The Fiscal Straits of Federalism: constitutional, fiscal, and human challenges for state and local leaders.

08/11/17

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Good Morning! In this a.m.’s blog, we consider the dire state of Hartford, Connecticut and the ongoing constitutional and fiscal challenges to the U.S. territory of Puerto Rico.

Fiscal Heart for Hartford? With no state budget in sight, the first day of school looming, Moody’s this week gloomily wondered whether the capitol city can avoid chapter 9 municipal bankruptcy via a path of debt restructuring and labor concessions as it contemplates looming debt payments of $3.8 million next month, and then $26.9 million in tax anticipation note payments in October. Moreover, given the grim state of Connecticut’s own fisc—upon which Hartford relies for half its municipal budget, Halloween could bring more than fiscal ghouls. Its options, moreover, as we have previously noted, are slim: with one fifth of its municipal budget composed of fixed costs, the option of increasing taxes—in a city with the highest tax rates in the state—would risk the loss of key businesses, potentially reducing, rather than increasing vital revenues. Thus, the challenge of meeting increased debt service costs and rising OPEB and pension obligations seem to more and more point to municipal debt restructuring.

If anything, the fiscal challenge is further complicated by the uncertainty on the state front: Connecticut has yet to adopt the budget for the fiscal year that began on July 1st: legislators have been unable to achieve consensus on a new two-year plan the governor will sign to address the state’s own projected $3.5 billion deficit. Indeed, Gov. Daniel P. Malloy’s budget, which proposes shifts of state education aid from wealthier communities to poorer communities, promises difficult negotiations with an uncertain outcome. Patrice McCarthy, the deputy director and general counsel at the Connecticut Association of Boards of Education, warned that while there were previous state budget impasses in 1991 and 2009, this year could be much worse for public school officials: “In those years, while we didn’t have a finalized budget, people had a better idea in each community about how much they’d be receiving: This year, everything is up in the air.”

Fundido. In Latin America, the word fundido can be translated to “dead beat;” while in English, the old expression that one cannot beat a dead horse might seem apt for the challenge confronting U.S. District Judge Laura Taylor Swain, who is presiding over the PROMESA version of a chapter 9 municipal bankruptcy process—a process created under the statute adopted by Congress which Theodore Olson, the former Solicitor General of the United States, this week described in an op-ed to the Wall Street Journal as a law which blatantly violates the Appointments Clause of the U.S Constitution.

Judge Swain this week approved an agreement intended to address creditors’ competing claims with regard to Puerto Rico’s sales tax revenue by the end of this year as part of an effort to resolve an agreement between the island’s two biggest creditor classes, General Obligation bondholders and COFINA bondholders, in part through appointing an agent for each side—agents charged with pursuing the best resolution for their debtor’s estate as a whole, as opposed to advocating for particular creditors of that debtor. (COFINA’s bonds are backed by Puerto Rico’s sales and use tax revenue, unlike Puerto Rico’s General Obligation debt, which carries a constitutional guarantee providing a claim on all of Puerto Rico’s revenues.) Thus, unsurprisingly, Judge Swain had been placed in the position of Solomon: she could threaten to cut the baby in half if the two sides do not reach an agreement by December 15th.  Here, the judicial combatants, who, together, claim to hold approximately half the U.S. territory’s $72 billion in debt, are fighting over which side has the primary claim on sales and use tax revenues.

Separately, Judge Swain this week has held off on responding to a request by creditors of Puerto Rico’s bankrupt power utility, PREPA, to appoint a receiver at the agency, denying a motion by a group of cities and towns to form an official committee in the case, whose attorneys’ fees would be paid by the island’s bankruptcy estate. Judge Swain informed the parties it was unclear whether the municipalities had valid claims against Puerto Rico’s government, a claim which, as we have previously noted, is critical, as Michael Rochelle, an attorney for the muncipios, told the judge his clients are confronted with budget cuts of as much as 50 percent; he plead: “This place will become Greece…We will have municipalities needing to be bankrupted.” Increasingly, too, there are fears that exorbitant legal fees, fees which some experts believe could run to in excess of $1 billion, are coming at the expense of Puerto Rico’s future. In so informing the muncipios, Judge Swain rejected a motion by several municipalities to have a committee representing their interests in Puerto Rico’s Title III case: she said that §1102 of the bankruptcy code allowed committees for creditors or equity security holders, but the municipalities are not the latter, and the municipalities’ principal concerns are not those of being creditors, adding that the municipalities are adequately represented without having their own committee.

The president of the Association of Puerto Rico Mayors, Rolando Ortiz, yesterday made clear the gravity of the fiscal situation, warning that 45 municipalities will be inoperative as early as the close of the fiscal year, under the fiscal plan submitted by Gov. Ricardo Rosselló and certified by the Federal Fiscal Control Board. He noted that the proposal would eliminate a loan of some $350 million, which was granted to municipalities in exchange for exempting public corporations from paying the tax on real property—or, as he stated: “From the fiscal point of view, it leaves us without protection of the judicial apparatus of the country and limits our capacity to serve to the citizens to the extent that they take away resources that we have always used to help the people that we attend in the different cities.”

Indeed, it appears the fiscal impact has already begun to have an effect on the pockets of municipal employees, who have experienced reductions in working hours in 22 municipalities: Arroyo, Toa Alta, Cabo Rojo, Yauco, Las Piedras, Juana Diaz, Comerío, Vieques, Aguadilla, Mayagüez, Toa Baja, Salinas, Adjuntas, Vega Baja, Sabana Grande, Villalba, and Trujillo Alt; five other municipalities had applied the reduction of working hours in previous years. (Ponce, Ciales, Luquillo, Maunabo, and Camuy.) The likely next step, he warned, would be that more municipalities will join the lawsuits filed by the municipalities of San Juan and Caguas—litigation in response to which they said: “The decision of (Judge Swain) what she is going to bring is more cases on the part of the municipalities.” The Mayor of Caguas, a municipality  founded in 1775 of about 150,000 located in the Central Mountain Range, William Miranda Torres, regretted the closure of the judicial door to the municipalities, describing it as a “scenario where they have made decisions, by blow and blow, to make use of our monies without allowing us fair participation,” describing it as “clear discrimination against the municipalities,” noting that the municipalities offer direct services to the citizenry, including  maintenance to infrastructure, health, safety, emergency management, programs to the elderly, garbage collection, cultural programs, fine arts programs and sports programs—adding: “The central government has been stripping municipalities of important resources to provide essential services that will now be very difficult to cover. The humanitarian crisis has come and closing doors give us very few possibilities to fight it from where we can best do it.”

For her part, San Juan Mayor Carmen Yulin Cruz recalled that her municipality continues along the route to sue under PROMESA’s Title VI, even as she praised the management of mayors who filed their appeal by way of Title III: “If the judge (Judge Swain) said it was not for Title III, at least those comrades dared to challenge PROMESA.”

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.

