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 30th; 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 9th.) 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.”

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Is the Federal Government Using a Double Standard in Responding to Puerto Rico, adding to its Fiscal and Physical Distress?

eBlog

January 19, 2017

Good Morning! In today’s Blog, we consider the ongoing federal and fiscal challenges to fiscal recovery for the U.S. territory of Puerto Rico.

Denial of Assistance. As if there has not been enough evidence of a double standard with regard to the provision of federal aid to the hurricane devastation to Puerto Rico, the Federal Emergency Management Agency (FEMA) and the U.S. Treasury have written to the Puerto Rico Fiscal Agency and Financial Advisory Authority Executive Director Gerardo Portela that, because the Commonwealth of Puerto Rico’s  central cash balance, as publicly reported, has consistently exceeded $1.5 billion in the months following the hurricanes, and “considering the implications of the $6.875 billion of total cash deposits across the Commonwealth, the federal government will institute, as a matter of policy, a cash balance policy that will determine the timing of Community Disaster Loans (CDLs) to the Commonwealth and its instrumentalities, including the Puerto Rico Electric Power Authority and the Puerto Rico Aqueduct and Sewer Authority.” Translated into English, that means Puerto Rico may have too much cash to be eligible for a federal loan—notwithstanding the discriminatory treatment compared to Houston or Florida, much less that still, nearly four months after the devastating storm—a storm to respond to which President Trump offered paper towels—some four months after the storm, many residents are still without electricity. Nevertheless, according to FEMA, the island is at risk of not receiving federal community disaster loans, because its cash balances may be too high.

For its part, the government of Puerto Rico has opted to pay up its arrears accounts with both the Electric Power Authority and the Aqueduct and Sewer Authority—as well as focus its efforts on legislation to address FEMA’s concerns—in a critical effort to free up federal assistance—assistance already approved by Congress. At the same time, Puerto Rico’s Financial Advisory Authority and Fiscal Agency Wednesday admitted that if FEMA opts not to grant the disaster loan to the U.S. territory, very hard decisions will confront the citizens of Puerto Rico and their leaders—or, as Sen. Anibal Jose Torres put it: the challenge will be to “ensure basic services to the population, the payment of pensions, and the payroll of public employees,” concerns which appear not to be apprehensions of the Trump Administration, even as Gerardo Portela Franco, the Executive Director and Chairman of the Board of Puerto Rico’s Fiscal Agency & Financial Advisory Authority, noted: “We will continue negotiating with the Treasury until we achieve that CDL,” adding: “We have faithfully complied with all the requirements,” referring to the negotiations his agency has had with the U.S. Treasury since last October. The contretemps emerged after El Nuevo Día Wednesday  revealed that FEMA and the U.S. Treasury had halted the disbursement of funds to Puerto Rico under the CDL program until adopting “a cash balance policy” which will determine when and how much funding FEMA will provide to Puerto Rico to address its operational expenses in trying to recover from the effects of Hurricane Maria, theoretically in “consultation” with the Fiscal Oversight Board created by Congress, even as the two stateside federal agencies made clear Puerto Rico will have to “cover its cash needs and those of the PREPA and the AAA.

Unsurprisingly, Héctor Figueroa, the President of the SEIU noted that it was “inconceivable that FEMA and the Treasury retain the aid funds approved three months ago for Puerto Rico following the scourge of Hurricane Maria…Puerto Rican working families continue to be considered second class citizens by the administration of (Donald) Trump and by Congress.”

The situation is further complicated, despite some four months of negotiations, by the fact that FEMA and the U.S. Treasury have yet to specify the specific conditions to be mandated—now, nearly four months after Congress approved a package of aid for Puerto Rico, as well as for the states of Florida, Texas, California, and the U.S. Virgin Islands: in that aid package which Congress approved, however, it appears there was a stipulation that, before the federal government could be obliged to provide aid, Puerto Rico, as collateral, had to pledge the unencumbered revenues from the Sale and Use Tax (IVU) or those paid by foreign corporations under Law 154—albeit it remains unclear whether the specific terms with regard to collateral are still being negotiated. What is clear, however, is a double standard, as the epistle from FEMA does not seem to reflect the human or fiscal urgency of the situation, especially in the wake of the fiscal warnings at the end of last September that “As a result of hurricanes Irma and María, the government, PREPA and AAA projected at the end of September 2017 that it would deplete its operational funds on or near October 31, 2017.” In their letter, however, FEMA and the Treasury opined that, as of December 29, 2017, the central government’s cash balance was approximately $1,700 million—an amount which, according to Portela Franco, does not detract from the fact that Puerto Rico is in a state of “insolvency.”

The head of the Puerto Rico Fiscal Agency and Financial Advisory Authority, the public corporation and governmental instrumentality in Puerto Rico which has assumed the majority of the fiscal agency and financial advisory responsibilities previously held by the Government Development Bank for Puerto Rico, and the Puerto Rican entity in charge of collaboration, communication, and cooperation between the Government of Puerto Rico and the PROMESA Oversight Board, noted that the figure cited in the letter includes the reserves required by La Junta de Supervisión y Administración Financiera (JSF) to finance the process of renegotiation of the debt in court, as well as the payment of pensions and public payroll, two priority items for Governor Rosselló Nevares.

Indeed, a review of Puerto Rico’s most recent liquidity report seems to validate Mr. Portela Franco’s views, noting, for instance, in his January 5th report, that the Department of Hacienda projections include the collections which are regularly sent to Cofina—reports still awaiting the attention of U.S. Judge Laura Taylor Swain—a figure in the range of  $316 million. In addition, the report reveals that, so far this fiscal year, Puerto Rico’s central government has withheld $ 437 million from the Automobile Accident Administration (ACAA) and the Highway and Transportation Authority (ACT), among others—even as government suppliers are owed about $ 331 million and government agencies hold $ 276 million in debt to each other, including water and electricity bills. Thus, as Portela Franco and Andrés Méndez, in charge of liquidity matters in the Aafaf, noted: the government seems to undress a saint to dress others such as the AEE and the AAA: “As we have to inject liquidity to the AAA and the AEE, that balance of the Treasury’s TSA account will fall precipitously,” adding that, without the FEMA loan, it would be necessary to continue adopting what he termed “difficult decisions,” such as stretching payments to suppliers.

Unsurprisingly, Governor Rosselló Nevares, described the epistle from Washington, D.C. as one in which the “government of Puerto Rico and the Treasury have reached an agreement. The agreement is that when the collections go down in Puerto Rico, the loans begin to arrive. What does this mean? That at the moment, we still have resources that are going to be running out,but that they will want to transfer those loans once it happens to that.” The Governor also rejected that the Oversight Board has an additional responsibility in the process of granting the CDL, because PROMESA had already established that the federal entity will have authority to interfere in any loan that Puerto Rico receives. (The epistle from FEMA and the U.S. Treasury notes that the cash policy for the loan from Puerto Rico will be adopted “in consultation with the government and the JSF.”

As of the end of last month, Puerto Rico had $1.7 billion of available cash, notwithstanding earlier predictions by local officials that the government would run out of money in late October because of the economic toll of responding to the hurricanes: by the end of November, it still had funds in other accounts, albeit some of it was earmarked for specific uses and could not be used to keep Puerto Rico’s government operating.

