The Steep Climb Out of Municipal Bankruptcy

eBlog

        Share on Twitter

eBlog, 7/12/16

In this morning’s eBlog, we focus—again—on the ongoing challenges over Detroit’s future: a new study indicates that lingering impacts from the Great Recession are contributing to an exodus of middle and upper income families from the city, a trend which will create hard governance challenges. Then we look at the challenges in Puerto Rico—where Congress acted yesterday to pass and send to the Senate legislation to give investors equal protection to those in the rest of the U.S., and where the challenge of access to capital for the island’s water and sewer authority awaits action by the White House to name the island’s oversight panel created under the new PROMESA law. As we have already learned from Flint, the ability of a municipal utility to provide water and wastewater services is critical.  

The Steep Climb out of Municipal Bankruptcy. Professor Jonathan Silberman of Oakland University, author of a new Economic Data Center report, has written that the two-tier autoworker wage structures, flat compensation rates in recent labor contracts, and lingering effects of the Great Recession are among the key reasons metro Detroit is in a minority of metro regions which is experiencing a decline in middle- and upper-income households. His study makes a correlation between manufacturing sector declines, the growth of lower-income households, and a decline in middle- and upper-income households. Coming against a backdrop of significant uncertainty about the future for Detroit’s public schools, the research data find that the metropolitan region experienced a 6.9 percentage point increase in lower-income homes, from about 21.2 percent to 28.1 percent of all households; middle-income households declined by 3.7 percent, and upper-income households by 3.2 percent to just over 20 percent. Professor Silberman attributes the demographic change to recession after-effects, two-tier wages, and few recent union gains in contracts with the automakers: he notes that the average manufacturing production worker hourly wage fell from $31.57 in 2004 to $22.02 in 2014 by 2014 dollars; total manufacturing employees were off by about 50,000 in the Detroit-Warren-Livonia metropolitan statistical area over the same period. In his original report, Kevyn Orr, the Emergency Manager appointed by Gov. Rick Snyder to take over Detroit and guide it into and out of chapter 9 municipal bankruptcy, described the city as “dysfunctional and wasteful after years of budgetary restrictions, mismanagement, crippling operational practices and, in some cases, indifference or corruption.” We noted that residents could “escape these debts simply by moving away; many have done just that: Of the 264,209 households in Detroit, only 9.2% are married couple families with children under 18. Another 78,438 households — or 29.7% of the total — are families headed by women—of which families more than half have children under 18.” This news does not gainsay the significant strides and progress Detroit has made, but demonstrates how great the challenges it faces are.

Equal Protection for Puerto Rico. The U.S. House of Representatives yesterday approved the U.S. Territories Investor Protection Act of 2016 (H.R. 5322), a bill to put an end to a current legal loophole that a lawmaker contends has led to financial losses for many Puerto Rican investors and retirees. The legislation, authored by Rep. Nydia M. Velázquez (D-NY) would close a decades-old loophole that has caused significant financial losses for many Puerto Rican investors and retirees. The bill (HR 5322) would extend to investment companies operating in Puerto Rico and all the U.S. territories the same rules as those that apply on the U.S. mainland—or as the Congresswoman yesterday told her colleagues: “For too long, this massive oversight in federal investment law meant that residents of Puerto Rico did not have the same consumer safeguards as are available on the mainland…The result has been that many retirees and others have suffered enormous losses on financial products they have been sold by unscrupulous companies.” She noted that it has been publicly reported that some actors in Puerto Rico have used the current law’s loophole to act both as an underwriter for the issuance of bonds, and then repackaged those same bonds into mutual funds which are sold exclusively to investors on the island—something permissible in Puerto Rico, but prohibited on the U.S. mainland. Now, as the Congresswoman notes, “The situation has been compounded by Puerto Rico’s ongoing debt crisis. Puerto Rican investors holding government bonds have suffered massive losses and are claiming that some financial companies did not properly disclose the risks of these funds, due to this conflict of interest”—adding: “I’ve heard of people losing their hard earned savings because of these gaps in the law: This bill would ensure statutory parity and prevent working families in Puerto Rico from being sold unsound investments that could not be marketed anywhere else in the U.S.” At the time the exemption was enacted in 1940, it was suggested that Puerto Rico and other “U.S. possessions” were physically located too far away for the Investment Act protections to be enforced.  Since then both Hawaii and Alaska, which are farther away from the mainland than Puerto Rico, have been granted statehood and, ergo, the protections in the 1940 Act. Additionally, air travel between the U.S. and Puerto Rico is common and many of these financial instruments are today traded electronically. Rep. Velasquez added the bill would ensure statutory parity and prevent working families in Puerto Rico from being sold unsound investments that could not be marketed anywhere else in the U.S.—noting that Puerto Rico’s current fiscal crisis has only compounded the negative effects of the loophole.

