Governing for a Sustainable Fiscal Future: How Does One Balance Between Past Commitments versus Future Investment?


March 10, 2015
Visit the project blog: The Municipal Sustainability Project

Confronting Action to Avoid Municipal Bankruptcy. Wayne County, Michigan Executive Warren Evans has ordered a spending freeze for county government as he grapples with an impending financial crisis, stating: “This is the first step to resolve the county’s financial crisis…It’s critical we begin (to) take the necessary steps to solve our financial crisis and restore fiscal health. Reducing expenditures wherever possible must be our first priority.” The order, which includes a hiring freeze, was issued more than a month after Wayne County leaders warned that because of the county’s growing risk of a potential default — the surrounding county to Detroit could run out of cash next year and faces a $70-million structural deficit, as well as a pension system that is only about 45 percent funded. Under the freeze, all vacant positions will remain vacant and no employees will get a raise unless it is required under an existing contract. The order restricts overtime, travel, repairs, acquisitions, and other expenditures. The announcement came as the County Executive is trying to do everything in his power to try and prevent a takeover by the State of Michigan. Mr. Evans has now created an “executive review committee” to oversee the implementation of the freeze among other duties. The committee includes the county’s chief restructuring officer, budget director, corporation counsel, and his chief of staff. With the county under threat of burning through all its cash by a year from August absent extraordinary steps, Moody’s and S&P have downgraded the county’s bond rating to junk status—a ratcheting up putting the county between the Scylla of greater costs of borrowing and the Charybdis of greater requirements to borrow in order to remain afloat. Under Mr. Evans’ executive order, all vacant positions within the county will stay vacant, and no current employees will receive a pay increase unless mandated by a collective bargaining agreement: the order creates an executive review committee consisting of
• The County Executive’s chief of staff,
• The chief restructuring officer,
• The budget director,
• Corporation counsel, and
• Director of personnel/human resources or their designees “to implement further restrictions to increase savings and reduce expenditures.”

Under the order, there will be no renewal or replacement of employees working on a contractual basis unless deemed essential by the executive committee; the order also imposes restrictions on overtime, travel, operating services, supplies, professional services, acquisitions, major repairs, cellular phones, subscriptions, memberships, equipment and capital purchases—although it allows for exemptions to the hiring freeze for public health and safety, such as declared emergencies, expenditures for housing juvenile offenders in detention facilities, and budgeted sheriff deputies and assistant prosecutors. “Federal or state funded expenses, those mandated by the county charter, state or federal law, court orders and cooperative agreements, are also not affected,” according to the County.

