Bankruptcy: To Be Eligible or Not to Be, that is the question.

October 5, 2015

Who’s on First in Atlantic City? There was a bankruptcy filing in Atlantic City yesterday: American Apparel is filing for Chapter 11 bankruptcy protection, a filing which came after the Los Angeles corporation reported that its U.S. retail stores will continue to operate and that its international stores are not affected, but a plan which would, pending approval by a federal bankruptcy court, erase more than $200 million in bonds held by the retailer in exchange for equity interests. Lenders will provide about $90 million in debtor-in-possession financing. The company’s board has approved the restructuring plan, which is expected to be completed in about six months—and then will await the court approvals. In contrast, there has been no municipal bankruptcy filing by Atlantic City, notwithstanding the continued silence from Presidential candidate and New Jersey Governor Chris Christie with regard to whether and when he might interrupt his campaign to sign financial relief provisions long since sent to him by the New Jersey legislature to authorize the city’s casinos to make payments in lieu of taxes over the next 15 years and reallocate the casino alternative tax to pay debt service on Atlantic City-issued municipal bonds. In the strange municipal leadership dilemma in which Mayor Don Guardian sits—awaiting action by an absentee Governor and not fully clear about the hydra-headed governance situation where the mostly absentee governor has appointed an emergency manager to act in an ill-defined role as a quasi co-mayor—Mayor Guardian nevertheless is focused on efforts to signally change the city’s fiscal dependence on casinos by diversifying the city’s economic base. Nevertheless, with a $101 million deficit and delayed FY2016 budget (adopted last week), in addition to a withering credit rating; Mayor Guardian has cut the city’s personnel by 400 positions, and worked with his Council to help plug the budget gap—even as he and his fellow elected Councilmembers await Emergency Manager Kevin Lavin’s expected second report, which is to include fiscal sustainability recommendations—recommendations in this strange, two-headed quasi municipal governance situation—and in which the missing Governor’s action will be critical. Notwithstanding his tenuous authority under New Jersey’s unique municipal bankruptcy laws, Mayor Guardian is not just sitting around twiddling his thumbs; rather he is focused on his city’s future, telling the Bond Buyer’s Andrew Coen: “I want to prepare my city for the next recession…Whether that is five or 10 years away, I want to make sure that we’re a lot more than just a resort town so that we become resilient.” That focus, especially since quasi hurricane San Joaquin opted to not vent its physical fury on the city, will be easier in the wake of New Jersey’s Local Finance Board approval of the city’s budget, which opened the way for Atlantic City to proceed with fourth-quarter tax bills and tax-lien sales for some big delinquent properties among current and former casino hotels.

The Anomalies of Municipal Bankruptcy. Hillview, Kentucky, the small (population under 10,000) home rule-class municipality in Bullitt County, Kentucky—a rural farming community just a hop, skip, and jump from Louisville, which filed for chapter 9 municipal bankruptcy in August—the first filing for a municipality since Detroit’s filing more than two years’ ago—might find its filing unavailing. Having ignored the electronically musically and sound advice of retired U.S. Bankruptcy Judge Steven Rhodes, who oversaw the largest municipal bankruptcy in U.S. history, Steven Rhodes, the small city could be digging itself into a deeper fiscal trough, even as it preps to argue before U.S. Bankruptcy Judge Alan C. Stout. Judge Stout will have to determine if the municipality’s filing was done in good faith, in addition to assessing the justifications. The municipality’s largest creditor, Truck America LLC, which has been awarded an $11.4 million judgment against Hillview (with the interest bring the growing amount of said award now up to $15 million) has filed an objection with the U.S, bankruptcy court, arguing the municipality is ineligible because its petition to the federal court which the municipality relied on to file for reorganization “suffers from a fatal flaw: it refers only to the now-repealed Bankruptcy Act.” The objection, which in a sense echoes earlier moody warnings from credit rating agency Moody’s that: “Generally, a municipality must prove that it is not paying its debts on time or is unable to pay the obligations as they become due,” a bar which the credit rating agency had noted would be difficult to overcome, as the municipality had the fiscal capacity to increase its property and occupational license taxes—not to mention the authority and ability to issue bonds to pay for losses in legal judgments, according to the credit rating agency. In its objection to the federal court, Truck America’s attorney wrote that Kentucky courts would likely require that the Kentucky Legislature amend state law (in this instance, §66.400), the Bluegrass State’s municipal bankruptcy statute, under which two municipal entities, both utility districts, have previously filed. Truck America, in its brief, also wrote that Hillview had not negotiated in good faith to settle its court-awarded $11.4 million claim over a contract dispute as required by the bankruptcy code, noting: “Hillview did not file Chapter 9 in good faith to adjust its debts, or to ameliorate bona fide financial distress…Rather, it admits to being ‘fiscally sound’ and filed this case for the specific purpose of minimizing the amount it will be required to pay one creditor—Truck America—on account of a judgment affirmed by Kentucky’s appellate courts,” adding that impairing a single creditor is not a legitimate municipal bankruptcy objective. Interestingly, in its filing, Truck America wrote that the municipality had not complied with Kentucky’s constitution—specifically the provision therein which requires that the state’s municipalities raise taxes in order to pay authorized indebtedness, such as a judgment, within 40 years. If that were not enough of a fiscal nightmare, last August, Hillview Mayor Jim Eadens said the city is exploring malpractice claims against its former attorney. He did not provide any details.

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The Importance of Being Earnest for a Municipality in federal Bankruptcy Court

eBlog

September 21, 2015

Don’t Count Your Marbles Before They’s Hatched. In a decision U.S. Bankruptcy Judge Meredith Jury acknowledged “puts a bunch of marbles on the road to reorganization” for San Bernardino, Judge Jury last Thursday ruled San Bernardino had not met its legal obligation to bargain with the fire union before outsourcing the Fire Department. The costly setback now means the city has an expensive pothole to repair—something which will consume both time and the city’s inadequate fiscal resources—and as the municipal election and the consequently related issues draw ever closer. San Bernardino, to comply with Judge Jury’s decision, will now have to re-open negotiations if it is to implement its proposed fire services outsourcing—a key fulcrum in its proposed plan of debt adjustment: a plan through which the city had anticipated operating and capital savings, as well as new parcel tax revenues, which would have increased annual general fund revenues by $12 million. The rocky road to exiting municipal bankruptcy also demonstrated the dysfunction created by the city’s fiscal year, throwing off the finely honed timeline under which the proposed outsourcing would have become by July 1. Missing that deadline means waiting 12 months for the beginning of the next fiscal year. If there is one fiscal ray of hope, it is that Judge Jury determined San Bernardino could continue negotiating an interim contract with the San Bernardino County fire district and working through the annexation process required by the Local Agency Formation Commission for San Bernardino County.

The legal setback for the city could make its road to exiting bankruptcy steeper, as San Bernardino’s integrity also appeared to be at risk. While Judge Jury claimed she was uninterested in assigning blame with regard to the negotiation breakdown between San Bernardino and its fire union, telling the courtroom the future should instead be the focus, she was critical of San Bernardino’s claim that it had met about fire outsourcing—a claim Judge Jury found to be contradicted by the city’s own evidence: According to a transcript of a meeting last October at which the city said it had negotiated over outsourcing, for instance, labor attorney Linda Daube and City Manager Allen Parker both say multiple times that contracting out is not part of the proposal they were discussing, with Mr. Parker, according to the transcript, stating: “I am in no position to even recommend that.” That meeting preceded last October’s imposition of new terms of employment on the city’s firefighters, terms which Judge Jury had ruled the city could implement, albeit, as she put it, she had not ruled on the specifics with regard to what the city imposed—adding that, once that happened, San Bernardino, essentially, had used up what she referred to as its “free pass” that municipal bankruptcy gave it to change contracts without going through the normally required process: “Once they have changed the terms and conditions of employment…my reading is they have created then a new status quo, and if they want to modify it further, then they have to modify it under state law, which would require bargaining with the union.”

