Assessing the Promise of PROMESA

D-Day, 2018

Good Morning! In this morning’s eBlog, we consider the status—and promise—of the quasi chapter 9 municipal bankruptcy process in the U.S. territory of Puerto Rico.

Nearly two years after the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) was enacted to establish a federally appointed oversight board to oversee a quasi-chapter 9 municipal bankruptcy process for restructuring or adopting a plan of debt adjustment of the U.S. territory’s debt—a statute which enabled the territory to suspend debt payments effective July 1^st in 2016 on its debt in excess of $123 billion, the end might be looming. The statute also cleared the way for deep cuts in Puerto Rico’s public service budget—including cuts to health care, pensions, and education. Just over a year ago, Judge Laura Taylor Swain began the process of overseeing the quasi chapter 9 municipal bankruptcy process in search of some consensus on a quasi-plan of debt adjustment. Now that plan is beginning to take shape, with, this week, the Puerto Rico Financial Advisory Authority and Fiscal Agency (Fafaf) ) informing Judge Swain that, as early as next month, there will be a plan to adjust the debt of the Government Development Bank. Attorneys for the Agency have indicated to Judge Swain that as early as June 22^nd they intend to provide drafts of the legal documents which are prerequisites to renegotiate the debt of the Government Development Bank (GDB) and the deposits of third parties which the Bank has retained in its custody since its decapitalization about two years ago. The adjustment with the creditors, whether bondholders or depositors, would occur in light of Title VI of the PROMESA statute—the title which provides for a voluntary negotiation between the parties and on which the judicial branch does not issue direct judgment regarding its reasonableness. The goal is to complete such submission by August, according to Christian Sobrino, the Governor’s chief advisor for economic development, who noted: “It is anticipated that at some point in August, the transaction must be closed,” as he discussed details of the quasi plan of debt adjustment process that would mark a milestone in the restructuring of Puerto Rico’s quasi municipal bankruptcy, noting: “This is the only agreement that has both the government and the Oversight Board, and this will demonstrate the ability of Puerto Rico to reach consensual agreements,” as he stressed the importance of the agreement reached with many of the government’s creditors, adding: “Given that they will be negotiable instruments, it will be the first issue of restructured debt issued by Puerto Rico since 2014.”

According to the agency’s motion, the government would open the application process to seek the consent of the creditors on July 5th. According to Mr. Sobrino, the process of compliance with Title VI of PROMESA would begin one day later, when it is expected that Aafaf, after receiving the approval of the Oversight Board, will file a request for a qualified modification of the GDB debt in court. He notes that PROMESA’s Title VI process requires presenting a breakdown of claims by creditors according to their guarantee or priority, but that process would have already been substantially completed upon the approval of the Debt Restructuring Agreement with various funds. (At present, some six credit unions have sued the government for the renegotiation of GDB debt.)

According to the RSA, the agreement between the Puerto Rico Electric Power Authority (PREPA) and its creditors to extend several deadlines under their restructuring support agreement, will be modified again to reflect the changes in the transaction calendar: the GDB bondholders would receive 55 cents of each dollar they lent to the former fiscal agent. Meanwhile, the depositors, including muncipios, would recover a similar amount for the deposits they have put in custody with the GDB—with, in their case, Mr. Sobrino stressing they would receive 55% of the deposits held in the bank. However, if the muncipios have loans in the GDB, their deposits would be used to settle dollar-to-dollar financing, without reflecting the 45 cents which will apply to the rest of the credits: “The approval request will seek to establish clear procedures related to the approval of the qualified amendment, including the timetable for the parties to object the vote portfolio, the request and the tabulation processes, thus ensuring that all parties with an interest in the restructuring of the GDB have an opportunity to be heard in relation to Title VI.”

To date, according to the RSA (the restructuring support agreement), through last December, the GDB owed approximately $3,765 million; it also owed $376 million in deposits to private and similar companies; and another $507 million in deposits from agencies and government entities. The proposed transaction contemplates repaying the bondholders of the municipal loans and government agencies that the GDB still hopes to recover, as well as the sale of properties of the institution, which closed its doors last March.

The Puerto Rican agency’s motion came less than 48 hours before Judge Swain is due back to preside over the general hearing of the Title III cases today—a hearing where Judge Swain must decide whether to authorize a second payment to the professionals involved in PROMESA cases.

Intergovernmental Federalism Fiscal Recovery Challenges

March 26, 2018

Good Morning! In this morning’s eBlog, we consider the ongoing fiscal challenges to Connecticut’s capitol city of Hartford, and the fiscal challenges bequeathed to the Garden State by the previous gubernatorial administration, before wondering about the level of physical and fiscal commitment of the U.S. to its U.S. territory of Puerto Rico.

Capitol & Capital Debts. The Hartford City Council is scheduled to vote today on whether to approve an agreement between the city and the state on a fiscal arrangement under which the state would pay off Hartford’s general obligation debt of approximately $550 million over the next two decades as part of the consensus seemingly settled as part of the Connecticut state budget—an agreement under which the state would assume responsibility to finance Hartford’s annual debt payments, payments projected to be in excess of $56 million by 2021, while the city would continue to make payments on its new minor league ballpark, about $5 million per year—a fiscal pact described by Hartford Mayor Luke Bronin as the :”[K]ind of long-term partnership we’ve been working for, and I’m proud that we got it done.” Mayor Bronin is pressing Council to vote before April Fool’s Day, which happens to be the city’s deadline for its next debt payment: if executed by then, the state would pay the $12 million which Hartford currently owes, under the provisions in the current state fiscal budget which, when adopted, had pledged tens of millions of dollars in additional fiscal assistance to the state capitol, fiscal assistance regarded as vital to avert a looming chapter 9 municipal bankruptcy—and, under which, similar in a sense to New Jersey’s Atlantic City, the aid provided included the imposition of state oversight. The effect of the state fiscal assistance meant that in the  current fiscal year, Connecticut would assume responsibility for Hartford’s remaining debt of $12 million; in addition, the state is to provide Hartford another $24 million to help close the city’s current budget deficit—and, in future years, assume the city’s full debt payment. The agreement provides that the state could go further and potentially finance additional subsidies to the city. Mayor Bronin had sought approximately $40 million in extra aid each year, in addition to the $270 million the city already receives—albeit, the additional state aid comes with some fiscal strings attached: a state oversight board, as in Michigan and New Jersey, is authorized to restrict how the municipality may budget, and finance: contracts and other documents must be run by the panel, and the board will have final say over new labor agreements and any issuance of capital debt. Going further, under the provisions, even if the oversight board were to go out of existence, Hartford’s fiscal authority would still be subject to state oversight: e.g. if the city wished to make its required payment to the pension fund, such payment(s) would be subject to oversight by both the Connecticut Treasurer and the Secretary of Connecticut’s Office of Policy and Management—where a spokesperson noted: “Connecticut cannot allow a city to default on its bond obligations or financially imperil itself for the foreseeable future: This action will ultimately best position Hartford to move into a better financial future.”

Mayor Bronin, in reflecting on the imposition of state fiscal oversight, noted that while the state assistance would help offset Hartford’s escalating deficits, deficits now projected to reach $94 million by 2023, noted: “This debt transaction does not leave us with big surpluses: “We’re looking to achieve sufficient stability over the next five years, and we can use that period to focus on growth.” Hartford Council President Glendowlyn Thames likewise expressed confidence, noting: “This plan is really tight, and it’s just surviving: We have to focus on an economic development strategy that gets us to the point where we’re thriving.”

State Fiscal Stress. For its part, with less than a week before the state enters its final fiscal quarter, the Connecticut legislature still has its own significant state debt issue to resolve—with Gov. Dannel P. Malloy warning he still expects the state legislature will honor a new budget control it enacted last fall to help rebuild the state’s modest emergency reserves, stating: “I don’t think I have given up any hope, or all hope” that legislators will close the $192 million projected shortfall in the fiscal year which ends June 30^th; however, the Governor also said legislative leaders professed commitment to both write and commit to a new, bipartisan budget may be waning, stating: “The grand coalition seems to be fraying, and I think that’s what gives rise to the inability to respond to the budget being out of balance,” he said, referencing last October’s grand bargain under which there was bipartisan agreement on a new, two-year plan to balance state finances—an agreement achieved in a process excluding the Governor, who, nevertheless, signed the budget to end the stalemate, despite what he had described as significant flaws, including a reliance on too many rosy assumptions, hundreds of millions of dollars swept from off-budget and one-time sources, as well as unprecedented savings targets the administration had to achieve after the budget was in force. Indeed, meeting that exacting target is proving elusive: the fiscal gap in January exceeded $240 million in January, before declining to the current $192 million: it has yet to meet the critical 1% of the General Fund threshold—a threshold which, if exceeded, mandates the Comptroller to confirm, and triggers a requirement for the Governor to issue a deficit-mitigation plan to the legislature within one month.