Getting into and out of Municipal Bankruptcy

07/10/17

Good Morning! In this a.m.’s eBlog, we consider the exceptional fiscal challenge to post-chapter 9 Detroit between building and razing the city; then we head East to Hartford, where the Governor and Legislature unhappily contemplate the Capital City’s fiscal future—and whether it will seek chapter 9 bankruptcy, before finally returning the key Civil War battlefield of Petersburg, Virginia—where a newly brought on Police Chief mayhap signals a turnaround in the city’s fiscal future.  

Raising or Razing a Municipality? Detroit, founded on July 24th in 1701 by Antoine de la Mothe Cadillac, the French explorer and adventurer, went on to become one of the country’s most vital music and industrial centers by the early 20th century; indeed, by the 1940’s, the Motor City had become the nation’s fourth-largest city. But that period might have been its apogee: the combination of riots and industrial restructuring led to the loss of jobs in the automobile industry, and signal white flight to the suburbs; since reaching a peak of 1.8 million in the 1950 census, Detroit’s population has declined precipitously: more than 60%.  Nevertheless, it is, today, the nation’s largest city on the U.S.—Canada border, and, with the imminent completion of the Gordie Howe Bridge to Canada, the city—already the anchor of the second-largest region in the Midwest, and the central city of a metro region of some 4.3 million Americans at the U.S. end of the busiest international crossing in North America; the question with regard to how to measure its fiscal comeback has been somewhat unique: it has been—at least up until currently, by the number of razed homes. Indeed, one of former Mayor Dave Bing’s key and touted programs was his pledge to raze 10,000 homes—a goal actually attained last year under Mayor Mike Duggan—under whose leadership some 11,500 homes have been razed. Mayor Duggan reports his current goal is to raze another 2,000 to 4,000 annually—so that, today, the city is host to the country’s largest blight-removal program—a critical component of Detroit’s future in a municipality which has experienced the loss of over one million residents over the last six decades—and where assessed property values of blighted and burned homes can be devastating to a municipality’s budget—and to its public schools. Worse, from a municipal governing perspective, is the challenge: how do the cities’ leaders balance helping its citizens to find affordable housing versus expenditures to raze housing—especially in a city where so many homeowners owed more than their homes were worth after the 2008 housing collapse?

Mayor Duggan’s response, moreover, has attracted the focus of multiple investigations, including federal subpoenas into bidding practices and the costs of demolitions—even as a separate grand jury has been reported to have subpoenaed as many as 30 contractors and Detroit municipal agencies, and Michigan officials have sought fines, because contractors mishandled asbestos from razed homes. Mayhap even more challenging: a recent blight survey by Loveland Technologies, a private company which maps the city, questions whether demolition is even keeping pace with blight in Detroit: the report indicates that vacancies in neighborhoods targeted for demolition have actually increased 64% over the last four years.

Hard Fiscal Challenges in Hartford: Is there a Role for the State? The Restructuring of Municipal Debt. Connecticut Gov. Daniel Malloy stated that the state would be willing to help the City of Hartford avoid chapter 9 municipal bankruptcy—but only if the city gets its own financial house in order, with his comments coming in the wake of the decision by Mayor Luke Bronin to hire an international law firm with expertise in municipal bankruptcies—with the Mayor making clear the city is also exploring other fiscal alternatives. Gov. Malloy has proposed offering millions more in state aid to the capital city in his budget proposal, to date, the state legislature, already enmired in its own, ongoing budget stalemate—has not reacted. Thus, the Governor noted: “I don’t know whether we can be all things to all people, but I think Hartford has to, first and foremost, help itself…But we should play a role. I think we need to do that not just in Hartford, but in Bridgeport and New Haven, and other urban environments and Waterbury. There’s a role for us to play.” The stakes are significant: Hartford is trying to close a $65 million fiscal gap—a gap which, should it not be able to bridge, would mean the city would have to seek express, prior written consent of the Governor to file a municipal bankruptcy petition (Conn. Gen. Stat.§7-566)—consent not yet sought by the city—or, as the Governor put it on Friday: “There’s no request for that…I don’t think they’re in a position to say definitively what they are going to do. I’m certainly not going to prejudge anything. That should be viewed as a last resort, not as a first.”

House Speaker Joe Aresimowicz (D-Berlin and Southington) and a former Member of the Berlin Council, reports the legislature could vote as early as a week from tomorrow on a two-year, $40 billion state budget, albeit some officials question whether a comprehensive agreement could be reached by that date, after the legislature has missed a series of deadlines, including the end of the legislative session on June 7th, not to mention the fiscal year of June 30th.  Meanwhile, the city awaits its fiscal fate: it has approved a budget of nearly $613 million, counting on nearly half the funds to come from the state; meanwhile, the city has hired the law firm of Greenberg Traurig to begin exploration of the option of filing for bankruptcy—or, as Mayor Bronin noted: “One important element of any municipal restructuring is the restructuring of debt…They will be beginning the process of reaching out to bond holders to initiate discussion about potential debt restructuring.”

Municipal Physical & Fiscal Safety. The fiscally challenged municipality of Petersburg, Virginia has brought on a new Chief of Police, “Kenny” Miller, a former Marine with 36 years of law enforcement experience.  Chief Miller views his new home as an “opportune place to give back” after a “blessed” career with one of Virginia’s largest police agencies—in the wake of serving 34 of his 36 years as an officer with the Virginia Beach Police Department. Chief Miller, who was sworn in last Friday afternoon, in the wake of a national search, noted: “You got to get out there and engage people…If people see that you care, they know you care. You can’t police inside of a building,” adding: “Engagement means working with the community…Solving problems together. People that live in the communities know the problems better than I do just passing through…We need to break down some barriers and get some trust going.” Chief Miller commences in his new role as the historic city seeks to turn around a fiscal and leadership crisis—one which left some parts of city government in dysfunction. The police department has had its own woes—including the Police Department, where, a year and a half ago, former Petersburg Chief John I. Dixon III acknowledged, after weeks of silence, that an audit of the department’s evidence and property room turned up $13,356 in missing cash related to three criminal cases—a finding which led former Petersburg Commonwealth’s Attorney Cassandra Conover to ask Virginia State Police to investigate “any issues involving” the police department that had come to her attention through “conversations and media reports” of alleged police misconduct or corruption—an investigation which remains ongoing. But the new Chief will face a different kind of fiscal challenge in the wake of the resignations of 28 sworn officers who have resigned in the last nine months after the city’s leaders imposed an across-the-board 10 percent pay cut for the city’s nearly 600 full-time workforce a year ago—and dropped 12 civilians from emergency communications positions. Nevertheless, Chief Miller said he was attracted to Petersburg because “the job was tailor-made for me. It’s a city on the rise, and I wanted to be part of something good…I don’t do it for the money. I’ve been blessed. I want to give back, (and) Petersburg is the opportune place to give back…The community members and the city leadership team are all working together to bring Petersburg to a beginning of a new horizon: “So why not be a part of that great opportunity?”

