A Steepening Road to Municipal Recovery

October 9, 2015

Steeper Road to Recovery—where failure is not an option: U.S. Bankruptcy Judge Meredith Jury yesterday warned San Bernardino that the city will have to produce much more extensive information than the 77-page disclosure statement it has submitted if it is to gain the federal court’s approval of any plan of debt adjustment—the critical hurdle if the city is to emerge from the longest municipal bankruptcy in U.S. history. For the city, which has been attempting to put together its proposed plan of debt adjustment now for a longer period than any other applicant municipality for chapter 9 bankruptcy, the stern warning comes less than a month before looming municipal elections—a hurdle itself—and increases apprehensions about the city’s ability to meet any deadlines—and at what cost. Yesterday’s hearing on the adequacy of the disclosure statement the municipality had filed unsurprisingly drew objections from the city’s multiple creditors, undoubtedly raising further questions with regard to the city’s progress. For instance, the attorney for creditor Ambac Assurance Corp., the company which is the securer for San Bernardino’s $50 million in pension municipal obligation bonds, testified in the courtroom of his apprehensions, noting: “[I]t is pretty clear the city plans to pay unsecured (creditors) the least it can get away with, not the most it can afford…They’re trying to disclose a plan that is fundamentally flawed.”

For her part, Judge Jury raised mayhap a much more fundamental apprehension: can the bankrupt city present the federal court with convincing data and information to demonstrate the city’s proposed plan of debt adjustment would ensure the city would not collapse back into a second bankruptcy in a few years, noting: “I don’t really think it’s in anybody’s objection, but the public perception — the media perception –— of the two cities with confirmed (bankruptcy exit) plans, that being Vallejo and Stockton, is that they’re already in trouble because they didn’t impair CalPERS,” referring to the decision, a proposal also made by San Bernardino, to pay every cent of what the municipality owes to the CalPERS as those costs grow. Judge Jury added: “I don’t think there is adequate discussion of how much those raises are going to be. I have heard other things, I think in this court, that it is an exponentially increasing number that will have to be paid in order to keep retirement plans intact. There comes a point where no matter what I confirm it will fail.” San Bernardino’s actuaries project as part of the bankruptcy exit plan that $29 million a year will go to CalPERS by 2023-24—or an amount more than double its current annual payment. Ergo, for Judge Jury, the grave question is from whence will cometh those funds?

Equally unsurprisingly, San Bernardino’s creditors—all of whom understand that every day further into what has become the longest municipal bankruptcy ever—recognize that each additional day without an approved plan, the less resources remain to be divvied up amongst the city’s thousands of creditors. That apprehension led the attorney for creditor EEPK, a Luxembourg-based bank, which is the holder of San Bernardino’s municipal bonds secured by Ambac, to tell Judge Jury the city needed, in its proposed plan of debt adjustment, to show the value of properties held by the city and why many of them could not be sold to pay creditors—and explain why the city was not pursuing municipal tax increases—reminding the federal court of the critical and daunting fiscal action Stockton’s leadership took to anchor not just its plan of debt adjustment, but also its long-term recovery—or, as he told the court: “The city’s explanation for why it’s not pursuing some substantial potential revenue sources which require voter approval is ‘it would be hard…’ It’s not enough, when you’re paying creditors 1 cent on the dollar, to say ‘It’s hard.’ ” It is difficult to imagine Judge Jury could have emerged from the session with much optimism; nevertheless, she obtained a commitment from the city that it would provide more comprehensive information and responses by the day before Thanksgiving—at which point creditors will respond in writing, leading to still another day—and ever mounting costs—to assess the adequacy of the financial information provided by the city. Judge Jury also informed the parties she is trying to allow San Bernardino to exit bankruptcy as soon as is prudent: “I do intend to keep this pace moving, but not at a pace that is unreasonable.”

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.

Municipal Bankruptcy & The Role of Intergovernmental Relations

August 18, 2015

Municipal Bankruptcy, Intergovernmental Relations, & Democracy. The San Bernardino City Council voted 4-2 late Monday to appropriate over half a million dollars to fund a new community center on the bankrupt city’s Westside—notwithstanding apprehensions the city might not be allowed to use the modular that will now be used for that purpose, much less concerns about how it might affect the city’s already difficult relations with the state. The center, once constructed, is intended to provide classes on aerobics, Zumba, nutrition, mental health, and English as a second language, in addition to partnering on other services. The financing is not to come from the bankrupt city’s general fund, but rather from the city’s CDBG grants. But it was only after a citizen at the session raised a question—after the first of the two votes needed to approve the center—that there appeared to be some recognition of a problem. The citizen asked how it was that that since the state had taken control of redevelopment how it was the Council could “wonder why the state is mad at you, you wonder why the state doesn’t want to help you? Maybe listen to yourselves, and wonder, ‘What am I doing?’” Indeed, City Manager Allen Parker responded to a follow-up question to staff that last year, when the city had requested the California Department of Finance to transfer redevelopment assets — items such as desks, computers, and this $158,000 modular, which the city-controlled agency had used until the statewide shut-down — to San Bernardino so the city could control them: the request had been rejected. The response triggered two Councilmembers to change their votes from aye to nay, with Councilmember Henry Nickel noting: “We have some very delicate negotiations going on with the state right now…The last thing I want to do is upset them. I want to be very clear on the legal ramifications of taking a $150,000-plus asset and using that for city use.” Notwithstanding, the rest kept their votes unchanged, demonstrating one of the many intergovernmental challenges that confront the city as it seeks to put together a plan of debt adjustment for the U.S. bankruptcy court’s approval, even as—in an election year—it must continue to govern the municipality. Indeed, community members have been asking for the community center since the city promised it before the state’s dissolution of the redevelopment agency.