The new state local fiscal oversight arrangement provides that, even if the state oversight board goes away, the city’s fiscal practices would remain subject to state oversight—where any perceived failures would subject the city fiscal scrutiny by the Connecticut Treasurer and the Secretary of Connecticut’s Office of Policy and Management, a spokesperson for which noted: “Connecticut cannot allow a city to default on its bond obligations or financially imperil itself for the foreseeable future: This action will ultimately best position Hartford to move into a better financial future.” Hartford City Council President Glendowlyn Thames asserted her confidence with regard to the contract, but noted more work needed to be done: “This plan is really tight, and it’s just surviving: We have to focus on an economic development strategy that gets us to the point where we’re thriving.”

Post Christie Garden State? New Jersey Gov. Phil Murphy, in his first post Chris Christie fiscal challenge is targeting state tax incentives as a potential source of revenue for the cash-starved state, noting, in his first fiscal address earlier this month that $8 billion in corporate state tax credits approved by the New Jersey Economic Development Authority under former Gov. Chris Christie had made the state’s fiscal cliff even steeper to scale, noting that one of his first fiscal actions was to sign an executive order directing the state Comptroller’s office to audit the New Jersey Economic Development Authority’s tax incentive programs, dating back to 2010 (the current program is set to expire in 2019), describing the programs as “massive giveaways, in many cases imprecisely directed, [which] will ultimately deprive us of the full revenues we desperately need: “These massive giveaways, in many cases imprecisely directed, will ultimately deprive us of the full revenues we desperately need to build a stronger and fairer economic future,” as the new Governor was presenting his $37.4 billion budget to the Garden State state legislature, noting: “We were told these tax breaks would nurse New Jersey back to health and yet our economy still lags.” Under his Executive Order the Gov., in January, had directed Comptroller Philip James Degnan to examine the Grow New Jersey Assistance Program, the Economic Redevelopment and Growth Grant Program, and other programs which have existed under the NJEDA since 2010 when former Gov. Christie assumed office: the audit is aimed at comparing the economic impact from projects that received the tax breaks with the jobs and salaries they created: it is, as a spokesperson explained: “[A]n important opportunity to evaluate the effectiveness of the State’s existing incentive programs.” New Jersey Policy Perspective, in its perspective, notes that the $8.4 billion of tax breaks NJEDA approved under former Gov. Christie compared to $1.2 billion of subsidies awarded during the previous decade, subsidies which the organization frets have hampered New Jersey’s fiscal flexibility to fund vital investments such as transportation and schools. Indeed, a key fiscal challenge for the new Governor of a state with the second lowest state bond rating—in the wake of 11 downgrades under former Gov. Christie, downgradings caused by rising public pension obligations and increasing fiscal deficits—will be how to fiscally engineer a turnaround—or, as Fitch’s Marcy Block advises: “It’s always a good idea for a new administration to see what the tax incentives program is like and what potential revenue they are missing out on,” after Fitch, last week, noted that the new Governor’s budget proposes $2 billion in revenue growth, including $1.5 billion from tax increases,” adding that the Governor’s proposed plan to readjust the Garden State’s sales and use tax back up to 7% from the 6.625% level it dropped to under former Gov. Christie was a “positive step” which would provide $581 million in additional revenue, even though it would impose strict fiscal restraints: “These increased revenues would go to new spending and leave the state with still slim reserves and reduced flexibility to respond to future economic downturns through revenue raising: The state has significant spending pressures, not only due to the demands of underfunded retiree benefit liabilities, but also because natural revenue increases resulting from modest economic growth in recent years have gone primarily towards the phased-in growth in annual pension contributions.”

For his part, Gov. Murphy has emphasized that while he opposes many of the state tax expenditures doled out by the former Christie administration, a $5 billion incentives program that the NJEDA’s Grow New Jersey Program is offering Amazon to build its planned second headquarters in Newark would be a positive for the state. (Newark is on Amazon’s short list of 20 municipalities it is considering for a new facility that could house up to 50,000 employees: the city is offering $2 billion in tax breaks of its own to create $7 billion in total subsidies.) The Governor noted a win here would be “a transformative moment for our state: It could literally spur billions of dollars in new investments, in infrastructure, in communities and in people,” as he noted that the Commonwealth of Massachusetts has grown jobs at a rate seven times greater than New Jersey in recent years, despite only spending $22,000 in economic incentives per job compared to $160,000 for each job in New Jersey, noting that other priorities beyond taxes are important to lure businesses, such as investments in education, workforce housing, and infrastructure: “Even with these heralded gifts, our economic growth has trailed almost every other competitor state in the nation in literally almost every category: “Massachusetts and our other competitor states are providing businesses a greater value for money and with that value in hand they are cleaning our clocks.”

Free, Free at Last? Announcing that “We’ve reached an agreement that is beneficial both for the taxpayer and for the people of Puerto Rico,” referring to a pact that is to lead to the release of some held up $4.7 billion in federal disaster recovery assistance reached between Puerto Rico Gov. Ricardo Rossello and U.S. Treasury Secretary Steven Mnuchin, the pair has announced at the end of last week agreement on the release of some $4.7 billion in disaster recovery loans which Congress had signed off on six months ago—but funds which Sec. Mnuchin had delayed releasing on account of disagreement over the terms of repayment, describing it as a “super-lien” Community Disaster Loan. After a meeting between the two, the new, tentative agreement would allow Puerto Rico access to the fiscal assistance once the cash balance in its treasury falls below $1.1 billion—a level more than the Secretary’s initial request of $800 million. (As of March 9th, U.S. territory had about $1.45 billion in cash.) The agreement ended half a year of tense negotiations over what were perceived as discriminatory loan conditions compared to the terms under which federal assistance had been provided to Houston and Florida in the wake of the hurricanes. Indeed, Gov. Rossello had written to Congress that the Treasury was demanding that repayment of those loans be given the highest priority, even over the provision of essential emergency services in Puerto Rico—even as the Treasury was proposing to bar Puerto Rico’s eligibility for future loan forgiveness. Under the new agreement, the odd couple have announced that the revised agreement would grant high priority to repayment of the federal loans—not above the funding of essential services, but presumably above the more than $70 billion Puerto Rico owes to its municipal bondholders. From his perspective, Sec. Mnuchin noted: “We want to make sure that the taxpayers are protected: It’s not something we’re going to do for the benefit of the bondholders, but it is something we would consider down the road for the benefit of the people if it’s needed,” opening the previously slammed door for access by Puerto Rico to the full amount approved by Congress, more than double the amount the Trump Administration had sought to impose. Nevertheless, notwithstanding the agreement, the terms must still be agreed to by Puerto Rico’s legislature, the PROMESA oversight board, and the federal court overseeing the quasi-chapter 9 bankruptcy proceedings. Under the terms of the agreement, Puerto Rico may borrow up to $4.7 billion if its cash balances fall below $1.1 billion. (Puerto Rico’s central bank account had $1.45 billion as of March 9^th.) Governor Rosselló described the federal loan as one which will have a “super lien: There will be a lien within the Commonwealth, but it won’t be a lien over the essential services…I think both of our visions are aligned. We both want the taxpayer to be protected, but we also want the U.S. citizen who lives in Puerto Rico to have guaranteed essential services. And both of those objectives were agreed upon,”  noting that the U.S. government frequently forgives these types of loans. For his part, Secretary Mnuchin said the topic of loan forgiveness would be dealt with later “based on the facts and circumstances at the time,” and that, if and when the topic came up, the Treasury would consult with FEMA, the Congressional leadership and the administration, noting: “It’s not something we’re going to do for the benefit of bondholders, but it is something we would consider down the road for the benefit of the people of Puerto Rico.” The discussions come as the Commonwealth continues in the midst of its Title III municipal-like bankruptcy process affecting more than $50 billion of Puerto Rico’s $72 billion of public sector debt—with a multiplicity of actors, including: Puerto Rico’s legislature, the PROMESA Oversight Board, and Title III Judge Laura Taylor Swain. Under the terms, Puerto Rico would be allowed to draw upon the money repeatedly, as needed, according to Gov. Rossello, who noted that the U.S. Virgin Islands has already taken four draws totaling $200 million. The access here would be to fiscal resources available until March 2020.