In FEMA’s epistle to Gerardo Portela, the Executive Director of Puerto Rico’s Fiscal Agency and Financial Advisory Authority, FEMA noted: “Under this cash balance policy, funds will be provided through the CDL program when the commonwealth’s central cash balance decreases to a certain level.” Executive Director Portela, earlier this week, noted that, because of the delay in federal loans, Puerto Rico’s central government will begin procedures to allow it to lend money to the island’s public electricity and water utilities, even as he urged the federal government to distribute the loans, stating: “AAFAF has complied with all the demands of federal agencies; however, despite our continuous efforts, to date, the Treasury Department and FEMA have not provided the final terms and conditions under which they will disburse the funds granted by the Congress.” With damage from Hurricane Maria estimated to total as much as $100 billion, Governor Ricardo Rossello earlier this month warned that Puerto Rico’s electric utility may be unable to continue recovery work in February due to lack of funds—even though, more than 100 days after the storm slamming into an island which had already filed a record-setting quasi chapter 9 municipal bankruptcy in May devastated Puerto Rico’s economy and destroyed its electrical grid: still today, about 45 percent of Puerto Rico Electric Power Authority customers are still without power.

The Epistle:

Mr. Gerardo J. Portela Franco

Executive Director and Chairman of the Board

Fiscal Agency and Financial Advisory Authority

Government of Puerto Rico

Robe1io Sanchez Vilella Government Center

De Diego Avenue, Stop 22

San Juan, Puerto Rico, 00907

Dear Mr. Portela Franco:

This letter summarizes the Federal Government’s policy for providing Community Disaster Loan (CDL) Program assistance to the Commonwealth of Puerto Rico, its instrumentalities, and municipalities as a result of Hurricanes Irma (DR-4336-PR) and Maria (DR-4339-PR). The purpose of the CDL Program is to provide loans to eligible recipients that have suffered a substantial loss of tax and other revenues as a result of a major disaster and that demonstrate a need for Federal financial assistance to perform essential governmental functions. The Additional Supplemental Appropriations for Disaster Relief Requirements Act of 2017, signed into law by the President on October 26, 2017, included $4.9 billion for CD Ls to assist the Commonwealth of Puerto Rico, the U.S. Virgin Islands, and local governments in Florida and Texas in maintaining essential services as a result of Hurricanes Harvey, Irma, and Maria.

Implementing the CDL Program in the Commonwealth must be undertaken in a manner that is compatible with the ongoing financial restructuring of the Commonwealth’s financial obligations, including pursuant to the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). For example, pursuant to PROMESA the Financial Oversight and Management Board (FOMB) must approve any new debt incun-ed by the Conunonwealth or by any of its instrumentalities that the FOMB has designated as covered territorial instrumentalities under PRO MESA, including the Puerto Rico Electric Power Authority (PREP A) and the Pue1io Rico Aqueduct and Sewer Authority (PRASA). Title III of PRO MESA also established a bankruptcy-like restructuring process for Puerto Rico and its covered territorial instrumentalities. As you are aware, the Commonwealth and PREPA have filed for Title III restructuring; PRASA has not.

As a result of Hurricanes Irma and Maria, the Commonwealth, PREP A, and PRASA projected in late

September 2017 that they would exhaust their operating funds on or about October 31, 2017. However, as of December 29, 2017, the Commonwealth’s central cash balance was approximately $1.7 billion. It is our understanding that the higher-than-expected central cash balance three months after the hurricanes resulted from greater-than-expected receipts, strategic management of payables, and the structure of relief funds from FEMA and other federal agencies, among other factors, although a review of the underlying detail is still underway. In addition to its central cash balance, on December 18, 2017, the Commonwealth released a report indicating that $6.875 billion in unrestricted and restricted cash was on deposit in over 800 accounts across all Commonwealth governmental entities. Despite these Commonwealth cash balances, the Commonwealth now indicates that PREPA and PRASA have an imminent need for liquidity in January 2018, and, as a result, each entity has applied for a CDL to cover operating expenditures.

Because the Commonwealth’s central cash balance, 1\S publicly reported, has consistently exceeded $1.5 billion in the months following the hurricanes, and considering the implications of the reported $6.875 billion of total cash across the Commonwealth, the Federal Government will institute, as a matter of policy, a Cash Balance Policy that will determine the timing of CD Ls to the Commonwealth and its instrumentalities, including PREP A and PRASA. Under this Cash Balance Policy, funds will be provided through the CDL Program when the Commonwealth’s central cash balance decreases to a certain level. This Cash Balance Policy level will be dete1mined by the Federal Government in consultation with the Commonwealth and the FOMB.

The current posture of the Federal Government is to disburse CDL program financing directly to the Commonwealth, which could then sub-lend to its various entities (including PREP A and PRASA), although this approach may be revised over time. Subsidiary borrowers will be expected to comply with remmitting, repayment, and collateral requirements that apply to the primary borrower. Unless the Cash Balance Policy level is reached, however, the Commonwealth will need to support its own liquidity needs and those of PREPA and PRASA.

Notwithstanding the above policy, local governments (as such term is defined in 42 U.S.C. §5122(8)) in Puerto Rico, including the 78 municipalities, will be eligible to apply directly for CD Ls independent of the Commonwealth under the traditional terms and conditions of Section 417 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act, 42 U.S.C. §5184 (irrespective of the cash balance of the Commonwealth). Under these terms, a local government demonstrating a substantial loss of revenues may receive a streamlined CDL up to 25 percent of its annual budget, subject to a $5 million cap. FEMA will make arrangements to meet directly with the local governments and their management associations the week of January 15, 2018, in Puerto Rico to facilitate applications to the CDL Program onthe most timely basis possible consistent with program terms and requirements. If it is determined that a local government should require assistance beyond the $5 million cap, the Federal Government will consider providing additional financing under different terms and conditions, as appropriate.

FEMA and the Department of Treasury look forward to continuing to work with the Commonwealth of Puerto Rico and its instrumentalities and local governments to ensure funding is available for operating expenses to perform governmental functions while respecting the PROMESA Title III proceedings, the statutory authorities granted to the FOMB under PROMESA, and the overall fiscal condition of the Commonwealth and its instrumentalities and local governments.

Respectfully,

Alex Amparo

Assistant Administrator Recovery Directorate

Federal Emergency Management Agency

Gary Grippo

Deputy Assistant Secretary for Public Finance

U.S. Department of Treasury

 

cc: Governor Ricardo Rossello Nevares, Commonwealth of Puerto Rico

Financial Oversight and Management Board, Commonwealth of Puerto Rico

Puerto Rico State Agency for Emergency and Disaster Management

U.S. Office of Management and Budget

Fiscal, Legal, Physical & Human Challenges

October 4, 2017

Good Morning! In today’s Blog, we consider the President’s visit to address the fiscal, legal, physical, and human challenges to Puerto Rico.