Judge Jury further noted it was “suspect” that San Bernardino reported in September that it had authorized the city manager in an April closed session meeting to request proposals to provide fire services. But, Judge Jury, who has prior experience representing cities before becoming a judge, said that under California’s open meeting law, the Brown Act, that decision would normally be made in open session —and actions taken during closed session are usually reported publicly immediately afterward — not months later, after a litigant says authorization was never given, adding: “The timing of this is disturbing…It would appear that that (purported closed session vote) was not done, but I can’t make a finding on that today.” In the courtroom, fire union attorney Corey Glave said he might argue that San Bernardino had violated the Brown Act provision which mandates city council approval of contracts over $25,000—adding that because of that the Request for Proposals was improperly issued and would have to be discarded, he would testify at a hearing next week whether the union would pursue that argument. That created still another uh-oh moment, with Judge Jury telling the courtroom that if she agrees with that claim, it could set the city’s municipal bankruptcy case back months—meaning the prohibitively expensive municipal bankruptcy will almost certainly become the longest in American history, and leading Judge Jury to note: “I take this ruling very seriously…“I understand it has a significant impact on this case, and it’s probably the first time I’ve ruled in such a way against the city.”

Steepening Hurdles to Bankruptcy Completion. The timeline setback—and diminution of assets that might be available to be divvied up under a revised San Bernardino plan of debt adjustment can only make more miserable some of San Bernardino’s other creditors, for now the wait will not just be longer, but the assets available under any revised plan of debt adjustment are certain to be smaller. So it can hardly come as a surprise that municipal bond insurers—who now stand to be on the hook for ever increasing amounts—are objecting to San Bernardino’s just sent back to the cleaners proposed plan of debt adjustment. Paul Aronzon, of municipal bond insurer Ambac, filing for his client, wrote, referring to the pre-rejected plan of debt adjustment: “The long-awaited plan is a hodgepodge of unimpaired classes and settlements in various stages – some finalized, some announced but not yet documented, and some that are hinted at, but appear to be more aspirational than real, at this point.” Ambac could be on the hook for its insurance for some $50 million in pension obligation bonds. Fellow worrier and insurer, Erste Europäische Pfandbrief-und Kommunalkreditbank AG (EEPK) attorneys fretted too, claiming San Bernardino proposed “an incomplete set of solutions” based upon “internally inconsistent, and stale, data.” Ambac’s attorneys, referring to the now tossed out plan of debt adjustment’s proposed/anticipated savings from outsourcing fire services and other revenue sources, which the municipal bond insurers claim were not considered in calculating the impairment to the city’s pension bondholders, adding that San Bernardino had not justified the need for $185 million in capital investments to the city’s infrastructure and that the municipality had failed to include $3.9 million in income from the sale of assets to be transferred to the city from its redevelopment successor agency. But they saved their greatest vitriol to claim that the most remarkable feature of San Bernardino’s now partially rejected plan of debt adjustment came from the city’s proposed “draconian” impairment of both the pension obligation bond claims and general unsecured claims, on which the city has proposed to pay roughly 1 penny on the dollar, according to Ambac’s attorneys. EEPK’s attorneys told the federal court that if San Bernardino had utilized its ability to raise sales and use taxes or even parking taxes, it would be able to repay the city’s pension obligation debt in full, or at least substantially more than the 1 percent offered, noting that the severity of the discount warranted explanation. Nevertheless, EEPK’s attorneys added, “[N]owhere does the disclosure statement even attempt to articulate how or why the city formulated the oppressive treatment it proposes for these classes,” in urging Judge Jury to reject the plan—adding that : “In short, the city must be held to its twin burdens of both disclosure and proof that its plan endeavors to pay creditors as much as the city can reasonably afford, not as little as the city thinks it can get away with…The city can and should do better for its creditors — and indeed must do so if its plan is to be confirmed.”

Bankruptcy Protection? The Obama administration late last week urged Congress to move precipitously to address Puerto Rico’s debt crisis, with U.S. Treasury Secretary Jacob Lew stating: “Congress must act now to provide Puerto Rico with access to a restructuring regime…Without federal legislation, a resolution across Puerto Rico’s financial liabilities would likely be difficult, protracted, and costly.” The warning came in the wake of Puerto Rican elected leaders warning the U.S. territory might be insolvent by the end of the year—and with Congress only scheduled to meet for portions of eight weeks before the end of the year. In the Treasury letter to Congressional leaders, Sec. Lew appeared to hint the Administration is proposing to go beyond the municipal bankruptcy legislation proposed to date: rather, any Congressional action should, effectively, treat the Commonwealth in a manner to the way municipalities are under current federal law, so that Puerto Rico, as well as its municipalities, would be eligible to restructure through a federal, judicially overseen process—or, as Secretary Lew wrote to U.S. Sen. Judiciary Chairman Orrin Hatch (R-Utah) in July, “a central element of any federal response should include a tested legal bankruptcy regime that enables Puerto Rico to manage its financial challenges in an orderly way.”

The Rocky Fiscal Road to Recovery. Wayne County’s road to emergency fiscal recovery was helped by a Wayne County Circuit Court decision denying a request from a union representing more than 2,500 Wayne County workers to block any wage and benefit changes made under the county’s consent agreement with the state, but fiscally threatened by the County’s recent disclosure that the IRS is conducting a targeted audit of $200 million of bonds—a problem, because, as Moody’s moodily notes: the fiscally stressed largest county in Michigan could face a hard time covering the full costs of the bond payments were the bonds deemed taxable. The denial came in the wake of a Wayne Circuit Court restraining order last week to block wage and benefits changes for Wayne County Sheriff Supervisory Local 3317 union’s affiliates, last week. The decision, according to county officials, “[P]ermit Wayne County to continue its restructuring efforts and move closer to ending the financial emergency.” In its suit, the union had alleged the defendants “have illegally bound themselves by a ‘consent agreement’ with the state’s Executive Branch,” and that “protected and accrued benefits will be dramatically slashed or terminated, contrary to the U.S. Constitution.” The successful appeal comes in the wake of the county’s budget action last week to eliminate what it estimates is left of Wayne County’s $52 million structural deficit; the budget decreases Wayne’s unfunded health care liabilities by 76 percent, reduces the need to divert funds from departments to cover general fund expenditures and, mayhap most critically, creates a pathway to solvency. On the investigation front, however, the county’s recent disclosure that the IRS is conducting a targeted audit of $200 million of bonds is, according to Moody’s, not such good news; rather it is a credit blow for Wayne—to which Moody’s currently assigns the junk-rating of Ba3. The audit involves some $200 million of recovery zone economic development bonds Wayne County issued in 2010 to finance construction of a jail in downtown Detroit—a jail which has subsequently been halted amid cost overruns—and municipal bonds for which the county currently receives a federal subsidy equal to 45% of annual interest payments on the bonds. As Moody’s moodily notes: “The [IRS] examination is credit negative, because it raises the possibility that the county will have to repay $37 million of previously received subsidies and lose $41 million of subsidies over the next five years,” or, as Moody’s analyst Matthew Butler succinctly put it: “Such a loss would further strain the county’s weak but improving fiscal condition,” adding that “Due to statutory limitations on revenue raising, the county would not be able to raise revenue for the increased interest cost.” Mr. Butler gloomily added: “[M]anagement would be challenged in offsetting the loss by implementing further cuts beyond the significant operating cuts already made.” Unsurprisingly, the jail in question has its own financially sordid history: undertaken by former Wayne County Executive Robert Ficano, the fiscal undertaking had led to the indictment of Wayne County’s former CFO and two others connected to the project for misconduct and willful neglect of duty tied to the jail financing. Unsurprisingly, current Wayne County Executive Warren Evans has said that addressing the failed project is his top priority after eliminating the structural deficit. That is a fiscal blight for which successful action is important not just to Wayne County, but also for Detroit.