Municipio Assistencia. In addition to the federal terms worked out for the territory, the new terms also provide that the U.S. Treasury will be making loans available for up to $5 million to every Puerto Rico municipality. FEMA is planning to make more than $30 billion available for rebuilding, while HUD is considering grants of more than $10 billion—leading Sec. Mnuchin to add: “There’s a lot of money to be allocated here, and I think it is going to have an enormous impact on the economy here: I think we are well on the path to a recovery of the economy here.” The Secretary added he would be returning to Puerto Rico on a quarterly basis to meet with the Governor, assess progress, and examine the island’s economy. His announcement came as the federal government is scaling back the number of contractors working on Puerto Rico’s electrical grid—critical work on an island where, still today, an estimated 100,000 island residents still lack power, with, last week, the U.S. House Oversight and Government Reform Committee hearing testimony from U.S. officials about bureaucratic challenges to power-restoration efforts, leading to bipartisan questioning about the drawdown of personnel there by the U.S. Army Corps of Engineers. The Corps, which brought in Fluor and PowerSecure as contractors to spearhead reconstruction of damaged transmission and distribution lines, has already reduced the number of contract workers by nearly 75%, according to tweets from the official Army Corps Twitter account, even as nearly 100,000 customers still lack service. Worse, of the restoration challenge remaining, the bulk is projected to fall mostly on Puerto Rico’s bankrupt public power utility, PREPA, especially after, last week, Fluor halted its subcontract efforts. Despite the Corps pledge to “do all possible work with the funds available” before the contractors leave Puerto Rico, access to vital construction materials, such as concrete poles, transformers and conductors were in short supply, and the Army Corps struggled to purchase and transport materials quickly enough, hindered, no doubt, in part by the discriminatory shipping rules (the Jones Act), increasingly forcing linemen to scrounge for replacement parts. The Corps has acknowledged the supply shortages, noting that natural disasters last year in Texas, Florida, and California strained supplies of construction materials across the U.S. Twelve Democratic Senators have written to Army Corps officials to inquire whether keeping its contractors in place would accelerate the timetable for power restoration—PREPA, last week, reported last week that 32% of the 755 towers and poles that were downed by Hurricane Maria still have not been repaired, and that, of 1,238 damaged conductors and insulators, 28% have not. Rep. Jenniffer González-Colón, Puerto Rico’s Republican delegate to Congress, in a letter to Army Corps officials last week, wrote: “The average citizen on the street in those communities cannot tolerate even the perception that at this point we will begin to wind down the urgent relief mission and that the process of finishing the job will slow down.”

Muhnicipal Bankruptcy in the Home Stretch

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eBlog, 11/18/16

Good Morning! In this a.m.’s eBlog, we consider San Bernardino’s home stretch to emerging from the nation’s longest-ever chapter 9 municipal bankruptcy—and guidance by U.S. Bankruptcy Judge Meredith Jury to steps the city might consider to avoid its emergence early next year from being appealed—a la Jefferson County, Alabama. Indeed, we then visit Jefferson County, where it appears the County’s elected leaders appear on the verge of finally getting their day in court with regard to the appeal related to the county’s plan of debt adjustment. From thence, we observe the political waves rolling ashore where Donald Trump’s bankrupt casinos grace Atlantic City’s beaches—and where the New Jersey League of Municipalities featured Gov. Chris Christie in town and some more discussion of the evolving state takeover of Atlantic City by what Mayor Don Guardian deemed the “occupation force.” We consider the role of the state and mechanisms for a state takeover—as well as the options for the municipality. Finally, we journey back to Detroit where a federal investigation is underway with regard to the city’s unique and innovative demolition program: The challenge for a city in which in 1950, there were 1,849,568 people, but, by 2010, only 713,777, ergo, at the time of its chapter 9 filing, a city home to an estimated 40,000 abandoned lots and structures: Between 1978 and 2007, Detroit lost 67 percent of its business establishments and 80 percent of its manufacturing base. In its efforts to address the issue, Detroit undertook extraordinary measures to address vast tracts of abandoned homes—nests of crime—but maybe triggering a federal investigation.

The Last Hurdle? U.S. Bankruptcy Judge Meredith Jury this week has ordered San Bernardino officials into mediation with one of the municipality’s few creditors still challenging the city’s chapter 9 plan of debt adjustment, writing that she is weeks away from the “final confirmation hearing” of what has been the longest chapter 9 municipal bankruptcy in history. Judge Jury added she had been prepared to make a ruling on some of the issues still blocking her ability to confirm San Bernardino’s plan, more than fifty-one months after the city filed with the U.S. Bankruptcy Court. Judge Jury made clear she now intends to rule on December 6^th on both issues raised by one creditor, the Big Independent Cities Excess Pool (BICEP), as well as on other remaining issues, noting, efficiently, that that ought to prevent the mediations from prolonging what is already the record holder for the longest municipal bankruptcy in the nation’s history. Moreover, Judge Jury noted, the mediation could save time, in no small part by preventing an appeal—an outcome with which Jefferson County, Alabama leaders would surely agree. As Judge Jury noted: “This really doesn’t slow down the process, and it might, over the years, if you reach a mediated solution, speed things up.” Judge Jury added that the confirmation hearing would be labeled on the calendar as final, which, while not a 100 percent guarantee it would be the final, does offer hope it shall, writing: “I’m not requesting anything from the city, except to come prepared to potentially put a bow on this case on the 6th – but potentially not.” The mediation in question commences today in Reno, Nevada with retired U.S. Bankruptcy Judge Gregg Zive. (San Bernardino and creditors have noted with respect Judge Zive’s previous mediation sessions as having been key to brokering major settlements as part of the city’s chapter 9 case, including the resolution with the city’s largest creditor, CalPERS. Nonetheless, the proposed mediation has both sides publicly discounting its chances of success: San Bernardino’s attorney, Paul Glassman, noted: “BICEP could have sought mediation six months ago, but instead placed the legal dispute before the court and pressed to block confirmation of the plan unless it got its way…Caving in to BICEP’s intransigence and efforts at delay is not in the best interests of the City’s creditors. It’s too late for mediation.” (BICEP is a risk-sharing pool of large Southern California cities for claims against any of the member cities, and its disputes with San Bernardino involve whether the city or BICEP is responsible for claims of more than $1 million.) Providing an idea of how complex the challenge of extricating one’s municipality from chapter 9 municipal bankruptcy can be, the BICEP issue is related to another outstanding issue in this record-length, complicated chapter 9 case: objections from the group referred to in court as the civil rights creditors. Juries previously awarded those creditors compensation for their claims, such as the $7.7 million awarded to Paul Triplett after a jury found San Bernardino police in 2006 broke Mr. Triplett’s jaw, arm, ribs, leg, ankle, and foot, leaving him comatose for three days. Under the city’s proposed plan of debt adjustment, because these creditors are in the unsecured class, the pending plan of debt adjustment would pay 1 percent or $77,000, in Mr. Triplett’s case. Nevertheless, Judge Jury, in a previous hearing, noted that while she sympathized with Mr. Triplett, she saw no legal reason to argue he did not belong in the unsecured class of creditors, 95 percent of whom voted in favor of the city’s plan of debt adjustment. That would mean any avenue of relief would be for the challenge to demonstrate that experts the city hired were wrong when they argued, with extensive documentation, that San Bernardino could not afford to pay more than 1 percent to its unsecured creditors. However, Judge Jury this week noted that those creditors’ interest now aligned with the city in its battle with BICEP, and that they could attend the mediation in Reno. On a high note, from the city’s perspective, Judge Jury also rejected the proposal by another of the challenging civil rights attorneys, Richard Herman, that the plan be modified in light of the possible “financial bonanza” recently legalized marijuana would bring: Judge Jury said the amount of those revenues would not be known for years, and she was unwilling to delay the case that long, especially when city services were underfunded in many other ways.