Visit the project blog: The Municipal Sustainability Project 

Physical & Fiscal Mayhem. President Trump, visited Puerto Rico yesterday (nearly two weeks after Hurricane Maria, only 6.89% of the island has electricity, 22.54% of the telecommunications towers operate, 24% of the commercial flights operate, while the water and gas distribution problems persist in means of enormous damage to infrastructure. More than 9,000 people still live in shelters, according to official figures.). The President suggested the removal of Puerto Rico’s large debt so that Puerto Rico can to respond, short and long-term, to the emergency: “We have to work on something,” albeit adding Puerto Rico should be proud that only 16 died, unlike what he deemed “the real catastrophe” of Katrina. The devastating hurricane left some $90 billion in damage—on top of the $74 billion in debt Puerto Rico and the PROMESA Board (relocated to New York City) are confronting. The President added: “You have to look at the whole structure of the debt‒you owe a lot of money to your friends on Wall Street, and we’ll have to eliminate that. We’ll have to say good-by to that. I do not know if it’s Goldman-Sachs, but whoever it is, you can say goodbye to that. We will have to do something, because the island’s debt is huge.” The President’s remarks, however, coming as the PROMESA Board was meeting in New York City, created a question with regard to his intentions: did he mean the Administration is contemplating forgiving its debts? If so, what would that mean to the territory’s bondholders? Moreover, it is unclear whether the President even has such authority.

President Trump has called for Puerto Rico to have its crippling debt forgiven, describing the potential precedent as tough luck for the Wall Street holders of the debt, telling Fox New’s Geraldo Rivera: “They owe a lot of money to your friends on Wall Street, and we’re going to have to wipe that out,” with his comments coming in the wake of considerable political heat for one of his earliest tweets on Hurricane Maria, in which he had written that Puerto Rico was already suffering because of its huge debt burden, which liberals interpreted as blaming the victim.

The President told Puerto Rico officials they should feel “very proud” they haven’t lost thousands of lives like in “a real catastrophe like Katrina,” while adding that the devastated island territory has thrown the nation’s budget “a little out of whack,” with his comments coming as he touched down in San Juan amid harsh criticism of the slow federal response to the natural disaster, and after he had praised himself earlier in the day for his administration’s “great job” and “A-plus” response to Hurricane Maria, marking his brief, only visit to Puerto Rico since the storm ravaged the U.S. territory nearly two weeks ago. The President commented: “Every death is a horror, but if you look at a real catastrophe like Katrina, and you look at the tremendous—hundreds and hundreds and hundreds of people who died, and you look at what happened here, with really a storm that was just totally overpowering, nobody’s ever seen anything like this.”  The President said this, then turned to a local official to ask how many people had died in storm. “What is your death count as of this moment? 17? 16 people certified, 16 people versus in the thousands.”

The hurricane, which killed at least 36, left millions without power and tens of thousands without access to drinkable water; it compounded a volatile economic situation in the territory, which is roughly $70 billion in debt. The President, at one point, stated that Puerto Rico had “thrown our budget a little out of whack.” President Trump, who in the past week has boasted about the federal government’s response to the disaster, evidence to the contrary notwithstanding, told Govs. Ricardo Rosselló of Puerto Rico and Kenneth Mapp of the U.S. Virgin Islands:  “You can be very proud of all of your people, all of our people working together,” adding, however, “I hate to tell you, Puerto Rico, but you’ve thrown our budget a little out of whack.”

San Juan Mayor Carmen Yulín Cruz, who has been deeply critical of the government’s relief efforts and whom the President Trump has criticized on Twitter, also joined the President for his first briefing. The President said: “I think it’s now acknowledged what a great job we’ve done, and people are looking at that…And in Texas and in Florida, we get an A-plus. And I’ll tell you what, I think we’ve done just as good in Puerto Rico, and it’s actually a much tougher situation. But now the roads are cleared, communication is starting to come back. We need their truck drivers to start driving trucks,” adding his thanks to Governor Rosselló for positive comments he had made about the Trump administration’s work in Puerto Rico, saying, “He has said we have done an incredible job, and that’s the truth.”

Unsurprisingly, the President’s statements were also marked by the controversy he has had with the San Juan Mayor Carmen Yulin Cruz, who had earlier stated publicly that citizens were dying on the island for lack of federal assistance—in response to which the President had tweeted “poor leadership” demonstrated by the Mayor. Her comments came shortly after the President said she should be proud that only 16 Americans died, unlike the “real catastrophe” of Katrina. Actually, so far, the storm has taken the lives of 34 Americans, leading the Mayor to state, in the wake of the President’s visit: “This is not a joke.”

In a subsequent interview, the President yesterday declared he would eliminate Puerto Rico’s debts, stating he has many friends on Wall Street, noting: they will have to say good-by to their investments, “I don’t know whether it is Goldman Sachs, but whoever it is, they will have to say good-by.” The President added, however, that what he had seen was not a “real catastrophe.”

While the cost of replacing and restoring critical public infrastructure destroyed by Hurricane Maria will largely fall to the Federal Emergency Management Agency, funding for other essential services, such as police and emergency rescue appears likely to remain Puerto Rico’s responsibility, according to FEMA experts—albeit something fiscally virtually out of reach: Puerto Rico’s fiscal capacity, beset by a shrinking population, spiking pension costs, and a looming health-care-funding cliff, now is confronted by hundreds of thousands of its citizens still without power and other basic necessities; its economic activity will take some time to restart, and it can expect severe interruptions in its tax collections for a time, according to Jim Millstein, a financial restructuring adviser to Gov. Ricardo Rosselló’s administration. Mr. Millstein adds: “On the revenue assumption side, you can assume they’re going to fall short: While they have a huge influx of FEMA funds over the next 6 months, those are for designated purposes, and not necessarily for running the government.”

He predicted that Puerto Rico could lose up to two months’ of tax collections, even as the government lacks resources to finance essential services and other government operations—likely leading to seeking critical assistance from the Federal Reserve and the U.S. Treasury—requests, however, already, unsurprisingly, opposed by the territory’s existing creditors, who are battling the PROMESA Board for payments on $73 billion in municipal-bond debt—or, as ACG Analytics has noted: a U.S. loan package “would, presumably, be structured to have priority” over payments to current bondholders.

The White House did, this week, act to ease the potential liquidity squeeze, waiving certain cost-sharing requirements for six months. Meanwhile, PREPA creditors offered $1 billion in new loans this week to jump-start rebuilding efforts, an offer which Gov. Rosselló’s fiscal advisers rejected as “not viable.” In Congress, meanwhile, no immediate action appears likely: Congressional leaders anticipate passing a second disaster aid package later this year with more specific directives with regard to how federal dollars sent to Puerto Rico should be spent, even as the Trump administration, facing criticism for its response to Hurricane Maria, has installed a U.S. Army commander to oversee federal relief efforts, and the PROMESA oversight Board has said Puerto Rico can afford to pay bondholders roughly a quarter of what they are owed over the next decade. While the Treasury Department had considered the option of authorizing so-called “super municipal bonds,” the concept found little support in Congress, where there is antipathy about setting any precedents for federal bailouts of financially struggling municipalities.

The Fiscal Agony of the Absence of Chapter 9

eBlog

Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy.