Underwater in the Windy City. In a new filing on the MSRB’s EMMA, Chicago reports it is almost $400 million underwater on 24 swaps tied to $2.4 billion of floating-rate general obligation and revenue-backed paper. Nevertheless, the city has reported significant headway in curtailing the risks on its swaps portfolio: Chicago has terminated seven swap or swap options on $1 billion of floating-rate debt and restructured more favorable terms on termination triggers on 12 derivatives tied to $1.3 billion of debt since 2011, according to its filing. Most of the financial transactions which are today coming back to haunt the city are vestiges of the former administration of Mayor Richard M. Daley—and all, today, have a negative mark-to-market, adding to the steady deterioration of the city’s credit ratings, as laid out in its filing of its swap portfolio, letter of credits, direct purchase facilities, and line of credit agreements last Friday in the wake of Moody’s credit rating downgrade. CFO Lois Scott, in her introductory note, wrote: “The city is also providing voluntary disclosure of certain other recent events…The city is not obligated to provide further additional updated or supplemental information with respect to the bonds except as otherwise required.” The downgrade initially triggered termination events on four swaps, according to Moody’s. To avoid a separate $20 million payment related to currency valuations, Chicago has renegotiated terms with BMO Harris Bank on a $66.8 million floating-to-fixed-rate swap that was part of a $223 million 2005 floating rate GO issue; Chicago reported in its filing that the latest downgrade triggered termination events on three interest rate swap contracts with Wells Fargo Bank with a negative valuation of $38 million. In addition, in its new filing, Chicago reported it has posted as collateral a letter of credit issued by PNC Bank in connection with a 2005 sale/leaseback transaction the city entered into in 2005 on the city-owned portion of the Orange Line rail transit route to Midway Airport—a lease scheduled to last through 2031. The new, voluntary disclosure come as part of the ongoing, leadership effort by CFO Scott to improve investor relations through better disclosure—steps regarded by observers as critical if the city hopes to keep in check its already steep interest rate penalties due to concerns over its solvency. It also illustrates the precipitous issues that could trigger further credit rating deterioration for the city, including an adverse ruling by the Illinois Supreme Court on state-level pension reforms, growth in direct and overlapping debt, and a narrowing of city reserves. On the public pension front, the new disclosure provides an update on a legal challenge launched by unions, retirees, and employees against the reforms approved by the Illinois Legislature last year to Chicago’s municipal and laborers’ funds—funds which were on course to exhaust assets in 2026 and 2029, respectively, noting that, should the reforms be reversed or voided by the courts, “[I]t is not clear whether or how the unfunded status or insolvency of the two affected pension funds might be resolved or what, if any, impact such a resolution may have on the city.” Should the Windy City’s credit ratings slide more, it could be confronted, moreover, with even more swap termination triggers—or, as the disclosure puts it: “The city intends to continue managing the risks associated with its variable rate debt and swaps by renegotiating or terminating swaps and converting variable rate debt to fixed rate when market opportunities warrant.” Any termination payments due in the future on the city’s revenue bond credits would be drawn from pledged revenue streams. A default under the city’s revolving lines of credit would allow the termination of its credit facilities, requiring Chicago to immediately pay all outstanding amounts. The city currently has $294 million outstanding under its short term borrowing program which has a capacity of $900 million. An additional draw of $170 million is expected this month.

On the Horns of a Nebraskan Dilemma. As we have noted in covering municipal bankruptcies, the greatest tension in resolving or agreeing upon a plan of debt adjustment tends to be between a municipality’s bondholders versus its public retirees or pensioners. Now, in the Cornhusker state, the Nebraska Banking, Commerce and Insurance Committee has approved and reported municipal bankruptcy amendments, Legislative Bill 67, to the floor of the state’s unicameral legislature. Between 1980 and 2012, some 55 Cornhusker utility districts have sought such protection—triggering current law provisions under which, if one-third of resident freeholder’s petition, the municipality is required to enter into negotiation. LB 67 would amend the law to provide general obligation bondholders a statutory lien to ensure their payment priority over all other creditors, including municipal public pensioners, in the event of a municipal bankruptcy. Nebraska State Sen. Paul Schumacher said the proposal to amend the state’s municipal bankruptcy statute is an effort to address on a state level the national uncertainty about the status of pensions versus bondholder battles that emerged during the municipal bankruptcies of Detroit and Stockton. A lobbyist for the Nebraska bankers association was the sole supporter of LB 67 during last week’s public hearing, but the proposed legislation drew opposition from municipal leaders from Omaha and Lincoln, who testified that the issue of creditor preference should be, as it is under current federal law, left up to a federal bankruptcy judge.

Pensions & State/Local Municipal Bondholders on the Teeter-Totter


February 10, 2014
Visit the project blog: The Municipal Sustainability Project

State of the Motor City. Detroit Mayor Mike Duggan will deliver Detroit’s first State of the City address following the city’s historic exit from municipal bankruptcy tonight. The address will come amid the Mayor’s aggressive blight removal campaign that includes demolishing thousands of vacant houses and finding owners for others that can be rehabilitated—as well as his initiative to lower property tax assessments for many residential properties in Detroit.