A Big Hill of Debt to Climb. Hillview, the Kentucky home rule-class city of just over 8,000 in Bullitt County—which filed for chapter 9 municipal bankruptcy last month—has been anticipating that Truck America LLC—the municipality’s largest creditor–would “aggressively” challenge the city’s petition—where objections must be filed by a week from Thursday—reports, according to City Attorney Tammy Baker in her discussions with the Bond Buyer, that Hillview plans no restructuring of any of its municipal bonds in its proposed plan of debt adjustment. The small municipality is on the losing side of a court judgment to Truck America for $11.4 million plus interest—a debt significantly larger than the $1.78 million it owes as part of a 2010 pool bond issued by the Kentucky Bond Corp. and $1.39 million in outstanding general obligation bonds Hillview issued in 2010. Nevertheless, City Attorney Tammy Baker advised The Bond Buyer Hillview “does not intend to restructure any of its outstanding municipal bonds through the filing.” The U.S. bankruptcy court’s acceptance of the municipality’s filing triggered the automatic stay on any city obligations, thereby protecting Hillview’s ability to retain some $3,759 in interest payments to the company which have been accruing each and every day on its outstanding trucking debt. According to the city’s filing, the judgment, plus interest totaled $15 million that is due in full—an amount equivalent to more than five times the municipality’s annual revenues. Nonetheless, Moody’s opines that Hillview could face an uphill battle in the federal bankruptcy court in convincing the court that it is insolvent and, thereby, eligible for chapter 9, because, as the credit rating agency notes: “Generally, a municipality must prove that it is not paying its debts on time or is unable to pay the obligations as they become due.” But Moody’s notes the small city could raise its property and/or business license taxes—or it could even issue more debt to finance its obligations to TruckAmerica.

The Seemingly Irreconcilable Challenge between Addressing Debt & Investing in the Future

September 11, 2015

Investing in Kids? S&P has lowered its ratings on the Michigan Finance Authority’s series 2011 revenue bonds to A from A-plus and series 2012 revenues bonds to A-minus from A-plus with a negative outlook—bonds issued by the MFA for the Detroit Public Schools, with S&P analyst John Sauter writing: “The district’s continued overall financial and liquidity deterioration is another contributing factor.” The bonds, which are payable from the repayment of loans made by the MFA to the Motor City’s school district—loans secured by all appropriated annual state aid to be received by the school district—which has irrevocably assigned 100% of its pledged state aid to the loans (and thereby to the authority’s bonds). The district’s 2011 obligation holds a first-lien pledge of state aid, and the 2012 obligation a second lien. The district’s limited-tax general obligation (GO) pledge also secures both obligations. The ratings reflect the strength and structural features of the district’s state aid pledge to its obligations. Mr. Sauter noted: “The downgrade is based on severe declines in the district’s enrollment, and subsequently, pledged state aid available to pay debt service.” DPS’ credit downward trajectory appears to reflect continued fiscal stress as indicated by significant growth in DPS’ accumulated operating fund balance deficit from FY2014 and ongoing declines in enrollment—declines which pressure operating revenue, as well as the perception that DPS lacks the capacity to reverse the negative operating trend. But the rating also takes into consideration the weak economic profile of the City of Detroit (B3 stable), DPS’ substantial debt burden, and an operating budget constrained by high fixed costs. Absent enrollment and revenue growth, fixed costs will comprise a growing share of DPS’s annual financial resources and potentially stress the sufficiency of year-round cash flow. The unholy combination of falling revenue, rising costs, and credit downgrades can raise the cost of borrowing money—creating a vicious cycle that erodes the fiscal capacity to invest in Detroit’s future taxpayers. Michigan law prohibits its school districts from raising property taxes for operating funds over 18 mills on non-homestead properties; thus, many districts have cut spending, laid off teachers and other staff and eliminated some school programs. DPS has been under the auspices of a state emergency manager for several years and has about $483 million in debt. The district’s enrollment was once well above 100,000 students, but now is about 47,000. Former state superintendent of Public Instruction Mike Flanagan wrote earlier this year in a report to education appropriation subcommittees as he was leaving his post that cash needs could force Detroit Schools to refinance even more debt. The downgrade affects both costs and reputation: for Detroit, its ability to leverage families to move into the city is inherently dependent upon the reputation of its public school system.

Planning Debt Adjustment. When a municipality is in bankruptcy, it is forced to juggle thousands upon thousands of issues relating to constructing a plan of debt adjustment with its creditors that will secure the federal court’s approval—a process made ever more difficult with the approach of elections. This adds stress—and confusion—as could be observed in San Bernardino in the wake of a brief welter of confusion yesterday when a tentative contract agreement already reported to U.S. Bankruptcy Judge Meredith Jury was abruptly pulled off the City Council agenda—a contract with the city’s general unit, which represents some 357 employees who are not in another union, such as police or management. Nevertheless, the contract is now set for the Council to review in closed session at the city council’s meeting scheduled for a week from Monday—in this instance, a contract with regard to leave policy for the city’s employees, who have been working under a contract which expired June 30th as they negotiated with the city for a new contract. The need for a revision arose in the wake of the city’s implementation of one part of its 2012 bankruptcy plan — freezing leave which had accrued before August 2012, when the city filed for bankruptcy protection. That meant that by this year, many employees wound up with negative leave balances—a situation which a city official described to the Council as “very detrimental to the employees.”

Debt Restructuring Outside of Bankruptcy. If you can imagine an NFL football game without any referees or under-inflated footballs, you can begin to imagine the chaos triggered by the release in Puerto Rico this week of its quasi plan of debt adjustment—a plan which, unsurprisingly, calls for its municipal bondholders in each of the nation’s 50 states to accept less than they are owed. The U.S. territory has $13 billion less than it needs to cover its debt payments over the next five years—and that is even after taking into account the proposed spending cuts and measures to raise revenue in the newly proposed plan. Puerto Rico officials estimate that the island will have only $5 billion of available funds to repay $18 billion of debt service on $47 billion of debt, excluding obligations of its electric and water utilities. The projected debt-funding shortfall is after anticipated savings from the consolidation of 135 public schools, reductions in health-care spending, additional subsidy cuts and reductions in payroll expenses. So now, in an unrefereed, unprecedented fiscal process, Puerto Rico’s fiscal team plans to present its investors with a debt-exchange offer in the next few weeks. It also intends to seek a moratorium on principal payments. And it will not have long: the whistle will blow by the end of the year, leaving the unenviable challenge and task of seeking to get all the creditors on the field quickly: Puerto Rico is on course to run out of cash by the end of this calendar year unless it can refinance its debt—or as non-football BlackRock analyst Peter Hayes yesterday put it: “They have a real solvency issue…They have a liquidity crisis on their hands that grows very dire by the end of the year.” And the fiscal threat and challenge was exacerbated by S&P’s dropping of Puerto Rico’s tax-backed debt to CC from CCC-, and removal of the U.S. territory’s ratings from CreditWatch, where they had been placed with negative implications July 20. The outlook is negative. With the near certainty of a default or restructuring—or fiscal event, there is an increased likelihood of either a missed debt service payment or a distressed exchange which would resemble a default. Gov. Alejandro Garcia Padilla stated that if Puerto Rico’s creditors are unwilling to partake in restructuring negotiations, Puerto Rico would have no alternative but to proceed without them even if it involved “years of litigation and defaults.”

Herding Angry Sheep. In a television address, Gov. Padilla yesterday announced the appointment of a team of debt restructuring experts to negotiate with Puerto Rico’s creditors—a process which would be unprecedented as those creditors run from some of the world’s most sophisticated to tens of thousands of individual municipal bondholders in each of the nation’s 50 states—and a process which, absent action by Congress, might more resemble gladiators in a coliseum than the kinds of overseen negotiations which took place under the aegis of U.S. Bankruptcy Judge Steven Rhodes in Detroit. Adding to the uncertainty, the report on which such negotiations is premised is technically only a recommendation. Try and imagine a football game not only without referees or under inflated balls, but also without agreed upon rules. That report projects Puerto Rico’s treasury will exhaust its liquidity by November—and only until then if Puerto Rico takes extraordinary measures to preserve cash. Unlike a non-governmental corporation—Puerto Rico has no ability to act unilaterally: actions require legislative and gubernatorial action and concurrence. Moreover, it is not just Puerto Rico, but also the Puerto Rico Government Development Bank (GDB)–which is projected to exhaust its liquidity before the end of calendar 2015. And there are dozens and dozens of municipalities at growing fiscal risk (Puerto Rico’s municipalities cannot file for Chapter 9 bankruptcy protection, and a local debt-restructuring law enacted in June 2014 was thrown out by a federal judge in San Juan.). But, like in football game, there is a clock: and it is already running: we know that Puerto Rico will not have fully sufficient fiscal resources in FY2016 to make payment on its scheduled tax-supported debt, including its General Obligation (GO) debt, so that for creditors, it is almost as if the music for a game of musical chairs has already started. The report released this week forecasts a total central government deficit as a whole, including the general fund, GDB net revenue, COFINA, federal programs, and Puerto Rico Highways & Transportation Authority (HTA) net revenue, in fiscal 2016 of $3.2 billion, or about 16 percent of expenditures, including payment of debt service; it projects only a $924 million surplus available before payment of debt service. That is, it appears, as in musical chairs, that there simply will be insufficient fiscal capacity to meet the obligations to pay $1.8 billion of GO and GO-guaranteed debt service (GO debt service alone is $1.2 billion), much less total central government debt service, including GO debt, of $4.1 billion. Or, as Mr. Hayes wrote: “We rate all Puerto Rico tax-backed debt at the same ‘CC’ level, except for Puerto Rico Public Finance Corp. (PFC) debt, which is currently in default and rated ‘D,’ reflecting the report’s projection of limited liquidity to meet all debt service before the end of calendar 2015, including GO debt service, and the report’s recommendation to enter restructuring discussions with all tax-backed debt holders.”

