. The 20 counts reflects a dramatic reduction of criminal counts from the original more than 470, including many tied to fiscal decisions during his service as Mayor, a period which had propelled the city to the verge of chapter 9 municipal bankruptcy—and a leftover severe set of fiscal challenges still bedeviling the state capitol. The former mayor, in his comments to the press after the proceeding, described it as “gut-wrenchingly humiliating.” The Patriot-News of Harrisburg reported that Mr. Reed, who served as mayor from 1982 to 2009, admitted to taking 20 historic artifacts, but said he had no criminal intent. Judge Kevin Hess scheduled a sentencing hearing for Friday in the Dauphin County Court of Common Pleas in Harrisburg. The trial commenced in the wake of then Pennsylvania Attorney General Kathleen Kane in July of 2015 announcing the indictment of the former Mayor: prosecutors asserted he had diverted municipal bond proceeds, notably related to an incinerator retrofit project, to a special projects fund he allegedly used to purchase as many as 10,000 Wild West artifacts and other “curiosities” for himself—including a $6,500 vampire hunting kit—a series of disclosures which contributed to the city’s descent into receivership due to municipal bond financing overruns related to an incinerator retrofit project; the Harrisburg City Council filed for chapter 9 municipal bankruptcy in October of 2011, notwithstanding the objection of then-Mayor Linda Thompson; however, a federal judge two months later negated the filing, and a state-appointed receivership team pulled together a recovery plan approved by the Commonwealth Court of Pennsylvania in September of 2013. Yesterday, Christopher Papst, author of the book Capital Murder an Investigative Reporter’s Hunt for Answers in a Collapsing City, noted: “Stephen Reed’s guilty plea concerning his stealing of city artifacts is a good start for the people of Harrisburg who deserve answers and justice. But far more needs to be done and more people need to be held accountable for the city’s financial collapse…A strong message must be sent that any impropriety concerning municipal financial dealings will not be tolerated.”

Rebalancing Motor City’s Tax Wheel Alignments. Detroit Mayor Mike Duggan has announced that about 55% of residential property owners in the city will see a reduction in their property tax obligations later this year. His announcement came in the wake of the city’s completion of a three-year reappraisal project, as required under Detroit’s plan of debt adjustment approved by the U.S. Bankruptcy Court. According to Mayor Duggan, about 140,000 residents will realize an average reduction of $263 on their tax bills, while 112,000 will see an average increase of $80. The reappraisal process, unlike past years, assessed each property individually. Tax assessments were mailed Monday. The city, despite boasting one of the broadest tax bases of any city in the U.S., (its municipal income taxes constitute the city’s largest single source of revenues), nevertheless have been constrained by the state: only Chrysler and DTE Energy pay business taxes; moreover, state law bars cities from increasing revenues by adding a sales tax or raising residential property tax rates more than inflation. Moreover, in the years leading up to the city’s fiscal collapse into chapter 9 bankruptcy, homeowners had complained that their property taxes did not compare to the market value of their homes. Ergo, now Mayor Duggan is hopeful that the new assessment will improve property tax collections—or as he put it yesterday: “It turns out, when people feel they’re being assessed fairly, they pay their taxes….For years, we basically have taken entire neighborhoods or sections of the city and taken averages, which is the best that could be done with the data available.” But the new assessments are based upon house-by-house reassessments using aerial and street-level photography as well as field visits. In addition, the city digitized field cards for every single residential property, allowing employees to inspect the condition of homes based on the historical information and new ground and aerial photos, according to City Assessor Alvin Horhn—or, as Mr. Horn notes: “Where everything matched up, fine. Whenever there was a difference, we sent people out to look…For the most part, this was done at a desktop (computer) review.” Next up: a citywide reassessment of all commercial and industrial properties will be completed for the winter 2018 tax bills. According to city data, collections have increased steadily from about 68% in 2012-14 during the city’s municipal bankruptcy to 79% in 2015 and a projected 82% last year: from 2015 to 2016, the city reported that property tax collections increased approximately $8 million.