The Puerto Rico Aqueduct & Sewer Authority (PRASA) wants to issue the debt through a new agency to finance construction work delayed by the government’s fiscal crisis. As an inducement to skeptics, the agency would give investors first claim on revenue it collects from water and sewer bills, according to Efrain Acosta, the PRASA Finance Director. It may also exchange an additional $1.1 billion of securities for its outstanding bonds to investors willing to accept less than they’re owed. Yet, as Mr. Acosta notes, the municipal market is “tough at this moment,” adding: “[W]e have to go forward with our plan and see if we can get new money to pay our contractors and try to restart our construction plan.” Puerto Rico has not sold municipal bonds for more than two years. Now the uncertainty about new municipal debt issuance is further clouded by the uncertain governance situation: when will the PROMESA oversight board be named—and, when it is named by the White House—how will it act with regard to any new issuance of debt. Indeed, the day after President Obama signed the PROMESA act into law, Puerto Rico defaulted on nearly half of $2 billion of principal and interest that was due—a default which marked the single greatest payment failure ever in the U.S. municipal-bond market; instead PRASA negotiated with creditors to delay $12.7 million that it owed. That is, Puerto Rico is entering a very different kind of municipal finance territory than Detroit, Central Falls, Jefferson County, etc.—all previous chapter 9 municipal bankruptcy filers which have been able, post-bankruptcy—to return to the issuance of capital debt; but chapter 9 is not available to Puerto Rico, so now it has the very challenging task of determining what promise there might be in PROMESA: can the yet-to-be-named oversight board—as previous such boards did in New York City and Washington, D.C. help realign the fiscal stars to allow Puerto Rico to regain its fiscal feet. In addition to selling new municipal debt, PRASA would offer municipal bond investors a chance to exchange their securities at a 15 percent loss, according to Mr. Acosta: such new bonds would be backed by a pledge of as much as 20 percent of PRASA’s revenue.

How Can a Government Provide Essential Services and Create a Plan of Debt Adjustment outside the Protection of a federal Bankruptcy Court?

July 28, 2015

Taking on Fiscal Sustainability. The Detroit News’ insightful columnist Daniel Howes yesterday wrote that Detroit Mayor Mike Duggan’s “readiness to challenge professional fees associated with Detroit’s historic bankruptcy is paying dividends,” noting that those astute challenges had already resulted in some $30 million in reduced borrowing needs, or, as Mayor Duggan’s deputy chief of staff reported: “It’s hugely helpful: For those years the debt service is reduced in principal and interest, you have that much more you can provide in services.” Mr. Howes added: “That’s not all. As part of its expected refinancing in the municipal bond market (the same market that experts predicted would spurn Detroit’s post-Chapter 9 borrowing efforts), the city also plans to restructure repayment schedules to eliminate what would have been larger payments in future years.” That is to note that the kind of fiscal discipline emerging in post-bankrupt Detroit is providing for not just more disciplined financial certainty and disciplined budgets, but also more fiscal resources to support delivery of basic public services—or, as Mr. Howes wrote: “an improved financial profile that could be reflected in credit ratings upgrades, perhaps as early as this week,” adding: “That’s in Detroit, little more than six months after completing the largest municipal bankruptcy in American history. That’s in record time and in a largely consensual proceeding that, for the first time in a very long time, also produced collective bargaining agreements with all the city’s unions.”

Wayne’s World. Wayne County commissioners are expected, today, to discuss options for resolving the county’s financial emergency when they meet as a committee of the whole this afternoon, less than a week less than a week after Gov. Rick Snyder said he agreed with an independent financial review team’s assessment that a financial emergency exists in Wayne County—giving the County until tomorrow afternoon to request a hearing before the state treasurer on the financial emergency declaration. Should they opt, this afternoon, to request such a hearing, the hearing will take place in Lansing on Thursday morning—after which Gov. Rick Snyder can either confirm or revoke his determination that the county is in a financial emergency. Wayne County commissioners eventually could vote for one of four options for state intervention: a consent agreement (which would impose benchmarks the county would have to accomplish); mediation; state appointment of an emergency manager, or filing for Chapter 9 municipal bankruptcy. Wayne County Executive Warren Evans has said he hopes the Commissioners will opt for a consent agreement to fix the county’s finances. The county, which encompasses Detroit and 27 other municipalities, is facing a $52 million structural deficit, caught in a vise between its underfunded pension system and a $100 million yearly drop in property tax revenue since 2008. The county’s accumulated deficit is $150 million.