Chief Miller enters the job as Petersburg is straining to overcome a fiscal and leadership crisis that left some parts of city government in dysfunction; moreover, the police department has had its own woes. Seventeen months ago, former Petersburg police Chief John I. Dixon III acknowledged after weeks of silence that an audit of the department’s evidence and property room turned up $13,356 in missing cash related to three criminal cases. That led former Petersburg Commonwealth’s Attorney Cassandra Conover to ask the Virginia State Police to investigate “any issues involving” the police department which had come to her attention through “conversations and media reports” of alleged police misconduct or corruption. Nevertheless, Chief Miller reports he was “intrigued” by those officers who stayed with the force in spite of the pay cut “and showed virtue with respect to policing: Policing isn’t something that you do, it’s what you are: There are men and women there who really care about the city, and (those) people stayed.” He adds, he was attracted to Petersburg, because “the job was tailor-made for me. It’s a city on the rise, and I wanted to be part of something good…I’m now in my 36th year in law enforcement…And I don’t do it for the money. I’ve been blessed. I want to give back, (and) Petersburg is the opportune place to give back. The community members and the city leadership team are all working together to bring Petersburg to a beginning of a new horizon: So why not be a part of that great opportunity?” According to an announcement of his appointment as Petersburg’s Chief on Virginia Beach’s Facebook page: “[H]is connection with multiple civic leaders and groups throughout the city have forged and strengthened deep bonds between the Virginia Beach community and the police department.”

Are There non-Judicial Avenues to Solvency?

Good Morning! In this a.m.’s eBlog, we consider the increasing threat to Hartford, Connecticut’s capitol, of insolvency; then we look at the nearing referendum in Puerto Rico to address the U.S. Territory’s legal status.

Can Chapter 9 Be Avoided? As the Connecticut legislature nears ending its session, House Majority Leader Matthew Ritter (D-Hartford) has been taking the lead in efforts to commit tens of millions of state dollars to rescue the city—but, as the Leader noted: “There are going to be strings;” the price to the municipality will be greater state control—however, what that control will be and how implemented remains unclear. One key issue will be the city’s looming pension challenge: the city’s current $33 million in annual obligations is projected to increase to $52.6 million by FY2023—ergo, one option for the state would be to utilize an oversight board to re-negotiate union contracts, a move used before by the state for Waterbury—and a step Mayor Luke Bronin had proposed last year—only to see it rejected. His efforts to seek a commitment for $15 million in givebacks by the unions this year succeeded in getting only one tenth that amount, $1.5 million—and came as the local AFSCME Council recently rejected a contract which could have saved the city $4 million.

The inability to agree upon voluntary steps to address the nearing insolvency has pushed state leaders, increasingly, to discuss the creation of a state financial control board as a linchpin to any state bailout of the city—with leaders discussing a board composed evenly of state, local, and union representatives. Connecticut’s law (§7-566) requires the express prior written consent of the Governor—obligating him to submit a report to the Treasurer and General Assembly—actions taken twice before in the cases of Bridgeport (1991) and the Westport Transit District; however, each case was resolved without going through the legal process and submission of a plan off debt adjustment. Indeed, there is, as yet, little consensus in the state legislature with regard to what oversight governance would include: one option under consideration would impose a spending cap, while another would provide for state preemption of the city’s authority to negotiate with its unions: the Majority Leader notes: “I think that if we could get these concessions agreed to and reach the savings that have been targeted…it would go a long way to limiting the amount of oversight in the city of Hartford.” Whatever route to restoring solvency, tempus fugit as the Romans used to say: time is fleeing: the city’s deficit is just under $50 million, even as the departure of one of its biggest employers, Aetna, looms—and, as we had reported in Providence, the city has a disproportionate hole in its property tax base: state and local government agencies, hospitals, and universities occupy 50% of the city’s property. Add to that, the city’s current authority to levy property tax limits such collections to an assessed value of 70 percent.

Mayor Bronin, recognizing that state help is critical, notes his “goal and hope is that legislators from around the state of Connecticut will recognize that Hartford cannot responsibly solve a crisis of this magnitude at the local level alone.” State aid will be critical for an additional reason: absent such assistance, the city’s credit rating is almost certain to deteriorate, thereby driving up its costs for capital borrowing.  Adding to the urgency of fiscal action is the pending departure of Aetna from the city: even though city leaders believe the giant health care corporation will keep many of its 6,000 employees in Connecticut, notwithstanding its negotiations with several states to relocate its corporate headquarters from Hartford, Aetna has stated it remains committed to its Connecticut employees and its Hartford campus. (Aetna and Hartford’s other four biggest taxpayers contribute nearly 20% of the city’s $280 million of property-tax revenues which make up nearly half the city’s general fund revenues.) The companies have imposed a fiscal price, however: Aetna, together with Hartford Financial Services and Travelers have offered to contribute a voluntary payment of $10 million annually over the next five years to help the city avoid chapter 9 municipal avoid bankruptcy, but only on the condition there are comprehensive governing and fiscal changes. But the companies have said they want to see comprehensive changes in how Hartford is run—including vastly reducing reliance on the property tax—a tax rate which the city has raised seven times in the past decade and a half to rates 50% greater than they were in 1998. Thus, with time fleeing, the city confronts coming up with the fiscal resources to finance nearly $180 million in debt service, health care, pensions, and other fixed costs for its upcoming fiscal budget—an amount equal to more than half of the city’s budget, excluding education; that is, the city’s options are increasingly limited—and the Mayor has made clear that he will not reduce essential public safety. As the Majority Leader describes it, it is in the state’s best interest to make sure the city has a sustainable future, noting that a municipal bankruptcy would not “just affect Hartford: It would affect neighboring communities, it would affect the state, it would probably affect our credit ratings.”

Eliminating local power? Hartford City Council President Thomas Clark is apprehensive with regard to state preemption of local authority, noting hisconcern has always been if this bill is passed–in whatever form it gets passed–what does that do to the elected leadership at the local level?…And I think until we see what that actually includes, we’re just going to be uncomfortable with this concept.” From the Mayor’s perspective, he notes: “Understandably, Connecticut residents do not want their hard-earned tax dollars being used wastefully, or simply funding an increase in the cost of city government…I don’t mind anybody looking over my shoulder…and I don’t mind having the books open. I’m confident in the decisions that we’ve made.” That contrasts with his colleagues on the City Council—and the city’s unions, who have previously charged: “The Governor and this mayor are clutching at their last chance at unconditional and overreaching power.” The unions have claimed there are measures which could be taken without resorting to negating collective bargaining rights and municipal bankruptcy; yet, as we have seen in Detroit, San Bernardino, etc., those efforts were ineffective compared to the pressure of a U.S. bankruptcy judge.

