Indices of Municipal Recovery & The Challenge of Fiscal Sustainability

May 21, 2015
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Tapering Off? Detroit has one of the broadest tax bases of any city in the U.S.: its municipal income taxes constitute the city’s largest single source, contributing close to 21 percent of total revenue in 2012, or $323.5 million, the last year in which the city realized a general fund surplus. Thereafter, receipts declined each year through 2010, reflecting both a rate reduction mandated by the state and the recession. The declining revenues also reflected not just the significant population decline, but also the make-up of the decline: the census reported that one-third of current residents were under the poverty line and that the composition of businesses—unlike any other major city in the nation—was primarily made up of public organizations. Today, according to the Census, Detroit is still losing residents, but the exodus is tapering: Detroit’s population was 680,250 as of last summer, down an estimated 6,424 residents from the previous year—but a decline or outflow smaller than the previous year—when the drop was 10,072―and significantly lower than the annual average decline of 24,000 which Detroit experienced in the first decade of this century. Kurt Metzger, director emeritus of Data Driven Detroit, not only a demographer, but also the Mayor of Pleasant Ridge, notes that the influx is from young and older people moving in: Last year, Detroit issued 806 building permits for new construction, mostly for apartments, more than double the influx from the prior year. And, on the other side of the equation, the population outflow is slowing—or, as Mayor Metzger puts it: “There is just less housing available for those people who want to leave…If they haven’t left by now, they have decided to stay.” Detroit Mayor Mike Duggan sums it up: “It’s trending in the right direction…A number of people have decided to stay and see how things go…More people are staying in neighborhoods and more people are moving in.” Nevertheless, the Southeast Michigan Council of Governments has reported that the Motor City’s population is actually closer to 648,002 and the COG forecasts the population will continue to decline until 2030 when it would have about 610,000 residents.

Indeed, home sales in the four-county metro Detroit region inched up 1.4 percent year over year in April, while the median home sale prices climbed 18.9 percent, according to a report released this week. Farmington Hills-based Realcomp Ltd. II reported there were 4,004 home sales last month, compared to 3,947 in April of last year in Wayne, Oakland, Livingston and Macomb counties. Median sale prices rose from $121,900 in April 2014 to $145,000 last month. Oakland County had the greatest increase in home sales, rising 12.6 percent from 1,286 in April 2014 to 1,448, while Macomb had the second-highest increase of 7.3 percent, from 862 to 925 last month, according to Realcomp. Wayne County sales, however, fell 10.2 percent from 1,553 in April 2014 to 1,395 last month. In contrast, however, Wayne County sale prices rose 42.7 percent from $70,000 to $99,900.

Fire over Privatizing Essential Municipal Services. Despite the 6-1 affirmation by Mayor Davis and the City Council this week to contract out for fire and emergency response as part of San Bernardino’s proposed plan of debt adjustment—which is to be submitted to the U.S. Bankruptcy Court by Saturday, the proposal to do that is now drawing its own fire—not only from within the city, but also beyond its borders. The proposal, projected to save as much as $7―$10 million annually, depending on bids due in late yesterday and to be made public next week, has fired the head of Local Firefighters union 935 north to the state capitol in an effort to seek to preempt the proposal. Yet the proposed privatization has become a pivotal part of the city’s plan to successfully exit municipal bankruptcy—not only could it result in substantial operating and capital savings, but also the proposal could reduce some of its overbearing debt to the California Public Employees’ Retirement System, according to City Manager Parker—whose City Council endorsed plan for fiscal recovery and sustainability proposes that fire/emergency response and refuse services be the highest-priorities for outsourcing. With a demographic trend demonstrating that retirees are likely to live much longer than prior generations—but smaller municipal workforces in California municipalities, there is greater and greater awareness that California cities and counties are, increasingly, walking a fiscal tightrope where fiscal sustainability is increasingly at risk. That is not to say that contracting out will not create challenges: it would force recalibration of mutual aid decisions.