Tropical Fiscal Typhoon. With the expiration of the freeze on litigation against the U.S. territory of Puerto Rico expiring yesterday, municipal bondholders filed suit against the Puerto Rico, likely marking the front end of a number of suits in the wake of Puerto Rico’s under the PROMESA law after its default on $1.3 billion of principal owed since the previous Governor declared the $70 billion public debt load unpayable in June of 2015. Bondholders filed two new lawsuits, even as the stay was lifted from at least 13 others. In the suits, the plaintiffs are seeking 11 declaratory judgments, two writs of mandamus, and three permanent injunctions. The fiscal meltdown came against a wavering political backdrop, as a demonstration in Puerto Rico’s capital, San Juan, against the PROMESA board’s austerity measures Monday turned violent: there was extensive damage to a Banco Popular office building’s windows, fires being lit, and car windows being smashed. The newest suits come after the administration of Gov. Ricardo Rosselló was unable to negotiate any agreement with the territory’s municipal bondholders after the May 1st deadline of the litigation freeze. His Chief of Staff, William Villafane, told the AP just hours before the freeze expired that the government preferred to reach a deal with bondholders, adding, however, that a municipal bankruptcy-like process could be an option if negotiations were to fail. A group representing those who bought a portion of the $16 billion worth of municipal bonds backed by Puerto Rico’s sales tax, charged that the government plan to cut its $70 billion debt was unconstitutional; they accused government leaders of perpetrating “unfair, unjust, and illegally punitive terms.” Ambac Assurance Corp. filed its own suit, accusing the government of illegally retaining $300 million owed to bondholders. The suit alleges it had been forced to pay more than $52 million in insurance claims because of ongoing defaults by Puerto Rico’s government. The tropical storm of litigation, coming on top of nearly a dozen lawsuits prior to the freeze imposed under the PROMESA law, came as Aurelius Capital Management LP, and other hedge funds, sued Puerto Rico in New York state court, seeking to recoup past-due payments on some $1.4 billion in defaulted general obligation bonds.

The precipitous storm of litigation appeared to mark the collapse of restructuring negotiations, as well as to signal the PROMESA board will vote to trigger the PROMESA Title III provisions to trigger a quasi-chapter 9 municipal bankruptcy proceeding. The fiscal disruption, at the same time, appeared to come as a physical disruption of riots and active lawsuits, leading the Dean of chapter 9 municipal bankruptcy, Jim Spiotto, to note: “Sometimes it is darkest before the dawn.” Counselor Spiotto added that a “litigation meltdown is not a solution” to the Puerto Rico debt problem; rather, he added: “You may have all the rights in the world, but if the [debtor] party doesn’t survive, thrive, your ability to get repaid is severely diminished,” noting that litigation is the least likely means of reaching a long-term solution, since the debtor is going to be hit by substantial attorney’s fees. Further, he explained, even were the PROMESA Oversight Board to initiate Title III to consolidate all Puerto Rico debt cases into a single quasi-bankruptcy process, that would simply open the way to a long and costly trail of appeals; thus, he notes that instead, all parties need a “time out” if there is to be a realistic chance of a fiscal solution, noting that would almost surely lead to a better outcome for all parties. Or, as U.S. Rep. Nydia Velázquez (D.-NY.) put it: “The power to comprehensively restructure 100 per cent of Puerto Rico’s debt is the reason why I voted ‘yes’ on [PROMESA] last year….Inconceivably, today, May 2, 2017, the island is on the same path as it was prior to the enactment of the law. This is unconscionable. It is imperative the board use this powerful tool and vote to file for a Title III proceeding immediately.”

The fiscal collapse also creates a constitutional and governance crisis. Article VI of Puerto Rico’s constitution (§8) provides 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, and other disbursements shall thereafter be made in accordance with the order of priorities established by law;” however, Title III of the federal PROMESA statute would supersede this.

The growing challenge spread also, as Ambac filed suit against the U.S. Treasury Secretary Steven Mnuchin, seeking to bar access by the U.S. territory to a federal excise tax imposed on rum manufactured in the territory and sold in the mainland U.S. Moreover, Ambac also filed two other lawsuits over Puerto Rico’s alleged efforts to break the lien securing some $17 billion in sales-tax municipal bonds—one suit in federal court, the other in New York state court. One, in federal court, sought a court order safeguarding the revenue stream that backs those bonds.

Amid the various court challenges, Gerardo Portela, the Executive Director of Puerto Rico’s Financial Advisory and Tax Agency, yesterday claimed: “We are talking to all the different groups of bondholders,” after leaving La Fortaleza after holding a meeting with Governor Rosselló. Moreover, with the increasing threat to critical public services, Puerto Rico Property Secretary Raul Maldonado yesterday provided assurances that the government already has part of the money required by the Fiscal Supervision Board to avoid the reduction of working hours in public employees.

Just to provide some scale of what is unfolding, the quasi chapter 9 municipal bankruptcy here under a federal court-supervised restructuring for a portion of Puerto Rico’s $70 billion debt would be 800% larger than Detroit’s—which to date, has marked the largest chapter 9 bankruptcy in American history. However, with Puerto Rico neither a municipality, nor a state, it falls into a legal and fiscal Twilight Zone. In the wake of bondholder rejection, over the weekend, of an offer to pay 50 cents on the dollar to holders of Puerto Rico general obligation and sales-tax bonds backed by Puerto Rico’s constitution, it increasingly appears a non-federal bankruptcy court will be pressed to try to put Humpty Dumpty back together again.

Meanwhile, in Congress, federal legislation, HR 1366, the U.S. Territories Investor Protection Act of 2017, a bill to try to close a legal loophole which some in Congress believe allowed broker-dealers to defraud Puerto Rico investors was passed on a voice vote by the House and will now move to the Senate for consideration. The legislation would extend all the rules under the Investment Company Act of 1940, which apply, to investment companies on the U.S. mainland to those investment companies operating in Puerto Rico and the other U.S. territories. Rep. Velázquez, in introducing the bill, noted: “Today’s bipartisan action in the House is a huge step for the people of Puerto Rico, and I will keep applying pressure for Senate action.” A companion bill in the Senate (S. 484), sponsored by Sen. Robert Menendez, D-N.J., has already cleared the Senate Banking Committee. The Congresswoman said that the legislators had “acted in the best interest of retirees and individual investors in Puerto Rico,” adding that: “For far too long, Puerto Rican retirees and others have been preyed on by unscrupulous investors who have exploited this disparity in the rules…By passing this measure in the House, we are one step closer to putting an end to these abuses.”

The Roads out of Municipal Bankruptcy

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eBlog, 2/24/17

Good Morning! In this a.m.’s eBlog, we consider the post-chapter 9 municipal bankruptcy trajectories of the nation’s longest (San Bernardino) and largest (Detroit) municipal bankruptcies.

Exit I. So Long, Farewell…San Bernardino City Manager Mark Scott was given a two-week extension to his expired contract this week—on the very same day the Reno, Nevada City Council selected him as one of two finalists to be Reno’s City Manager—with the extension granted just a little over the turbulent year Mr. Scott had devoted to working with the Mayor, Council, and attorneys to complete and submit to U.S. Bankruptcy Judge Meredith Jury San Bernardino’s proposed plan of debt adjustment—with the city, at the end of January, in the wake of San Bernardino’s “final, final” confirmation hearing, where the city gained authority to issue water and sewer revenue bonds prior to this month’s final bankruptcy confirmation hearing—or, as Urban Futures Chief Executive Officer Michael Busch, whose firm provided the city with financial guidance throughout the four-plus years of bankruptcy, put it: “It has been a lot of work, and the city has made a lot of tough decisions, but I think some of the things the city has done will become best practices for cities in distress.” Judge Jury is expected to make few changes from the redline suggestions made to her preliminary ruling by San Bernardino in its filing at the end of January—marking, as Mayor Carey Davis noted: a “milestone…After today, we have approval of the bankruptcy exit confirmation order.” Indeed, San Bernardino has already acted on much of its plan—and now, Mayor Davis notes the city exiting from the longest municipal bankruptcy in U.S. history is poised for growth in the wake of outsourcing fire services to the county and waste removal services to a private contractor, and reaching agreements with city employees, including police officers and retirees, to substantially reduce healthcare OPEB benefits to lessen pension reductions. Indeed, the city’s plan agreement on its $56 million in pension obligation bonds—and in significant part with CalPERS—meant its retirees fared better than the city’s municipal bondholders to whom San Bernardino committed to pay 40 percent of what they are owed—far more than its early offer of one percent. San Bernardino’s pension bondholders succeeded in wrangling a richer recovery than the city’s opening offer of one percent, but far less than CalPERS, which received a nearly 100 percent recovery. (San Bernardino did not make some $13 million in payments to CalPERS early in the chapter 9 process, but did set up payments to make the public employee pension fund whole; the city was aided in those efforts as we have previously noted after Judge Jury ruled against the argument made by pension bond attorneys two years ago. After the city’s pension bondholders entered into mediation again prior to exit confirmation, substantial agreement was achieved for th0se bondholders, no doubt beneficial at the end of last year to the city’s water department’s issuance of $68 million in water and sewer bonds at competitive interest rates in November and December—with the payments to come from the city’s water and sewer revenues, which were not included in the bankruptcy. The proceeds from these municipal bonds will meet critical needs to facilitate seismic upgrades to San Bernardino’s water reservoirs and funding for the first phase of the Clean Water Factor–Recycled Water Program.