Chartering a Post Insolvency Future? Voters and taxpayers in the U.S. Territory of Puerto Rice go to the polls this Sunday to vote on a referendum on Puerto Rico’s political status—the fifth such referendum since it became an unincorporated territory of the United States. Although, originally, this referendum would only have the options of statehood versus independence, a letter from the Trump administration had recommended adding “Commonwealth,” the current status, in the plebiscite; however, that recommendation was scotched in response to the results of the plebiscite in 2012 which asked whether to remain in the current status—which the voters rejected. Subsequently, the administration cited changes in demographics during the past 5 years as a reason to add the option once again, leading to amendments incorporating ballot wording changes requested by the Department of Justice, as well as adding a “current territorial status” as provided under the original Jones-Shafroth Act as an option. Notwithstanding what the voters decide, however, it remains uncertain what might happen—much less how a Trump Administration or how Congress would react. The referendum was approved last January by the Puerto Rico Senate—and then by the House, and signed by Gov. Rossello last February.

Perspectives on Municipal Bankruptcy

eBlog

Good Morning! In this a.m.’s eBlog, we consider the potential descent into municipal bankruptcy by Hartford—and whether, if, and if so, how, the state might help. Then, as U.S. Judge Laura Swain preps for deliberations to begin tomorrow in Puerto Rico, we consider preliminary agreements yesterday with the U.S. territory’s Government Development Bank. 

A State Capital’s Near Bankruptcy. The Hartford City Council is letting Mayor Tony George get his way in dealing with the Connecticut city’s crushing debt, having voted 3-2 to borrow up to $52 million to restructure the city’s long-term debt (the city has $550 million total debt outstanding), a plan Mayor George has been seeking for months—indeed, the Mayor had given an ultimatum to the Council to approve the plan, or he would seek to have the city declared financially distressed under the state’s Act 47. Councilman Tony Brooks, who had previously opposed the plan, broke the tie, stating: “If I have to choose between debt or a tax increase, I will choose debt.” The votes came in the wake of Mayor Bronin and Hartford Corporation Counsel Howard Rifkin acknowledging that Hartford had been soliciting proposals for law firms in the event of a Chapter 9 bankruptcy filing, even as Gov. Malloy was proposing to draw on the state’s reserves in an effort to the Nutmeg State’s current fiscal-year budget balance in the wake of his Budget Secretary’s reduction in projected state revenues by $409.5 million, a reduction plunging the general fund deficit to minus $389.8 million—making it seem as if the pleading was to Mother Hubbard just when her cupboard was bare.

The cratering fiscal situation was underlined by the additional credit rating downgrade yesterday from S&P Global Ratings, with analyst Victor Medeiros noting: “The downgrade and the credit watch placement reflect the heightened uncertainty on whether the state will increase intergovernmental aid or otherwise lend the necessary state support to enable Hartford to achieve structural balance and prevent it from further fiscal deterioration.” Last year, S&P and Moody’s each hit the city with four-notch downgrades, citing rising debt-service payments, higher required pension contributions, health-care cost inflation, costly legal judgments from years past, and unrealized concessions from most labor unions. Now the Mayor and Council face deficits of $14 million this year and nearly 400% higher next year. Yet even with such projected deficits, Mayor George he has been unable to gain meaningful union concessions—and the outlook for his requested $40 million in additional state aid seems bleak. Mayor Bronin describes the fiscal crisis this way: “Acting alone, Hartford has no road to a sustainable budget path.” Hartford City Administrator Ted Wampole advised the elected officials that the proposed borrowing and debt restructuring plan would put the city in a better cash flow position headed into the new year, albeit warning it would just be the first in a series of difficult decisions the city faces when it comes to finances; he added that all expenses will be evaluated, as will possible ways to increase revenues, noting: “This is the very beginning of what will be a long process…This is something we needed to do. The alternative is we run out of money.”

Could the State Really Help? If there is grim news for Hartford, it is that the state is itself fiscally strapped: Connecticut Governor Danel Malloy has called for virtually wiping out the state’s rainy-day fund.  In Connecticut, a municipality may only file with the express prior written permission or consent from the Governor (see Conn. §7-566)—with Bridgeport, in 1991, the only previous city to ever file for chapter 9 [a filing dismissed in August of the same year]). Now legislative gridlock persists as thousands of state employees face layoffs. Bond rating agencies have hammered both the state and capital city Hartford over the past year. Fitch Ratings at the end of last week dropped Connecticut’s issuer default rating to A-plus from AA-minus, the first to move the state out of the double-A category. Nevertheless, according to Mr. Medeiros, uncertainty over state aid prompted Hartford to seek solicitations for a bankruptcy lawyer: “While a bankruptcy filing remains distant, in our opinion, by raising the possibility, we believe that elected officials are seeking to better understand the legal qualifications, process, and consequences associated with this action if there is no budgetary support at the state level.” Governor Malloy has also announced deficit-mitigation actions in an effort to close the current-year shortfall, writing to Nutmeg state legislators: “I find it necessary to take aggressive steps.” Such steps include draining all but $1.3 million of the budget reserve fund, nearly $100 million in revenue transfers, $33.5 million in rescissions, and $22.6 million in other actions—including cuts in state aid to local governments—cuts which will require legislative approval. Gov. Malloy has also begun a contingency plan for laying off state workers—especially in anticipation, as the state faces a possible FY2018-19 $5 billion shortfall—and political as well as fiscal challenges in a state where the Senate is split evenly between Democrats and Republicans 18-18, and the Democrats hold a slim 79-72 advantage in the House of Representatives.

Gov. Malloy last February proposed a $40.6 billion biennial budget, proposing a shift of teacher pension costs to municipalities—hardly a proposal which would help Hartford—and one which has, so far, encountered little support in the legislature. In a seeming understatement, S&P Ratings noted: “This could help stabilize the share of the state’s budget devoted to its substantial fixed costs, a potentially positive credit development, although it may pressure local government finances.” According to Moody’s, Connecticut continues to have the highest debt-service costs as a percent of own-source governmental revenues among the 50 states, even though it declined from 14.3% to 13.3%. 

Tropical Fiscal Typhoon. Preparations in the Federal Court, in Hato Rey, the U.S. territoriy’s banking district and the closest thing to a downtown that Puerto Rico has, for tomorrow’s first hearing related to the process of restructuring the public debt of Puerto Rico, under Title III of PROMESA before federal Judge Laura Swain are underway: the preparations alone will necessitate rejiggering court rooms, including ensuring one is available for closed circuit TV coverage and another for the general public.  Title III of the federal law PROMESA permits a process of public debt restructuring, which is supervised by a Tribunal, as long as the creditors and the government do not reach agreements that benefit them both.