Municipal Bankruptcy Is Large, Complicated, & Seemingly Unending

September 10, 2015

Fiscal Gales in the Windy City. As the City of Chicago grapples with its growing unfunded pension liabilities, the city’s fiscal sustainability has become increasingly at risk—putting Mayor Rahm Emanuel nearer to a fiscal cliff for the Windy City. Increasingly the unfunded pension liabilities are threatening the city’s fiscal future, and the options on the table—such as a potential huge property tax hike to fund the city’s pension liabilities portray how risky the city’s fiscal future and options are: would a huge property tax increase discourage businesses and families from moving into Chicago? Or, as the ever insightful Laurence Msall, president of the Chicago Civic Federation, puts it: “How is Mayor Emanuel going to convince the City Council and the citizens of Chicago that with this very painful and, we believe, necessary increase?” The question arises as Mayor Emanuel may seek a record half billion property tax increase to address the city’s rising pension costs—and avoid bankruptcy. The city is also considering the imposition of a new levy for garbage collection, as well as other revenue sources to respond to a $328 million to $550 million scheduled annual spike in police and fire pension contributions under a prior state unfunded mandate requiring the city to make such contributions on an actuarial basis. The window for the Mayor is winnowing down: he is scheduled to release his proposed budget a week from Tuesday—a budget in which, in addition to tax and revenue proposals, Mayor Emanuel is also expected to propose a long-term fiscal plan which will also include changes in both spending habits and debt practices in what Mr. Msall denotes as a day of reckoning for Chicago. Chicago’s fiscal dilemma is further complicated by the ongoing stalemate in Springfield, where Gov. Bruce Rauner and the legislature remain deadlocked, so that there is still no FY2016 budge—where the stalemate shows little sign of abatement. For Mayor Emanuel, no matter the stalemate in the state capitol, he has just over 10 days to put together a proposed $754 million budget—one likely to incorporate a $233 million operating deficit, $93 million in increased city contributions owed to the municipal and laborers’ pension funds, and about $100 million in debt repayment the city previously intended to defer in its amortization schedule. The budget is almost certain to propose a $328 million hike in contributions for Chicago’s police and firefighters’ pension funds—but mayhap larger if the legislature and Gov. in Springfield are unable to reach consensus on pending state legislation which would re-amortize payments.

Fiscal Teetering in Pa.’s Capitol City. In his State of the City address this week, Harrisburg Mayor Eric Papenfuse warned that the city’s plan it adopted two years ago when the city narrowly averted filing for municipal bankruptcy must be amended—noting that the revenues assumed under that plan are falling short and will be insufficient by next year—and making clear that the deficiencies could not be offset by cost-cutting alone, especially since, he noted: “While the City is starving for capacity, we have already cut discretionary funding to the bone.” Indeed, Mayor Papenfuse noted the city has reduced its work force by nearly half over the last decade and that this fiscal year “will mark the second year in a row that we have significantly underspent our adopted budget.” Nevertheless, he warned, this city is simply not on a “sustainable course.” Therefore, he has proposed three key fiscal changes: 1) Tripling the municipality’s $1-per-week tax on employees working within the city limits to $3 per week; 2) Expanding the city’s sanitation operations, and 3) Transitioning to home rule authority.

Planning Debt Adjustment. The nation’s last large municipality in municipal bankruptcy, San Bernardino, has reached a tentative contract agreement with its largest employee group, its so-called general unit. The announcement, Tuesday, reached after last month’s agreement with the city’s Police Officers Association, means that San Bernardino now has plan of debt adjustment agreements with nearly all its employees—except its firefighters—where multiple legal complaints by the fire union against the city continue. Indeed, in the wake of the city’s rejection of its bargaining agreement with the fire union and implementing changes, including closing fire stations—in an election year—the city hopes to reach agreement on the fire front within a week, even as the city is proceeding in its process of having its fire department annexed into the San Bernardino County fire protection district—a key step anticipated to add more than $12 million to the bankrupt municipality’s treasury: $4.7 million in savings and $7.8 million in revenue from a parcel tax, according to San Bernardino’s bankruptcy attorney, Paul Glassman—or more than the $7 million to $10 million in savings the city incorporated into its proposed plan of debt adjustment it submitted to U.S. Bankruptcy Judge Meredith Jury—proposing that the funds should go toward pension obligation bondholders whom San Bernardino proposes to pay 1 cent for every dollar they are owed, according to the bondholders’ attorney—a proposal certain to be bitterly challenged in the federal courtroom. Complicating the process—and quite unlike any other major municipal bankruptcy—is that it remains unclear what might occur were the proposed annexation process to break down between now and July — especially were a sufficient number of San Bernardino voters to protest the tax and trigger an election. Although missing the deadlines required to complete the annexation process by July 2016 would be costly (because it would trigger a full fiscal year delay), an interim agreement with the San Bernardino County Fire Department would continue to provide services. Next up: Judge Jury has scheduled a hearing in her federal courtroom next month on the adequacy of San Bernardino’s financial statements and its modified plan of debt adjustment for October 8th.

Debt Restructuring Outside of Bankruptcy. The U.S. territory of Puerto Rico yesterday proposed a five-year plan Document: Puerto Rico’s Debt Plan under which the island would broadly restructure its unpayable debts, restructuring more than half its $72 billion in outstanding municipal bond debt, and seeking to implement major economic overhauls—and act under the direction of a financial control board—somewhat akin to the actions taken in New York City and Washington, D.C. to avert municipal bankruptcy. The proposed plan also proposed changes, such as welfare reform, changes to labor laws, and elimination of corporate-tax loopholes. Under the proposal, the governor would select a five-member control board from nominees submitted by creditors, outside stakeholders, and, possibly, the federal government—a panel which would have the power to enforce budgetary cuts. The document explains that Puerto Rico confronts a $13 billion funding shortfall for debt payments over the next five years—even after taking into account proposed spending cuts and revenue enhancement measures outlined in a long-awaited fiscal and economic growth plan. The report from Puerto Rico Governor Alejandro Garcia Padilla’s administration notes that Puerto Rico will seek to restructure its debt in negotiations with creditors as an alternative to avoid a legal morass which could further weaken the territory’s economy: it offered no estimates of what kind or level of potential losses would be anticipated from the owners spread across each of the nation’s 50 states of Puerto Rico’s $72 billion in outstanding municipal debt. The plan details the grim situation of Puerto Rico’s fiscal challenges—and of the dire consequences to the island’s 3.5 million residents: Puerto Rico will have less than a third of the fiscal resources to meet its obligations: it has only about $5 billion available to pay $18 billion of principal and interest payments to its municipal bondholders spread all across the U.S. and coming due between 2016 to 2020—and that only if the plan’s proposed savings from the consolidation of 135 public schools, reductions in health-care spending, additional subsidy cuts, and reductions in payroll expenses were realized. Mayhap the greatest obstacle under the proposed plan will be its proposal to restructure Puerto Rico’s general obligation bond debts, municipal bonds which were sold to investors with an explicit territorial constitutional promise that Puerto Rico would commit to timely repayments—repayments which would take priority over all other governmental expenditures. Nevertheless, the plan proposes to renege on the so-called ‘full faith and credit’ pledge attached to municipal bonds issued by state and local governments on so-called general obligation or ‘full faith and credit’ bonds—a proposal which is unconstitutional under the territory’s constitution—but which the island’s leaders contend is critical lest Puerto Rico were to run out of cash by next summer—as its current fiscal projections indicate is certain absent access to municipal bankruptcy protection or triggering a proposal such as has been now proposed. The plan leaves unclear how it squares with Puerto Rico’s constitution; yet island officials made clear that were Puerto Rico to continue to make such required payments, Puerto Rico’s treasury would be depleted by next summer—with such payments, were they not cut back, leaving the government short of cash for vital public services as early as November. Under the proposed fiscal blueprint, Puerto Rico will provide its creditors with more detailed cash flow projections so that negotiations could begin on repayment alternatives and options—negotiations not only pitting the island’s essential services against bondholders in every state in the U.S., but also between classes of municipal bondholders—with general obligation bondholders anticipated to seek the most favorable treatment. One of the exceptional challenges will be that—unlike in Jefferson County, Detroit, Stockton, or San Bernardino—there will be no referee, no federal bankruptcy judge—to oversee the process. In addition to the debt restructuring, the new five-year plan calls for an ambitious series of steps to deliver public services and collect taxes more efficiently, stimulate business investment and job creation and carry out long-overdue maintenance on roads, ports and bridges. Many of the measures will require legislative approval.