As we have previously noted, the uneasy relationship between California cities and the state has played an important role in San Bernardino’s municipal bankruptcy, whether it be the suit filed by the state’s California retirement agency (CalPERS) for non-payment of the city’s prescribed contribution to the state’s public retirement system for its employees, or the—to this point—takeover and dissolution of local redevelopment agencies in 2012, a takeover at least in some part triggered by disagreement as to whether cities were consistently using the revenues from these redevelopment agencies as originally intended. More broadly, of course, the withdrawal of most California state direct financial aid to cities, which commenced some three decades ago in the wake of Proposition 13, has not only negatively impacted most cities in the state, but especially poorer cities such as San Bernardino—with fiscal insult added to injury via California’s redirection of some non-state revenues to specific programs including education and public safety, thereby shifting the expenditure burden from the state to its cities. State aid constitutes a very small percentage of revenue for cities in California—2% in the case of San Bernardino. This minute amount does little to even out disparities in fiscal capacity and need for cities such as San Bernardino. State actions in recent years—including changes in the motor vehicle license taxes and redevelopment agencies— have only served to exacerbate, rather than ameliorate San Bernardino’s fiscal problems.

The Painful Cost of Recovery. Notwithstanding some of the unique and fiscally creative partnerships engineered as part of the resolution of the Motor City’s record municipal bankruptcy recovery, Detroit will find that getting back on its four wheels will come at a high price: the city is expected to have to pay interest rates close to 5 percent in its maiden return to the municipal bond market on its sale set for tomorrow of some $245 million in bonds—the city’s first sale since emerging from municipal bankruptcy. The sale, which will be done through the Michigan Finance Authority, will provide that bondholders will have the first claim on Detroit’s income tax revenues, so as to ensure investors in the recovering city are repaid. Ergo, the 14-year bonds are being marketed at an initial yield of 4.75 percent, according to persons familiar with the sale, some 2.1 percentage points more than top-rated municipal securities. The high cost to Detroit’s taxpayers and the city’s budget is a reflection of the significant cuts the city’s g.o. bondholders received as part of the court-approved plan of debt adjustment, nearly a 60 percent reduction. Nevertheless, for the city—in stark contrast to virtual bankruptcy in state-local fiscal relations in California (please see above)—this is a key factor in the likely successful sale tomorrow: Michigan Gov. Rick Snyder, together the bipartisan leadership of the state leadership, enacted legislation to provide prospective Detroit municipal bondholders first claim to the Motor City’s income taxes—an innovative step to help in the city’s recovery—and one which earned an A rating for tomorrow’s sale from S&P–nine levels higher than its grade on Detroit’s general obligations. Moody’s, in mayhap a surprisingly upbeat mode, noted that Detroit’s employment has risen 3 percent over the past four years; more generously, the rating agency wrote that the Motor City’s income tax revenue rose 18 percent from 2010 to 2015. The proceeds from this week’s sale are intended to be devoted to repayment of a loan from Barclays plc that was a key to the city’s emergence from bankruptcy, as well as to help finance city projects, including upgrades for the fire department’s fleet. S&P wrote that Detroit’s income tax collections are strong enough to cover the bonds.

Arriba! The Puerto Rico Treasury Department reports that last month’s General Fund tax revenues for the U.S. territory of Puerto Rico came in 3.5% higher than budgeted, with sales and use tax collections coming in at a rate more than ten times (35.7%) greater than those for a year ago. The increased revenues included $21.1 million more than projected for the island’s General Fund. But the most significant increase came from individual income taxes: some $7.2 million more than projected, as well as foreign corporation excise taxes ($4.6 million ahead), and alcoholic beverage taxes ($4.5 million above projections). The biggest shortfall was for motor vehicle taxes, at $2.7 million. No doubt, the increase in the territory’s sales and use tax revenues was due in no small part to the rate rise from 7 to 11.5% which went into effect last July 1st; nevertheless, the Treasury reported the increased rate only contributed about $8 million directly to the sales and use tax revenue increase of $40.6 million in July compared to one year earlier—moreover, as Puerto Rico Treasury Secretary Juan Zaragoza Gómez noted, the sales and use tax realized revenue increases might have been spurred by a rush-to-beat-the rate increase which went into effect July 1st. But Sec. Zaragoza Gómez also noted that Puerto Rico’s completion last May of the last phase of an Integrated Merchant Portal collection of sales and use taxes at ports also likely contributed to the improvement in these tax collections. Finally, the Secretary also noted the government had reached settlements for back sales and use taxes owed with several large retailers last month—adding: “These collection efforts will continue during the coming months.” The rising revenues from traditional tax sources came as a Puerto Rican study group has recommended going ahead with converting Puerto Rico’s sales and use tax to a value added tax effective April Fools’ Day next year.