Incumplimiento Técnico. When Puerto Rico failed, last week, to transfer to transfer cash to a Public Finance Corporation (PFC) trustee ahead of an August 1 debt service payment, that trigger a technical default, or, in Spanish, an incumplimiento technico, a step ahead of what could become the U.S. territory’s first payment default if sufficient funds have not been advanced by the end of this week. Our astute market observers at MMA have already noted to their institutional investor clients: “we expect that even a single default anywhere in Puerto Rico’s capital structure enhances the political viability of additional defaults everywhere else.” MMA notes that “Puerto Rico issuers now account for 59% of all impaired municipal par across all sectors, states, and categories. This creates a challenge in showing that the municipal industry as a whole has very low default and impairment rates. A summarization of all current, non-Puerto Rico impairment across the industry by sector, rating category, etc., shows that the rest of the municipal industry still has very low default rates.” The island’s public utility, PREPA, is seeking to push debt maturities on its $8.1 billion of municipal bonds back by five years, during which time no principal would be paid and interest would be cut to 1%, unless the authority’s cash position warrants it—a different approach—MMA notes, than the more common approach of simply cutting principal and interest payments. That stance by the utility is comparable to what Puerto Rico Governor Alejandro Garcia Padilla is advocating as part of what is shaping up to be the biggest municipal debt restructuring in U.S. history: “The ultimate goal is a negotiated moratorium with bondholders to postpone debt payments a number of years,” albeit, under the utility’s proposed plan, insured debt would be excluded from these treatments. As the potential for default escalates, and the chances of Congress providing access to a U.S. Bankruptcy court evaporate by week’s end with Congress departing for its five week vacation; the pressure is increasing on Puerto Rico’s Working Group for Economic Recovery to cobble together proposals for restructuring the commonwealth government’s debt by September 1st—a process sure to be unprecedented and rocky—already a report released by a group of hedge funds which own $5.2 billion of Puerto Rico municipal bonds wrote that Puerto Rico’s central government can pay what it owes—a thunderous shot over the bow as the island’s leaders seek, with ever diminishing time, to restructure its $72 billion of debt. According to the hedge fund commissioned report, budget cuts and tax increases would allow Puerto Rico to stabilize its finances. The hedge funds are, unsurprisingly, among the first bondholders to challenge Puerto Rico’s claim in June  that it needs to defer debt payments—at least until Gov. Padilla’s administration completes its draft proposal by the end of August for restructuring the island’s debt, an unprecedented effort in the U.S. which is certain to be challenged in court. The public challenge for Puerto Rico, in effect, is how to put together a plan of debt adjustment without the protection of bankruptcy to ensure uninterrupted ability to maintain essential public services. Remembering that Detroit’s process of putting together and obtaining Judge Steven Rhodes’ approval of its plan of debt adjustment consumed 18 months, one can appreciate not just the fiscal, but also the moral dilemma—or, as the Gov.’s chief of staff, Victor Suarez, puts it: “[T]he simple fact remains that extreme austerity placed on Puerto Ricans with less than a comprehensive effort from all stakeholders is not a viable solution for an economy already on its knees.” That is, there is no longer any question that Puerto Rico’s creditors will not be held harmless—Moody’s has already speculated that some investors may receive as little as 35 cents on the dollar on some securities, while owners of debt with the greatest safeguards could receive more than twice as much. Indeed, Moody’s, in its report, noted that it is a near certainty that Puerto Rico will default on some of its securities, possibly as early as this Saturday, when $36.3 million of bonds sold by its Public Finance Corp. become due—the legislature simply has not appropriated the funds. Thus will begin the great gladiator battles: different legal protections for Puerto Rico’s securities promise to pit owners of Puerto Rico general-obligation bonds, which have a constitutional pledge of repayment, against holders of other bondholders, such as sales-tax debt, which are backed by dedicated revenue sources. The hedge-fund group holds both types of securities.

Our perceptive friends at MMA note that were Puerto Rico able to avert a default, that would leave the proverbial door or “puerta” open to the idea of voluntary concessions by bondholders to remain viable for at least a bit longer; avert a new round of costly and goodwill‐consuming litigation from creditors; and, most importantly, reduce the risk of other island stakeholders organizing to protect their interests. The key point MMA makes is that: “we continue to strongly believe that a Puerto Rican default on any government‐related security would greatly increase the risk of additional defaults elsewhere. However, should Puerto Rico actually default on a debt payment, the implication would be that the U.S. territory has either chosen not to pay (perhaps referencing the government’s police power—the ultimate trump card vis‐à‐vis bondholders—as did the director of Puerto Rico’s OMB last week) or cannot pay while cash and liquidity are so scarce. Both scenarios are deeply unfavorable to [municipal] bondholders and could signal the start of a new, more adversarial chapter in creditor negotiations.” The ever perceptive MMA adds that the fiscal road ahead will, if anything, become more precipitous, as there is a projected sharp decline in expected FY15 commonwealth revenues, the government’s holdback of nearly 50% of 2015 income tax refunds, and what the Washington Post quotes a Pew director describing as, “the biggest movement of people out of Puerto Rico since the great migration of the 1950s.”

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

             August 28, 2014

Visit the project blog: The Municipal Sustainability Project 

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

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

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

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

 