Now, with some eager anticipation of Judge Jury’s final verdict, Assistant San Bernardino City Attorney Jolena Grider advised the Mayor and Council with regard to the requested contract extension: “If you don’t approve this, we have no city manager…We’re in the midst of getting out of bankruptcy. That just sends the wrong message to the bankruptcy court, to our creditors.” Ergo, the City Council voted 8-0, marking the first vote taken under the new city charter, which requires the Mayor to vote, to extend the departing Manager’s contract until March 7th, the day after the Council’s next meeting—and, likely the very same day Mr. Scott will return to Reno for a second interview, after beating out two others to reach the final round of interviews. Reno city officials assert they will make their selection on March 8th—and Mr. Scott will be one of four candidates.

For their part, San Bernardino Councilmembers Henry Nickel, Virginia Marquez, and John Valdivia reported they would not vote to extend Mr. Scott’s contract on a month-to-month basis, although they joined other Councilmembers in praising the city manager who commenced his service almost immediately after the December 2nd terrorist attack, and, of course, played a key role in steering the city through the maze to exit the nation’s longest ever municipal bankruptcy. Nevertheless, Councilmember Nickel noted: “Month-to-month may be more destabilizing than the alternative…Uncertainty is not a friend of investment and the business community, which is what our city needs now.” From his perspective, as hard and stressful as his time in San Bernardino had to be, Mr. Scott, in a radio interview while he was across the border in Reno, noted: “I’ve worked for 74 council members—I counted them one time on a plane…And I’ve liked 72 of them.”

Exit II. Detroit Mayor Mike Duggan says the Motor City is on track to exit Michigan state fiscal oversight by next year , in the wake of a third straight year of balancing its books, during his State of the City address: noting, “When Kevyn Orr (Gov. Rick Snyder’s appointed Emergency Manager who shepherded Detroit through the largest chapter 9 municipal bankruptcy in U.S. history) departed, and we left bankruptcy in December 2014, a lot of people predicted Detroit would be right back in the same financial problems, that we couldn’t manage our own affairs, but instead we finished 2015 with the first balanced budget in 12 years, and we finished 2016 with the second, and this year we are going to finish with the third….I fully expect that by early 2018 we will be out from financial review commission oversight, because we would have made budget and paid our bills three years in a row.”

Nonetheless, the fiscal challenge remains steep: Detroit confronts stiff fiscal challenges, including an unexpected gap in public pensions, and the absence of a long-term economic plan. It faces disproportionate long-term borrowing costs because of its lingering low credit ratings—ratings of B2 and B from Moody’s Investors Service and S&P Global Ratings, respectively, albeit each assigns the city stable outlooks. Nevertheless, the Mayor is eyes forward: “If we want to fulfill the vision of a building a Detroit that includes everybody, we have to do a whole lot more.” By more, he went on, the city has work to do to bring back jobs, referencing his focus on a new job training program which will match citizens to training programs and then to jobs. (Detroit’s unemployment rate has dropped by nearly 50 percent from three years ago, but still is the highest of any Michigan city at just under 10 percent.) The Mayor expressed hope that the potential move of the NBA’s Detroit Pistons to the new Little Caesars Arena in downtown Detroit would create job opportunities for the city: “After the action of the Detroit city council in support of the first step of our next project very shortly, the Pistons will be hiring people from the city of Detroit.” The new arena, to be financed with municipal bonds, is set to open in September as home to the Detroit Red Wings hockey team, which will abandon the Joe Louis Arena on the Detroit riverfront, after the Detroit City Council this week voted to support plans for the Pistons’ move, albeit claiming the vote was not an endorsement of the complex deal involving millions in tax subsidies. Indeed, moving the NBA team will carry a price tag of $34 million to adapt the design of the nearly finished arena: the city has agreed to contribute toward the cost for the redesign which Mayor Duggan said will be funded through savings generated by the refinancing of $250 million of 2014 bonds issued by the Detroit Development Authority.

Mayor Duggan reiterated his commitment to stand with Detroit Public Schools Community District and its new school board President Iris Taylor against the threat of school closures. His statements came in the face of threats by the Michigan School Reform Office, which has identified 38 underperforming schools, the vast bulk of which (25) are in the city, stating: “We aren’t saying schools are where they need to be now…They need to be turned around, but we need 110,000 seats in quality schools and closing schools doesn’t add a single quality seat, all it does is bounce children around.” Mayor Duggan noted that Detroit also remains committed to its demolition program—a program which has, to date, razed some 11,000 abandoned homes, more than half the goal the city has set, in some part assisted by some $42 million in funds from the U.S Department of Treasury’s Hardest Hit Funds program for its blight removal program last October, the first installment of a new $130 million blight allocation for the city which was part of an appropriations bill Congress passed in December of 2015—but where a portion of that amount had been suspended by the Treasury for two months after a review found that internal controls needed improvement. Now, Major Duggan reports: “We have a team of state employees and land bank employees and a new process in place to get the program up and running and this time our goal isn’t only to be fast but to be in federal compliance too.” Of course, with a new Administration in office in Washington, D.C., James Thurber—were he still alive—might be warning the Mayor not to count any chickens before they’re hatched.

Fiscal Challenges Amid Governance Transitions

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eBlog, 12/06/16

Good Morning! In this a.m.’s eBlog, we consider the ongoing health and fiscal challenges of Flint, Michigan as we await the outcome of today’s mayoral recall election in the insolvent municipality of East Cleveland, after which we attempt to update readers on the porous state of Atlantic City’s municipal utility. Then we seek to escape winter by heading south to Puerto Rico—where the combination of changing administrations in both the U.S. and Puerto Rico leave unclear what the fiscal path forward will be if the U.S. territory is to avoid not just fiscal, but also health care insolvency.