An Appealing Route to Full Recovery? Jefferson County Commission President Jimmie Stephens yesterday noted: “I am delighted that our case is now set and that we will have our day in court,” referring to yesterday’s announcement that the 11th U.S. Circuit Court of Appeals has scheduled oral arguments on the appeal of Jefferson County’s chapter municipal bankruptcy plan. The court set December 16^th as the date—albeit, this marks the eighth time the court has set a date, so that whether this will finally prove to be the date which could offer the final exit from the county’s municipal bankruptcy remains incompletely certain. It has now been nearly three years since Jefferson County filed with the court an adjustment to its post-chapter 9 filing to adjust debt primarily related to it sewer system obligations (the county had exited its chapter 9 bankruptcy in the wake of issuing some $1.8 billion in sewer refunding warrants to write down $1.4 billion of the sewer system’s debt.) As structured, the agreement incorporates a security provision for the county’s municipal bondholders to allow investors to return to federal bankruptcy court should County Commissioners fail to comply with their promise to enact sewer system rates that will support the 40-year warrants. It was that commitment which provoked a group of sewer ratepayers—a group which includes local elected officials and residents—to challenge the constitutionality of the provision. Ergo, they filed their appeal to Jefferson County’s plan of debt adjustment in January of 2014 with the U.S. District Court in the Northern District of Alabama. Jefferson County has argued that the U.S. Bankruptcy court oversight has been a key security feature to give investors in its bonds reason to purchase its 2013 warrants, and that the ratepayers’ appeal became moot when the chapter 9 plan of adjustment was implemented with the sale of new debt; however, U.S. District Court Judge Sharon Blackburn two years ago opined in the opposite, writing that she could consider whether portions of the County’s plan are constitutional, including the element allowing the federal bankruptcy court to retain oversight. It is Judge Blackburn’s decision that the County has appealed; and it is Jefferson County President Stephens who notes: “I am very confident that the facts and prevailing law support Jefferson County’s position.”

What Does a State Takeover of a City Mean? Atlantic City convened its first City Council meeting since the state officially took the municipality over earlier this week—and since it appeared to be clear that Gov. Chris Christie will not become a member of President-elect Donald Trump’s cabinet—so that the state’s unpopular Governor was himself in Atlantic City for the annual meeting of the New Jersey State League of Municipalities—indeed, where six mayors representing urban areas gathered at the conference to discuss what they would like to see in a new governor and how he or she can help people who are living and struggling in cities across the state—but where, as one writer noted, the elephant in the room, and throughout the entire conference, has been the state’s decision to take over Atlantic City’s government. Indeed, Mayor Don Guardian addressed that and other issues during a speech at The Governor’s Race and the Urban Agenda seminar, noting: “We need a governor that won’t take over Atlantic City, but rather one that will lend us a helping hand,” adding: “I talk to 10 business leaders and developers every single week, and all they tell me is they can’t afford to do business in New Jersey.” Mayor Albert Kelly, of Bridgeton, said he’s frustrated because he feels towns like his get forgotten with the current administration. He said Bridgeton has lost state funding for various programs: “Because we’re a smaller town in New Jersey, we often get overlooked.”

As for the city itself, Mayor Guardian, speaking to his colleagues from around the state, noted, referring to the state takeover: “They can use all of the power, they can use some of the power, and in a very shocking instance, they can use none of the power…This is uncharted territory in our city.” He noted this unrestricted power means any of the items named in the so-called state takeover act enacted earlier this year, including breaking union contracts, vetoing any public-body agenda, and selling city assets. Atlantic City’s state takeover leader, former New Jersey Attorney General and U.S. Senator Jeffrey Chiesa, was in Atlantic City, where he noted he had impressed upon himself the importance of making himself known to the city and the City Council. Earlier in the week, during a radio interview, Governor Christie had lauded Mr. Chiesa as “someone who has provided extraordinary service to the state” and is now determined to revive one of New Jersey’s most iconic cities, adding: “More importantly than that, he’s an outstanding person who cares about getting Atlantic City back on track and working with the people of Atlantic City and the leaders of Atlantic City to get the hard things done. Because if we make the difficult decisions now and do the difficult things, there is no limit to Atlantic City’s future.”

Under the terms of the state takeover, Mr. Chiesa is granted vast power in the city for up to five years, including the ability to break union contracts, hire and fire workers, and sell city assets and more. In his first session with Mayor Don Guardian and members of the city council, Mr. Chiesa noted he had “a chance to listen to (the mayor’s) concerns” and looks forward to gathering more information “so we can make decisions in the city’s best interest,” adding he did not know what his first decisions would be. Atlantic City Councilman Kaleem Shabazz said after the meeting he remains optimistic the city and state can still work together to pull the resort back on its feet: “I’m taking (Chiesa) at his word, what he said he wanted to do, which is work in cooperation with the city.”

With Gov. Christie in Atlantic City yesterday for the League meeting, the Mayor preceded Gov. Christie in speaking to the session, and later sat to the Governor’s right; however, the two avoided any takeover talk at the annual conference luncheon at Sheraton Atlantic City Convention Hotel: that is, the elephant in the room of greatest interest to every elected municipal leader in the room went unaddressed. Or, as Mayor Guardian put it: “Obviously, I was surprised he did not.” Instead of Atlantic City, Gov. Christie discussed his possible future in a Donald Trump White House and defended raising the gas tax to fund road and bridge projects. For his part, the Mayor, in what was described as a fiery speech at an urban mayors’ roundtable discussion, said he needed a new governor with heart, brains and courage—and one who “won’t take over Atlantic City, but rather one that will lend us a helping hand.” New Jersey Senate President Steve Sweeney, who introduced the so-called takeover law, was also a guest at the conference: he noted that, in retrospect, Atlantic City officials would have been better advised to have provided a draft recovery plan to the state much sooner, rather than wait until just before the deadline, adding: “You hope that we can move forward and find a way to put this city back together in a place where the taxpayers can afford it.”

Fiscal Demolition Threat? The U.S. Attorney’s Office yesterday ordered FBI agents to acquire documents yesterday from the Detroit Land Bank Authority, an authority which is under federal criminal investigation relating to Detroit’s demolition program, albeit the office clarified it was a “scheduled visit to provide records, not a raid.” Ironically, the raid occurred in a building owned by Wayne County, which had received a courtesy call from building security that the FBI was present inside the building. The FBI actions relate to a federal investigation related to the city’s federally funded demolition program, which has been under review since last year when questions were raised about its costs and bidding practices. The raid comes just a month after Mayor Mike Duggan revealed that U.S. Treasury had prohibited the use of federal Hardest Hit Funds for demolitions for two months beginning last August in the wake of an investigation conducted by the Michigan Homeowner Assistance Nonprofit Housing Corp., in conjunction with Michigan State Housing Development Authority, which turned up questions with regard to “certain prior transactions” and indicated specific controls needed to be strengthened. In addition, a separate independent audit commissioned last summer by the land bank revealed excessive demolition costs were hidden by spreading them over hundreds of properties so it appeared no demolition exceeded cost limits set by the state—turning up mistakes over a nine month period between June 2015 and February, including inadequate record keeping, bid mistakes, and about $1 million improperly billed to the state. Mayor Duggan has admitted the program has had “mistakes” and “errors.” That admission came after the Office of the Special Inspector General for the Troubled Asset Relief Program, or SIGTARP, sent the city a federal subpoena for records.

Auditor General Mark Lockridge acknowledged his office received the federal subpoena after it released preliminary findings from a months-long audit into the city’s demolition activities. The federal subpoena was seeking documents supporting the preliminary audit; now a Wayne County Circuit judge next month is expected to revisit a battle over the release of the subpoena the land bank received from SIGTARP, after Judge David Allen had, last August, ruled the subpoena could stay secret for the time, albeit he believed it ultimately was “the public’s business.” Judge Allen has scheduled an update on the stage of the investigation during a hearing slated for Pearl Harbor Day. In addition, Detroit’s Office of Inspector General is also conducting a review of an aspect of the program.

The city has taken down more than 10,600 blighted homes since 2014.

The Pressure of Looming Deadlines in Municipa Finance

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eBlog, 6/22/16

In this morning’s eBlog, we explore the difficult transition challenge in Detroit of the state’s public school system after 7 years of state control back to the city; we observe the deteriorating fiscal collapse of the small municipality of Opa-locka, Florida; and we observe the increasingly frantic negotiations, threats, and litigation in Puerto Rico as its big deadline approaches the week after next.