Failing Grade. S&P downgraded the Windy City’s Chicago Public Schools three notches, finding that its proposed budget would do little to address either its structural or liquidity woes. The rating agency also removed the credit from CreditWatch with negative implications and assigned a negative outlook, with analyst Jennifer Boyd scholastically writing: “The rating action reflects our view of the proposed fiscal 2016 budget, which includes what we view as the [school] Board’s continued structural imbalance and low liquidity with a reliance on external borrowing for cash flow needs.” The poor grades appear to reflect the system’s increased reliance in its proposed $6.4 billion FY2016 budget on more than $300 million from one-time revenues, not to mention an almost mythical assumption that the stalemated Governor and state legislature will provide CPS with $480 million in public pension funding assistance this year to close a $1.1 billion deficit—or, as CEO Forrest Claypool put it: “This budget reflects the reality of where we are today — facing a squeeze from both ends — in which CPS is receiving less state funding to pay our bills even as our pension obligations swell to nearly $700 million this year.” The hopes from CPS come as the stalemate in Springfield over passage of the state’s FY2016 budget has shown little to no progress—even as Chicago’s kids are already, no doubt, dreading the September 2nd return to the classrooms. CPS’s proposed budget assumes Illinois will help assume almost $200 million in CPS pension contributions—not unreasonable, as that would be in line with what the state contributes on behalf of other districts. The package could also be made up by shifting $170 million of the teachers’ contribution now paid by the district over to teachers, extending a payment amortization period, and possibly higher property taxes. Further, CPS last month announced some $200 million in cuts in the wake, last month, of its failed efforts to delay its FY2015 pension payment. The budget also relies on $250 million of debt relief primarily from $200 million in so-called scoop and toss refunding in which principal payments coming due are pushed off. CPS is proposing to draw down $75 million from reserves. Unsurprisingly, S&P does its math differently than CPS: the rating agency questions the school system’s arithmetic, wondering how it all adds up, especially because of CPS’ reliance on $480 million in, to date, unsecured state assistance for debt restructuring and reserves, both non-recurring revenue sources, adding: “The rating is also based on our view of the challenges the board faces in attempting to secure a sustainable long-term solution to its financial pressures, given the state’s own financial problems reflected in the current budget stalemate, and the board’s fiscal 2016 budget proposal that shows the continuation of a structural imbalance even if the board gets the assistance from the state.” The challenged fiscal math has already exacted a cost: CPS is paying a premium to borrow: its most recent issuance came at a yield of 5.63 percent on 25-year bonds—and that even with not only the system’s full faith and credit pledge, but also security via an alternate revenue pledge of state aid. The convoluted math, S&P totes up, is further jeopardized by next year’s expiration of the district’s teachers’ contract.

August 13, 2015

Municipal Bankruptcy & Public Safety. In California alone, 16 wildfires are burning 229,713 acres. So it is unsurprising that citizens and their elected leaders in San Bernardino have a significant stake in ensuring that any plan of debt adjustment approved by U.S. Bankruptcy Judge Meredith Jury ensures confidence, thereby guaranteeing there will be significant interest in the 28-page report (www.tinyurl.com/oraatpk) by fire consultant Citygate Associated the city released last night—a report recommending that the city’s fire department be annexed into the San Bernardino County Fire District. The report is consistent with the proposal recommended by San Bernardino City Manager Allen Parker; it is contrary to the position of the San Bernardino Fire Management Association. For both the city’s residents—and Judge Jury—the issue in bankruptcy is how to ensure the continuity of essential public services.  In its report to the city, Citygate evaluated the ability of three bidders — county fire, city fire, and Florida-based private firm Centerra — to meet certain key staffing standards. The report recommends San Bernardino County take over, under a plan which would include keeping 10 current city fire stations open, closing two, and adding the use of one additional county fire station, noting: “The best cost-to-services choice is County Fire’s Option C for 14 units and 41 firefighters (per shift) at $26,307,731 which includes sharing the use of a nearby County Fire station and Battalion Chief that can assist with covering part of the western City.” While the mere suggestion of privatizing or turning over control of a municipality’s fire department to another jurisdiction has traditionally been a sure fire road to unelection, it has actually become more prevalent in other parts of San Bernardino County and other areas in California. Indeed, San Bernardino Councilman Henry Nickel compared the modest opposition by constituents to the proposal to the outpouring of opposition when a community sent a robocall asking citizens to oppose privatizing the Fire Department, noting to the San Bernardino Sun yesterday: “My phone was literally on fire for two days…My voice mail filled up within about an hour of that robo call going out, and it took me two or three days to catch up. But since this article came out (outlining the report), I’ve received one phone call today regarding the county versus city debate…I think it’s very clear that Centerra is not something the public by and large supports, but — I hate to use the word resignation, but I think much of the public understands that the county medicine is probably the one we’ll have to take…It’s not something we want to do, but it’s something we might have to do.” City spokeswoman Monica Lagos posted a summary of the report and the city’s next steps here (www.tinyurl.com/pbogaxr). A special meeting, including a presentation of the report and a chance for resident comment, is scheduled for a week from Monday.