Act 54 Where Are You? Puerto Rico Gov. Ricardo Rosselló has signed into law an extension of Act 154’s tax on foreign corporations (mainly corporations manufacturing pharmaceuticals and other high-tech products), a key action to preserve revenues which provide a quarter of the U.S. Territory’s general fund revenues; the action came as Public Affairs Secretary Ramon Rosario Cortés submitted a measure to replace Puerto Rico’s Moratorium Law, an action which he said could mean Puerto Rico could dedicate some of the savings from which to provide “payment of interest or some part of the principal” in negotiations with the island’s creditors: “The obligations of the government of Puerto Rico will be fulfilled in an orderly process. The government is going to commit itself to the policy that what it is directed is to pay the obligations of the government of Puerto Rico. The first thing is essential services.” The discussion occurs at a pivotal point, as, since before the administration of newly elected Governor Ricardo Rosselló Nevares taking office, Senate President Thomas Rivera Schatz had announced that they were in tune to extend the expiration of the moratorium scheduled for the end of this month. If the government does not extend the litigation deadlock, it will face $1.3 billion in February, leaving it with no cash for operations, according to a liquidity report by Conway Mackenzie. Secretary Cortés, in response to a query yesterday with regard to interest payments, did note that would be possible “with the savings that are achieved, guaranteeing priority, which are essential services…The government of Puerto Rico will be making savings with this measure and the savings that will be made will be part of the renegotiation process, which could include the payment of interest or some part of principal, but in negotiation with creditors.” The revenues, as reported over the most recent half fiscal year, accounted for 25% of all General Fund revenues—more even than the $713 million in individual income taxes. The Act, adopted in 2010 to help address the dire fiscal imbalance, was set to impose a continually declining levy rate on foreign corporations until it would phase out this year, based on Treasury regulations promulgated six years ago which allow corporations to take tax credits against temporary excise taxes. Now a tricky shoal to navigate in the midst of the major transition in power in Washington, D.C. The issue involves whether the IRS will grant an extension of Act 154 past its current scheduled expiration at the end of this calendar year. According to Puerto Rico, 10 corporations and partnerships paid some 90 percent of all Act 154 taxes in FY2016. The law mainly affects corporations manufacturing pharmaceuticals and other high-tech products on the island.

Getting Ready for the Checkered Flag in the Motor City

September 16, 2014

Visit the project blog: The Municipal Sustainability Project 

Getting Ready for the Checkered Flag. Detroit’s trial before U.S. Bankruptcy Judge Steven Rhodes resumed yesterday after he refused to grant an extension of the timeout requested by FGIC, with Martha Kopacz, the court-appointed financial expert, asked by the court: “Is it likely that the City of Detroit after (emerging from bankruptcy) will be able to sustainably provide basic city services to the citizens of Detroit and meet the obligations in the plan without the probability of a significant default?” Ms. Kopacz answered in the affirmative.  Judge Rhodes followed up by asking Ms. Kopacz whether she was confident in her conclusions. She testified that she was. Later testimony focused on the financial assumptions the city used to establish how much its two pension systems were underfunded and forecasts for future pension investment returns and liabilities. The trial will resume this morning at 8:30.

The Denouement. Judge Rhodes’ query to Ms. Kopacz will be the question—in the end—that Judge Rhodes, alone, will have to answer. As the pace of the trial has accelerated inside and outside the courtroom, both the allotted time for the trial is elapsing, as is the time for Governor Rick Snyder’s Emergency Manager Kevyn Orr. Mr. Orr’s tenure as emergency manager under Public Act 436 is scheduled to end at the end of the month—at which point the Council can force his departure. It appears that Mr. Orr will transition to what Mayor Mike Duggan last week termed a “bankruptcy adviser” to the Mayor and Council, and governance of the Motor City will revert to self-governance—but governance overseen by a financial oversight board. Detroit’s mayor and a City Council led by President Brenda Jones will have the powers of their respective offices fully restored. But as the wise columnist for the Detroit News, Daniel Howes, asks: “[W]ill their collective posture change and become more resistant to the requirements of a restructuring plan they did not draft?” That is to write that the question burning in Judge Rhodes—who, after all, can only say ‘yes’ or ‘no’ to Mr. Orr’s proposed plan of adjustment—is after Mr. Orr leaves, will the right leaders be in place to administer a plan they did not write—and that no one knows for certain can work?

Less Harried in Harrisburg. Pennsylvania’s House Urban Affairs Committee yesterday unanimously approved legislation to enable the state’s capital city Harrisburg to develop vacant, desolate, underused, or abandoned space under the City Revitalization and Improvement Zone or CRIZ program—a program which authorizes the investment of Pennsylvania tax revenues in designated zones to enable new investment in local economies by redeveloping eligible vacant, blighted, and/or abandoned properties for commercial, hospitality, conference, retail, community, or other mixed-use purposes.. Under the program, eligible municipalities are authorized to create an authority to issue bonds for redevelopment projects, with the bonds repaid using most state and local taxes generated within the CRIZ area during and after construction. Developers are required to supply at least 20 percent of the development cost for the project through private funding. The program, which was created last year, is based on Allentown’s neighborhood improvement zone program, which resulted in more than $500 million in new investment for the city. Under the original legislation, third-class cities with populations above 30,000, except for Harrisburg, which—in the wake of opting not to file for federal bankruptcy protection, went under state receivership, could enroll in the program. Even though Harrisburg successfully exited receivership last March, the committee determined it should be able to participate.