Out like Flint. University of Michigan researchers have more than tripled their estimate of the number of water service lines in the small city of Flint which will need to be replaced, nearly quadrupling the number of lead or galvanized steel lines the city has from 8,000 to 29,100—or more than half service lines leading to 55,000 homes and businesses in Flint, according Mayor Karen Weaver, who notes the updated report makes it important that the city move beyond the use of filters and instead move toward wholesale replacement of water lines: “These findings make it even more imperative that the state and federal government step up to pay for replacing lead-tainted service lines.” The figures are daunting: of the municipality’s 29,100 parcels, 17,500 would need full replacement of service lines, while 11,600 would require partial replacement, according to the researchers. The estimate was mandated by EPA to comply with the requirements of the federal Lead and Copper Rule: because the lead in the city’s water supply exceeded the federal action level of 15 parts per billion, the city is mandated to replace more than 2,000 service lines by next June—a physical and fiscal challenge given that Flint’s records describing the location of lead service lines in Flint have proven to be unreliable, and records for some parcels appear to not even exist, according to city officials—meaning that visual inspections, more time-consuming and expensive route—has served as the city’s only means to obtain an accurate assessment of where lead and galvanized steel service lines were installed. Thus, under Mayor Weaver’s initiative, municipal crews continue to replace service lines in neighborhoods most likely to have lead service lines, and where a significant number of young children or seniors live: the Mayor’s goal is to have service lines replaced at 1,000 homes by the end of this month, although the actual number may be fewer if bad weather occurs—weather with this morning’s chilled rain at temperatures just above freezing augurs ill. To help, the state of Michigan has set aside $25 million to pay for pipe replacements through September of next year—estimated to be sufficient to pay for replacing pipes to about 5,000 homes. In addition, Congress is considering an aid package that would bring tens of millions of dollars to Flint which could be used to repair the city’s damaged water system. If the 29,100 figure proves accurate, replacing the other 28,100 service lines could cost at least $140 million. A key element on this health and fiscal challenge could be yesterday’s agreement between U.S. House and Senate leaders on a bipartisan bill to authorize $170 million for Flint and other cities beleaguered by lead in drinking water, and to provide relief to drought-stricken California. A vote on the water-projects bill could take place this week as Congress wraps up its legislative work for the year.

The Utility & Atlantic City. Atlantic City’s utility water authority board members last week raised rates in an effort to cover an unexpected budget hole—but then topped it off by paying themselves a $3,000 per board member, even as the Municipal Utilities Authority (MUA) board approved the 10 percent rate hike for next year, a 20 percent increase over what had been set at last week’s special meeting to cover lost revenue from a contract change with New Jersey American Water. Under the new plan, residential rates would increase to $50 per quarter from $45 last year; nevertheless, the utility’s rates would still rank near the bottom for the region, according to Atlantic County Utilities Authority data. The MUA’s $14.7 million 2017 budget, down just under 10 percent from last year, is scheduled to be adopted on December 21st, according to an authority news release. The increase would appear unlikely to garner much favor in the insolvent city—especially in the wake of the board’s decision to award themselves $3,000 gifts this December “for their dedicated service,” according to a resolution, notwithstanding that the money was supposed to be a parting gift, not a Christmas gift, according to one board member. Board Vice Chairman Gary Hill yesterday claimed the “December 2016” was an error in the resolution’s language. It appears it has been a tradition that MUA Board members are to receive a cash bonus or gift once they leave the board: the authority’s seven board members make $6,000 salaries and can receive benefits, according to public records. Now, however, the Board’s challenge could be complicated by a different kind of fiscal disruption: American Water, a private company which had been considered a potential buyer of the MUA, which had a $1.7 million contract with the MUA, and was the MUA’s top customer, has recently notified the MUA it no longer needs it to provide water; it turns out that capital improvements to its Atlantic County system have increased its water capacity and “in essence eliminated NJAW’s need to purchase water from the ACMUA,” according to the company letter to the authority; instead, American Water wanted to buy 500,000 gallons of water per day, down from the 1.2 million gallons per day it has recently purchased; however, the lower volume would convert the company from a “bulk purchaser” to a “commercial customer,” meaning it would have to pay a $7 million connection charge, according to the letter, so that, according to the company’s statement: “We cannot justify the additional costs the ACMUA’s proposal would have on the company and its customers, since these significant capital investments eliminate the need for New Jersey American Water to purchase additional water.” Ergo, the contract change and its effect on the MUA budget led to the special board meeting where rates were raised—and bonuses were raised; now MUA and American Water are discussing a potential agreement under which the company would only buy water from the MUA in emergency situations, according to Chairman Hill: the MUA could get just $200,000 under such an arrangement. The fiscal and physical situation is, of course, further complicated from a governance perspective as the city’s public water utility has been at the center of debate between Atlantic City and the State of New Jersey—which has just taken over the city. American Water lobbyist Philip Norcross attended a 2015 meeting with city and state officials in which the MUA was discussed. Mr. Norcross’ brother is South Jersey powerbroker George Norcross. Authority officials questioned the timing of the contract change, hinting it was a strategic move by American Water to get the valuable water works, according to the meeting transcript. “They’re putting pressure on,” said Deputy Executive Director Garth Moyle.

Administration Transitions & Puerto Rico. The new PROMESA law to create a quasi-chapter 9 mechanism for the U.S. territory of Puerto Rico will face signal challenges as the governance of both the U.S. and Puerto Rico are in transition to new administrations. Unsurprisingly, President-elect Trump devoted little time to addressing what his position would be with regard to the implementation and administration of the new law. Thus, while Congress and the Treasury Department have put together both a framework and a Board to assist in Puerto Rico’s recovery; whether and how those might be modified or addressed now will depend upon both the incoming administration in Washington and new Governor in Puerto Rico—where the new head of the Senate’s Health Commission, Ángel Chayanne Martínez Santiago, yesterday urgently requested a meeting with House Speaker Paul Ryan (R-Wisc.) to discuss a possible health emergency declaration because of apprehension that all federal health care funds could expire on the island by this summer, writing that the federal health care assistance affects some 1.6 million U.S. citizens: “We need to declare a health emergency in Puerto Rico immediately. We have no doubt that this is a matter of vital importance—nor can there be any question but that this is a matter of vital importance for Congress and the White House.” The letter warns that, without a doubt, the greatest portion of the territory’s existing Affordable Health Care funds will have been spent before the end of this month, noting: “We are urgently requesting this meeting with Speaker Ryan to set out a strategy to avoid having Puerto Ricans losing all access to health care.”

The situation is further complicated as Puerto Rico is going through its own governance transition. Thus, the U.S. territory’s Governor-elect, Ricardo Rosselló, now must determine not only how to coordinate with the PROMESA board, but also how to address Puerto Rico’s budget, debt, and grave health care situation—and how to seek to work with the new Trump administration after reviewing both the numbers in the Commonwealth’s current 10-year fiscal plan submitted last October by outgoing Gov. García Padilla. A critical issue will be Medicaid—an issue on which the outgoing administration had warned Congress “ultimately will have to address Puerto Rico’s inequitable treatment under Medicaid and its need for economic growth incentives.” The pending proposal by the outgoing Administration of President Obama opined that Congress create Medicaid parity between Puerto Rico and the states, and extend certain tax credits to the Commonwealth: this has now become a more urgent issue as Medicaid funding for Puerto Rico is due to expire near the end of 2017, creating what is called a “Medicaid cliff.” And even that challenge can be expected to be further muddied by potential consideration by the incoming Trump Administration to convert Medicaid’s entitlement status to a block grant program to the states. The risk for Puerto Rico in all this would be if it were to fall between the cracks: should that happen, Puerto Rico’s government, where annual health care expenditures are near $2.4 billion annually, the U.S. territory would either have to raise revenues and find ways to cut expenses while providing consistent levels of care or drastically pare healthcare benefits—benefits already significantly lower than to Americans living in the other 50 states, because Puerto Rico’s Medicaid funding is capped, rather than entitled—meaning that, despite disproportionate health care needs, it receives disproportionately less than any of the 50 states.  