The uncontrollable nature of wildfires adds a combustible to the already complex challenge of elected leaders of a municipality in bankruptcy—with elections pending in November—creating a difficult balancing set of public as compared to campaign responsibilities. Unlike Donald Trump, the decision to file for bankruptcy for the city’s elected leaders is something no elected leader ever wants to do. And then the responsibility to approve a plan of debt adjustment to the federal bankruptcy court—even while contemplating a re-election campaign amidst the combustion of wildfires and politics is evidence of the extraordinary challenges and decisions ahead which will affect so many citizens—and their safety—not to mention the future of a city.

Jailhouse Rock. Wayne County’s elected leaders are scheduled to consider the proposed fiscal consent agreement between Michigan and the County today—an agreement intended to offer ways to improve Wayne County’s cash position, reduce underfunding in its pension system, and eliminate the county’s$52 million structural deficit—and be a governing alternative starkly different than in neighboring Detroit where the state preempted local authority through the appointment of an emergency manager. The consent agreement allows for the commission and Chairman Evans to “retain their respective authority.” The document has a number of highlighted sections on issues such as employee relations and changes that can be made to expired contracts, state financial management and technical assistance, and a prohibition against new debt unless approved by the State Treasurer. It also specifically mentions pension obligations and other employee contract commitments as at least a factor in the county’s financial troubles. But the major point of the agreement that will likely gain close scrutiny by many who work for the county is the authority it grants Chairman Evans to act as the sole agent of the county in collective bargaining with employees or representatives and approve any contract or agreement. The agreement will also address—and affect—the county’s jails, whose conditions have already been the subject of a court order this year, as Wayne County—and jail host Detroit—consider the future of the unfinished facility. In its review of Wayne County’s finances, the state noted the county’s unfinished jail and its $4.5 billion in long-term obligations as problems that need to be addressed, and mandated Wayne County to put together a plan to “adequately meet the county’s needs for adult detention facilities…” The County’s elected leaders, who are scheduled to discuss the agreement tomorrow, have just over three weeks in which to approve the document—an agreement which Wayne County Chairman Warren Evans very much hopes will be the key to resolving the county’s structural debt and unsustainable fiscal future: the proposed recovery plan lays out $230 million in cuts over four years.

Whether and how the plan will get the County and Detroit out from behind the fiscal bars will be a subset—but one with critical implications for the future relationship of the two jurisdictions, as well as for the county’s fiscal sustainability. The jail—in downtown Detroit on which Wayne County broke ground for construction four years ago—is an exceptional fiscal millstone: some two years after construction was halted because of ballooning expenses, the failed Wayne County jail project is still costing taxpayers more than $1 million a month. The plan was to build a $300-million state-of-the-art jail in downtown Motown four years ago—a plan which today features a costly pile of steel and concrete — fenced and guarded — with construction costs of $151 million, and an ever growing fiscal tab for county taxpayers of an average of $1.2 million every month. Thus, not only is the jail a sticking point between the two jurisdictions, but also a severe fiscal drain—or as the County described the situation last May: “Due to the county’s financial state, anything done on the Gratiot jail will just add to the deficit. Once the deficit has been solved, the county can move forward with options on whether to finish the Gratiot site or renovate the three existing jails. As the county makes progress on its recovery plan, it will better be able to solve the jail issue.” Worse, it appears that much of the debt issued by Wayne County for the jail’s construction has been diverted for other purposes—meaning Wayne County is spending as much as $1.2 million each month from its general fund. According to County officials, only $49 million remains from the $200 million in bonds Wayne County sold to finance the unfinished jail—a borrowing forcing the county to make interest payments on of $1.1 million monthly—even as it is spending nearly $55,000 each month on unfinished jail-related costs, including: security ($10,849), sump pump maintenance ($12,852), and electricity to the site ($4,000).

June 30, 2015

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

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

The key takeaways from the report:

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

June 29, 2015

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

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

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

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

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

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

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

June 25, 2015

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

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

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

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

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

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

The Extreme Challenges of Governance in Bankruptcy

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June 19, 2015
Visit the project blog: The Municipal Sustainability Project

Wait a Minute, Mr. Postman. In the wake of Wayne County Executive Warren Evans’ request for Michigan to declare the county in a financial emergency, Wayne County yesterday announced it would defer a $186 million note sale originally scheduled for today—a step taken so that potential investors have time to settle—and the county, which surrounds Detroit, might be able to enter into a consent agreement with the state. The sale is intended to tide over the county in order to make up for late property tax collections for its local governments. (Wayne County has 34 cities, including Detroit, and 9 townships—making it the 19th largest county in the nation.) Nevertheless, Wayne County cannot wait long: Deputy Treasurer Christa McLellan reports Wayne wants the money by the end of its fiscal year—June 30th, advising the Bond Buyer: “The request for state review will necessitate a delay in the sale of the notes which was to have taken place today, June 18,” Ms. McLellan said. “It is now expected to be rescheduled to Wednesday or Thursday of next week, in order to give investors time to digest and react to the executive’s announcement as well as understand the strengths and vitality of the delinquent tax program…Although the executive’s announcement has delayed our timing slightly, we are moving forward with a goal of closing on the notes before the end of this month.”