Public Schooling on Municipal Bankruptcy. Detroit Public Schools Emergency Manager and retired U.S. Bankruptcy Judge Steven Rhodes plans to meet with both Michigan officials and Detroit families this week to explain and discuss the implementation of the state’s $167 million “rescue” plan for the Detroit Public Schools (DPS) which Gov. Rick Snyder signed into law yesterday—which includes $467 million in debt relief and $150 million in start-up costs for creation of a new debt-free school district—at a meeting today at which key players from Gov. Rick Snyder’s office, the state Treasury, and the Michigan Department of Education are expected. Under the new laws, the school district will be divided on July 1 into two corporations as part of this plan enacted to prevent the system from filing for municipal bankruptcy: The existing DPS district will stay intact for tax-collection purposes to retire $617 million in debt over 8½ years, including $150 million for transitional startup costs to launch a new district and to ensure it has enough cash flow to operate. The new district, which will receive the $617 million infusion of state funds to cover the lost tax revenue, will educate students. A new school board will be elected in November, and a commission of state appointees that oversees city budgets will also review the schools’ finances. The new law splits the old DPS in two, leaving the old entity to pay off debt through existing millage, while a new debt-free district will receive its full state funding allowance to focus on education. Judge Rhodes is expected to serve as an official “transition manager” for the newly created school district. Under the legislation, the transition manager would run Detroit schools until new school board members take office next January after November’s elections. Judge Rhodes wants to ensure everyone “is on the same page as it relates to knowledge” of the legislation, so that participants can begin working together on a project management plan to implementing the state assistance package and launch of a new Detroit Public Schools Community District.

The learning curve will be challenging: the state assistance plan was adopted on a partisan vote without a single vote of any Detroit legislator: the greatest challenge is likely to be with regard to charter school proliferation in the city and the growing percentage of special education students who attend the traditional public school district. Because the new state law omits a proposed commission which would have had governing authority with regard to the placement of traditional and charter schools in the city, there are expected to be significant challenges for the new DPS. Indeed, Michigan Education Superintendent Brian Whiston yesterday noted: “The conversation isn’t going away,” adding that charter school proliferation is also causing challenges for other urban school districts in Saginaw, Benton Harbor, and Pontiac—or, as Mr. Whiston described it: work creatively to get more funding (for DPS) if we have to…and also to look at how we manage the opening and closing of schools — to do it in a way that provides parents’ choices, which is important, but also in a way that we manage those choices.” (One of the newly enacted state DPS provisions directs the state to develop an “A-to-F” grading system, so Detroit parents can better decide which schools, whether traditional or charter, are the best.

Will There Be a State Bailout? Opa-locka, Florida leaders have met in an effort to address critical financial crises which threaten to plunge the small municipality into municipal bankruptcy—with Commissioners voting earlier this week to dip into resources in the city’s wastewater reserve fund to make payroll this week—even as the small municipality has stopped payments to mechanics who work to keep the municipality’s old police cars working: Opa-locka is over $1 million in debt. But even that debt seems to pale compared to the growing, day-to-day challenge of operating, a challenge so severe the city commission had felt compelled to dip into the municipality’s sewer fund reserves. Florida’s Gov. Rick Scott has already declared a state of emergency for the city—and now recognizes it might have to act to bail the city out. Even the city’s governance has been challenged, with the commission appointing former mayor John Riley to fill an open commission seat after former commissioner Terence Pinder killed himself—as he was confronting bribery charges. The new Commissioner Riley told his colleagues: “First of all, I want to really find out the status of the city and what’s been done and what’s not been done.”

Tropical Fiscal Storm. Hedge funds Jacana Holdings, Lex Claims, MPR Investors, and RRW I yesterday filed suit in federal court in New York, seeking to have the federal court bar Puerto Rico from using its April-adopted Puerto Rico Emergency Moratorium and Financial Rehabilitation Act for its general obligation bonds—and to seek the court’s intervention to mandate that Puerto Rico prioritize the payment of the it general obligation (GO) bonds.  (The plaintiffs filing currently hold bonds from Puerto Rico’s $3.5 billion 2014 GO bond sale—municipal bonds for which the bond’s indentures specify the underlying bonds are to be governed by New York law and use New York’s courts to resolve disputes.) The suit charges that “Governor Alejandro García Padilla has willfully violated the first priority guaranteed to general obligation bonds by Puerto Rico’s constitution and has flouted centuries-old federal constitutional protections for contract and property rights…,” adding that the “Moratorium Act is transparently unlawful.” Unsurprisingly—and even as the U.S. Senate could act by as early as next week to take up and consider the House-passed PROMESA legislation—the U.S. territory of Puerto Rico decried the resort to litigation as a failure to “continue good faith negotiations…” much less to “acknowledge the reality of the commonwealth’s fiscal crisis: This attempt by hedge funds to disrupt the commonwealth’s ability to keep the lights on and provide essential services for the 3.5 million Americans on the island makes clear that the Senate must act and pass PROMESA before July 1.”

In filing suit—rather than awaiting Congressional action or working for good faith resolution, the plaintiffs, in their filing, charged that the “Puerto Rico legislature lacks the legislative authority to modify New York’s law of contracts…,” adding that “In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid,” but also adding that Puerto Rico’s Moratorium Act breaks the contract and due process clauses of the U.S. constitution. The filing occurs in the midst not only of Congressional action, but also confidential creditor debt negotiations, including with some of the litigants and other holders and insurers of Puerto Rico GO and Sales Tax Finance Corp. (COFINA) debt—negotiations which the Puerto Rico Government Development Bank yesterday reported had broken down.

Yesterday’s hedge fund suit followed in the wake of a growing pile of suits against Puerto Rico: last month hedge funds holding more than $750 million of the debt of the GDB revived a lawsuit, accusing the U.S. territory’s government of “changing the rules of the game” by amending the Moratorium Act, seeking in the revived litigation to overturn the Moratorium Act and Law 40, which Puerto Rico amended last month. Last week, municipal bond insurer National Public Finance Guarantee sued Puerto Rico in the U.S. District Court for the District of Puerto Rico, seeking to overturn the Moratorium Act. The resort to federal court likely emerges from both the faltering confidential talks with some of Puerto Rico’s municipal bondholders, as well as perceptions that litigation might produce a richer outcome for hedge funds than the pending PROMESA legislation likely headed to the signature of President Obama. All this comes as the proverbial clock is running down to next week’s deadline for Puerto Rico to pay $2 billion it does not have in interest and principal due on a variety of securities, which Governor Alejandro Garcia Padilla has made clear Puerto Rico cannot pay in full. Bloomberg reported that Puerto Rico’s benchmark general-obligation bonds traded yesterday at about 66 cents on the dollar to yield 12.8 percent.

Who Will Take Responsibility for Detroit’s Future?

January 19, 2016. Share on Twitter

What About the Future? Children are cities’ futures, so it is understandable that Detroit Mayor Mike Duggan is trying to change not only the math of the system’s failing fisc, but also the failed governance of a system currently under a state-imposed emergency manager. With black mold climbing the interior walls of some classrooms, and free ranging, non-laboratory rats occupying classrooms, the arithmetic of the schools’ finance merit an F: Of the $7,450-per-pupil grant the school district will receive this year, $4,400 will be spent on debt servicing and benefits for retired teachers, according to the Citizens Research Council. Absent a turnaround, the failing school system is hardly likely to spur young families to move into Detroit.

Math, as in any school system, is a fundamental issue: in Michigan, unlike other states, for more than two decades, the Detroit Public School System (DPS) has been funded, not from property tax revenues, but rather through state sales and income taxes—a system which provides the state with a disproportionate role in how Detroit’s schools are managed—or mismanaged. In addition, DPS, which has been on fiscal life-support since 2009: DPS is currently managed by the fourth state-appointed emergency manager—hardly an augury of stability—and with little indication the series of state appointees have earned good grades: DPS currently carries debt of over $3.5 billion, which includes nearly $1.9 billion in employee legacy costs (such as unfunded pension liabilities) and cash-flow borrowing, as well as $1.7 billion in multi-year bonds and state loans. For the fourth time since 2009.

DPS last year ranked last among big cities for fourth- and eighth-graders (children aged 8-9 and 13-14) in the National Assessment of Educational Progress, a school-evaluation program mandated by Congress. If attendance is some measure of the public’s trust, the report card is miserable: over the last decade, attendance has declined more than 66 percent: a majority of families have moved their children to charter schools. Today, the majority of Detroit’s schoolchildren attend state-funded, but privately managed charter schools. Although the massive shift has enabled DPS to reduce its staff by nearly two-thirds, the system’s fixed costs remain high because of its former size. That augurs for a bad report card: Michelle Zdrodowski of DPS recently warned that DPS will run out of cash in April. Mayhap unsurprisingly, the legislature has been not just unenthusiastic about crafting another Detroit rescue plan, but also uneager to even consider the draft, $715 million bill proposed by Governor Rick Snyder: a bill which would create a debt-free DPS, run by a state-appointed board, and with a shell that assumed DPS’s debt. Gov. Snyder is also proposing closing poorly performing charter and traditional schools. Michigan’s constitution proclaims primary and high-school education to be a right. But in freezing, rat-infested Detroit schools, some 50,000 children who might someday determine Detroit’s future are soon to learn how the Michigan legislature defines that “right.”