Awkward Transition & Fiscal Death Spiral? Puerto Rico Governor-Elect Ricardo Rosselló this weekend declined outgoing Gov. Alejandro García Padilla’s offer to work on a fiscal plan for the federal PROMESA oversight board. Under the PROMESA law, the U.S. territory’s governor is mandated to submit a five-year plan which itemizes steps to bring about fiscal responsibility, regain access to capital markets, fund essential public services, fund provisions, and achieve a sustainable debt burden. Last October, Gov. Padilla indeed presented a 10 year plan to PROMESA’s Oversight Board which noted that Puerto Rico simply could not afford paying down its debt without federal aid, noting that the government would be still $6 billion short for operating expenses over the next decade absent federal help and without paying any debt service. Last month, the PROMESA Oversight Board members indicated they believed substantial cuts to Puerto Rico government spending beyond those included in the outgoing Governor’s plan were necessary—adding that the Board expected a revised version of the plan from Governor Padilla by next week—a demand with which Governor Padilla said he would not cooperate if it meant revising the plan to include additional austerity, noting the island has had enough austerity, so that further budget cuts would only lead to an “economic death spiral.” Thus, last Friday the Governor Padilla sent a letter to Governor-elect Rosselló to invite him to become part of a joint effort to put together a revised fiscal recovery plan. Gov.-elect Rosselló, however, publicly rejected the outgoing Governor’s offer, responding, at least according to El Vocero’s news website, that Governor Padilla had not released sufficient financial data for the incoming Governor to work with him—leaving the incoming Governor little time or opportunity to offer his own plan—and the PROMESA Board is scheduled to certify (or not) the plan set before it by the end of next month.

Municipal Governance: The Challenges of Severe Fiscal Distress

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eBlog, 11/30/16

Good Morning! In this a.m.’s eBlog, we consider the difficult trials and tribulations of governance in a municipality confronting severe fiscal distress—in this case in the historic municipality of Petersburg, Virginia, before heading West to San Bernardino where the old expression “When it rains, it pours,” might be an apt description as a physical rather than fiscal earthquake appears to be adding to the city’s fiscal challenges as it seeks to emerge early next year from the nation’s longest ever chapter 9 municipal bankruptcy. Then we journey back to Ohio, where a municipal election next week in the virtually insolvent municipality of East Cleveland appears to offer little optimism of any resolution of its insolvency. Then we continue east to Connecticut, a state now confronting serious fiscal pressures. Finally, we head south, not to escape winter, but rather to observe the difficulty of governance created by a federal oversight board and an incoming new Governor.    

Is It a Municipal Government of the People? The ACLU of Virginia released a letter Monday criticizing the Petersburg City Council for meeting practices it said violate “the spirit of open government laws.” The organization claimed the City Council over-relied on special meetings, sometimes called at the last-minute, during the work day, or held in cramped quarters, to vote on matters of governance and financial management even as the city veered into insolvency. In the letter, ACLU executive director Claire Guthrie Gastañaga warned: “Holding meetings at inconvenient times and in small spaces that cannot accommodate the public violates the spirit of open government laws that serve to promote an increased awareness by all persons of government activities and afford every opportunity to citizens to witness the operations of government.” Part of the reaction reflects the growing anger of city residents and taxpayers with regard to the ways in which the Mayor and Council allowed the fiscal crisis to grow unattended—and then to hire at steep prices turnaround specialists from Washington, D.C. Indeed, some believe that the Council’s decision to hire the Robert Bobb Group—especially the way it did so—to try to avert insolvency and potential chapter 9 bankruptcy violated the municipality’s own rules and possibly the city charter, because of the procedure of forcing the matter to a second vote days after an initial vote for the partnership failed to pass, with two council members absent. The Petersburg City Council’s rules require a month delay; the city’s charter provides that a reconsideration vote must have as many members present as were there for the initial vote. The city attorney has defended the vote, asserting that nothing illegal or untoward transpired during the second consideration of the Bobb Group contract, which sealed the $350,000, five-month fee from the nearly bankrupt municipality with the firm. The aftertaste led citizens to publicly lambaste Mayor W. Howard Myers at a council meeting following the vote: now those citizens are actively circulating a recall petition to force the Mayor to step down. As Barb Rudolph, an organizer of the community group Clean Sweep Petersburg, put it: “For the many citizens of Petersburg who want to better understand what our elected leaders are deciding and why, this letter is most welcome…It puts City Council on notice that they can’t hide behind their misinterpretation of FOIA laws and inadequate commitment to open government.”

The vote last month on hiring the Bobb Group took place at one of 13 special meetings called by the City Council between March and October, according to the ACLU’s review. The Council publicized some in advance as being called solely for closed-session discussions, which “has the result of suppressing interest in attending and participating,” according to Ms. Gastañaga, who is pressing for the Council to be more open and resort less to executive sessions, or, as she puts it: “Even if legally permitted, the Council should hold all meetings in public unless there is a specific and important policy reason for the Council to meet outside of the hearing of the residents and public the Council was elected to serve.”

A Physical, not a Fiscal Quake. San Bernardino municipal employees are one step closer to completely moving out of City Hall, not because of the city’s chapter 9 bankruptcy—from which the city expects to emerge next March, but rather in response to a substantial earthquake risk: the City Council voted 7-0 Monday night to authorize City Manager Mark Scott to lease office space in two adjacent buildings in the wake of seismic experts’ warnings that the 43-year-old City Hall building is likely to collapse during a strong earthquake. The plan is to seek a grant to retrofit City Hall so that it could comply with modern earthquake standards and employees can return; however, for the municipality hoping to emerge from the nation’s longest chapter 9 municipal bankruptcy early next year, the physical disruption will be costly: it will take more than $14 million and an extended period of time, according to the city’s engineering study. Moreover, because the city was unable to obtain a lease for less than two years, the city will pay a total of $42,688 and $21,566—per month for the first year of the two-year lease, and a bit more for the second year. Additional costs associated with the move, including Information Technology costs and a moving company, approach $500,000, according to the staff report. Mayhap unsurprisingly, the plan was blasted at a Council session Monday by all of the members of the public who spoke—with one member of the public telling the Mayor and Council: “Anybody that votes yes on (the lease proposal) at this time, with as little studying as has been done, deserves to be removed from their office.”

The city, now addressing its fiscal earthquake, has received two independent engineering evaluations, in 2007 and 2016, which warn that City Hall sits atop two large faults, making it unsafe in an earthquake. The February study concluded that a magnitude 6.0 earthquake would lead to “a likelihood of building failure” for City Hall, which was designed before code updates following the 1971 Sylmar and 1994 Northridge earthquakes. With a greater than 90 percent chance of an earthquake of 6.0 or greater striking the region within 50 years, it would appear that steps not anticipated in the city’s chapter 9 plan of debt adjustment will require spending not included in that plan—spending not well received by the city’s taxpayers, who fear such spending will likely come at the expense of what they already complain is inadequate spending to combat crime, homelessness, and other issues. Moreover, the time contemplated—nine years—has added to citizen frustrations. Or as one citizen testified before the Council referring to the seismic information provided to the city nearly a decade ago: “Nine years?…I’ve heard of slow bureaucracy, but what kind of an emergency is it, if it’s nine years down the road?”