Getting Ready to Rumble. At the first hearing in U.S. Bankruptcy Judge Meredith Jury’s courtroom this week, the bulk of San Bernardino’s creditors were generally positive about the city’s proposed plan of debt adjustment—and how the city had finally come together to complete it. Unsurprisingly, the attorney representing San Bernardino’s municipal bondholders—creditors with some $50 million at risk—was less than enthusiastic about a plan under which, if approved by the federal court, those bondholders would receive about one penny on the dollar. The issue, very much as in Stockton’s bankruptcy case before U.S. Bankruptcy Judge Christopher Klein, will pit the city’s bondholders against almost all its other creditors—creditors in this case who generally told the federal court they respected the progress in a case that began with San Bernardino’s initial filing for chapter 9 municipal bankruptcy in August of 2013. The bondholder’s attorney charged that San Bernardino’s foot-dragging on the case had already been demonstrated by the city’s failure to propose a date for the hearing, which the attorney said would be standard practice, and he criticized the municipality for proposing a plan of debt adjustment which he noted might not work, because, he told Judge Jury, it depends on changes to the city charter that cannot be voted upon until 2016, and, it could then be rejected, testifying: “(The city’s filing) fails in our view in what was intended to be its central purpose, which was to finally move this case along…And raises once again the question of what the city has been doing for the almost three years that it has been under the protection of Chapter 9 (bankruptcy).” Democracy, of course, is quite different than a quasi-dictatorship: as we have noted, a key distinction between state laws which provide for municipal authority to seek federal bankruptcy protection, is whether such laws provide for an emergency manager or receiver, as opposed to leaving the elected leadership in place. Democracy can be messy—especially with regard to such agonizing public decisions. Indeed, interestingly, Ron Olinor, who represents the San Bernardino Police Officers Association, testified in praise of the city’s progress: “Obviously bondholders — Wall Street — don’t like the plan, and they’ll take their shots…You forced the city to move forward. They made hard decisions…I would say today is a very good day for the city and a very good day for this case.” The attorney representing a committee of retirees, Steven Katzman, also took issue with the bondholders’ attorney: “What Mr. Marriot ignores — even though I don’t think it’s the right place (to discuss it), but he brought it up…my committee has agreed to forsake $40 (million) to $50 million in health care benefits…It’s about the same amount of money that they’re owed. To say that they’re in the same place as us is sort of like saying Bill Gates and I are in the same place. They’re Bill Gates — they’re well off, they’re well-heeled — and my clients are giving up the same amount of money as his clients are.” For his part, San Bernardino City Attorney Paul Glassman testified the city’s proposed plan of debt adjustment does not depend on voters approving changes to the charter: “We’re simply talking about a reorganization that would assist the city and be viewed as helpful…We worked very hard to put together a plan that is not dependent upon an election happening.” Counselor Glassman told Judge Jury San Bernardino was operating under an interim charter agreement—a challenge to governance, and another hurdle drawing further criticism from the bondholders’ counsel, who told the court: “I don’t know how long the city can operate on a basis that’s inconsistent with its own charter.” The pension obligation bondholders are already appealing Judge Jury’s earlier decision that bondholders do not have to be paid the same as the California Public Employees’ Retirement System (CalPERS)—a replay of a similar challenge from the Stockton bankruptcy case. It appears now the next step will come next month, when Judge Jury will hear arguments about the fire union’s temporary restraining order against the city’s attempt to outsource the Fire Department—a key provision in the city’s plan of debt adjustment that could reduce its debts by as much as $7-10 million, but which the city’s fire union contends is prohibited by the city charter. Judge Jury has scheduled a hearing for October 8th to determine whether the financial disclosure statement San Bernardino filed along with its plan of debt adjustment is adequate, noting the city’s fiscal situation could change significantly by then.