Financial Control Board. The plan proposes a five-member board of independent fiscal experts who would be selected from a list of candidates nominated by different parties, including classes of creditors, the federal government, and others. Such a board would be charged with: how to deal with disproportionate and inequitably imbalanced creditors—creditors imbalanced not just fiscally, but also in terms of capacity to represent themselves. How do the island’s poorest U.S. citizens (an estimated 48 percent of Puerto Ricans are Medicaid recipients) fare against some of the wealthiest U.S. citizens who live in Alaska, California, New York, etc., and who own Puerto Rican G.O. bonds? That is, as members of Governor Padilla’s working group have noted, the inability to have access to a neutral federal court and legal process could put the island—and especially its poorest Americans—at the greatest disadvantage.

Fiscal Challenges. Gov. Padilla’s working group plan projected that, if the plan were adopted and implemented, it would be key to bringing Puerto Rico’s five-year total fiscal deficit down to about $13 billion. To close it, however, they made clear, Puerto Rico could not meet its full municipal bond payment obligations. The working plan estimated that over the next five years, Puerto Rico would have to make $18 billion in principal and interest payments to municipal bondholders on some $47 billion in outstanding municipal bond debt—but that they would propose diverting $13 billion to finish paying for essential public services over the coming five years, leaving for a Solomon’s choice about how to apportion deep cuts in Puerto’s Rico’s constitutionally obligated payments to bondholders scattered all across America—and no road map or federal bankruptcy judge to opine what might be the most equitable means in which to opt to make such payments—much less what legal ramifications might trigger. Put in context, the plan proposes a fiscal restructuring significantly larger than Detroit’s record municipal bankruptcy filing—a filing with U.S. Bankruptcy Judge Steven Rhodes which involved some $8 billion of municipal bond debt. Puerto Rico entities are unable to access Chapter 9.

Muni Bankruptcy Is Large, Complicated, & Seemingly Unending. Jefferson County, which emerged from what was—at the time—the largest municipal bankruptcy in U.S. history nearly two years ago now can better appreciate that it “ain’t over until it’s over,” finding itself before the 11th U.S. Circuit Court of Appeals this week where a group of the County’s residents claimed they were denied constitutional protections under the decision of the U.S. bankruptcy court’s approval of Jefferson County’s plan of debt adjustment, with their attorney testifying: “The essence of our client’s position to the 11th Circuit Court of Appeals is that our clients are entitled to their day in court on the merits of the legal issues presented by the Jefferson County plan of adjustment,” adding that while it was “understandable that the U.S. bankruptcy court wanted to bring the case to closure…fundamental constitutional issues simply cannot be trumped by such concerns.” The issue is whether the court should accept or reject Jefferson County’s appeal of a September 2014 ruling by U.S. District Judge Sharon Blackburn, in which Judge Blackburn rejected the county’s arguments that the ratepayers’ municipal bankruptcy appeal was moot, in part because the plan had been significantly consummated, but also because Judge Blackburn claimed she could consider the constitutionality of Jefferson County’s plan of debt adjustment, which ceded Jefferson County’s future authority to oversee sewer rates to the federal bankruptcy court. The odoriferous legal issue relates to Jefferson County’s issuance—as part of its approved plan of debt adjustment—to issue $1.8 billion in sewer refunding warrants—an issuance which not only paved the way for Jefferson County to write down some $1.4 billion in related sewer debt, but also to exit municipal bankruptcy and the overwhelming costs of the litigation. Thus, with the sale of the new warrants consummated, Jefferson County exited (or at least believed it had…) municipal bankruptcy. The county’s sewer ratepayers, however, are claiming Jefferson County’s plan contains an “offensive” provision which would enable the federal bankruptcy court to retain jurisdiction over the plan for the 40 years that the sewer refunding warrants remain outstanding—a federal oversight which Jefferson County has argued has provided a critical security feature that has been key to attracting investors to purchase the warrants it issued in 2013—a transaction which the County alleges cannot be unwound—and added that the appeal by the residents is constitutionally, equitably, and statutorily moot, because the plan has already been implemented. The ratepayers have countered that even if the federal oversight provision were to be deleted from the County’s approved plan of adjustment, the indenture for the 2013 sewer warrants provides greater latitude to resolve a default: noting that were a subsequent fiscal default to occur, “the trustee shall be entitled to petition the bankruptcy court or any other court of competent jurisdiction for an order enforcing the requirements of the confirmed plan of adjustment.” (Such requirements include increasing rates charged for services, so that the sewer system generates sufficient revenue to cure any default.) But it is the provision allowing the federal bankruptcy court to maintain oversight which is central to Jefferson County’s position—in no small part because it offers an extra layer of security for bondholders and prospective bondholders of a municipality which opts to avail itself of a provision in the U.S. bankruptcy code which allows the judicial branch of the U.S. to retain oversight of a city or county’s plan of fiscal adjustment—or, as the perennial godfather of municipal bankruptcy Jim Spiotto puts it, the question in Jefferson County’s case involves an interpretation over what the U.S. bankruptcy code permits and whether the federal court’s supervision is actually the act of setting rates or insuring that the county complies with the covenants that it promised.

In Jefferson County, as in most cities and counties, sewer system rates have been set by resolutions approved by the Jefferson County Commission to fix rates and charges sufficient to cover the cost of providing sewer service, including funds for operations and maintenance, capital expenditures, and debt service on the 2013 warrants. Jefferson County’s attorneys have added that neither the plan of adjustment or U.S. Bankruptcy Judge Thomas Bennett’s confirmation order “changes the substantive law of the state of Alabama with regard to the enforcement of rates established pursuant to contract or legislation….Rather, the plan merely retains the bankruptcy court as an available forum in which such substantive law may be enforced, using the same remedies available in Alabama state court…In no event will the bankruptcy court ever set sewer rates; it is simply a forum to enforce the plan and related contracts – just as an Alabama state court could.” Ergo, part of the federalism issue and challenge relates to the Johnson Act, which essentially prohibits federal courts from taking actions that directly and indirectly affect the rates of utilities organized under state laws. In this instance, the ratepayers have claimed that the removal of the “retention of jurisdiction provision” from Jefferson County’s bankruptcy confirmation order would not unlawfully impose a new, involuntary plan on the county and its residents because “the indenture explicitly contemplates that the purchasers of the new sewer warrants may seek relief from courts other than the bankruptcy court.” Moreover, they claim the transaction would not have to be unwound were the U.S. district court to strike the jurisdictional retention provision from the plan, because the sewer bondholders could seek relief from other courts were Jefferson County to fail to increase sewer rates. The court directed Jefferson County to respond to its challenging sewer ratepayers by Monday, September 28th. Stay tuned.