The trial begins after, yesterday, Puerto Rico announced that the Government Development Bank, which had served as the primary fiscal agent for the U.S. territory, had reached a liquidation agreement with its creditors, avoiding a protracted bankruptcy, with the agreement executed under the terms of Title VI of the PROMESA statute, according to Gov. Ricardo Rossello’s office—an agreement which would avoid a Title III bankruptcy, and, under which the bank’s assets will be split between two separate entities, according to a term sheet made public yesterday. Under the agreement, the first entity, holding $5.3 billion in GDB assets, would issue three tranches of debt with different protections in exchange for varying principal reductions: beneficiaries would include municipal depositors and bondholders, such as Avenue Capital Management, Brigade Capital Management, and Fir Tree Partners. The second entity, funded with public entity loans and $50 million in cash, would benefit all other depositors. While the details remain to be confirmed, the agreement would appear to mean a haircut of approximately 45% for a group of small municipal bondholders in Puerto Rico, with potential losses of up to 45 percent for some bondholders. A spokesperson for the Governor issued a statement on his behalf noting: “[B]efore we are bondholders, we are Puerto Ricans, and we recognize the circumstances that Puerto Rico faces.”

The government bank’s plan represents an end to what was once the equivalent of a central bank in charge of holding deposits from government agencies and Puerto Rico’s nearly 100 municipalities—and marks the steps to comply with the PROMESA Board’s approval last month of steps to wind down the bank.

State Oversight & Severe Municipal Distress

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eBlog, 04/24/17

Good Morning! In this a.m.’s eBlog, we consider the unique fiscal challenge confronting Detroit: when and how will it emerge from state oversight? Then we spin the tables to see how Atlantic City is faring to see if it might be on the shores of fiscal recovery; before going back to Detroit to assess the math/fiscal challenges of the state created public school district; then, still in Detroit, we try to assess the status of a lingering issue from the city’s historic municipal bankruptcy: access to drinking water for its lowest income families; before visiting Hartford, to try to gauge how the fiscally stressed central city might fare with the Connecticut legislature. Finally, we revisit the small Virginia municipality of Petersburg to witness a very unique kind of municipal finance for a city so close to insolvency but in need of ensuring the provision of vital, lifesaving municipal services. 

Fiscal & Physical Municipal Balancing. Michigan Deputy Treasurer Eric Scorsone is predicting that by “early next year, Detroit will be out of state oversight,” at a time when the city “will be financially stable by all indications and have a significant surplus.” That track will sync with the city’s scheduled emergence from state oversight, albeit apprehension remains with regard to whether the city has budgeted adequately  to set funds aside to anticipate a balloon pension obligation due in 2024. Nevertheless, Mr. Scorsone has deemed the Motor City’s post-bankruptcy transformation “extraordinary,” describing its achievements in meeting its plan of debt adjustment—as well as complying with the Detroit Financial Review Commission—so well that the “city could basically operate on its own.” He noted that the progress has been sufficient to permit the Commission to be in a dormancy state—subject to any, unanticipated deficits emerging. The Deputy Treasurer credited the Motor City’s strong management team under CFO John Hill both for the city’s fiscal progress, but also for his role in keeping an open line of communication with the state oversight board; he also noted the key role of Mayor Mike Duggan’s leadership for improving basic services such as emergency response times and Detroit’s public infrastructure. Nevertheless, Detroit remains subject to the state board’s approval of any contracts, operating or capital budgets, as well as formal revenue estimates—a process which the Deputy Treasurer noted “allows the city to stay on a strong economic path…[t]hese are all critical tools,” he notes, valuable not just to Detroit, but also to other municipalities an counties to help ensure “long term stability.”

On the Shore of Fiscal Recovery. S&P Global Ratings, which last month upgraded Atlantic City’s general obligation bond rating two notches to CCC in the wake of the city’s settlement with the Borgata Casino, a settlement which yielded the city some $93 million in savings, has led to a Moody’s rating upgrade, with the credit rating agency writing that Atlantic City’s proposed FY2017 budget—one which proposes some $35.3 million in proposed cuts, is a step in the right direction for the state taken-over municipality, noting that the city’s fiscal plan incorporates a 14.6% cut in its operating budget—sufficient to save $8 million, via reductions in salaries and benefits for public safety employees, $6 million in debt service costs, and $3 million in administrative expenses. Nevertheless S&P credit analyst Timothy Little cautioned that pending litigation with regard to whether Atlantic City can make proposed police and firefighter cuts could be a fly in the ointment, writing: “In our view, the proposed budget takes significant measures to improve the city’s structural imbalance and may lead to further improved credit quality; however, risks to fiscal recovery remain from pending lawsuits against state action impeding labor contracts.” The city’s proposed $206.3 million budget, indeed, marks the city’s first since the state takeover placed it under the oversight of the New Jersey’s Local Finance Board, with the state preemption giving the Board the authority to alter outstanding debt, as well as municipal contracts. Mr. Little wrote that this year will mark the first fiscal year of the agreed-to payment-in-lieu-of-taxes (PILOT) program for casino gaming properties—a level set at $120 million annually over the next decade—out of which 10.4% will go to Atlantic County. Mr. Little also notes that the budget contains far less state financial support than in previous years, as the $30 million of casino redirected anticipated revenue received in 2015 and 2016 will be cut to $15 million; moreover, the budget includes no state transitional aid—denoting a change or drop of some $26.2 million; some of that, however, will be offset by a $15 million boost from an adjustment to the state Consolidated Municipal Property Tax Relief Act—or, as the analyst wrote: “Long-term fiscal recovery will depend on Atlantic City’s ability to continue to implement fiscal reforms, reduce reliance on nonrecurring revenues, and reduce its long-term liabilities.” Today, New Jersey state aid accounts for 34% of the city’s $206.3 million in budgeted revenue, 31% comes from casino PILOT payments, and 27% from tax revenues. S&P upgraded Atlantic City’s general obligation bond rating two notches to CCC in early March after the Borgata settlement yielded the city $93 million in savings. Moody’s rates Atlantic City debt at Caa3.

Schooled on Bankruptcy. While Detroit, as noted above, has scored high budget marks or grades with the state; the city’s school system remains physically and fiscally below grade. Now, according to the Michigan Department of Education, school officials plan to voluntarily shutter some of the 24 city schools—schools targeted for closure by the state last January, according to State Superintendent Brian Whiston, whose spokesperson, William DiSessa, at a State Board of Education meeting, said:  “Superintendent Whiston doesn’t know which schools, how many schools, or when they may close, but said that they are among the 38 schools threatened for closure by the State Reform Office earlier this year.” Mr. DiSessa added that “the decision to close any schools is the Detroit Public School Community District’s to make.” What that decision will be coming in the wake of the selection of Nikolai Vitti, who last week was selected to lead the Detroit Public Schools Community District. Mr. Vitti, 40, is currently Superintendent of the Duval County Public Schools in Jacksonville, Florida, the 20th largest district in the nation; in the wake of the Detroit board’s decision last week to enter into negotiations with Mr. Vitti for the superintendent’s job, Mr. Vitti described the offer as “humbling and an honor.” The school board also voted, if Mr.Vitti accepts the offer, to ask him to begin next week as a consultant, working with a transition team, before officially commencing on July 1st. The School Board’s decision, after a search began last January, marks the most important decision the board has made during its brief tenure, in the wake of its creation last year and election last November after the Michigan Legislature in June approved $617-million legislation which resolved the debt of Detroit Public Schools via creating the new district, and retaining the old district for the sole purpose if collecting taxes and paying off debt.