Prepping in the Motor City for Trial & Rechartering in San Bernardino

August 27, 2014

Visit the project blog: The Municipal Sustainability Project 

COPs and Sobbers.  U.S. District Court Chief Judge Gerald Rosen, the Detroit bankruptcy mediator appointed by U.S. Bankruptcy Judge Steven Rhodes, filed an order yesterday to require a mediation session today with the Certificates of Participation or COPs parties, as Judge Rosen seeks to resolve one of the last major obstacles to the Motor City’s potential exit from the nation’s largest municipal bankruptcy before the confirmation trial begins next Tuesday. The order went to the City of Detroit, Syncora Capital Assurance, Inc.; Syncora Guarantee, Inc.; Berkshire Hathaway Reinsurance Group; Wilmington Trust Company, National Association, as successor to U.S. Bank National Association, as Trustee and Contract Administrator Successors-in-interest to EEPK Bank and its affiliates, and the Ad Hoc COP Holders (Dexia Credit Local, Dexia Holdings, Inc., Norddeutsche Landesbank Covered Finance Bank, S.A.) (the “Hedge Funds”), and Financial Guaranty Insurance Co. to appear at the federal courthouse this morning at 10 a.m. in a last ditch effort to resolve the disputes between the city and the holders and insurers of $1.4 billion of pension certificates of participation—with the COP investors and insurers the critical, objecting creditors to the Motor City’s proposed plan of adjustment of its $18 billion in debts. The order notes that the “parties and counsel should be prepared to stay overnight in Detroit for a continuation of the mediation session on Thursday, August 28, 2014 in the event the mediators deem it necessary.” The issue involves Detroit’s suit, which seeks to invalidate the COPs, because, Detroit claims, the certificates were issued illegally in the original 2005 transaction; therefore, the city should have no obligation to repay. (Detroit defaulted on the debt a year ago last June and has offered holders pennies on the dollar.) Judge Rosen’s order follows Monday’s session before U.S. Bankruptcy Judge Rhodes, when Detroit sought to have the federal court strike a portion of Syncora’s objection to the city’s plan of adjustment and impose sanctions on the insurer in the wake of Syncora’s accusation that Judge Rosen conspired to protect pensioners and the Detroit Institute of Arts over bondholders.

Drip. As the Michigan Finance Authority yesterday began issuing about $1.8 billion of municipal revenue bonds on behalf of the Detroit Water and Sewerage Department to finance the purchase of debt from investors, S&P upped its rating on the bonds three levels up from junk bond territory—expressing greater confidence than either Fitch or Moody’s.  The sale includes a $121 million uninsured senior-lien portion maturing in July 2044, which is being offered at just under 5 percent, according to Bloomberg. The sale is another key piece in the puzzle of resolving the Motor City’s municipal bankruptcy—especially in the wake of the Motor City’s agreements with its general obligation bond holders and its retirees. If the refinancing proceeds as planned, investors and bond insurers would drop their objections to the water and sewer portions of Detroit’s debt-cutting plan, enhancing the prospects for Detroit to exit municipal bankruptcy. Thus, S&P’s investment grades (BBB+) denote that the bonds are at low risk of default. The issuance is important, because, according to DWSD CFO Nicolette Bateson, the refinancing could save $11.4 million annually over the first 19 years of the deal, and it could also raise $150 million for projects to improve the city’s sewage system. The refinancing transaction is expected to achieve debt service savings of at least $240 million, and it is intended as an alternative to the Motor City’s current bankruptcy plan for the revenue bonds, which calls for the impairment of nearly 50% of the debt by either stripping out call protection or replacing the current coupon with a lower interest rate. In the wake of the sale, Detroit intends to amend its plan of adjustment to treat all the debt as unimpaired, with the untendered bonds continuing to get the scheduled principal and interest payments. The bonds are secured by a lien on net revenues of each respective water and sewer system that include user fees, investments, and earnings. While the DWSD system’s funds and accounts are separate from the city with excess revenue invested by the bond trustee at the direction of the water and sewer department, investors have been warier. Indeed, the Detroit Water and Sewer Department provides service to some 43% of Michigan’s population, with over 70% of operating revenues coming from suburban customers. The sale includes a $121 million uninsured senior-lien portion maturing in July 2044—which was offered at a 4.85 percent yield, according to Bloomberg. Some bonds are backed by Assured Guaranty Municipal Corp. and National Public Finance Guarantee Corp., according to the people with knowledge of the deal. The refinancing transaction is expected to achieve debt service savings of at least $240 million.

Charting San Bernardino’s Future. Even as the City of San Bernardino continues its closed-door discussions with its creditors under the aegis of U.S. Bankruptcy Judge Meredith Jury, the city’s voters are preparing to weigh in themselves in the wake of the city council’s decision earlier this month (4-3) to put two ballot measures on the November ballot, which would determine how police and firefighter salaries are determined and repeal a longstanding formula used for determining those wages. The first measure, Measure Q, would repeal a section of the city charter establishing the criteria for police officer and firefighter salaries. (Under Section 186 of the city charter, salaries for police and firefighters are determined based on what police and firefighters are paid in 10 other cities of comparable size and population.) The other measure (Measure R) proposes to eliminate paying fired employees while they are appealing their terminations to the civil service commission until the commission makes a decision on whether or not to reinstate the employee. In addition, demoted employees appealing their demotions would be paid their adjusted wage until the civil service commission determined they should go back to what they were previously paid. Now the actual wording for the ballots arguing for and against changing the city charter have been resolved—with the arguments in favor of both proposed amendments signed by Cal State San Bernardino economics professor Thomas Pierce, who was on the citizen committee which recommended the two measures voters will see.  The opposition to Measure Q — which would set police and firefighter salaries by collective bargaining instead of the average of 10 like-sized cities — is signed by Amelia Sanchez-Lopez, community advocate; Vinson Gates Jr., retired fire captain; Ronald Coats, business owner and citizen; Jim Eble, community advocate; and Marie Negrete, community leader. In contrast, on the second measure, Measure R, no one filed an argument against the Measure in time, according to the city clerk’s office. The affirmative position voters will see states: “This simply doesn’t make sense. The City and its taxpayers should not be forced to pay an employee that lost his or her job due to disciplinary reasons simply because the employee is appealing the decision.” The text — the language on the ballot — would eliminate the existing language of Section 186, including its salary-setting formula, shift requirements, and the one mention of paramedics — saying the council “may authorize additional salary to be paid to local safety members of the Fire Department, assigned to duty as paramedics, during the period of such assignment.” In its place would be the following: “Salaries. The Safety of the people in the City is a highest priority of its government. Compensation of police, fire and emergency safety personnel shall be set by resolution of the Mayor and Common Council after collective bargaining as appropriate under applicable law, as it does for other City employees.”