The Hard Choices Forced by State or Local Fiscal Distress

eBlog

August 28, 2015

The Distressing Costs of Municipal Debt Adjustment. For a municipality, state, or—in this case, U.S. territory in serious fiscal distress, without access to bankruptcy so that the options for ensuring sufficient cash to provide essential services are at risk, just the costs of structuring a plan to return to a fiscally sustainable future can be daunting. Indeed, early reports indicate Puerto Rico has already spent as much as $60 million over the last two years as it nears its deadline for proposing a quasi-plan of debt adjustment in this twilight zone where there is neither a U.S. bankruptcy court nor any other official arbiter to adjudicate whatever proposals Governor Padilla ends up proposing next week to address Puerto Rico’s unpayable $72 billion in accumulated debts. Moreover, of course, the meter is still running—each day consuming more legal and consulting fees that leave less and less for upset creditors, public services, and the island’s bondholders in every state of the U.S. Fabulous Matt Fabian of Municipal Market Analytics tersely sums up the dilemma: “It’s an incredibly complex restructuring, with a lot of different investor groups, a lot of different securities and moving parts.” Puerto Rico’s public power utility and its creditors face a Tuesday deadline on a restructuring plan for its $9 billion of debt or an agreement that keeps discussions out of court will expire. Nevertheless, as the nation’s preeminent municipal bankruptcy wizard Jim Spiotto noted, the investment in these outside professionals could be critical to providing a way out for the commonwealth that will improve the economy and make its debt sustainable: “The analysis part is important in addressing it in an effective way, so that the money you spend is well spent, because you’re going to need a recovery plan that is going improve the situation, grow the commonwealth, and, thereby, improve the situation for everyone.”

What Options Does Congress Have? Even as Puerto Rican leaders are perusing options to sort out its overwhelming debt, the Congressional Research Service has offered Members of Congress options, “Puerto Rico’s Current Fiscal Challenges,” it could act upon in response to Puerto Rico’s fiscal crisis ranging from backstopping its debt to authorizing the U.S. territory access to municipal bankruptcy. The report notes that the U.S. government “has generally been reluctant to offer direct financial assistance to individual states in fiscal distress, although Congress at times has adjusted technical parameters of federal programs to provide direct or indirect support for states…The independence of state governments to set their own fiscal paths has been linked to an expectation that those governments take responsibility for the consequences of their fiscal decisions.” Under the dual sovereignty of our form of government there are constitutional limitations on any federal authority.  Arkansas, Illinois, Indiana, Louisiana, Maryland, Michigan, Mississippi, and the former Territory of Florida all recorded bankruptcies in the period running up to and through the great Panic of 1837. By 1841, 19 of the then 26 states, as well as two of the three U.S. territories had issued municipal bonds and incurred state debt—debt on which these aforementioned states and Florida defaulted. Ironically, the majority of state debt was owed to parties outside the U.S., primarily Europe. Nevertheless, the state debts were largely paid off in full by the late 1840s, notwithstanding that no direct sanctions were enacted to force repayment.

In this new report to Congress, the CRS author noted that Congress could:

• amend the current Chapter 9 bankruptcy law to allow access to Puerto Rico’s public corporations and municipalities; or,
• backstop Puerto Rico’s debt, which would help reduce its borrowing costs (noting that this has been done in the U.S. and elsewhere, usually contingent on budgetary or structural reform requirements.)

CRS also reported that the U.S. government guaranteed Mexico’s government debt in 1994-1995, as well as provided indirect credit support to some states in the 1930’s through 1950’s via the Reconstruction Finance Corp., noting, for example, the RFC “acted as an intermediary in helping to roll over $136 billion in debt for the State of Arkansas” after Arkansas had defaulted on its debt in 1933. The report also suggested Congress could waive the Jones Act for Puerto Rico—a significant unfunded federal mandate which requires ships operating between U.S. ports to be owned by U.S. citizens or companies, to have been constructed in the U.S., and to be operated by U.S. citizens. The CRS report also noted that Congress, as it did for the District of Columbia in 1995, could call for a financial control board. Finally, the CRS report notes that whilst Congress has traditionally been reluctant to provide assistance to states overwhelmed by fiscal storms, it has not been reluctant after natural storms—mayhap timely given yesterday’s memories of the federal assistance granted to Louisiana in the wake of Hurricane Katrina—and, Congress provided both direct and indirect support for New York City in the wake of its fiscal crisis in 1975.

First Chapter 9 since Detroit. Hillview, Kentucky City Attorney Tammy Baker has described the small city’s filing for federal bankruptcy protection as “a very difficult decision” for the city’s elected leaders, but, because of the mounting interest costs from a court judgment against the city, costing it more than $3,700 a day, she notes: “The city really ended up with no choice…With the interest accruing at that rate, it’s just really going to be impossible for the city to pay that judgment.” Counselor Baker has advised the Bond Buyer that the Kentucky municipality, which has filed for municipal bankruptcy, does not intend to restructure its municipal bond debt as part of its plan of debt adjustment. Hillview, the first municipality to file for bankruptcy since Detroit, filed its petition in order to halt payments it owes of thousands of dollars in accruing interest in the wake of an $11.4 million judgment against it—or, as Counselor Baker described it: “What the [municipal] bankruptcy has allowed is breathing room for the city…The interest has been stopped.” The effective halt on the interest payments offers breathing room for the small municipality to develop a plan to address the breach of contract judgment it lost to Truck America Training LLC. Its plan of debt adjustment will have to address some $1.39 million in debt it owes on outstanding general obligation municipal bonds Hillview issued in 2010, and $1.78 million as part of a 2010 pool bond issued on its behalf by the Kentucky Bond Corp. However, in her email to the Bond Buyer, Counselor Baker wrote: “The city does not intend to restructure any bonds through the filing…In fact, we are of the belief that such a restructuring could not be done.” In describing why the city filed its abrupt municipal bankruptcy last week, Ms. Baker noted: “The main reason the city filed for bankruptcy is to halt the crushing interest [of] $3,759 daily from accruing while we develop a plan.” While the filing might provide some instant r-o-l-a-i-d-s for the small municipality, it comes not only with the kinds of costs Puerto Rico is experiencing, but also in terms of borrowing costs: S&P last Friday dropped the municipality’s credit rating five notches to B-minus from BB-plus, and placed the lower rating on CreditWatch with negative implications pending a determination by the federal bankruptcy court on the city’s petition—the lower rating appears to have already translated into at least a ten percent increase to the cost of capital borrowing for Hillview—which, in its petition to the federal bankruptcy court, estimated its liabilities as high as $100 million versus assets of $10 million.

How Does One Define “Essential Public Services” for a Municipality in Distress?

July 31, 2015

Securing a Safe & Sustainable Fiscal Future. Michigan Gov. Rick Snyder yesterday affirmed his declaration that Wayne County is in a financial emergency—an affirmation almost certain to trigger a partial state takeover of the county—a county which encompasses not just Detroit, but also 33 other cities and 9 townships. In his statement yesterday, Gov. Snyder said: “Officials have taken steps to begin addressing the county’s crisis, but there can be no disputing that a financial emergency exists and must be addressed swiftly and surely to ensure residents continue to receive the services they need and deserve and the county can continue its economic recovery.” The decision immediately started a stopwatch which will give the Wayne County Board until next Thursday to choose among four options offered under Michigan law to municipalities in financial emergencies:

• municipal bankruptcy;
• a consent agreement with the state;
• authority to request a neutral evaluator; or
• an emergency manager.

Wayne County Executive Warren Evans has said he has been hoping for a consent agreement to fix the county’s finances: such an agreement would spell out specific budgetary steps and reforms the county would have to undertake and complete to address the county’s $52 million structural deficit. Wayne County has been caught between a rock (significant declines in property tax revenues, estimated to be as much as $100 million annually since 2008) and a hard place: its underfunded public pension system. The county is confronted with an accumulated deficit of $150 million. Should the county opt for entering into a consent agreement, such an option would give Wayne Count broader authority to impose reforms on expired labor contracts and would leave the bulk of the restructuring under local, rather than state control. But, as some of the county’s commissioners warn, a consent agreement could instead lead to a preemption of local authority and a state takeover—as happened to Wayne County’s largest city: Detroit. Perhaps Wayne County Commission Chairman Gary Woronchak described it best: “We have a difficult decision ahead of us, because we have to choose from one of these four options…They may seem simple on their face, but there are little trap doors along the way that we should well be aware of while we’re making this decision.”