The twenty-four schools slated for closure emerged from a list of 38 the State of Michigan had targeted last January—all from schools which have performed in the bottom 5 percent of the state for at least three consecutive years, according to the education department. The Motor City had hoped to avoid any such forced state closures—hoping against hope that by entering last month into partnership negotiations with the Michigan State Superintendent’s office, and working with Eastern Michigan University, the University of Michigan, Michigan State University, and Wayne State University, the four institutions would help set “high but attainable” goals at the 24 Detroit schools to improve academic achievement and decrease chronic absenteeism and teacher vacancies. The idea was that those goals would be evaluated after 18 months and again in 36 months, according to state officials. David Hecker, president of the American Federation of Teachers Michigan, noted that he was not aware which schools might be closing or how many; however, he noted that whatever happens to the teachers of the closing schools would be subject to the collective bargaining agreement with the Detroit Federation of Teachers. “If any schools close, it would absolutely be a labor issue that would be governed by the collective bargaining agreement as to how that will work … (and) where they will go,” Mr. Hecker said. “We very strongly are opposed to any school closing for performance reasons.”

Thirsty. A difficult issue—among many—pressed upon now retired U.S. Bankruptcy Judge Steven Rhodes during Detroit’s chapter 9 municipal bankruptcy came as the Detroit Water and Sewer Department began shutting off water service to some of nearly 18,000 residential customers with delinquent accounts. Slightly less than a year ago, in the wake of numerous battles in Judge Rhodes’ then U.S. bankruptcy courtroom, the issue was again raised: what authority did the city of Detroit have to cut off the delivery of water to the thousands of its customers who were delinquent by more than 90 days? Thus it was that Detroit’s Water and Sewerage Department began shutting off service to customers who had failed to pay their bills—with, at the time, DWSD guesstimating about 20,000 of its customers had defaulted on their payments, and noting that the process of shutting off service to customers with unpaid bills was designed to be equitable and not focused on any particular neighborhood or part of the city—and that the agency was not targeting customers who owed less than a $150 and were only a couple of months behind, noting, instead: “We’re looking for those customers who we’ve repeatedly tried to reach and make contact,” as well as reporting that DWSD was reminding its delinquent customers who were having trouble paying their water bills to contact the department so they may be enrolled in one of its two assistance programs — the WRAP Fund or the “10/30/50” plan. Under the first, the WRAP Fund, customers who were at 150 percent of the poverty level or below could receive up to $1,000 a year in assistance in paying bills, plus up to $1,000 to fix minor plumbing issues leading to high usage. This week, DWSD is reporting it has resumed shutoffs in the wake of sending out notices, adding the department has payment and assistance plans to help those with delinquent accounts avoid losing service. Department Director Gary Brown told the Detroit Free Press that everyone “has a path to not have service interruption.” Indeed, it seems some progress has been achieved: the number of families facing shutoffs is down from 24,000 last April and about 40,000 in April of 2014, according to The Detroit News. In 2014, DWSD disconnected service to more than 30,000 customers due to unpaid bills, prompting protests over its actions. Nonetheless, DWSD began the controversial practice of shutting off water service again this week, this time to some of the nearly 18,000 residential customers with delinquent accounts, in the wake of notices sent out 10 days earlier, according to DWSD Director Gary Brown. Nevertheless, while 17,995 households are subject to having their water turned off, those residents who contact the water department prior to their scheduled shutoffs to make a payment or enter into an assistance plan will avoid being cut off—with experience indicating most do. And, the good gnus is that the number of delinquent accounts is trending down from the 24,302 facing a service interruption last April, according to DWSD. Moreover, this Solomon-like decision of when to shut off water service—since the issue was first so urgently pressed in the U.S. Bankruptcy Court before Judge Rhodes—has gained through experience. DWSD Director Brown reports that once residents are notified, about 90 percent are able to get into a plan and avoid being shut off, and adding that most accounts turned off are restored within 24 hours: “Every residential Detroit customer has a path not to be shut off by asking for assistance or being placed into a payment plan…I’m urging people not to wait until they get a door knocker to come in and ask for assistance to get in a payment plan.” A critical part of the change in how the city deals with shutoffs comes from Detroit’s launch two years ago of its Water Residential Assistance Program, or WRAP, a regional assistance fund created as a component of the Great Lakes Water Authority forged through Detroit’s chapter 9 municipal bankruptcy: a program designed to help qualifying customers in Wayne, Oakland, and Macomb counties who are at or below 150 percent of the federal poverty level—which equates to $36,450 for a family of four—by covering one-third of the cost of their average monthly bill and freezing overdue amounts. Since a year ago, nearly $5 million has been dedicated to the program—a program in which 5,766 Detroit households are enrolled, according to DWSD, with a retention rate for those enrolled in the program of 90 percent. DWSD spokesperson Bryan Peckinpaugh told the Detroit News the department is committed to helping every customer keep her or his water on and that DWSD provides at least three advance notifications encouraging those facing a service interruption to contact the department to make payment arrangements, adding that the outreach and assistance efforts have been successful, with the number of customers facing potential service interruption at less than half of what it was three years ago.

Fiscally Hard in Hartford. Hartford Mayor Luke Bronin has acknowledged his proposed $612.9 FY2018 budget includes a nearly $50 million gap—with proposed expenditures at $600 million, versus revenues of just over $45 million: a fiscal gap noted moodily by four-notch downgrades to the Connecticut city’s general obligation bonds last year from two credit rating agencies, which cited rising debt-service payments, higher required pension contributions, health-care cost inflation, costly legal judgments from years past, and unrealized concessions from most labor unions. Moody’s Investors Service in 2016 lowered Hartford GOs to a junk-level Ba2. S&P Global Ratings knocked the city to BBB from A-plus, keeping it two notches above speculative grade. Thus, Mayor Bronin, a former chief counsel to Gov. Daniel Malloy, has repeated his request for state fiscal assistance, noting: “The City of Hartford has less taxable property than our suburban neighbor, West Hartford. More than half of our property is non-taxable.” In his proposed “essential services only” budget, Mayor Bronin is asking the Court of Common Council to approve an increase of about $60 million, or 11%, over last year’s approved budget—with a deadline for action the end of next month. An increasing challenge is coming from the stressed city’s accumulating debt: approximately $14 million, or 23%, of that increase is due to debt-service payments, while $12 million is for union concessions which did not materialize, according to the Mayor’s office. Gov. Malloy’s proposed biennial budget, currently in debate by state lawmakers, proposes $35 million of aid to Hartford. Unsurprisingly, that level is proving a tough sell to many suburban and downstate legislators. On the other hand, the Mayor appears to be gaining some traction after, last year, gaining an agreement with the Hartford Fire Fighters Association that might save the city $4 million next year: the agreement included changes to pension contributions and benefits, active and retiree health care, and salary schedules. In addition, last month, Hartford’s largest private-sector employers—insurers Aetna Inc., Travelers Cos. and The Hartford—agreed to donate $10 million per year to the city over five years. Nonetheless, rating agencies Moody’s and S&P have criticized the city for limited operating flexibility, weak reserves, narrowing liquidity, and its rising costs of debt service and pension obligations. Gurtin Municipal Bond Management went so far as to deem the city a “slow-motion train wreck,” adding that while the quadruple-notch downgrades had a headline shock effect, the city’s fundamental credit deterioration had been slow and steady. “The price impact of negative headlines and credit rating downgrades can be swift and severe, which begs the question: How should municipal bond investors and their registered investment advisors react?” Gurtin’s Alex Etzkowitz noted, in a commentary. “The only foolproof solution is to avoid credit distress in the first place by leveraging independent credit research and in-depth, ongoing surveillance of municipal obligors.”