For Detroit, now more than a year after emerging from the largest municipal bankruptcy in American history, a new municipal bankruptcy might be in the report cards, as DPS is within months of insolvency—especially if the state legislature continues to spurn Gov. Snyder’s proposals. By next month, the amount of state aid to DPS which will have to be sidetracked to pay off debt is projected to be roughly equivalent to what DPS is spending on salaries and benefits—or, as Hetty Chang of Moody’s describes it: “It’s not sustainable…” adding that absent action soon, “they will run out of money.” Her colleague, Andrew Van Dyck Dobos, added that the “Continued sickouts (by teachers) may further incentivize students to flee the district, resulting in lower per-pupil revenues from the State of Michigan and continuing a downward spiral of credit quality.” DPS, Moody’s projects, will see its expenses rise by $26 million a month beginning in February—after our friend in Pennsylvania sees—or does not see—his shadow: February is when DPS is on the line to begin repaying cash flow notes issued to paper over operations—part of the depressing math that will now, inexorably, begin to eat into DPS’s monthly expenses: the increasing debt service will equal about one-third of DPS’ monthly expenses, according to Moody’s. Indeed, without some form of restructuring, Moody’s warns that DPS could lose even more students as it is forced to divert funds from the classroom—adding that teeming long-term pressures on the near-term operational debt payments as the district will impose a $53 million annual expense to repay long-term operational debt through FY2020. In Lansing, Gov. Snyder’s proposal to ask the state legislature to approve the $715 million in state funding, as unappealing to the legislature as it may seem, would prove more affordable to state taxpayers than an eventual default or potential legal action due to a municipal bankruptcy filing.

DPS’s burdensome debts.  President Barack Obama plans to visit Detroit tomorrow to witness the Motor City’s progress firsthand as part of his trip that includes a tour of the auto show. The trip will also be an opportunity to assess the outcomes of his creation of a federal coordinator and an interagency Detroit Working Group to help 20 federal agencies assist Detroit—agencies through which the federal government has since invested $300 million in Detroit through grants and programs involving blight demolition, transportation, and public lighting. The President will also visit the North American International Auto Show in an effort to showcase the record auto sales of 2015, the 640,000 new auto-industry jobs created since the federal auto bailout, and emerging technologies that could help reduce U.S. dependence on oil and keep the industry competitive. The visit could also help the White House assess the successes and failures of its own efforts to help Detroit out of bankruptcy—efforts, obviously, profoundly different than the federal bailouts of the bankrupt automobile industry in Detroit, including “embedding” full-time federal staff inside city government to help identify federal resources to help Detroit and cut through red tape. Among the Administration-supported projects provided to Detroit has been $130 million in federal funds for blight removal, and allowing the city to demolish more than 7,500 blighted buildings in fewer than two years—federal funds made available from the 2009 Hardest Hit Fund mortgage aid program. Among the projects that Mayor Duggan’s office continues to discuss with federal officials are expanding Detroit’s youth employment program and securing more aid for blight elimination. It is hard to imagine that the future of DPS will not be on the table too.

June 30, 2015

Is Puerto Rico at the Tipping Point? Puerto Rico Gov. Alejandro García Padilla yesterday praised a report, “Puerto Rico—a Way Forward,” by Anne Krueger, Ranjit Teja, and Andrew Wolfe—which calls for a comprehensive solution to Puerto Rico’s problems, including debt restructuring. The report, which Puerto Rico commissioned, calls for fiscal adjustment, structural reforms, and debt restructuring. As for the latter, the authors say that even after Puerto Rico took major revenue and expenditure measures, there would be large financial gaps. These would peak at about $2.5 billion in fiscal 2016 and generally decline to about $0 in fiscal 2024. By comparison, the total commonwealth government debt service in fiscal 2016 is slated to be about $3.6 billion. The report notes: “Debt relief could be obtained through a voluntary exchange of old bonds for new ones with a later/lower debt service profile. Negotiations with creditors will doubtlessly be challenging.” They make clear the general obligation as well as other commonwealth government debt should be restructured. The authors also call for negotiations on the public corporations debt and for the federal government to make the corporations eligible for Chapter 9 bankruptcy.

The report warns that Puerto Rico will need to seek relief from principal and interest payments falling due from 2016 to 2023; however, it also warns that any restructuring of general obligation, or central government debt, would set a precedent as “no U.S. state has restructured (such debt) in living memory,” and any such attempt would face legal challenges—even as it made clear there are limits with regard to how much more expenditures can be cut or taxes raised. Or, as Adam Weigold, senior portfolio manager at Eaton Vance, put it last Friday: This coming week “is the tipping point:” Puerto Rico’s debt problems could lead to a reduction in government services. Nevertheless, Reuters noted that the island is not contemplating a partial or full shutdown of government services. With some of Puerto Rico’s creditors, restructuring negotiations are already underway: late last week, Puerto Rico officials and creditors of the island’s electric power authority were apparently close to a deal which would avoid a default on a $416 million payment due the day after tomorrow, and, with other payment deadlines looming, Gov. Padilla and his staff said they would begin looking for possible concessions on all forms of government debt.

The key takeaways from the report:

• This is a problem years in the making;
• The problems are structural–not cyclical;
• This is a “vicious cycle” where unsustainable public finances are feeding uncertainty and low growth;
• “failed partial solutions argue for a comprehensive approach;
• “[the]single most telling factor is that 40% of the adult population — versus 63% on the mainland — is employed.” Why? Because the minimum wage; local overtime, paid vacation, benefits are too costly to the governments—and to the 147 municipalities; local welfare benefits are more generous than the minimum wage.
• Public sector debt has risen each year–reaching 100% of GNP by the end of FY’14;
• “If federal obstacles could be overcome, there is no reason why Puerto Rico could not grow in new directions…”

June 29, 2015

More Trouble in River City. A critical issue for any municipality is an audit; that is even more the case when a city or county files for bankruptcy: it provides that outside review important to the city’s taxpayers, the federal bankruptcy court, and the municipality’s creditors. While an audit, technically, is not necessarily required by San Bernardino’s charter committee, City Attorney Gary Saenz had warned that failure to have those audits by the deadline would be “devastating for the city.” City Manager Allen Parker had agreed, last spring, with council members who said its absence in the city’s plan of debt adjustment would allow San Bernardino’s creditors to attack the plan before the federal court as unprepared and undeserving of bankruptcy protection. Notwithstanding that apprehension, Deputy City Manager Nita McKay has now confirmed the audit has not been completed, and, obviously, not been included in the city’s plan of debt adjustment. Worse, the city’s accounting firm, Macias, Gini and O’Connell LLP, not only has missed repeated deadlines, but had also requested nearly half a million dollars—more than double its original cost estimate given to the city—to complete it. Unsurprisingly, the attorney representing San Bernardino’s municipal bondholders had charged in U.S. Bankruptcy Judge Meredith Jury’s first hearing earlier this month that San Bernardino had failed in its duty to the court and the city’s creditors by not even disclosing that its plan of debt adjustment did not mention the missing audits—either in its submitted plan or in its testimony before the court. Nor, the attorney charged, had the city proposed a hearing date at which Judge Jury could consider the adequacy of San Bernardino’s financial disclosure statement. For her part, Judge Jury has noted that a bankrupt entity normally would have proposed such a date to keep momentum in the case. Instead, Judge Jury set the hearing date for October 8th. The problem appears to lie not just with the city’s auditor, Macias, Gini and O’Connell LLP accounting firm, but also with the city’s own transparency and at least perceived competency. While there is every indication San Bernardino staff have been responsive to every request from the auditor—according to the auditor; as late as last Thursday, the firm’s audit managers gave the city staff a new list of outstanding items—a list city staff described as one which “contains 29 items, 24 of which have not been requested before the time of the meeting…For eight of these items, they could not articulate what it is that they are requesting, i.e. ‘changes to General Fund accounts receivable resulted in additional testing being needed for $3.7 million. Sample to follow.’” San Bernardino Councilmember Fred Shorett at the end of last week stated the seemingly obvious: the city might need to consider starting over with a new firm, even though that would present difficulties: “This sounds as though this auditing firm is incompetent or (not) working…Giving no responses to you and coming at us with requests at the eleventh hour is not acceptable. This whole situation needs review. I’m very concerned that this firm has some kind of agenda that is not helpful to us.” Councilman Rikke Van Johnson also questioned the firm’s motives. “Sounds as if they are playing us and trying to get more money!” he wrote. The auditing firm is surely on notice that, despite its 13^th hour demands for a significant increase in payments for a job not done, it is requesting said increases as, now, one of many creditors in bankruptcy—it will not be paid one hundred cents on the dollar—but its integrity and competence, as well as the failure of the city to oversee—or disclose—the absence seem hardly likely to curry respect from Judge Jury.