The arguments for and against Measure Q’s change to Section 186 follow:

  • Pro: “In every other city in California, the salaries of public safety employees are determined by collective bargaining and City Council resolution,” Measure Q’s backers begin. “Only in the City of San Bernardino is this not the case. Our City Charter dictates that outside forces will determine the salaries of our public safety employees.” The statement also says that by mandating shift hours for firefighters, Section 186 “locks the City into mandatory overtime, which comes to approximately $7 million in FY 2014-2015.”
  • Con: The group arguing against the changes to Section 186 argues it would add more politics to the salary-setting process, “cause our best-qualified firefighters and police to leave — making San Bernardino even less safe for residents” and do nothing to help the city’s finances…It puts taxpayers at risk while doing nothing to solve San Bernardino’s serious financial problems…Measure Q would reduce city paramedic services and make San Bernardino less safe for residents.”

While the argument says the change “will result in the outsourcing of paramedic services” and “the City Manager has publicly confirmed that the main purpose behind Measure Q is to outsource city paramedic services to an out-of-town corporation,” there remains uncertainty with regard to whether the amendment would have that effect. City Manager Allen Parker has stated he would like to consider the possibility of making the company AMR responsible for at least some paramedic services.

The 10-day examination period for the arguments for and against the ballot changes ends Sept. 2.

Key Step in San Bernardino; Puerto Rico beats its deadline

August 15, 2014

Visit the project blog: The Municipal Sustainability Project 

Progress in San Bernardino. The City of San Bernardino and the San Bernardino Police Officers Association (SBPOA) last evening announced to U.S. Bankruptcy Judge Meredith Jury that they have reached a tentative long-term agreement. The terms of the agreement are confidential and subject to the gag order imposed by Judge Jury, a development which Mayor Carey Davis. Chief of staff Michael McKinney noted “is an important step forward towards emerging from bankruptcy,” adding that it would bring “long-term stability for the San Bernardino Police Officers Association members and the city.” Ward 5 Councilman Henry Nickel said the police officers’ contract “is the biggest piece of the pie next to CalPERS (the California Public Employees’ Retirement System),” noting that San Bernardino’s bankruptcy emergence strategy has been to work on the “most complex aspects first.” Last night’s agreement is subject to approval by both the City Council and the police union’s members—with the city council set to consider it at a closed door session Monday.

Buying Tiempo. The Puerto Rico Electric Power Authority or PREPA reached an 11th hour agreement with its creditors prior to last midnight’s deadline, releasing a statement saying it’s reached an agreement with creditors to further extend its credit and that it has committed to appointing a chief restructuring officer by Sept. 8th. PREPA’s released statement said the agreements reached yesterday “provide PREPA with a consensual path forward to improve its operations and financial situation,” and will enable the authority to use some $280 million held in its construction fund for payment of current expenses and capital improvements. In addition, the Authority stated that insurers and bondholders controlling more than 60 percent of PREPA’s outstanding bonds have agreed to amend existing bond documents to provide PREPA with liquidity and time to “develop a plan to achieve a restructuring of its business:” the insurers and bondholders will not exercise remedies against PREPA during the term of these agreements, and PREPA will continue to make required debt service payments in full. Further, the authority reported that the banks that provide revolving lines of credit will extend until next March 31st agreements to not exercise remedies as a result of credit downgrades. PREPA will continue to delay certain payments that were due to these lenders in July and August. PREPA said it will file a notice today on the Electronic Municipal Market Access (EMMA) system outlining the key terms of its agreements with the creditor groups.

Detroit’s Confirmation Trial Set; San Bernardino makes progress

August 14, 2014
Visit the project blog: The Municipal Sustainability Project

Getting Ready to Rumble. In the wake of yesterday’s session with attorneys representing the Motor City and its creditors before U.S. Bankruptcy Judge Steven Rhodes, the Judge set deadlines and hearing dates for the confirmation trial to determine if Judge Rhodes will approve the city’s proposed plan of adjustment—allowing the city to emerge from the largest municipal bankruptcy in history by finding that that plan is fair and feasible; Judge Rhodes announced he would delay the trial by eight days, scheduling the historic proceeding to begin Aug. 29th—scheduling as many as 30 calendar days for hearings over the restructuring plan, to determine whether the city’s proposed plan of adjustment to eliminate more than $7 billion in liabilities and reinvest $1.4 billion over 10 years in services is fair and equitable. Judge Rhodes set hearings for: Aug. 29; Sept. 2-5, 8-12, 15-19, 22-24, and 29-30; and Oct. 1-3, 6-7, and 14-17—with the October dates falling after the deadline of October 1—when Mayor Duggan and the Detroit City Council have the authority to request Emergency Manager Kevyn Orr to depart. In the trial, the Motor City will seek to prove it has assembled a plan that will provide for fiscal sustainability and services solvency—and that its plan is equitable. Judge Rhodes said he would allow testimony from an Ernst & Young official at an Aug. 19th hearing to be included as part of the trial, and he said yesterday he would allow retirees who do not have lawyers to present their own evidence and call witnesses when the hearing begins. Attorneys for Detroit and its creditors will begin their opening statements Sept. 2nd. The nearly six weeks’ of hearings are expected to pit Detroit and its supporters—including the Official Committee of Retirees, the city’s two pension funds, several major unions, and (likely) water and sewer bondholders (Please see Motor City Savings on Tap below) against its two major bond insurers — Syncora and FGIC, as well as several hedge funds. Judge Rhodes has allocated 85 hours of trial time equally between supporters and opponents of Mr. Orr’s proposed plan of adjustment to present their cases.