September 15, 2014

Visit the project blog: The Municipal Sustainability Project 

Getting Ready for the Checkered Flag. David Heiman, an attorney for Detroit, this morning, in announcing a settlement with perhaps the bitterest adversary to the Motor City’s proposed plan of adjustment, bond insurer Syncora,  told U.S. Bankruptcy Judge Steven Rhodes that the once “passionate adversaries” had “laid down the swords” and achieved a comprehensive settlement. Among the elements of the deal, through which Syncora will withdraw objections and appeals tied to the city’s plan to shed $7 billion in debt, the bond insurer is expected to receive approximately 14 percent recovery on financing it supplied for the burgeoning pension debt, up from about 10 percent. The agreement involves a transfer of property owned by the city and extension of the Detroit-Windsor Tunnel lease to a Syncora subsidiary and a 30-year lease of a parking garage below Grand Circus Park. Syncora will also receive $6.25 million in settlement credits to be used on eligible properties, including the Joe Louis Arena, other parking assets, and real property located within three miles of the tunnel. Mr. Heiman testified that there are aspects of the agreement that still need to be addressed, including complications related to specific parcels that cannot be conveyed to Syncora, but indicated the sides expected to resolve the outstanding issues by close of business tomorrow. Syncora and the city had agreed to a tentative settlement last Tuesday in which the insurer would get a 20-year extension on its deal to operate the Detroit-Windsor Tunnel, a 30-year lease on a city parking garage and millions in bonds and options to purchase city property. Altogether, the deal is difficult to value, but people familiar with the agreement have estimated Syncora will ultimately collect 20% to 25% of the approximately $200 million it’s owed. Ryan Bennett, an attorney for Syncora, told Judge Rhodes the agreement was a “very complicated and creative” resolution to the firm’s relationship with Detroit—coming in the wake of marathon weekend negotiations. The breakthrough was accompanied by a formal apology by Syncora’s attorney for accusing bankruptcy mediators, especially Chief U.S. Judge Gerald Rosen, of “naked favoritism.” (Please see next item below.)

The abrupt announcements this morning could put the Motor City on the verge of reaching a comprehensive agreement on its bankruptcy exit plan with all its creditors—leaving bond insurer Financial Guaranty Insurance Co. (FGIC), which was previously allied with Syncora, remaining as Detroit’s single greatest obstacle to a successful emergency from insolvency, although several hedge funds and more than 600 individuals are still objecting to the city’s proposed plan of adjustment pending before the court for Judge Rhodes’ approval or disapproval. When the Motor City and Syncora reached their tentative agreement last week, there were apprehensions Syncora would first insist upon concessions from Bank of America and UBS, the two global banks — which had agreed to their own $85 million settlement with Detroit on the swaps agreement which the city had argued was illegal, and which had led to the conviction and imprisonment of former Detroit Mayor Kwame Kilpatrick  — with the banks demanding that Syncora and FGIC cover their losses on the interest-rate transaction brokered by Mayor Kwame Kilpatrick’s administration in 2005. Syncora, which is confronting its own solvency apprehensions, had been seeking a release by the two banks from its obligation to cover those losses. In their own settlement with Detroit, UBS and Bank of America are getting $85 million on interest rate swaps worth $290 million—potentially leaving Syncora on the hook for the remainder. Syncora also had objections related to Mr. Orr’s proposal for additional funds to provide millions more to two retiree health insurance trust funds if Detroit were successful in eliminating $1.4 billion in pension debt that Syncora and Financial Guaranty Insurance Co. insured. Nevertheless, Syncora’s decision to withdraw its objections to the city’s restructuring plan enhances the likelihood that Judge Rhodes would approve Detroit Emergency Manager Kevyn Orr’s proposed plan to eliminate $7 billion of the Motor City’s debts and reinvest $1.4 billion in the city’s future sustainability. At the same time, however, hopes for an agreement with Detroit’s key holdout creditor, FGIC, remain in question—albeit, with the clock clicking down, the pressure on FGIC to come to an agreement with the city or face a significant loss is tightening the screws. With Judge Rhodes making it ever so clear he will not allow Detroit to exit bankruptcy unless he is convinced the city’s proposed plan of adjustment will provide for a sustainable future, FGIC does not want to be the last creditor standing.