The Fate of a U.S. Territory. In preparation for a possible debt crisis, Puerto Rico Gov. Alejandro García Padilla is seeking legislation to grant immunity from some lawsuits to the leadership and staff of Puerto Rico’s Government Development Bank (GDB), because, unlike the directors of most corporations and banks, the GDB’s leadership lacks immunity from lawsuits over their decisions. The proposed legislation would provide immunity to the banks’ leaders should they opt to default on particular GDB debt obligations; nevertheless, the leaders could still be sued for embezzlement or other illegal actions. There has been some apprehension that absent such legal protections, the bank’s leadership would opt to resign rather than risk liability over their decisions. With uncertainty with regard  to unlikely action by Congress to offer the U.S. territory legal options available to U.S. states, Gov. García Padilla warns that the Commonwealth is in the greatest financial crisis in its history: the timeline is shrinking, as the commonwealth, last March, issued a report saying that it might not be able to pay all obligations coming due in July and August. There is about $72 billion in public sector debt in the commonwealth. Historically, the GDB has financially supported many of the debt issuers. There are now two immunity bills in the legislature, with some hopes for progress, as one is currently in conference between the Puerto Rico House and Senate right now, and Representative Jesús Santa Rodríguez’s spokesperson reports the conference committee is on the verge of approving the measure. The action comes as the Puerto Rico House hopes to complete and send to the Senate the territory’s FY2016 budget as early as today. The last minute budget and debt negotiations come as creditors of Puerto Rico’s nearly insolvent public power utility PREPA have agreed to extend a creditor agreement to the end of the fiscal year—a key step to ensure more time for restructuring negotiations, and to protect the PREPA from default: the agreement had been scheduled to expire last night. PREPA, with about $9 billion of debt, also has a June 30 deadline by which to reach a restructuring deal with creditors—with the issue being the reaction to its proposed quasi plan of debt adjustment, which needs some $2.3 billion in investments to make its business more sustainable: its long-term prospects depend on converting a largely oil-fired generation fleet to natural gas—a key to lowering operating costs, and improving collections and increasing efficiencies, while also keeping electricity rates at the lowest possible levels to help spur economic growth. With PREPA confronting a July 1 deadline for a $400 million payment to its bondholders, creditors are questioning the proposal—with one going so far as to describe the utility’s proposal as “unworkable.”

Can Sharing Services Be a Linchpin to a Sustainable Fiscal Future?

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June 3, 2015
Visit the project blog: The Municipal Sustainability Project

Fire in the Hole. San Bernardino Mayor Carey Davis and Councilwoman Virginia Marquez journeyed north yesterday to Gov. Jerry Brown’s office to seek assistance on six issues important to the city’s ability to not just emerge from municipal bankruptcy, but also to be able to realize a sustainable fiscal future. The key issue was to obtain the Governor’s support for getting Cal Fire—which serves or provides contract fire services to some 150 cities, counties, and special districts in the state, including in the regions around San Bernardino, to submit a bid, noting that the sharing of such services would save taxpayers money. In addition, the Mayor and Council requested the Gov.’s assistance in reversing what the city deemed a “penalty” of $2 million imposed on the city by the California Public Retirement System (CalPERS); removing the cash hold and threat of decertification of the San Bernardino Employment and Training Agency—San Bernardino’s local workforce development organization, and a key to its plan of debt adjustment provisions for sustainability; access to the state’s California Infrastructure Bank—especially for critical seismic rehab and its recycled water project; support for pending state legislation which would permit the City, should it opt for shared fire services with San Bernardino County, to transfer the assets and liabilities associated with its CalPERS services for its fire employees; help in dissolving its former redevelopment agency; and, finally, assistance in modifications of the way Amazon is taxed, so that instead of the current method—in which Amazon e-commerce centers are effectively deemed as sited statewide, rather than in the municipality—meaning that San Bernardino, which hosts not one, but two Amazon distribution centers which comprise over 1.5 million square feet, imposing significant traffic demands, are subject only to a 1% sales and use tax—the proceeds of which are shared statewide. The San Bernardino delegation received no promises on any of the sextet of issues they raised, but appeared positive both that the Gov.’s office seemed well-briefed on the city’s issues and that the delegation will receive specific responses to the issues and concerns they raised—issued presented in their five-page letter to the Governor and their Sacramento delegation of state Senators Connie Leyva and Mike Morrell and Assembly Members Cheryl Brown and Marc Steinorth. Shared fire services has been a key issue for San Bernardino, but Cal Fire has been, to date, the most recalcitrant about engaging and has consistently rejected San Bernardino’s attempts to have the state agency prepare an estimate of what it would cost to provide fire services for the city, citing the city’s financial instability “and the difference in staffing models between Cal Fire and the City.” Thus, in their epistle, the Mayor and his fellow Councilmembers noted that elected state officials have authority over the agency and that they should insist upon a proposal. At the same time, the letter notes the city is achieving some progress: San Bernardino County and a private firm have each responded to the city’s RFP, with each response, according to the city, noting that “both indicate that significant efficiencies are available.” Because San Bernardino’s plan of adjustment submitted at the end of last week to U.S. Bankruptcy Judge Meredith Jury assumes some $7 million annually in saving through the outsourcing of fire services, one can appreciate how important the issue is. Assembly Member Steinorth (R-Rancho Cucamonga), after the meeting yesterday, noted: “The idea of the meeting today was to engage the Governor’s office and the office of the mayor and council to determine what resources are available to our city to help during this transitional period…They were very receptive, very astute. You could tell they paid very close attention. The mayor and the council members were very prepared and had all the supporting documentation to help them with their discussion and their request.”