Motor City Savings on Tap? Detroit’s unique tender offer, for which it is seeking a go ahead from U.S. Bankruptcy Judge Steven Rhodes, for its $5.5 billion in water and sewer bonds, appears to be tapping into a potential a success. The offer, part of the city’s proposed restructuring of its DWSD bonds could prove a key step to alleviate a stalemate with the Department’s bondholders and, thereby, remove a difficult hurdle to the Motor City’s efforts to exit municipal bankruptcy. If the city is able to refinance the debt in a public offering, it projects interest rates would be at 5.75% or lower rate, even for uninsured bonds, according to documents filed in the federal bankruptcy court. In addition, Assured Guaranty has agreed to wrap at least some of the new bonds, which would feature a senior lien on the department’s revenues. The proposed refinancing includes the tender offer, a refunding of the tendered debt, a refunding of currently callable debt, and $190 million of new money bonds—with Emergency manager Kevyn Orr’s office warning that without the federal court’s approval, DWSD’s capital budget “will be perilously depleted beginning in October 2014.” That, in turn, could lead to federal EPA sanctions. The offer was cobbled together in the wake of mediation between the city and insurers Assured, Berkshire Hathaway Assurance Corp., Financial Guaranty Insurance Co., and National Public Finance Guarantee, as well as an ad hoc committee of water and sewer bondholders that includes Blackrock Financial Management Inc., Eaton Vance Management, Fidelity Management & Research Co., Franklin Advisors Inc., and Nuveen Asset Management, plus trustee US Bank NA. According to its filing with the court, “the tender would facilitate a consensual restructuring of DWSD’s capital structure, while rendering unimpaired all existing DWSD bond claims and resolving the DWSD bond objections to confirmation of the plan.” Under the proposal, each member of the ad hoc committee has agreed to tender a “significant portion” of its respective, impaired DWSD bonds—upon which Detroit would issue the new bonds either through a public offering, direct purchase, or a private placement—with the Motor City having sought Judge Rhodes’ affirmation that the pledge of DWSD net revenues would constitute a lien on “special revenues.” In the wake of payment to bondholders from the refinancing proceeds, the bondholders would be required to approve the city’s confirmation plan. In addition, under the agreement, the bondholders agreed the DWSD can pay $24 million annually to the Detroit’s general employee pension fund as part of its operation and management expenses—with the payment drawn from a pension liability payment fund that will be funded after payments are made into the state revolving fund junior-lien bond and interest redemption fund, according to the documents. The tender offer which began last week is scheduled to close a week from today—at which time the city will decide by Aug. 22 whether to tender the bonds. Detroit has asked the federal court to schedule a hearing on the motion on Aug. 25th—a motion which, if granted, would mean the bonds would go to market on or around Aug. 26, with a close scheduled for Sept. 4. The refinancing, if approved, would also let the city tap debt service reserve funds for current bonds that hold as much as $50 million, which it would use to reduce the size of the upcoming refunding.

A Taste of What’s to Come. Syncora Guarantee, a bond insurer and Motor City creditor bitterly opposed to the city’s proposed plan of adjustment, Tuesday filed an objection with Judge Rhodes challenging an $800 million settlement put together under the oversight of chief mediator, Gerald E. Rosen, Chief Judge of the United States District Court for the Eastern District of Michigan, whom Judge Rhodes had asked to serve during Detroit’s bankruptcy. Syncora charged that Judge Rosen had said repeatedly that he believed he ought to get the best outcome possible for a single group of creditors — the city’s retirees. Because, Syncora noted, the Motor City’s plan of adjustment was underpinned by the agreement worked out for the city’s retirees, the plan itself should be rejected as impermissibly tainted by the biases of its chief mediator, whose job it was to impartially negotiate out-of-court settlements of as many of the city’s debts as possible. While Syncora told the court it believed that Judge Rosen was acting out of good intentions, the federal court needed to assess whether that might unfairly bias against the requirement that similar creditors be treated equitably. Syncora is an unsecured creditor, as are Detroit’s retirees; but the insurer claims Detroit’s plan of adjustment – under which the city is seeking to repudiate the debt Syncora insured – is entirely inequitable, requesting that Judge Rhodes reject the plan immediately, calling the proposed settlement a “product of agenda-driven, conflicted mediators who colluded with certain interested parties to benefit select favored creditors to the gross detriment of disfavored creditors and, remarkably, the city itself.”