Is Puerto Rico at the Tipping Point? With the increasing likelihood that Congress will continue to ignore the U.S. territory of Puerto Rico’s looming insolvency—or even give Puerto Rico the ability and authority to offer its 147 municipalities access to chapter 9 municipal bankruptcy, Puerto Rico Governor Alejandro García Padilla stated:  “My administration is doing everything not to default…But we have to make the economy grow…If not, we will be in a death spiral.” Gov. Padilla has now conceded the commonwealth cannot likely pay its nearly $72 billion in outstanding debts, warning the island is in a “death spiral,” but, unlike any other U.S. corporation, denied access to the federal bankruptcy courts.

Puerto Rico needs to restructure its debts and should make reforms, including cutting the number of teachers and raising property taxes, a report by former International Monetary Fund economists on the Caribbean island’s financial woes said. Gov. Padilla, and senior members of his staff said last week that they would probably seek significant concessions from as many as all of the island’s creditors, which could include deferring some debt payments for as long as five years or extending the timetable for repayment: “The debt is not payable…There is no other option. I would love to have an easier option. This is not politics, this is math.” Gov. Padilla is also likely to release a new report today by former IMF economists, who were hired earlier this year by the Puerto Rico Government Development Bank to analyze Puerto Rico’s economic and financial stability and growth prospects—a report concluding that Puerto Rico’s debt load is unsustainable. The report suggests a municipal bond exchange, with the new bonds carrying “a longer/lower debt service profile,” noting that: “There is no U.S. precedent for anything of this scale or scope.” The report is not solely focused on Puerto Rico, however, but also seems aimed at the White House and Congress—neither of which appear to be willing to devote time or resources on these events affecting hundreds of thousands of Americans, although both New York Federal Reserve leaders and United States Treasury officials have been advising the island’s government in recent months amid the worsening fiscal situation.

Said report, according to Reuters, recommends structural reform and debt restructuring, writing: “Puerto Rico faces hard times…Structural problems, economic shocks, and weak public finances have yielded a decade of stagnation, out-migration, and debt… A crisis looms.” The report recommends restructuring of Puerto Rico’s general obligation debt, as well as suspending the minimum wage and reducing electricity and transport costs, noting the U.S. territory must overcome a legacy of weak budget execution and opaque data.

Seemingly overwhelmed by its staggering $73 billion debt load and faltering economy—and with its Government Development Bank running out of cash, Puerto Rico this week has a number of municipal bond payments coming due—even as its public power utility, PREPA, is in talks to avoid a possible default. The report warns that Puerto Rico will need to seek relief from principal and interest payments falling due from 2016 to 2023; however, warning that any restructuring of general obligation, or central government debt, would set a precedent as “no U.S. state has restructured (such debt) in living memory,” and any such attempt would face legal challenges—even as it made clear there are limits with regard to how much more expenditures can be cut or taxes raised. Or, as Adam Weigold, senior portfolio manager at Eaton Vance, put it last Friday: This coming week “is the tipping point:” Puerto Rico’s debt problems could lead to a reduction in government services. Nevertheless, Reuters noted that the island is not contemplating a partial or full shutdown of government services. With some of Puerto Rico’s creditors, restructuring negotiations are already underway: late last week, Puerto Rico officials and creditors of the island’s electric power authority were apparently close to a deal that would avoid a default on a $416 million payment due the day after tomorrow, and, with other payment deadlines looming, Gov. Padilla and his staff said they would begin looking for possible concessions on all forms of government debt.

The ever perceptive Mary Walsh Williams of the New York Times this morning notes “Puerto Rico’s municipal bonds have a face value roughly eight times that of Detroit’s bonds.” That is, as she wrote, Puerto Rico’s fiscal meltdown and inability to access U.S. bankruptcy courts could have fiscal implications for cities and counties throughout America, writing: “Its call for debt relief on such a vast scale could raise borrowing costs for other local governments as investors become more wary of lending. Perhaps more important, much of Puerto Rico’s debt is widely held by individual investors on the United States mainland, in mutual funds or other investment accounts, and they may not be aware of it. Puerto Rico, as a commonwealth, does not have the option of bankruptcy. A default on its debts would most likely leave the island, its creditors, and its residents in a legal and financial limbo that, like the debt crisis in Greece, could take years to sort out.” She writes that Puerto Rico must set aside as much as $93 million each month to pay the holders of its general obligation bonds — a critical action, because Puerto Rico’s constitution requires that interest on its municipal bonds—payments which go to citizens in every state in the U.S.—be paid before any other expense, adding that “No American state has restructured its general obligation debt in living memory.” The government’s Public Finance Corporation, which has issued bonds to finance budget deficits in the past, owes $94 million on July 15. The Government Development Bank — the commonwealth’s fiscal agent — must repay $140 million of bond principal by Aug. 1.

Here Come da Judge. It turns out that even though Congress appears determined to bar Puerto Rico from access to the U.S. Bankruptcy Court, Puerto Rico is creating its own wise investment, this month hiring retired U.S. Bankruptcy Judge Steven W. Rhodes, who presided over the largest municipal bankruptcy in U.S. history in Detroit’s 18 month municipal bankruptcy. In addition, Puerto Rico is also consulting with a group of bankers from Citigroup who advised Detroit on a $1.5 billion debt exchange with certain creditors. The ever electronically and musically perceptive Judge Rhodes told Ms. Williams that Congress needs to go further and permit Puerto Rico’s central government to file for bankruptcy — or risk chaos, telling her in an interview: “There are way too many creditors and way too many kinds of debt…They need Chapter 9 for the whole commonwealth.”

June 25, 2015

Not My Problem. A unique characteristic of the United States and federalism is dual sovereignty, making the U.S. and its kind of federalism unique among all nations. In the field of bankruptcy, it means Congress lacks Constitutional authority to even grant authority to states to file for bankruptcy; similarly, the federal government cannot grant municipalities such authority—except by means of authorizing states to, as is done under chapter 9. Unsurprisingly, then, not only do not all states authorize municipalities to file for municipal bankruptcy, but among those that do, virtually no two provide such authority the same way. Moreover, as we have noted, not only the differing statutes, but also the state role in those states where municipalities have filed for chapter 9 municipal bankruptcy, has been profoundly different. Key issues have related not only to whether, under such state authorizing legislation, the state asserts authority to preempt local authority by means of the appointment of a receiver or emergency manager—appointments which have meant suspension of any authority for the elected leaders of a city or county, but also the role of the state in contributing in some way to the development and implementation of an ensuing plan of debt adjustment—the plan which must be approved by a U.S. bankruptcy court for a city or county to successfully exit bankruptcy. U.S. Bankruptcy Judge Thomas Bennett keenly noted the precipitate role of the State Alabama in leading to Jefferson County’s bankruptcy, while in Michigan, Gov. Rick Snyder gradually began coordinating with key bipartisan leaders of Michigan’s House and Senate in making critical contributions to Detroit’s plan of debt adjustment—granted with some exceptionally innovative and creative contributions by U.S. Chief Judge Gerald Rosen. So it is that, unlike municipal bankruptcy in any other country around the world, states not only have a role under the U.S. Constitution, the federal municipal bankruptcy law, but also the unique politics and leadership within each state.

Ergo, mayhap ironically, California appears to be set on the Alabama model—spurning the more constructive roles taken by Rhode Island, Michigan, New Jersey, and Pennsylvania. If anything, that message appeared to be reinforced yesterday when Gov. Jerry Brown offered no positive reinforcement to San Bernardino’s Mayor Carey Davis in his quest to the state capitol in Sacramento. Mayor Davis, notwithstanding the absence of any affirmative state role in the municipal bankruptcies of Vallejo or Stockton, nevertheless had made the long trip just in case.