Municipal Integrity. The old expression that “when it rains, it pours,” might be apt for East Cleveland Mayor Gary Norton, who is seemingly waiting for Godot—that is, the State of Ohio to respond to the City’s request for authorization to file for chapter 9 municipal bankruptcy, but, instead, is confronted by an Ohio state board’s large fines for filing incomplete and late campaign finance reports related to next week’s municipal elections—in this case a recall election. Last month, the Ohio Elections Commission fined the Mayor $114,000—nearly sextuple the levy imposed by Ohio’s Attorney General last year. The most recent fines were levied in response to complaints from the Cuyahoga County Board of Elections that Mayor Norton did not file an annual report for 2015, turned in his 2014 report late, and did not resolve issues with his 2013 reports. In a series of letters, the Board of Elections asked Mayor Norton to fix a number of discrepancies in his 2013 reports—including incorrect fundraising totals and missing addresses. The board also requested proof of mileage, bank fees, phone expenses, and other spending for that year. Mayor and candidate Norton also is confronted by complaints over several missing finance reports from years prior to 2013, according to elections commission case summary records. Many of those reports have since been submitted and posted on the county board of elections website: a year ago last August, the elections commission imposed a $20,000 fine in connection with many of those cases. Mayor Norton’s last reported fundraising was in 2013, when he won a second term. He reported raising no money in 2014. Election commission fines balloon quickly. Mayor Norton’s grew by $100 for every day the problems remained unaddressed.

State Fiscal Sustainability? In Connecticut, where the state motto is Qui transtulit sustinet, or he who is transplanted still sustains, fiscal sustainability appears to be uncertain. Indeed, downgrades and related underperformance of the state’s debt are anticipated in the near-term, in no small measure due to weaker than expected revenue performance and rising fixed costs. The state confronts an expected expenditure reduction of more than 12 percent in FY2018, or $1.2 billion in non-fixed costs in FY18—a fiscal gap made more stressful because this year’s state budget relied on nearly $200 million in non-recurring revenues. The state’s Office of Fiscal Accountability recently revised state income and sales and use tax estimates down for FY17 by an aggregate of -$115.4 million; general fund revenues for FY18 are expected to post a decline of approximately $190 million from FY17 and aggregate revenue growth assumptions for FY19 and FY20 have also been downgraded. A significant factor has been fixed costs, especially from public pension obligations and other post-employment or OPEB benefits—in addition to municipal debt service and entitlements—which, together—like a Pac-Man are projected to account for 53% of expenditures in FY18. The state projects that pensions, OPEB, and debt service costs will rise by nearly 15%, while entitlements grow by nearly 5% in FY18. Worse, anticipated higher interest rates will add to future fixed costs in the form of debt service costs, while at the same time reducing bond premiums which the state has used over the past several years to reduce debt service appropriations. If there is any upside, it is that Connecticut has fully funded its pensions since 2012, albeit it has computed the liability using a relatively aggressive discount rate of 8 percent. Should the funds return less than this rate, pension costs will rise more than projected as the higher liability is amortized.

The Promise of PROMESA. Our insightful colleagues at Municipal Market Analytics note that the federally created PROMESA board has demanded that any fiscal reform plan adopted by the U.S. territory of Puerto Rico be:

  • honest with regard to any incremental federal aid Congress and the new Trump administration might provide,
  • that recurring revenues must actually be set to afford recurring expenses and vice-versa, and
  • that traditional capital market access cannot be assumed, but rather must be cultivated through balanced settlements.

MMA noted this to be “an unexpectedly earnest expression by the board and a very positive development for Puerto Rico in the long-term, although it also exacerbates short-term volatility by making standard extend-and-pretend restructuring strategies more difficult to pull off.” In response (or really non-response), outgoing Alejandro Javier García Padilla noted that although his own plan assumes massive injections of new federal aid, leaves current commonwealth spending levels unchanged, and disregards the market access issue entirely; he would not be submitting an amended version—a response that makes more difficult the PROMESA Board’s ambitious December 15th deadline for submitting its plan. MMA perspicaciously notes that the federal oversight board’s perspective could also pose a threat to the recent price appreciation in Puerto Rico’s municipal bonds, noting that to the extent to which the Commonwealth, nearing next month’s change of administrations, is forced to meaningfully address its massive structural budget deficit, there will be little room to project payment of debt service in the near– or medium-terms, with MMA noting: “In theory, more sustainable projections will reduce the size of any bondholder recovery, but will allow for higher bond ratings once a restructuring has been completed. Adding to medium-term issues, an acceptable plan’s likely need for sweeping layoffs, service austerity, and, potentially, pension payout reductions increases the potential for social unrest on the island: a development that will aid no parties besides partisans for independence.”  

Is There Promise in PROMESA? The Puerto Rico PROMESA Financial Oversight and Management Board has appealed a U.S. District Court ruling that stopped it from intervening in several consolidated suits filed against the government, having filed a motion in October to intervene in four consolidated lawsuits in order to make known its views on the plaintiffs’ pending motions to lift the automatic stay imposed under §405 of the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA). Thus, two weeks ago, U.S. District Court Judge Francisco Besosa denied the oversight board’s request to intervene in the suits filed by U.S. Bank Trust, Brigade Leveraged Capital Structures Fund Ltd, National Public Finance Guarantee Corp. and the Dionisio Trigo group of bondholders—a suit in which the plaintiffs were challenging the constitutionality of the Moratorium Act, which stopped payments to bondholders. Judge Besosa, early this month, had upheld a block on creditors’ ability to file lawsuits against the government of Puerto Rico in an attempt to extract repayment on defaulted municipal bonds to give time to the territory to restructure its $69 billion debt load—with the stay order part of the PROMESA Act: Judge Besosa consolidated the lawsuit filed by Altair with the suits by three other claimants and imposed a stay on them, writing: “The Court hastens to add that the Commonwealth defendants must not abuse or squander the ‘breathing room’ that the Court’s decision fosters. The purpose of the PROMESA stay is to allow the Commonwealth to engage in meaningful, voluntary negotiations with its creditors without the distraction and burden of defending numerous lawsuits.” (Besides Altair, the lawsuit was brought by Peaje Investments LLC and Assured Guaranty Corp against the government and outgoing Governor Alejandro Garcia Padilla.)

Unpromising? Puerto Rico Governor-Elect Ricardo Rosselló has opted to select his campaign manager, Elías Sánchez Sifonte, to replace public finance veteran Richard Ravitch as Puerto Rico’s non-voting representative to the PROMESA Oversight Board. Commencing next year, Senor Sánchez Sifonte will replace Mr. Ravitch, and losing the experience and expertise of a public finance veteran of the Detroit oversight board, as well as someone who played a key oversight role in the cases of both New York City and Washington, D.C. Mr. Sánchez Sifonte has held a variety of positions in recent years. Most recently he was campaign manager for Gov.-elect Rosselló’s bid for governorship. Prior to that he was human resources director for the city of Toa Baja, which according to the El Nuevo Día news web site had a payroll from $16 million to $23 million per year in the last 10 years. Senor Sifonte, a Republican, is a licensed attorney and provided legal advice to the Puerto Rico Senate from 2009 to 2011. He has run Veritas Consulting since 2011. According to El Nuevo Día he worked as a lobbyist to the Puerto Rico legislature without properly being registered as a lobbyist.