Speaking of Mediators….Key San Bernardino city officials and some of the city’s creditors met with their own court-appointed federal mediator, U.S. District Court Judge Gregg Zive, in Reno, Nevada—with discussions not including key creditor, the California Public Employees’ Retirement System, according to Michael McKinney, San Bernardino Mayor Carey Davis’ chief of staff. Likely CalPERS, the city’s largest creditor in its municipal bankruptcy, was not present, because the agency has forged an interim agreement with CalPERS in an effort to help form a plan for San Bernardino to exit bankruptcy protection—after the city withheld its employer portion of CalPERS pension payments from the time of its bankruptcy filing a year ago in July. CalPERS currently estimates San Bernardino’s debt to the agency at $16.5 million, plus interest—although in the outline of its pendency plan in 2012, the city had noted it intended to pay the full amount it owes CalPERS. Working toward a settlement between CalPERS and the city has been the centerpiece of mediation talks with, according to brief statements made in previous filings and court appearances—with the thinking being that once the largest piece of the city’s financial obligations was decided, the remaining parties would have certainty how much remained to adjust with the city’s other creditors.
Unchartering? San Bernardino’s Council could vote today on whether to put proposed amendments to the city charter up for a vote of the people. In our case study on San Bernardino, we noted that its city charter fragments decision-making authority over budgets, personnel, development, and other critical issues among the mayor, city manager, city council, and city attorney—not to mention several boards and commissions—constraints that we noted “Greatly reduce the ability and flexibility of the city to adapt to economic and fiscal conditions as they change over time.” Now, after consideration of five amendments put together by a citizen review committee and discussed at city council meetings, the Council has narrowed its focus to two possible changes which its elected leaders hope could save the city money. At its previous meeting, the council decided not to pursue other proposed changes—changes which would have added a potentially sweeping statement that if multiple interpretations of a provision are possible, the one enabling the city applies; eliminated language governing the school district, which the district does not use; and replacing the city’s policy for recalls and initiatives with state policy. The council has the option of putting either proposed change on the ballot, both on the ballot as one item, both separately, or taking no action. Of the two amendments approved:
• One would eliminate a provision (§186) that guarantees that police and firefighters be paid the average of what 10 other cities with 100,000 to 250,000 people pay. Instead, pay would be set by collective bargaining as it is for other city employees — long a flash point in the city and the focus of most citizens’ charter comments, pro and con, since before the review committee recommended it.
• The second would end the practice of paying any employee who has been terminated or demoted until that employee has the chance to appeal the city’s decision to the civil service board.
With regard to public safety compensation, Mayor Carey Davis said he understood the city cannot underpay its public safety personnel; “[h]owever, I support the committee’s suggestion that salaries should be determined by market forces and our ability to pay…The modifications to Section 186 do NOT represent an automatic pay decrease but it does provide some flexibility to the Council and our public safety personnel with regard to salary discussions which will still be subject to California Law.”

Getting Ready to Rumble in the Motor City & Fitch Likes Chapter 9 Fix for Puerto Rico

August 7, 2014
Visit the project blog: The Municipal Sustainability Project

Trial Delay. Rhythm guitar playing Steven Rhodes of the Indubitable Equivalents (see photo from the Wall Street Journal), who last month was strumming old band favorites for attendees at the American Bankruptcy Institute’s annual meeting in Vermont (classics for you to croon like: “Born to Be Wild,” “Honky Tonk Women,” and “Running on Empty”), yesterday played a different tune at the bar, where, as the U.S. bankruptcy judge overseeing the pending trial to determine whether to approve the Motor City’s proposed plan of adjustment, Judge Rhodes rejected Syncora Guaranty’s motion to delay the commencement of the trial scheduled to start on August 21st. Syncora, with some $7 billion at stake, and one of the few remaining holdout creditors of the city, argued before the bench that Detroit has missed critical deadlines to provide it with key documents. The judicial action came as Toyota yesterday pledged $1 million towards the so-called grand bargain—helping the Detroit Institute of Arts sum up some $80 million—or 80% of its announced goal of $100 million—with the funds, including $195 million from the State of Michigan, to be directed towards ensuring that no Detroit retiree falls below the federal poverty level and that the Detroit Institute of Arts could become a foundation—remaining a key institution in the Motor City.