Mea Culpa. In addition, this a.m., Syncora issued a formal apology to U.S. Chief Judge Gerald Rosen—filing a four-page apology to Judge Gerald Rosen and mediator Eugene Driker, who the firm had accused of engineering a “fraudulent” plan to rescue Motor City retirees and to preserve city-owned art at the Detroit Institute of Art at the expense of other creditors, writing “We are deeply sorry for the mistake we made and for any unfounded aspersions it may have cast on Chief Judge Rosen and the Drikers.” Judge Rhodes responded that the apology resolved a pending consideration from the judge to sanction the bond insurer over its “scandalous and defamatory” claims against the mediation team.

Detroit Bankruptcy Trial: Day 2: Let the Battle Begin

             September 4, 2014

Visit the project blog: The Municipal Sustainability Project 

Day 2.  The second day of the historic trial where Judge Rhodes will have to determine whether Detroit’s proposed plan of adjustment is fair, feasible, and in the best interest of creditors will be a task, as this day emphasized, more complex than any previous trial in U.S. history, because, under the city’s proposed plan, the city’s tens of thousands of creditors would get vastly different returns on their claims. Under the proposed plan, current and former employees, as well as investors, will be forced to take less than the $10.4 billion they are owed if Judge Rhodes approves the plan, which proposes to cut $7 billion of the debt. Detroit’s attorney, Bruce Bennett, began the second day of the trial by arguing that a dismissal will lead to higher taxes and a rush to the courthouse by creditors trying to recoup money. “Dismissal followed by increased taxes will only mean the downward spiral will continue or get worse,” Bennett told the judge. “We don’t need to guess about the future or gaze into crystal balls.” Bennett spoke for about three hours over two days. On Tuesday, he argued that Detroit will not survive being kicked out of bankruptcy court. “This is the city’s last, best chance and it’s going to work,” Bennett said early Wednesday. He acknowledged the plan, which includes about $1.4 billion to upgrade public safety and other services, is not perfect. “In the future, things will happen that we haven’t planned for,” Bennett said. “Unexpected things will most certainly happen and other people, not the emergency manager and not necessarily the team that put all this together is going to have to adjust to the future over time,” Bennett continued. “We expect those adjustments. We expect those changes. They are impossible to predict or nail down.” In closing, he paraphrased Gov. Rick Snyder, who authorized the city’s bankruptcy filing in July 2013. The bankruptcy “should not be viewed as the lowest point in the city’s history, but the beginning of the city’s recovery.” “The facts will show that Detroit has earned this court’s help in escaping from its current distressed state,” Bennett told Rhodes. The second day of Detroit’s municipal bankruptcy trial quickly got to the heart of the matter, with holdout creditor Syncora telling the federal court the Motor City had “a million ways” to raise funding to pay off its more than 100,000 creditors; while holdout creditor Syncora’s lawyer testified before Judge Rhodes that Detroit cannot legally justify treating its retirees better than financial creditors―demanding that it be paid 75 percent of what it believes it is owed, rather than pennies on the dollar—or as its attorney, Marc Kieselstein testified: “Something that’s within shouting distance” of Detroit pensioners.” Challenging everything from Detroit’s access to casino tax revenue and its ability to fix the city’s broken streetlights, pushing for the sale of city-owned art and trying to access retirees’ personal financial information; Mr. Kieslstein described Kevyn Orr’s proposed plan of adjustment as “record-breaking, bone-crunching” discrimination. Syncora and fellow bond insurer Financial Guaranty Insurance Co. — which is on the hook for more than $1 billion — claim the city’s debt-cutting plan pays them as little as 6 cents on the dollar for the $1.4 billion in troubled pension debt they insured to help former Mayor Kwame Kilpatrick prop up the city’s pension funds in 2005. Mr. Kieselstein argued that Detroit’s Emergency Manager and key architect of the city’s plan of adjustment pending before the court, Kevyn Orr, improperly considered the “human dimension” of pension cuts when he devised the plan of adjustment: “This plan has epic levels of discrimination…“It didn’t have to be this way.” He added: “This isn’t ‘Back to the Future.’ Mr. Orr is not Marty McFly. He cannot pilot the DeLorean back in time” and change the fact that the city’s plan does not meet the law’s requirement to be in the “best interests” of creditors. The deal should face higher scrutiny, and be rejected, because it causes “unfair discrimination’’ between two groups of unsecured creditors — retirees and bondholders, Mr. Kieselstein said. Detroit does not have any evidence that justifies the disparate treatment, he added.  But Sam Alberts, an attorney for the U.S. government-appointed Official Committee of Retirees, told the court the cuts would be “life-changing” for retirees and that they would otherwise face “drastic” reductions in health care benefits, adding that Detroit’s former work force was also seeing significant, costly changes to its health care benefits and was hardly getting away without pain: “The benefit reductions to these retirees are, by any measurement, life-changing.”