Fighting for a City’s Future. The small city of Petersburg. Virginia, is hardly new to the stress of battle. It was there that General Robert E. Lee’s men fought courageously throughout the Overland Campaign, even as Gen. Lee feared he confronted a campaign he feared could not be won, warning his troops—and politicians: “We must destroy this Army of Grant’s before he gets to the James River. If he gets there, it will become a siege, and then it will be a mere question of time.” Yet, even as he wrote, General Ulysses S. Grant’s Army of the Potomac was racing toward the James and Petersburg to wage an attack on the city—a highly industrialized city then of 18,000 people, with supplies arriving from all over the South via one of the five railroads or the various plank roads. Indeed, Petersburg was one of the last outposts: without it, Richmond, and possibly the entire Confederacy, was at risk. Today, the city, because of the city’s subpar credit rating, is at fiscal risk: it has been forced to beg its taxpayers to loan it funds for new emergency vehicles—officials are making a fiscal arrangement with private citizens to front the cost for new emergency vehicles, and offering to put up city hall as collateral for said arrangement, as an assurance to the lenders they will be paid back. The challenge: the police department currently needs 16 new vehicles, at a cost of $614,288; the fire department needs three new trucks, at a cost of $2,145,527. Or, as Interim City Manager Tom Tyrrell notes: “Every single day that a firefighter rolls out on a piece of equipment older than he is, or a police officer responds to an emergency call in a car with 160,000 miles on it, are days we want to avoid…We want to get this equipment as soon as possible.” Interim City Finance Director Nelsie Birch has included in the upcoming fiscal year budget the necessary funds to obtain the equipment—equipment Petersburg normally obtains via lease agreements with vendors, but which now, because of its inability to access municipal credit markets due to its “BB” credit rating with a negative outlook, makes it harder than ever to find any vendor—or, as Manager Tyrrell puts it: “We went out four different times…We solicited four different times to the market, and were unsuccessful in getting any parties to propose.” He added that when soliciting these types of agreements, you solicit “thousands of people.” Notwithstanding that the funds for the vehicles is already set aside in the upcoming budget, city officials have been unable to find anyone willing to enter into a lease agreement with the city because of the city’s financial woes.

Last week, the City Council authorized Mr. Tyrrell to “undertake emergency procurement action” in order for the lease of necessary fire and police vehicles, forcing Mr. Tyrrell and other officials to seek private funds to get the equipment—that is, asking individual citizens who have the financial means to put up money for the fire and police vehicles—or, as Mr. Tyrrell puts it: “We’ve reached out to four people, who are interested and capable,” noting they are property owners in Petersburg who will remain anonymous until the deal is closed, describing it thusly: “[This agreement] is outside the rules, because we couldn’t get a partner inside the rules.” Including in this proposed fiscal arrangement: officials must put up additional collateral, in addition to the cars themselves, and in the form of city-owned property—with the cornerstone of the proposal, as it were, being Petersburg City Hall, or, as Mr. Tyrrell notes: “What they’re looking for is some assurance that no matter what happens, we’re going to pay the note…It’s not a securitization in the financial sense, as much as it is in the emotional sense: they know that the city isn’t going to let it go.” He adds, the proposed financial arrangement will be evaluated in two areas: the interest rate and how fast the deal can close, adding: “Although it’s an emergency procurement, we still want to get the best deal we can.”

The Fiscal, Balancing Challenges of Federalism

eBlog, 2/16/17

Good Morning! In this a.m.’s eBlog, we consider the fiscal, balancing challenges of federalism, as Connecticut Governor Daniel Malloy’s proposed budget goes to the state legislature; then we return to the small municipality of Petersburg, Virginia—the insolvent city which now confronts not just fiscal issues, but, increasingly, trust issues—including how an insolvent city should bear the costs of litigation against its current and former mayor—including their respective ethical governing responsibilities. Finally, we seek the warming waters of the Caribbean to witness a fiscal electrical storm—all while wishing readers to think about the President who would never tell a lie…

The Challenge of Revenue Sharing—or Passing the Buck? S&P Global Ratings yesterday warned that Connecticut Governor Daniel Malloy’s proposed budget could negatively affect smaller towns while benefiting the cities, noting that from a municipal credit perspective, “S&P Global Ratings believes that communities lacking the reserves or budgetary flexibility to cushion outsized budget gaps will feel the greatest effects of the proposed budget.” S&P, as an example, cited Groton, a town of under 30,000, which has an AA+ credit rating, which could find its $12.1 million reserve balance depleted by a proposed $8.2 million reduction in state aid and a $3.9 million increase to its public pension obligations. Meanwhile, state capitol Hartford, once the richest city in the United States, today is one of the poorest cities in the nation with 3 out of every 10 families living below the poverty line—which is to write that 83% of Hartford’s jobs are filled by commuters from neighboring towns who earn over $80,000, while 75% of Hartford residents who commute to work in other towns earn just $40,000. Thus, under Gov. Rowland’s proposed budget, Hartford would receive sufficient state aid under the Governor’s proposal to likely erase its projected FY2018 nearly $41 million fiscal year 2018 budget gap, according to S&P, leading the rating agency to find that shifting of costs from the state to municipal governments would be a credit positive for Connecticut, but credit negative for many of the affected towns: “Those [municipal] governments lacking the budgetary flexibility to make revenue and expenditure adjustments will be the most vulnerable to immediate downgrades.” With the Connecticut legislature expected to act by the end of April, S&P noted that the state itself—caught between fixed costs and declining revenues, will confront both Gov. Malloy and the legislature with hard choices, or, as S&P analyst David Hitchcock put it: “Bringing the [budget] into balance will involve painful adjustments,” especially as the state is seeking to close a projected $1.7 billion annual deficit. Thus, S&P calculated that general fund debt service, pension, and other OPEB payments will amount to just under 30 percent of revised forecast revenues plus proposed revenue enhancements for FY2018, assuming the legislature agrees to Gov. Malloy’s plan to “share” some one-third, or about $408 million of annual employer teacher pension contributions with cities and towns, effectively reducing state contributions.