Betting on a City’s Future. Atlantic County—in which Atlantic City and 22 other municipalities may be found―Executive Dennis Levinson is proposing cutting the county Open Space Tax to decrease the burden on taxpayers by $1.5 million, after several mayors asked him to re-examine the county budget for savings. Under the proposal, the tax rate would decrease from one-half cent per $100 valuation, to one-eighth of a cent, according to Mr. Levinson’s letter last week to the county’s 23 mayors dated Feb. 5.
The response, according to Somers Point Mayor Jack Glasser, president of the Atlantic County Mayors’ Association, an average saving of $91.50—cuts offset by cutting back on county library hours (most branches would lose Monday night hours from 5 to 8 p.m.). In his epistle to the county’s mayors, Mr. Levinson said he is proposing the extra cuts because of “the unprecedented decline in Atlantic City’s ratable base and the effect it has on county government and property taxes in all Atlantic County municipalities,” noting that the uncertainty of what will happen with Atlantic City property taxes is making the budget process more complex this year. In New Jersey, the open space tax and the county library tax are paid by towns separately from the operating budget, which would remain up 2.7 percent from $196 million to $201 million. The Atlantic County budget was introduced at the end of last month; there will be a public hearing on it March 10. The tradeoffs demonstrate the difficulty—especially with the looming uncertainty about what Gov. Chris Christie will decide with regard to the fate of Atlantic City and its elected leaders—e.g. whether to, in fact, preempt their authority entirely and put the city into municipal bankruptcy—a threat which has already, as we have noted, imposed significant increases in borrowing costs for cities throughout the count—or, as Mayor Glaser puts it: “We still don’t know what will happen down the road. We’re still waiting for everything going on in Atlantic City.” In addition, the New Jersey legislature has still not voted on legislation to create a Payments in Lieu of Taxes, or PILOT, program that would require the casinos to pay $150 million annually in property taxes to Atlantic City for two years, and $120 million annually for the next 13 years—again because of uncertainty with regard to the Governor’s intentions: New Jersey State Senate President Steve Sweeney in the Philadelphia Inquirer last week was quoted as saying that he does not see a point in passing the legislation, if Governor Chris Christie is likely to veto it. The uncertainty comes despite an agreement between Mr. Levinson and Atlantic City Mayor Don Guardian.

Pensions & Bankruptcy. Illinois Gov. Bruce Rauner has proposed legislation to modify the state’s municipal bankruptcy law—which currently only applies to the state’s Illinois Power Agency, but which the new Governor has proposed to expand to municipalities—along with a constitutional amendment on pensions―an issue currently pending before the Illinois Supreme Court. The twin ears of corn, as it were―incorporated in his State of the State address—have yet to be fully detailed, but could be elucidated as early as next week, when the Gov. is expected to release his final FY2016 budget proposal. However, under the “Taxpayer Empowerment and Government Reform Package” section of the Governor’s plan, Gov. Rauner included that he intended to “pursue permanent pension relief through a constitutional amendment” and “extend to municipalities bankruptcy protections to help turn around struggling communities.” Some believe that such a constitutional amendment could offer a long-term solution to the state’s troubled pension system if the Illinois Supreme Court, in a ruling expected later this year, affirms the lower court’s holding that the legislature’s pension overhaul lawmakers passed in 2013 is unconstitutional. The state faces more than $100 billion of unfunded obligations. With regard to municipal bankruptcy, Illinois currently offers assistance for stressed communities with populations under 25,000 through its Fiscally Distressed City Act―after a municipality requests the General Assembly to appoint a special commission to consider whether the municipality meets the act’s criteria—upon which, if approved, the municipality can qualify for state financing assistance. The Grand Poohbah of Municipal Bankruptcy, Jim Spiotto, yesterday told the Bond Buyer: “The question is how do you want to approach it? Should there be―like in 12 other states―a second look?” (He noted that another 12 states do not require an additional layer of review, and that, since 1954, the rate of bankruptcy filings is four times higher in states with no second look compared to states that require another additional approval.), adding: “A second look requires the input of a supervising adult who can say there are other available options,” and the state has to “make sure it doesn’t cost its municipalities more borrowing costs” in the way it treats creditor classes.” The Governor’s proposal comes in the wake of State Rep. Ron Sandack’s (R-Downers Grove) recently introduced House Bill 298 to allow local governments to file for municipal bankruptcy protection, with Rep. Sandack noting: “As more and more municipalities are looking for relief and ways to deal with rising pension liabilities and other costs, this is a tool that can help them stabilize and reorganize financial affairs in ways that benefit taxpayers.” For his part, Mr. Spiotto, in concert with the crack Civic Federation of Chicago, has proposed the creation of an authority designed to intervene before fiscal strains reach crisis stage for local governments. Meanwhile, the fabulous Matt Fabian of Municipal Market Analytics notes: “In Illinois, it’s unlikely that a bankruptcy law would be passed, and even more unlikely that what might be passed would protect bondholders over employees: The cost of capital would very likely rise. Illinois’ local governments already pay interest rate penalties for the financial distressed of the state government.” He added, however, that a constitutional amendment on pension benefits, on the other hand, could offer sweeping relief down the line.