Nevertheless, Mr. Kieselstein further sought to attack the grand bargain, telling the court it would have a “devastating impact” on financial creditors — that it was nothing more than a “fraudulent transfer,” with Syncora’s lead attorney adding that all of the bankrupt city’s creditors could get 75 percent of their debt paid back if the city “maximized the value of the art collection as well as other assets.” The attorney further testified that Detroit “has many options for raising revenue that have not been explored fully enough,” promising this would be “proven during the course of court proceedings.” Those involved with $1.4 billion of certificates the city issued in 2005 could come away with little or nothing, while city workers with pensions would take comparatively smaller losses. “Bankruptcy is, sadly, the land of broken promises,” said Mr. Kieselstein, who said that the city had unfairly and needlessly chosen some creditors over others since it filed for bankruptcy protection in July 2013.

The Fine Art of Municipal Bankruptcy. Holdout creditors also attacked the city’s refusal, in its plan of adjustment, to sell the art from the Detroit Institute of Art—in effect attacking the dynamic heart of the city’s plan for exiting bankruptcy: the so-called grand bargain, with FGIC’s attorney, Alfredo Perez, attacking the city’s claim that it would be take a long time to determine whether art can be sold the world renowned DIA, and telling the court the Institute has limited economic value for the region—prompting Judge Rhodes to ask Mr. Perez: “If the city owned the schools that its children were educated in…would you want those sold or monetized too?”  To which Mr. Perez responded no, telling the court schools are vital to the wellbeing of the people of the city. (DIA attorney Arthur O’Reilly had already, in his opening statement, testified that it is clear the art is held in trust for the public’s benefit and cannot be sold under any circumstances, vowing to fight any future plans to sell art “on an object-by-object basis if necessary.”). Mr. Perez said most of the DIA’s collection was donated to the city without conditions attached — but that even those pieces could probably be sold because bankruptcy allows debtors to slash contracts. But Mr. O’Reilly testified that the grand bargain and the case “is about respecting charitable donations and the people’s right to art and culture.” He testified that about 95 percent of the DIA’s collection of 60,000 pieces was donated or acquired with donated money, warning that a bankruptcy case dismissal would jeopardize the art collection; he vowed to fight “piece by piece” any attempt to liquidate art, telling the court, the façade of the DIA reads: “Dedicated by the people of Detroit to the knowledge and enjoyment of art,” and asking: “What would that mean if that statement was rendered a dead letter?” O’Reilly asked the judge. O’Reilly spoke after the city’s lawyer wrapped up his opening statements in Detroit’s bankruptcy trial Wednesday. Bennett warned about dire results if the city is unable to dump more than $7 billion in debt and free up money for improved services.

Transition Back to Local Elected Leaders. Yesterday, attorneys for Mr. Orr’s team told Judge Rhodes that the proposed plan of adjustment’s $1.4 billion reinvestment plan has critical support from the city’s elected officials, despite some apprehensions about details of the plan—a key point, because Judge Rhodes has emphasized that the city’s elected leaders must be committed to the plan after Mr. Orr is gone—a departure that could happen within weeks. Mayor Mike Duggan and City Council President Brenda Jones are scheduled to testify during the trial that they understand the plan of adjustment and will implement it—albeit, Mr. Orr’s lead attorney in the trial, Bruce Bennett, yesterday acknowledged that some changes will be necessary to accommodate for unforeseen events. He argued that the plan of adjustment will place the city on a path to an economic recovery by restoring services and drastically reducing the city’s crushing debt load: “In the future things will happen that we have not planned for…(and the city) will have to adjust,” adding that the restructuring would prove that Michigan Governor Rick Snyder was correct to authorize the largest municipal bankruptcy in U.S. history.