As Mr. Hitchcock penned: “Rising state pension and other post-employment benefit payments are colliding with weak revenue growth because of poor economic performance in the state’s financial sector…Although other states are also reporting weak revenue growth and rising pension costs, Connecticut remains especially vulnerable to an unexpected economic downturn due to its particularly volatile revenue structure.” Unsurprisingly, especially given the perfect party split in the state Senate and near balance in the House, acting on the budget promises a heavy lift to confront accumulated debt: Deputy Senate Republican Majority Leader Scott Frantz (R-Greenwich) said the state’s—whose state motto is Qui transtulit sustinet (He who transplanted sustains)—financial struggles have been predictable for more than a decade, “with a completely unsustainable rate of growth in spending on structural costs and far too much borrowing that further adds to the state’s fixed costs, especially as interest rates rise….” adding: “The proposed budget is an admission that the state can no longer afford to pay for many of its obligations and will rely on the municipalities to pick up the slack, which means that local property tax rates will rise.” The Governor’s proposals to modify the state’s school-aid formula could, according to Mr. Hitchcock, be a means by which Connecticut could comply with state Superior Court Judge Thomas Moukawsher’s order for the state to revise its revenue sharing formula to better assist its poorest municipalities: “It could benefit poor cities at the expense of the rich and lower overall local aid;” however, he added that “[c]ombined with other local aid cuts, municipalities’ credit quality could be subject to greater uncertainty.” With regard to Governor Malloy’s proposed pension obligation “sharing,” our esteemed colleagues at Municipal Market Analytics described the shift in teacher pension costs to be “a more positive credit development for the state,” notwithstanding what MMA described as “quite high” challenges. Under the proposal, the municipalities of Hartford and Waterbury would receive about $40 million apiece in incremental aid, while 145 municipalities would lose aid after the netting of pension costs. Several middle-class towns, according to MMA’s analysis, could realize reductions in pension aid of more than $10 million—some of which might be offset by the Governor’s proposal to permit towns to begin assessing property taxes on hospitals, which in turn would be eligible for some state reimbursement.

Hear Ye—or Hear Ye Not. Petersburg residents who say their elected leaders are to blame for the historic city’s fiscal challenges and insolvency yesterday withdrew their efforts to oust Mayor Samuel Parham and Councilman W. Howard Myers (and former mayor) from office in court over procedural issues, notwithstanding that good-government advocates had collected the requisite number of signatures to lodge their complaints against the duo. An attorney representing the pair testified before Petersburg Circuit Court Judge Joseph Teefey that the cover letters accompanying those petitions were drafted after the signatures were gathered. Thus, according to the attorney, even if the petition signers knew why they were endorsing efforts to unseat the elected officials, they were not aware of the specific reasoning later presented to the court.

Not unsurprisingly, Barb Rudolph, a citizen activist who had helped spearhead the attempt, said she felt discouraged but not defeated, noting: “We began collecting these signatures last March, and in all that time we’ve been trying to learn about this process…We will take the information we have learned today and use that to increase our chances of success moving forward.” The petition cited “neglect of duty, misuse of office, or incompetence in the performance of duties,” charging the two elected officials for failing to heed warnings of Petersburg’s impending fiscal insolvency; they alleged ethical breaches and violations of open government law.

But now a different fiscal and ethical challenge for the insolvent municipality ensues: who will foot the tab? Last week the Council had voted to suspend its own rules, so that members could consider whether Petersburg’s taxpayers should pick up the cost of the litigation, with the Council voting 5-2 to have the city’s taxpayers foot the tab for Sands Anderson lawyer James E. Cornwell Jr., who had previously, successfully defended elected officials against similar suits. Unsurprisingly, the current and former Mayor—with neither offering to recuse himself—voted in favor of the measure. Even that vote, it appears, was only taken in the wake of a residents’ questions about whether Council had voted to approve hiring a lawyer for the case.

A Day Late & a Dollar Short? Mayor Parham and Councilmember Myers signed a written statement acknowledging their interest in the vote with the city clerk’s office the following day. The Mayor in a subsequent interview, claimed that the attorney hired by the city told him after that vote that the action was legal and supported by an opinion issued by the Virginia Attorney General’s Office, noting: “Who would want to run for elected office if they knew they could bear the full cost of going to court over actions they took?” To date, the two elected officials have not disclosed the contract or specific terms within it detailing what the pair’s litigation has cost the city budget and the city’s taxpayers. Nor has there been a full disclosure in response to Petersburg Commonwealth’s Attorney Cassandra Conover’s determination last week with regard to whether the Mayor and former Mayor’s votes to have Petersburg’s taxpayers cover their legal fees presented a conflict of interest.

Electric Storm in Puerto Rico. Yesterday, Puerto Rico Governor Ricardo Rosselló stated that the reorganization of the Puerto Rico Electric Power Authority (PREPA) Governing Board’s composition and member benefits will not affect the fiscal recovery process that is currently underway, noting: “I remind you that we announced a week or week and a half ago that we had reached an agreement with the bondholders to extend and reevaluate the Restructuring Support Agreement (RSA) terms. Everything is on the table,” referring to the extension for which he had secured municipal bondholders’ approval—until March 31. His statement came in the wake of the Puerto Rican House of Representatives Monday voting to approve a bill altering the Board’s composition and member benefits—despite PREPA Executive Director Javier Quintana’s warning that the governance model should remain unaltered, since its structure was designed to comply with their creditors’ demands. However, Gov. Rosselló argued that, according to PROMESA, the Governor of Puerto Rico and his administration are the ones responsible for executing plans and public policies: “Therefore, the Governor and the Executive branch should feel confident that the Board and the executive directors will in fact execute our administration’s strategies and public policies. We believe we should have the power to appoint people who will carry out the changes proposed by this administration.” The Governor emphasized: “We have taken steps to have a Board that responds not to the Governor or partisan interests, but to the strategy outlined by this administration, which was validated by the Puerto Rican people.”

Indeed, at the beginning of the week, the Puerto Rican government had approved what will be the Board’s new composition, which would include the executive director of the Fiscal Agency and Financial Advisory Authority (FAFAA), the Secretary of the Department of Economic Development and Commerce, and the executive director of the Public-Private Partnerships Authority among its members: “We campaigned with a platform, the people of Puerto Rico validated it, and the Oversight Board expects all of these entities to respond to what will be a larger plan,” he insisted. Gov. Rosselló added that adjustments are essential, due to the Government’s current fiscal situation, specifically referring to the compensation paid to the members of the Board, which can reach $60,000. If this measure becomes law, the compensation would be limited to an allowance of no more than $200 per day for regular or special sessions. (The measure, pending the Senate’s approval, would establish that no member may receive more than $30,000 per year in diet allowances.) Currently, the Governing Board’s annual expenses—including salaries and other benefits—are approximately $995,000 per year. Meanwhile, PREPA has a debt of almost $9 billion, including a $700-million credit line to purchase fuel and no access to the capital markets.