Bonds on Tap? After weeks of confidential mediation sessions with the city’s major bondholders and insurers, the Detroit Water and Sewerage Department yesterday confirmed it had reached an agreement by which it will be able to refinance up to $5.2 billion in debt, possibly helping to accelerate resolution of the Motor City’s successful exit from municipal bankruptcy and enabling the department to reduce rates to customers—an issue where, because of shutoffs for non-payment—the federal bankruptcy court has raised concerns. The Michigan Finance Authority would issue the debt. In a statement the authority released, it wrote: “This transaction has the potential to significantly lower the interest rate on existing DWSD bonds, reduce DWSD’s debt service costs, reduce risks and transaction costs, and enhance the department’s future cost of borrowing…The savings to DWSD customers could be in the millions.” Under the DWSD plan, effective today through the 21st, the day Judge Rhodes currently intends to open the confirmation trial for the City’s proposed plan of adjustment, holders of the water and bonds will have ten days in which to accept the offer to tender their debt to help the city embark on a massive refinancing of the water and sewer department debt portfolio―with the offer serving as an alternative to Detroit’s current proposals seeking to have its water and sewer bondholders either waive their call protection, allowing for a refinancing, or to accept a lower coupon rate. Under the proposal, bondholders may their bonds or tender them at a fixed tender offer price—a price which was not, as of yesterday, made public. The tender price will be financed either by a bridge loan from Citi, a public offering of exit tender bonds through the Michigan Finance Authority, or a combination of both. Under the plan, bondholders that do tender the bonds would have to agree to drop all objections to the Motor City’s plan of adjustment, and they would be deemed to have permitted debt to be described as “unimpaired” under the plan. Yesterday’s deal raises a legal question with regard to whether the so-called “special revenue” doctrine of chapter 9 would remain because of the voluntary nature of the proposed tender. In addition, the plan raises an issue with regard to whether insurers of the old, outstanding bonds might be afforded the opportunity to claim that their originally insured security is extinguished—so that they would no longer be obligated to pay the old interest amount. What is clearer is that emergency manager Kevyn Orr’s team believes the proposal could be a significant breakthrough, with Detroit’s attorney Heather Lennox yesterday alluding to a major agreement in the offing before Judge Rhodes in the federal bankruptcy court yesterday that could have a major impact on the length of the plan of adjustment confirmation hearings set to begin Aug. 21st. In the tabulation of creditors on the city’s proposed plan of adjustment, 119 out of 151 sub-classes of DWSD voted to reject Detroit’s plan of adjustment—upset that the Motor City was seeking to replace their current bonds without paying all future interest: ergo, a settlement with the DWSD bondholders and insurers would surmount a critical obstacle to Judge Rhode’s favorable approval of the city’s hopes to exit bankruptcy.

The Impact of Congressional Approval of Chapter 9 for Puerto Rico. Fitch Ratings yesterday wrote that the extension of Chapter 9, municipal bankruptcy protection “would be a positive and important development for Puerto Rico and holders of debt of its public utilities and public instrumentalities,” referring to the possibility of Congress approving legislation, HR 5305, the Puerto Rico Chapter 9 Uniformity Act of 2014, which would amend the municipal bankruptcy law to extend to the Commonwealth of Puerto Rico the authority to use Chapter 9 proceedings in federal bankruptcy court to adjust debts of its municipalities and public instrumentalities, or, as Fitch noted: place Puerto Rico on an equal footing with the 50 States, who can currently use Chapter 9 to achieve debt adjustment for their municipalities. The bill, which could be taken up by the House Judiciary Committee, is supported by the National Bankruptcy Conference—which has recommended the amendment be modified so that it would be retroactive. As we have reported, the island is confronted with grim fiscal challenges—leading it to enact a Recovery Act last June—with Fitch yesterday noting: “Given the economic and fiscal pressures facing the Commonwealth itself and its need to provide proper service levels for its citizens, its ability to continue to provide meaningful ongoing financial support to its public corporations going forward would be challenging, in Fitch’s view.” Fitch described the Commonwealth’s recovery act as “an effort to fill the void resulting from the absence of a federal bankruptcy alternative. The Commonwealth has attempted to forge its own framework for orderly debt restructuring applicable to its public corporations, including the Puerto Rico Electric Power Authority (PREPA) and Puerto Rico Aqueduct and Sewer Authority. While the Recovery Act is intended to restore solvency over the long-term, it entails debt restructuring that would trigger suspension of debt payments and preclude the timely payment of principal and interest during the pendency of the proceedings.” But the rating agency noted that the Recovery Act “specifically excluded the Commonwealth’s general obligation debt and certain instrumentalities of the Commonwealth, including the Puerto Rico Sales Tax Financing Corporation,” adding that “the adoption of the Recovery Act and the absence of any preemptive federal bankruptcy alternative, in Fitch’s view, suggest a degree of legal uncertainty regarding how the Commonwealth might act at a time of more severe financial stress to extend the same or a similar act to debt obligations of the Puerto Rico Sales Tax Financing Corporation.” Fitch added that the “adoption of the Recovery Act also spawned litigation and market volatility, potentially increasing the challenge to market access for the Commonwealth and its public corporations. The litigation challenging the Recovery Act will likely be costly to the Commonwealth, a distraction from more important governance activity and will continuously shroud the outcome of any proceedings or agreements entered into under the terms of the Recovery Act with uncertainty.” Fitch noted that while Puerto Rico’s Recovery Act has provisions that “mimic to a degree those in Chapter 9 (municipal bankruptcy),” there are also key distinctions; nevertheless, Fitch wrote: “[C]larifying the rules for restructuring and aligning them to a federal standard with understandable precedent, albeit limited, and providing a federal forum for the proceeding would benefit bondholders. It would also protect the Commonwealth from claims it is acting unjustly or arbitrarily and contrary to accepted norms,” adding that the “range of options available to the Commonwealth and its municipalities and public instrumentalities would be the same as those available in other states.” Fitch added that were Congress to able access to chapter 9 for Puerto Rico, it expected the Recovery Act would be withdrawn.