Scrambling in Scranton. Pennsylvania Auditor General Eugene DePasquale has warned that the City of Scranton could be forced to file for municipal bankruptcy in three to five years, because its pension funds are poised to run out of money. The sobering news, presented at a press conference at City Hall, is contained in an audit Mr. DePasquale’s office conducted of the funds’ condition from January 2011 to January 2013. The municipality’s pension funds face paying out as much as $10.5 million owed to retired police and firefighters because of the $21 million back pay court award to active members—a report the auditor general’s office did not even evaluate in its audit. With a funding ratio of just 16.7 percent, the city’s firefighters fund is in the worst condition of any plan in the state, according to the state auditor—with benefits at risk in as soon as 2½ years. The non-uniform fund isn’t much better, projected to be insolvent in 2.6 years, while the police fund has less than five years. The fiscal dilemma came as Mr. DePasquale is visiting municipalities across the Liberty Bell state to draw attention to the public pension crisis. Pennsylvania sports the greatest number of public pension systems of any of the 50 states—and the auditor’s office is apprehensive that hundreds of other municipalities have severely distressed plans, defined as having a funding ratio (the percent of liabilities covered by assets) of less than 50 percent. In Scranton, according to Mr. DePasquale, he is especially apprehensive about the 16.7 percent funding ratio for the firefighters fund. His audit shows the pension funds’ financial condition steadily deteriorated over the past few years, despite the city’s contributions. Six years ago, Scranton contributed $3.3 million to its three retirement funds; the city’s pension fund’s financial advisor last week announced the contribution for 2015 will be $15.8 million. However, the city could pay $12.3 million because a state law allows Act 47 distressed municipalities to reduce contributions. But, as the Auditor General noted: it’s clear the severely financially distressed city cannot afford to continue making those types of payments, making bankruptcy “a clear possibility within five years.” For its part, the city recently adopted a commuter tax, which is expected to raise $5 million annually for the pension funds. Now Scranton is considering selling its sewer authority to make a one-time payment to the funds. City officials are also talking with unions about possible pension concessions, according to the Mayor. While the Auditor General had praise for the city’s efforts to catch up, he is concerned that more must be done―focusing on reform to the municipal pension system, including: consolidating plans into a statewide system and increasing funding to municipalities with distressed plans, adding: “We don’t see any way this can be fixed by Scranton alone…I believe strongly that a statewide solution is needed.” Even though Gov. Tom Corbett and the Pennsylvania Legislature debated state pension system reform this summer, it has yet to address the pension crisis some municipalities face.

Rolling the Dice. With its economic mainstay—casinos—closing at a record pace, Atlantic City is turning to its homeowners to avoid insolvency and meet bond payments in the wake of some 33% of its casinos to go dark. The city’s $261.4 million budget for 2014, with 14% of revenue dedicated to debt service, includes a 29% increase in property taxes—that is a 29% increase in addition to last year’s 22% increase. Atlantic City Mayor Don Guardian plans for the city to issue $140 million of debt by year-end in order to satisfy tax appeals for casinos, which opened in Atlantic City in 1978 and heretofore have paid about 70 percent of the city’s property tax levies. But with the seemingly endless run of casino closings, the city is both being forced to issue more debt—and to find other revenue sources. Atlantic City homeowners paid an average of $5,273 annually last year, but this year, warns Finance & Revenue Director Michael Stinson, those amounts will likely have to increase as will its borrowing, although the city’s costs of borrowing will be state-supported under the Garden State’s Qualified Bond Act, with payments tied to $20 million in state aid. The program will earn the bonds a credit grade that is one level below New Jersey’s, notwithstanding Moody’s reduction in the city’s credit rating to junk this summer. Revel Casino Hotel, which closed this week, is the third gambling destination to shut this year, after Caesars’ Showboat last week, and the Atlantic Club in January. Trump Plaza is scheduled to close the week after next—meaning some 33% of the city’s casinos will have closed this year—at a cost of not just significant cuts in property tax revenues, but also about 7,300 jobs. In addition, Atlantic City faces payments to casinos that have appealed tax bills after the recession eroded their assessed property values. With a poverty level of approximately 30 percent –and a homeownership rate of 34 percent, about half the state average, according to Census data, the turn of gambling events could have significant repercussions for remaining homeowners. Atlantic City was the No. 2 U.S. gambling destination until 2012, when it was overtaken by Pennsylvania. New Jersey Governor Chris Christie has invited casino representatives, elected officials, and labor leaders to a meeting next Monday in an effort to reverse the adverse momentum—looking to draw up a blueprint based on retail, entertainment, tourism, and other non-casino revenue. The bleak fiscal situation comes just four years after Governor Christies announced a five-year plan to revive the city, including $261 million in tax breaks to the Revel Casino and the creation of a state-run tourism district. There is concern that was a bet that has not paid.

Detroit Preps for Historic Trial, Puerto Rico opts for power over bondholders, and Pennsylvania’s capitol city watches its purse.