Fighting over the Dregs

. With Congress apparently disinterested in the fiscal fate of the 3.6 million Americans living in 78 municipalities in Puerto Rico, meaning the U.S. Bankruptcy Court is unavailable to serve as an adult referee among the territory’s many, many classes of creditors; hedge funds and money managers are engaged in a growing war over the credit market’s scrap heaps. Bloomberg notes that some distressed-debt buyers are already engaging in what promises to be a trench war over the U.S. territory’s $72 billion of debt, a war which could pit investors such as Fir Tree Partners, which is among the firms which have purchased some $4.5 billion of municipal bonds—bonds which Puerto Rico must make payments on ahead of others of the territory’s debt obligations―against creditors, including Angelo Gordon & Co. and Knighthead Capital Management, who own a majority of the more than $8 billion of debt owed by the Puerto Rico Electric Power Authority (PREPA), which met with the financial adviser to its creditors Monday in an effort to restart restructuring negotiations—negotiations which could ask its bondholders to take a loss or wait longer to be repaid. According to Barclays Plc municipal-debt strategist Mikhail Foux, the island’s hedge funds now hold as much as 30 percent of the obligations of Puerto Rico and its agencies, or, as Joseph Rosenblum, director of municipal-credit research at AllianceBernstein Holding LP puts it: “It’s extremely disorderly and nasty…[this] messy approach to trying to resolve something with no clear structure or guidance doesn’t give a municipal bondholder any kind of confidence.” Bloomberg puts it concisely: “The reason so much hedge-fund money is riding on the island is simple: an increasing number of distressed-debt funds are chasing a declining number of opportunities. Little wreckage remains from the 2008 financial crisis, and six years of central-bank stimulus has kept tomorrow’s bankrupt companies flush with cash.” Ironically, two of the biggest borrowers that teetered after the financial crisis, Energy Future Holdings Corp., the Texas power producer formerly known as TXU Corp., and the main operating unit of Caesars Entertainment Corp., are now in the hands of federal bankruptcy judges—hands from which Congress has effectively barred Puerto Rico and its municipalities. Thus, with an eruption in growth of 24 new distressed-credit funds last year, the highest number since 2010, according to data provider Preqin, with total assets growing to $150.3 billion, shark hunting is under way, or, as Stephen Ketchum, chief executive officer of the $6.5 billion hedge-fund firm Sound Point Capital Management, put it: “There are not any obvious large distressed situations, such as a Caesars or a Lehman Brothers or TXU, coming down the pike…We were comparing Puerto Rico to some of the worst sovereign-debt situations in history, and it just didn’t make sense to us, especially since Puerto Rico is a U.S. territory.” Prices on Puerto Rico’s general obligation bonds plunged to as low as 55 cents on the dollar last July, according to data compiled by Bloomberg, albeit they have since rebounded to about 68 cents, while municipal bonds issued by PREPA reached 33 cents a year ago; these too have recovered to 56 cents. Angelo Gordon, Knighthead, D.E. Shaw & Co. and units of Goldman Sachs Group Inc. are among 11 firms which have agreed to delay a default on nearly $5 billion of PREPA’s debt until tomorrow—in the wake of PREPA’s Monday proposed restructuring plan—a plan some bondholders deemed a basis for further talks, while calling some aspects “unworkable.” So it is, ironically, that capital from the distressed funds or shark funds is currently the fiscal safety net offering borrowed—albeit at prohibitive rates—time in which the current government could act.

Indices of Municipal Recovery & The Challenge of Fiscal Sustainability

May 21, 2015
Visit the project blog: The Municipal Sustainability Project

Tapering Off? Detroit has one of the broadest tax bases of any city in the U.S.: its municipal income taxes constitute the city’s largest single source, contributing close to 21 percent of total revenue in 2012, or $323.5 million, the last year in which the city realized a general fund surplus. Thereafter, receipts declined each year through 2010, reflecting both a rate reduction mandated by the state and the recession. The declining revenues also reflected not just the significant population decline, but also the make-up of the decline: the census reported that one-third of current residents were under the poverty line and that the composition of businesses—unlike any other major city in the nation—was primarily made up of public organizations. Today, according to the Census, Detroit is still losing residents, but the exodus is tapering: Detroit’s population was 680,250 as of last summer, down an estimated 6,424 residents from the previous year—but a decline or outflow smaller than the previous year—when the drop was 10,072―and significantly lower than the annual average decline of 24,000 which Detroit experienced in the first decade of this century. Kurt Metzger, director emeritus of Data Driven Detroit, not only a demographer, but also the Mayor of Pleasant Ridge, notes that the influx is from young and older people moving in: Last year, Detroit issued 806 building permits for new construction, mostly for apartments, more than double the influx from the prior year. And, on the other side of the equation, the population outflow is slowing—or, as Mayor Metzger puts it: “There is just less housing available for those people who want to leave…If they haven’t left by now, they have decided to stay.” Detroit Mayor Mike Duggan sums it up: “It’s trending in the right direction…A number of people have decided to stay and see how things go…More people are staying in neighborhoods and more people are moving in.” Nevertheless, the Southeast Michigan Council of Governments has reported that the Motor City’s population is actually closer to 648,002 and the COG forecasts the population will continue to decline until 2030 when it would have about 610,000 residents.