Cornhusker Prioritization. The Cornhusker unicameral legislature has set a hearing date for proposed legislation, LB 67, to prioritize bondholders over pensioners in the event of a municipal bankruptcy. The hearing, in which the legislature could consider amendments to the state’s current statute §13-2524—under which some 55 municipal entities have previously sought protection― will be held on March 3rd; the legislature could also hold a hearing on a related measure, LB 66, which would require a county, city, village, school district or agency of state government to disclose on the front page of offering documents if bondholders have no priority over pensioners, but only after the LB 67 according to an aide to Sen. Paul Schumacher (R-Columbus), the author of both bills. Several muni market participants testified against LB 66 in a public hearing on the proposed legislation two weeks ago. Sen. Schumacher said the lack of clarity on the federal level regarding the position of bondholders versus pensioners prompted him to re-introduce the legislation.

A Kernel of Affirmation. Fitch has affirmed its A rating on Kern County, California’s outstanding pension obligation bonds (POBs) and its implied general obligation (GO) rating at A+ with a stable outlook, noting the county’s financial position presently is satisfactory, with healthy reserve levels, and that, even though fund balances are likely to be drawn upon to support operations over the near term due to anticipated revenue declines, they are expected to remain adequate for the rating. The rating agency expects a decline in property tax revenues, noting its tax base is highly concentrated in oil production properties that have been preliminarily assessed at a much lower value for fiscal 2016 due to the sharp drop in oil prices. Thus, Fitch notes, the county’s general fund and fire fund expect to lose approximately 6% and 14% of total revenues (relative to FY2014), respectively, due to the tax base decline. In addition, the agency determined the regional economy, because it is centered on oil and gas production and agriculture―industries expected to be negatively affected by the decline in oil prices and the ongoing drought—that any significant job losses in these industries could “negatively impact the county’s structurally high unemployment rate and below average income levels.” Nevertheless, Fitch perceives that Kern’s “unrestricted general fund reserve and traditionally conservative budgeting practices” are important factors in supporting the current rating, notwithstanding that a “material reduction beyond current projections would likely lower the unrestricted fund balance below levels commensurate with the level of financial risk facing the county, leading to negative rating action.” Finally, Fitch notes that the projected revenue decline in FY 2016 is significant, estimated at approximately $32 million or 6% of operating revenues (based on fiscal 2014), largely driven by preliminary estimates of assessed value (AV) that reflect large losses from oil properties due to the sharp drop in oil prices. While the figures are preliminary and subject to change, “oil properties are projected to lose more than 40% of their value, resulting in a nearly $44 million revenue loss to the county.” Fitch notes that management’s flexibility to reduce expenditures to match the projected revenue decline is constrained to some degree by increasing fixed costs, particularly pension contributions and POB debt service payments, with general fund pension and POB costs expected to climb by approximately $13.4 million (1.8% of fiscal 2014 spending) in FY2016. Another limitation is a lean budget following multiple years of constrained spending. It found that the loss of property tax revenue due to lower oil prices is expected to leave a $17 million (14% of fiscal 2014 revenues) budgetary gap in the county’s fire fund—and the general fund “may need to support the fund if costs cannot be restructured to match the lower revenue levels.”