Stopping the Fiscal Bleeding & Financing Essential Public Services. Wayne County’s Treasurer is getting ready this fall to auction off as many as 30,000 properties: a record number of tax delinquent properties, nearly half of which were eligible for foreclosure years ago. About $193 million is owed in taxes and fees on the 30,000 Wayne County foreclosures, including $95 million in debt on properties that had more than five years in unpaid bills. Of that record number, nearly half are delinquent on their property taxes for five or more years: Michigan law provides for foreclosure after three years of nonpayment. As in Detroit’s experience, failure to foreclose creates a double whammy: first, an ever-growing erosion of assessed property values and collected property taxes in neighborhoods, and an ever-increasing cost and burden to the county to foreclose: this year, the Treasurer’s office is trying to foreclose on Wayne County’s vast majority of tax delinquent properties. To get some idea of the scope, over the last seven years, Wayne County has taken 108,500 properties to auction. A key issue, of course, is tax delinquencies: when the patient is bleeding, it is critical to stanch the flow, because, as Wayne County Chief Deputy Treasurer David Szymanski wrote in an email to The Detroit News: “Payment of these delinquent taxes is essential to support essential government services.” Wayne County is scheduling a first round of tax auctions in September, which is when foreclosed properties will be sold for the full debt owed—with whatever is not sold re-offered the following month.

Shared or Different Fiscal Destinies? Robert Frost, in his wonderful poem “Mending Walls,” wrote “good fences make good neighbors,” and so it is that Detroit and Wayne County are more than neighbors—as Detroit is in Wayne County. But even as Wayne County is in a financial emergency, Moody’s yesterday upgraded the City of Detroit one notch to B2 from B3, with a positive outlook, reporting that its upgrade reflects Detroit’s improved financial position following its exit from municipal bankruptcy. Moody’s added that the upgrade incorporates management’s continued improvement of city financial operations and signs of economic development in the city—even as it pointed out the city’s ongoing population loss, persistent tax base weakness, and taxable valuation declines—declines which it projects will continue over the near-term.

How Does on Define “Essential Public Services”? Perhaps the single most critical value of municipal bankruptcy is the immediate protection of a city or county’s ability to ensure the provision of essential public services while its sorts out its debts under the ever watchful scrutiny of a federal bankruptcy judge—certainly a part of the great apprehension in Puerto Rico is that, absent such a judicial protection, those in most dire need and who have the least legal or fiscal resources will be ill-equipped to compete with the hedge funds. But that raises a hard question: just what are essential public services? In San Bernardino, that question is front and center as the city, with an 18.9% unemployment rate, has determined, by a 4-2 Council vote, to appropriate $250,000 to keep a job center open for at least another two months as it appeals the state’s decision to reject the Mayor and Council’s request for funding—that is, $250,000 that the bankrupt city does not have. Nevertheless, the vote affirms the city’s decision to keep the doors of opportunity open for some 138 individuals currently enrolled in training programs or on-the-job-programs, to close out grants, and to otherwise wind down the agency. One can appreciate how hard it would be to draw the fine line between what is essential and what is not. San Bernardino Councilmember Rikke Van Johnson, in the majority of those voting to keep the city’s 40-year-old program on temporary life support said: “It’s integral, if we’re going to move out of this bankruptcy, that we keep our assets that will aid us in getting out of bankruptcy…and that’s what the San Bernardino Employment and Training Agency will do.” While the city’s workforce development attorney, in a seven-page opinion for the Council, wrote that she believes the city will be reimbursed most or all of the money, there was little certainty whether that would, in fact, happen as well as the growing expense—even as the city faces ever-growing bills over the next twelve to eighteen months from the prohibitive costs of municipal bankruptcy. Already San Bernardino has had to cut public safety, outsource jobs, and agree to a settlement under which its retirees will lose some $40 million in health benefits. Councilmembers Fred Shorett and Jim Mulvihill, who voted against the funding, wondered whether and how the decision might affect the city’s case in the U.S. bankruptcy court before Judge Meredith Jury—including with regard to the city’s fiscal discipline, noting: “We’re in bankruptcy because previous councils refused to say no.”

As we have written before, the exceptional complications of democracy and municipal bankruptcy—as provided under certain state authorizations of municipal bankruptcy, such as Alabama and California—create singular civic challenges—challenges that are about governing—and in sharp contrast to municipal bankruptcies in states such as Michigan and Rhode Island, where the Governor appoints an emergency manager or receiver and the mayor and council are barred from any role or governance responsibility—as are the voters and taxpayers. So it was perhaps unsurprising this week to note that the San Bernardino community came out in force for the meeting to determine the fate of the agency, an agency which, over the last four years has served about 48,000 people through job training, placement, and other services.

Cadena de Eventos. With the Congress off in the hinterlands and having spurned any action to provide Puerto Rico or its municipalities any access to municipal bankruptcy, the U.S. territory is on the brink of setting in motion a chain of events (cadena de eventos) which will take us into a state and local bankruptcy twilight zone—as tens of thousands of creditors will be caught up in unrefereed negotiations about how to restructure Puerto Rico’s $72 billion debt—with the triggering event the almost certain default of the Puerto Rico Public Finance Corporation, for which the legislature has not appropriated the requisite $58 million necessary for the utility to make payment to its bondholders tomorrow. That the default will happen should hardly come as a surprise: Governor Alejandro Garcia Padilla made clear last month that Puerto Rico cannot repay its obligations and sought a delay in debt payments—even as he hopes to propose a debt-restructuring plan by September 1st. The non-payment at issue, defined as a moral obligation bond—as opposed to full faith and credit—because it is dependent on a legislative appropriation—is more like the first granules in an avalanche that offer the briefest of warnings of what could follow. Nevertheless, with the Public Finance Corp. having (technically) until the end of business on Monday to make the payment, Puerto Rico tomorrow will enter into an uncharted and unprotected fiscal future—a future lacking the protections of a U.S. bankruptcy court to ensure the provision of essential public services—and a future in which those most at risk—such as Puerto Rico’s retirees and poorest U.S. citizens—will be least equipped to achieve a fair outcome or a sustainable fiscal future. Puerto Rico’s largest pension fund, according to Moody’s, could deplete its assets by 2020: it has 0.7 percent of assets to cover $30.2 billion of projected costs, according to financial documents. The PFC default will not be the only one tomorrow: other Puerto Rican debt payments due tomorrow include $91.5 million of principal and interest on Municipal Finance Agency bonds repaid with payments from San Juan and other towns—in addition to $252 million of principal and interest on debt backed by the island’s sales-tax levy. There are also Government Development Bank bonds due tomorrow (The bank, which lends to the commonwealth and its municipalities, has $140 million of municipal bonds maturing $29 million in interest payments due, according to data compiled by Bloomberg.) Perhaps forgotten in this telescoping of fiscal events is that Puerto Rico and its instrumentalities are not just facing default, but also a perilous slope of capital borrowing costs: costs which have increased by close to one-third.