             August 28, 2014

Visit the project blog: The Municipal Sustainability Project 

Drip. Yesterday’s Michigan Finance Authority sale of some $1.8 billion in municipal revenue bonds on behalf of the Detroit Water and Sewerage Department to finance the purchase of debt from investors attracted orders from about 64 institutional buyers, including many who participated in the department’s tender offer program, according to the Detroit Water & Sewerage Department (DWSD), netting the Motor City an estimated $249 million of interest rate savings over the life of the bonds. DSWD officials credited the favorable outcome to bond rating upgrades, investor outreach, and U.S. Bankruptcy Judge Steven Rhodes approval Monday of the voluntary tender offer and refinancing, noting that despite the city of Detroit’s municipal bankruptcy status, its outreach and strategic and financial plan, combined with updates on the Detroit economy by community leaders, and a tour of the sewage treatment plant appear to have contributed to the successful sale of the $855 million of senior and second lien water bonds and $937 million of senior and second lien sewage bonds. Bond documents warn several times that Detroit is at risk of filing for Chapter 9 bankruptcy again—in which case, according to the documents―the water and sewer bonds are subject to extraordinary optional redemption at par. Detroit will amend its plan of debt adjustment and treat all of the water and sewer debt as unimpaired once the sale closes and the tendered bonds are purchased, with the untendered bonds continuing to get the scheduled principal and interest payments. DWSD’s bond portfolio totals $5.2 billion.

The Unfine Art of Municipal Bankruptcy.  Art Capital Group has offered to loan the Motor City as much as $4 billion, but only on the condition that the City would, in effect, broach the so-called Grand Bargain and instead pledge the Detroit Institute of Arts and its collection as collateral to secure the loan, in effect handing over rights to the city-owned museum’s internationally acclaimed collection—and, likely, forcing the city to sell some of the Institute’s artwork to help finance the loan. But the deal would require the city to pledge the Detroit Institute of Arts and its collection as collateral to secure the loan — a process that would be highly unlikely considering it would require a legal battle over rights to the city-owned museum’s prized collection. The pre-trial move by Art Capital Group LLC is supported by Financial Guaranty Insurance Co. (FGIC) and implicitly supported by Syncora Guarantee Inc., two holdout creditors of the city—with Art Capitol purporting that it has made the offer in an effort to provide “the city, and the entire community, $3 billion to $4 billion.” The New York-based Art Capital wrote in a prepared statement. “Our goal is to do everything we can to keep the DIA’s art collection in the city and intact. We’ll work with the city to structure the loan with the flexibility needed so it does not become an unreasonable burden.” FGIC called the Art Capital offer “a game changer,” adding: “It represents a real and viable solution that could enhance recoveries for all creditors by billions of dollars and catalyze the revitalization of the City — while also keeping the DIA collection in Detroit. Choosing to proceed with the inferior ‘Grand Bargain’ would be opting to disregard common sense at the expense of all parties…The city cannot ignore the fact that the Art Capital proposal is a game changer…It represents a real and viable solution that could enhance recoveries for all creditors by billions of dollars and catalyze the revitalization of the city – while also keeping the DIA collection in Detroit. It is an extremely attractive option for all stakeholders and a win for all sides. Choosing to proceed with the inferior ‘grand bargain’ would be opting to disregard common sense at the expense of all parties.” The offer, nearly double what the group offered last April, would reduce the city’s indebtedness by nearly 25 percent if accepted—but leave one of its most critical assets for its economic future at risk.  Emergency manager Kevyn Orr’s office yesterday responded that Detroit rejects the offer and stands behind the so-called Grand Bargain that would retain the DIA as an independent entity, and leverage $815 million in combined state aid and non-profit contributions to ensure no city retiree falls below the federal poverty level and that the prized art collection will remain a jewel of the city—with spokesperson Bill Nowling stating: “The city will not sell or leverage the art. This latest proposal is nothing but a thinly veiled attempt by our remaining hold-out creditors to improve their recovery at the expense of the city’s pensioners and its cultural assets,” asserting that acceptance of the proposal would force drastic, double-digit pension cuts to the city’s retirees and undercut the unprecedented state intervention package or grand bargain. FGIC supports the Art Capital offer, noting: “It represents a real and viable solution that could enhance recoveries for all creditors by more than $2 billion and catalyze the revitalization of the city, while also keeping the DIA collection in Detroit.” Detroit’s rejection of the offer also came in the wake of its requested assessment of the offer by ArtVest Partners co-founder Michael Plummer, who Mr. Orr hired to evaluate the value of the world-class Institute. Mr. Plummer determined in his assessment for the city that the Art Capital deal was “not economically viable.” Moreover, Mr. Orr’s office has also questioned whether the DIA’s property legally can be sold: DIA leaders have vowed a legal battle if the city were to pursue a sale or a collateralized loan.