Moody Blues. Moody analysts Josellyn Yousef, David Strungis, Orlie Prince, and Naomi Richman this week reported that the sale of New Jersey state-enhanced municipal bonds for Atlantic City, would remove a “major short-term obstacle” for the fiscally distressed municipality, but warned the city still faces long-term risks due to “numerous financial challenges.” The warning came as the city was seeking to complete the sale of some $40.5 million in general obligation municipal bonds this week, a sale benefited under New Jersey’s Municipal Qualified Bond Act program (The state program, called the Municipal Qualified Bond Act program, gives Atlantic City bondholders protections similar to the distributable state aid bonds issued by Detroit, Michigan.) The proceeds of the sale are to be used to pay off a $40 million emergency state bridge loan due by the end of this week. In addition, Atlantic City is planning to issue $12 million of additional MQBA bonds by the beginning of August in order to make payments due on maturing bond anticipation notes. The sale, according to the dynamic Moody quartet should “should improve [Atlantic City’s] market access; however, the relatively narrow debt service coverage from state aid makes it unclear whether the city’s bonds would carry the MQBA program rating (A3 negative), or a somewhat lower rating.” Moreover, notwithstanding the relatively sunnier outlook, the quartet noted many financial and fiscal hurdles still confronting the city, including a $101 million budget gap for the fiscal year ending Dec. 30th, poor liquidity, and ongoing property tax appeals on casino properties. They also wrote that heavier municipal reliance on MQBA-enhanced debt could mark the beginning of some erosion in New Jersey state aid to help the city cover debt service, noting that since the state aid never reaches the city’s coffers, ‘the protection is similar to Detroit’s distributable state aid bonds that avoided payment interruption during its recent bankruptcy.’ Thus the credit rating agency warned that additional MQBA bond issuances by Atlantic City could actually undercut its debt service coverage levels: “If all of this debt is issued through the MQBA program, debt service coverage could decline to at or near one times qualified state aid depending on interest rates…The state Local Finance Board will only approve an MQBA bond issuance if revenues are at least sufficient to meet debt service.” With the city having acted last March on a short-term plan to address Atlantic City’s $101 structural deficit that included the potential of debt payment deferrals, Moody’s analysts noted that while some steps have already been taken, including $7 million in salary and wage savings from 195 layoffs; nevertheless, proposed bills to redirect $47.5 million of additional revenues from the Atlantic City Alliance Fund and Investment Alternative Tax remain stalled in the state legislature. As Mayor Don Guardian noted at our conference with the Volcker Alliance earlier this Spring at the New York Federal Reserve, the state action is critical: absent a significant liquidity infusion, debt service payments still remain highly susceptible to default in 2015—or, as the analysts put it this week: Atlantic City’s “future operations continue to face pressure from a large structural deficit.”

Unequal Odds. The Commonwealth of Puerto Rico has warned in its latest quarterly filing that it may place a moratorium on debt payments in FY2016 if the government is unable to enact a new tax plan and reduce its rate of spending growth to both balance the island’s budget and to begin to whittle away at its massive accumulated debt. Its combination of rising debt, sluggish economy, and falling population has lifted the yields on the Commonwealth’s debt above those of Greece amid growing uncertainty—and doubt—whether the Commonwealth can repay its debt on time and in full—and whether Congress will act to give the U.S. territory authority to renegotiate its debts in a U.S. bankruptcy court: because the island is not a state, there is no state to grant the territory—or its municipalities—authority to file for municipal bankruptcy and work out its debts through a plan of recovery under a federal court’s supervision. Thus, absent the kinds of legal and fiduciary protections available to all other Americans, the elected state and local leaders—and their citizens—increasingly confront a process likely to be far more uncertain and expensive: lawyers for all the different parties—bond holders, banks, bond insurance companies, and government entities—will probably have to rack up lots of billable hours as they seek the best outcome for their clients. Unsurprisingly, the territory’s many municipalities can hardly afford comparable legal representation, so that, absent Congressional action, there is a signal risk of municipal harm. In contrast, a group of 35 hedge funds have retained Morrison & Foerster, as well as Washington-based Robbins Russell Englert Orseck Untereiner & Sauber. That is, hedge funds and distressed-debt buyers, rather than the public, appear to have the upper hand. Indeed, for nearly two years, hedge funds and investors in riskier municipal debt have been purchasing Puerto Rico securities at distressed levels. There is no indication such purchases have anything to do with public purposes or the interests of the U.S. citizens. A group of 35 hedge funds, led by Fir Tree Partners and others, holds $4.5 billion of Puerto Rico debt: that is, these are businesses which purchased public debt at a discount, hoping to make a profit on Puerto Rico municipalities that can either avoid a default or that offer recover rates higher than what the hedge funds originally paid to own the bonds. Prices on Puerto Rico’s GO bonds maturing in July 2041 fell to as low at 55 cents on the dollar back in July 2014: now they are trading at about 66 cents, according to data compiled by Bloomberg.