It was time and resources, scarce commodities for a city in bankruptcy, apparently for naught. Gov. Brown’s response, according to the city, was no. The key issue – ironically in the midst of the surge of the so-called sharing economy – was sharing vital public services. Or, as Mayor Davis’ chief of staff, Christopher Lopez, put it: the “cornerstone” of San Bernardino’s plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury is contracting out for some services, including fire protection. Specifically, the city has pressed for the 110-year old California state agency Cal Fire to submit a bid for providing fire services to San Bernardino—part of the city’s plan to contract out such services, and something the city has repeatedly sought to pressure Cal Fire to provide. Given the lack of any response, the delegation yesterday sought a prod from Gov. Brown—a prod which produced, apparently, not even a spark, or, as Mr. Lopez put it: “Governor Brown’s office has recently made San Bernardino aware that Cal Fire will not provide a proposal and that our additional requests will not be considered.” In contrast, the San Bernardino County Fire Department and a private firm, Centerra, have each submitted proposals to provide San Bernadino’s fire services—bids which the city guesstimates could save it as much as $7 million annually. Having struck out on the fire front, the Mayor and delegation then sought assistance on other key items on their list, including some relief from a potential California Public Employees’ Retirement System penalty, the threatened decertification of the San Bernardino Employment and Training Agency, a loan, help with the dissolution of the city’s redevelopment agency, and clarification on its tax agreement with Amazon. They went home empty-handed.

Send for Batman! In most instances, in the case of a potential drowning, a lifeguard at least throws a buoy, but in the wake of Wayne Count Executive Warren Evans’ request for Michigan state intervention, Standard & Poor’s put the county’s speculative grade rating on CreditWatch with negative implications yesterday. The downgrade will increase costs for the fiscally struggling county; the harder question is what S&P’s actions might mean to the many municipalities, including Detroit, within its boards. Jane Ridley, S&P’s analyst, wrote: “The CreditWatch placement reflects our expectation that with the onset of actions under Michigan Act 436, the county could lose some of the autonomy currently held by the CEO and his staff.” Ironically, Mr. Evans’ June 17^th request was intended to enable the county to enter into a consent agreement with the state (please not the stark contrast with the seeming lack of any intergovernmental commitment in California, above) to enhance Wayne County’s authority to deal with labor contracts and other pending issues critical to the county’s fiscal sustainability—and, as state officials have made clear, municipal bankruptcy or even the appointment of an emergency manager is not only not in the picture, but also Michigan state officials almost immediately made most clear that municipal bankruptcy is not only not in the picture, but also that they perceive Mr. Warren’s request as a positive, constructive step towards resolution of Wayne County’s fiscal challenges. Nonetheless, in its warning, S&P noted that under Michigan law, if the county’s request were approved by the state for a financial review, the Wayne County board would be faced by four options: a consent agreement; appointment of an emergency manager; a neutral evaluation; or it could pursue a Chapter 9 bankruptcy filing, with Ms. Ridley writing: “In our view, the county’s request for financial review does not signal the start of filing for bankruptcy, but rather a step in its stated goal of using all possible tools to regain structural balance…However, given the uncertainty associated with these four options—as well as the potential for a prolonged time frame to make additional meaningful structural changes while this process is underway—we have placed the rating on CreditWatch,” adding that its actions reflect apprehensions Wayne County’s autonomy in its restructuring could be diminished if an emergency manager is ultimately named: “In our view, this could mean that making the significant, meaningful adjustments necessary could be delayed or adjusted, which would have an impact on the county’s long-term financial health.” If, instead, Wayne County retains control over its restructuring, as seems to be not only its intent, but also the state’s impression, S&P noted it could remove the rating from CreditWatch and assign a negative outlook, reflecting the long-term budget pressures the county is facing. Interestingly, in light of the discussion re: federalism above, Ms. Ridley notes that S&P views the appointment of an emergency manager as more risky due to the loss of autonomy—a loss the credit rating agency notes which could lead to a credit rating downgrade: “Notwithstanding the uncertainty of the county’s near-term management control, without the county’s clear, demonstrable progress in the next year to regain structural balance and reduce its sizable pension burden, we could lower the rating…In addition, should Wayne County’s liquidity position deteriorate significantly, we could lower the rating.”

Trying to Balance its Budget. The Puerto Rican Senate is currently considering the U.S. territory’s FY2016 budget—a balanced budget, like every state in the U.S., albeit unlike any Congressional budget in modern times, which the House adopted and sent to the Senate early this week, and which includes austerity measures to improve Puerto Rico’s fiscal health. As passed, the House budget estimates $9.8 billion in revenues, and proposes $9.55 billion in spending. The House proposed $674 million in spending cuts, with much of the savings to anticipate the territory’s increasing debt service costs and public pension obligations; the House cut nearly 60 percent off the Puerto Rico Development Bank’s budget request of $700 million—with the bank facing potential insolvency later this summer when some $4 billion in debt it issued begins to become due. The House Chairman of Committee on Treasury and the Budget, Rep. Rafael Hernández Montañez, noted the development bank could be forced to restructure its debt, but that the House-passed budget would be sufficient to ensure Puerto Rico would not default on any of its general obligation or G.O. bonds, albeit, he warned that if the U.S. territory’s development bank encounters difficulties in meeting its obligations and is forced to restructure its debt, there might have to be some delay in setting aside the proposed funding in the House-adopted budget to meet pending general obligation bond payments—warning that the alternative would be a government shutdown—an alternative he made clear would be devastating to the island’s economy.

In the Fiscal Twilight Zone. Even as Puerto Rico’s elected leaders have been pressing to address the U.S. territory’s overwhelming debts—and hedge funds have mounted an expensive lobbying and advertising campaign with full page adds—“No Bailout for Puerto Rico”—in the Wall Street Journal as part of a heavily financed lobbying blitz in the U.S. Congress to bar granting Puerto Rico the same authority provided to every state in the U.S., or even broader authority so that the U.S. Bankruptcy courts could act to ensure the continuity of essential public services while overseeing the development of a plan of debt adjustment; Congress so far has been seemingly paralyzed—and it is focusing its attention in a diverting way, so that Puerto Rico’s Governor, Alejandro García Padilla, is urging Congress to act on pending legislation to give the U.S. territory access to municipal bankruptcy authority—and not divert its focus to the issue of potential statehood. The urgency came this week in the face of continued inaction by the House Judiciary Committee, but, instead, a hearing yesterday by the House Committee on Natural Resources Subcommittee on Indian, Insular and Alaska Native Affairs on proposed legislation to authorize a means for Puerto Ricans to determine what legal options might be available for its citizens to opt for statehood. Even with the U.S. territory nearing a potential default and insolvency, Chairman Don Young (R-Alaska) had scheduled the hearing earlier this month to consider legislation proposed by Rep. Pedro Pierluisi (D-P.R.) to authorize a U.S. sponsored vote to be held in Puerto Rico within one year of its enactment: the vote suggested in the bill would be solely on the question with regard to whether Puerto Rico should become a state—a status which, were it to be adopted, would render Puerto Rico not only able to authorize its 147 municipality’s the option to file for chapter 9 municipal bankruptcy, but also make the state-to-be eligible for billions of dollars in additional annual federal funding. Rep. Pierluisi stated: “I don’t seek special, different or unique treatment…I don’t ask (for Puerto Rico) to be treated any better than the states, but I won’t accept being treated any worse either. I want only for Puerto Rico to be treated equally. Give us the same rights and opportunities as our fellow American citizens, and let us rise or fall based on our own merits. Because I know that we will rise.” He testified of his apprehensions that, absent statehood, he worried there would be a continuing exodus of intelligent workers to the U.S. mainland in search of full rights available in the 50 states. Puerto Rico Attorney General César Miranda, testifying on behalf of Gov. Padilla, urged Congress to focus on the immediate, “truly dire” situation: Puerto Rico’s “state of fiscal emergency,” telling the Committee that diverting attention to the issue of authorizing a mechanism for considering statehood should await resolution of the island’s most crucial issue: granting bankruptcy authorization rights to the island: “We have the capabilities to come across and bring the island to a brighter condition…We need to have an instrument to deal with the debt that we are carrying now. That is why we support extending Chapter 9 to Puerto Rico.”