Electric Municipal Bond Jolts. Hedge funds have been negotiating with Puerto Rico’s public power authority (PREPA) over a possible restructuring of more than $8 billion in municipal bonds in the wake of a forbearance agreement the authority entered into two weeks ago, which includes a list of all the bondholders, who represent some 60 percent of PREPA’s $8.3 billion in outstanding municipal revenue bonds. While Puerto Rico’s municipal bonds have traditionally been held by municipal bond mutual funds, the territory’s deteriorating fiscal condition and inability to file for federal bankruptcy protection has led to financial contortions as a means of averting insolvency. The list includes 15 creditors, of which three of those were already known to have been a part of the forbearance agreement—and which three filed suit against Puerto Rico earlier this year to annul a new law that allows public corporations such as PREPA to restructure their debt. A key issue is that PREPA’s forbearance arrangements with creditors reinforce banks’ claims of priority over bondholders in receiving repayment—a situation which makes it more difficult for the territory’s municipal bondholders to force increases in PREPA rates. PREPA has about $8.3 billion in bonds outstanding; the utility has indicated it will restructure its debt next March. Under the first agreement, the bondholders gave up their rights to sue PREPA for at least several months and signed non-disclosure agreements. With insufficient resources to both continue operations and make interest payments to its municipal bondholders, the utility has been paying its operational expenses in order to ensure continuity in its operations—before making its interest payments to its municipal bondholders—almost as if it were in a chapter 9 municipal bankruptcy—even though, because it is not a municipality, it cannot legally seek federal authority to do so. According to PREPA’s forbearance agreements with the bondholders and the banks, PREPA has $8.3 billion in outstanding revenue bonds and owes $696 million to Citibank, Scotiabank de Puerto Rico, Banco Popular de Puerto Rico, Oriental Bank, and Firstbank Puerto Rico. Two weeks ago, PREPA made changes to its bond-governing agreement which would make it more difficult for its municipal bondholders during the forbearance period to initiate a legal process to force rate increases. That jolt likely electrified bondholders, because the pre-existing  1974 agreement with its bondholders provided that the utility would adjust its rates so that revenues, at a minimum, would be equal to at least PREPA’s current expenses plus a level covering at least 120% of aggregate principal and interest payments to its bondholders—and that, if PREPA failed to follow said agreement, and if 10% of the bondholders requested the bond trustee to take action, then the trustee was directed to sue PREPA to force it to increase its rates. However, under a critical portion of the forbearance portion of the agreement, triggering an adjustment would require 50 percent of the bondholders to initiate such a suit—an outcome considered unlikely, thereby putting off any potential electric confrontation until the current agreement expires next March, when the utility intends to introduce a restructuring plan. Moreover, the utility claims that if it were to file for the protection of the Public Corporations Debt Enforcement and Recovery Act for restructuring during the forbearance period, the forbearance agreement itself would be voided.

Harried in Harrisburg. Harrisburg, Pa. Mayor Eric Papenfuse, in the wake of charges by the Dauphin County DA that the capitol city’s Treasurer, John Campbell, had stolen from a nonprofit, Tuesday said there was no threat to the city: “All accounts are in order and the city treasury continues to function in the midst of this dilemma.” The clarification came hours after Dauphin County District Attorney Ed Marsico charged Mr. Campbell with writing 10 checks to himself totaling about $8,400 from the account of Historic Harrisburg Association while he was its executive director. Mayor Papenfuse Tuesday named former City Treasurer Paul Wambach to oversee the office in Campbell’s absence, with the municipality’s solicitor stating: “As chief executive officer of the city, the mayor has an obligation to protect the city’s assets…Under that, he can take whatever steps he deems necessary as long as it’s not contrary to state law or the Constitution.” The County is charging him with theft by failure to make required disposition of funds received and a charitable organizations act violation. The financial charges against Mr. Campbell come in the wake of Harrisburg’s so far successful efforts to recover from the brink of municipal bankruptcy. (Unrated Harrisburg late last year began implementing a financial recovery plan that erased $600 million of debt, largely through the sale of the city incinerator and a long-term lease of parking assets. The plan includes four years of balanced city budgets and other measures designed to repair Harrisburg’s reputation in the capital markets. Incinerator and parking bond sales both closed in late December.) The Mayor indicated he fully expected Mr. Campbell to resign, warning that if he did not, the city would go to court “to settle this matter once and for all…We have cut off Mr. Campbell’s Internet access and he will not be welcome here on the premises.” In addition, the Mayor made clear that the treasurer and city controller must sign off on all city checks—adding that the issue came to light (no pun) after the Historic Harrisburg Association noticed the money missing several weeks ago, when it intended to reimburse the city toward $24,000 it had pledged under its Lighten Up Harrisburg program to help fix street lights. The Mayor noted that the city has yet to receive any reimbursement.