Public Service Delivery Insolvency

July 30, 2015

Securing a Safe & Sustainable Fiscal Future. With a violent crime rate more than 500% of the U.S. national average, but empty city coffers, San Bernardino’s municipal bankruptcy filing was critical to stanching not just its credit, but also its ability to protect its citizens. A critical purpose of the federal municipal bankruptcy law, after all, is to preserve the ability of a city or county to continue to provide essential public services. Ergo, notwithstanding its bankruptcy, it appears that the City of San Bernardino could be a step nearer a more secure future, with all the ramifications that would have for assessed property values, in the wake of its announcement yesterday that after more than two years’ of watching its police officers leave the force and the city, city negotiators and the police union said they had agreed on a new contract, albeit one subject to ratification by the City Council. The San Bernardino Police Officers Association yesterday reported an overwhelming vote in support of the new pact, with their spokesperson noting: “We also anticipate that the deal…will hopefully keep men and women on the force from exiting the city of San Bernardino.” U.S. Bankruptcy Judge Meredith Jury, at a hearing on the city’s municipal bankruptcy yesterday, praised the two sides for reaching the pact and a mediation judge for helping broker it, noting: “It is an incredibly important step… It is a very big step, and I hope the city votes in favor next week.” Judge Jury added she hoped it would end adversarial court filings by the police union, which has been one of the city’s main creditor challengers in her courtroom, albeit Judge Jury added that she did not expect the adversarial nature of the fire union to change at all: “Obviously that’s not going to happen….” After the hearing, Mayor Carey Davis said the deal was “very favorable” to the city, while City Attorney Gary Saenz said it was a milestone in efforts to turn around the city: “This is a very good deal for the city and a very good deal for the police, but most of all, it’s a very good deal for the citizens of San Bernardino…The Police Department and the city are once more on the same side, and police will have the stability to improve the crime rate that many people, in the survey we did as part of the strategic planning process, identified as one of the main issues in the city.” The agreement, if ratified by the Council, would replace the current terms imposed by the city two years ago in January—terms which police officers believe have contributed to the high rate of turnover. Nevertheless, the agreement, even though praised by Judge Jury in her courtroom, will not go unchallenged: even though it means the city’s plan of debt adjustment before the federal bankruptcy court will—if the agreement is ratified by Council—be modified to incorporate the agreement; it is a change that would likely come at further expense to the bankrupt city’s municipal bondholders—creditors already slated under the city’s plan to only receive one penny on each dollar they are owed. Bondholders’ attorney Vincent Mariott yesterday testified before Judge Jury he was concerned by the slow pace with which he claimed San Bernardino has provided documents, especially with regard to those which purport to defend the city’s plan proposal to, in a manner similar to Stockton, make disproportionately deep cuts to creditor bondholders—or, as attorney Mariott put it: “We’re of course entitled to a full understanding of why the city believes that wiping us out is necessary…We do need the city to be more responsive than it has been to date.”

Resecuring Fiscal Sustainability. Motown is fixing for its amazing comeback, planning to issue its first sale of municipal debt on August 19th—with an estimated issuance of $245 million in municipal bonds, with the proceeds of the sale dedicated to repayment to Barclays for the $275 million loan which marked the final key step which secured Detroit’s exit from the largest municipal bankruptcy in U.S. history. Mayor Mike Duggan yesterday said the new bonds are essential to improving Detroit city services—and have earned an upgrade to A from Standard & Poor’s, adding: “If you had said six months ago there was any chance the city of Detroit could be borrowing with an investment-grade credit rating, people would have thought that was very unlikely…But it gives you an indication of how far we’ve come in a short period of time.” S&P awarded the grade, with a stable outlook, to the Michigan Finance Authority’s Local Government Loan Program revenue bonds, e.g., bonds issued on behalf of Detroit and based on a first-lien pledge of the city’s income tax. In addition, the bonds are secured by a limited-tax general obligation pledge. The upgrade, according to the city, could mean savings of as much as $2.5 million annually and $20 million in interest costs over the life of the Motor City debt. The financial recovery bonds were originally privately placed with Barclay’s Capital Inc., in December as the city made its exit from Chapter 9. The savings highlight the exceptional role the State of Michigan has taken—in stark contrast to the states of California and Alabama, for instance—especially in view of Detroit’s own S&P B rating— five grades below the lowest invest-grade rating. The improvement also reflects the remarkable revenue turnaround: Detroit’s tax revenue has been rising for the past four years, The improved rating also reflects an intriguing wrinkle: the bonds are secured by Detroit’s municipal income tax—tax revenues in this instance which will bypass the city treasury and go directly to a trustee so that the tax proceeds must first be dedicated only to pay bondholders, even going so far as to provide, under the terms of the bond documents, for daily deposits as tax revenue is collected—or, as S&P’s credit analyst Jane Ridley describes it: “The ‘A’ rating isn’t based on the credit of the city itself…It’s based on the strength of the revenue pledge and the income stream. It doesn’t really stay in the city’s hands at all. It’s designed to be immediately taken by the trustee for the benefit of bondholders.” Gov. Rick Snyder, in April, signed into law legislation giving bondholders a statutory lien on the city’s income-tax revenue as way to ease Detroit’s first post-Chapter 9 return to the capital markets. The law also gives the bonds an intercept feature, sending income tax revenue first to a bond trustee who will extract enough to cover debt service and send the rest to the city. Put another way by the ever insightful Lisa Washburn, a managing director for Municipal Market Analytics, Detroit’s overall creditworthiness is unlikely to change until it posts 1) several years of growth and stability in tax revenues, 2) increasing investment in the city, and 3) a stable city government which can improve city services, adding: that will be a multi-year process.” The proceeds of the municipal bonds here will be dedicated to financing key priorities, including the overhaul of its financial management system and the Detroit Fire and Police department fleets.

Referring to the sale at an MSRB seminar Tuesday, Kevyn Orr, Detroit’s former emergency manager who guided the city into and out of municipal bankruptcy, kidded the Board: “I hope you buy early and I hope you buy often.” Under the original agreement, Barclays was to hold the taxable debt for up to 150 days in a variable-rate mode, and the city was to refund the bonds publicly in a fixed-rate mode. The loan was extended by 90 days in May. Of the $275 million, $38 million of the taxable proceeds paid off the banks that acted as counterparties on the city’s interest-rate swaps. Another chunk of proceeds financed new information technology as well as other capital and operating upgrades. The city floated $1.2 billion of bonds in December to pay off creditors, but none of the debt was floated on the public markets. It was directly placed with creditors and participants, though they are securities that can be traded on the markets.

Remembering Motown & Public Service Delivery Insolvency. Reminiscing yesterday about his service in Detroit and its truly remarkable turnaround, Mr. Orr—at the MSRB—said that as the city plummeted into municipal bankruptcy,
• 9-1-1 response time to the highest priority police and emergency medical calls averaged 45 minutes to an hour;
• tax collection was at 65%; 75% of parks were closed; and
• 72 water main breaks occurred in one day last August.
Or (not a pun), as he noted, the noted rhythm guitar playing and now retired (but volunteering his musical and peerless services in Puerto Rico) U.S. Bankruptcy Judge Stephen Rhodes called the U.S.’s largest municipal bankruptcy a “service-delivery insolvency.” But, as he reported yesterday: “Detroit’s a much better credit than it was two years ago,” and he has few qualms about its fiscal future and sustainability: “We built enough of a surplus…They should be fine.”

Too Little, Demasiado Tarde? U.S. Treasury Secretary Jacob Lew Tuesday warned that a failure by Congress to help Puerto Rico resolve its debts may hit the retirement portfolios of average Americans. Secretary Lew’s statements came as Congress was fleeing Washington for its long summer vacation—a departure just days before Saturday’s potential default. Sec. Lew endorsed federal legislation to grant the commonwealth the same access to an orderly municipal bankruptcy regime as every state, noting it was critical to prevent a chaotic and protracted resolution of Puerto Rico’s fiscal challenges—warning that a default would be costly, not just for Puerto Rico, but also the U.S. In an epistle to Senate Finance Committee Chairman Hatch (R-Utah) (and not to Chairman Charles Grassley (R-Iowa), Chairman of the Senate committee of jurisdiction, the Senate Judiciary Committee), he wrote: “The continued deterioration of Puerto Rico’s economic and financial conditions has the potential to further harm retiree investment portfolios across the country…A significant portion of Puerto Rico’s debt is still held directly by individual retail investors or indirectly through the municipal bond funds they own.” On Saturday, long after Congress will have left Washington, D.C. until after Labor Day, $36.3 million of bonds sold by Puerto Rico’s Public Finance Corp. become due. Puerto Rico’s legislature has not appropriated the requisite funds to settle that payment. Because Puerto Rico has not transferred cash to its Public Finance Corporation (PFC) trustee ahead of Saturday’s August 1 debt service payment, the likelihood increases there will be a technical default, or, in Spanish, an incumplimiento technico, a step ahead of what could become the U.S. territory’s first payment default on Tuesday if sufficient funds have not been advanced by the end of this week—a default, which as our ever astute market observers at MMA have already observed: “[E]nhances the political viability of additional defaults everywhere else.”