Indeed, home sales in the four-county metro Detroit region inched up 1.4 percent year over year in April, while the median home sale prices climbed 18.9 percent, according to a report released this week. Farmington Hills-based Realcomp Ltd. II reported there were 4,004 home sales last month, compared to 3,947 in April of last year in Wayne, Oakland, Livingston and Macomb counties. Median sale prices rose from $121,900 in April 2014 to $145,000 last month. Oakland County had the greatest increase in home sales, rising 12.6 percent from 1,286 in April 2014 to 1,448, while Macomb had the second-highest increase of 7.3 percent, from 862 to 925 last month, according to Realcomp. Wayne County sales, however, fell 10.2 percent from 1,553 in April 2014 to 1,395 last month. In contrast, however, Wayne County sale prices rose 42.7 percent from $70,000 to $99,900.

Fire over Privatizing Essential Municipal Services. Despite the 6-1 affirmation by Mayor Davis and the City Council this week to contract out for fire and emergency response as part of San Bernardino’s proposed plan of debt adjustment—which is to be submitted to the U.S. Bankruptcy Court by Saturday, the proposal to do that is now drawing its own fire—not only from within the city, but also beyond its borders. The proposal, projected to save as much as $7―$10 million annually, depending on bids due in late yesterday and to be made public next week, has fired the head of Local Firefighters union 935 north to the state capitol in an effort to seek to preempt the proposal. Yet the proposed privatization has become a pivotal part of the city’s plan to successfully exit municipal bankruptcy—not only could it result in substantial operating and capital savings, but also the proposal could reduce some of its overbearing debt to the California Public Employees’ Retirement System, according to City Manager Parker—whose City Council endorsed plan for fiscal recovery and sustainability proposes that fire/emergency response and refuse services be the highest-priorities for outsourcing. With a demographic trend demonstrating that retirees are likely to live much longer than prior generations—but smaller municipal workforces in California municipalities, there is greater and greater awareness that California cities and counties are, increasingly, walking a fiscal tightrope where fiscal sustainability is increasingly at risk. That is not to say that contracting out will not create challenges: it would force recalibration of mutual aid decisions.

Moody Blues. Moody analysts Josellyn Yousef, David Strungis, Orlie Prince, and Naomi Richman this week reported that the sale of New Jersey state-enhanced municipal bonds for Atlantic City, would remove a “major short-term obstacle” for the fiscally distressed municipality, but warned the city still faces long-term risks due to “numerous financial challenges.” The warning came as the city was seeking to complete the sale of some $40.5 million in general obligation municipal bonds this week, a sale benefited under New Jersey’s Municipal Qualified Bond Act program (The state program, called the Municipal Qualified Bond Act program, gives Atlantic City bondholders protections similar to the distributable state aid bonds issued by Detroit, Michigan.) The proceeds of the sale are to be used to pay off a $40 million emergency state bridge loan due by the end of this week. In addition, Atlantic City is planning to issue $12 million of additional MQBA bonds by the beginning of August in order to make payments due on maturing bond anticipation notes. The sale, according to the dynamic Moody quartet should “should improve [Atlantic City’s] market access; however, the relatively narrow debt service coverage from state aid makes it unclear whether the city’s bonds would carry the MQBA program rating (A3 negative), or a somewhat lower rating.” Moreover, notwithstanding the relatively sunnier outlook, the quartet noted many financial and fiscal hurdles still confronting the city, including a $101 million budget gap for the fiscal year ending Dec. 30th, poor liquidity, and ongoing property tax appeals on casino properties. They also wrote that heavier municipal reliance on MQBA-enhanced debt could mark the beginning of some erosion in New Jersey state aid to help the city cover debt service, noting that since the state aid never reaches the city’s coffers, ‘the protection is similar to Detroit’s distributable state aid bonds that avoided payment interruption during its recent bankruptcy.’ Thus the credit rating agency warned that additional MQBA bond issuances by Atlantic City could actually undercut its debt service coverage levels: “If all of this debt is issued through the MQBA program, debt service coverage could decline to at or near one times qualified state aid depending on interest rates…The state Local Finance Board will only approve an MQBA bond issuance if revenues are at least sufficient to meet debt service.” With the city having acted last March on a short-term plan to address Atlantic City’s $101 structural deficit that included the potential of debt payment deferrals, Moody’s analysts noted that while some steps have already been taken, including $7 million in salary and wage savings from 195 layoffs; nevertheless, proposed bills to redirect $47.5 million of additional revenues from the Atlantic City Alliance Fund and Investment Alternative Tax remain stalled in the state legislature. As Mayor Don Guardian noted at our conference with the Volcker Alliance earlier this Spring at the New York Federal Reserve, the state action is critical: absent a significant liquidity infusion, debt service payments still remain highly susceptible to default in 2015—or, as the analysts put it this week: Atlantic City’s “future operations continue to face pressure from a large structural deficit.”

Unequal Odds. The Commonwealth of Puerto Rico has warned in its latest quarterly filing that it may place a moratorium on debt payments in FY2016 if the government is unable to enact a new tax plan and reduce its rate of spending growth to both balance the island’s budget and to begin to whittle away at its massive accumulated debt. Its combination of rising debt, sluggish economy, and falling population has lifted the yields on the Commonwealth’s debt above those of Greece amid growing uncertainty—and doubt—whether the Commonwealth can repay its debt on time and in full—and whether Congress will act to give the U.S. territory authority to renegotiate its debts in a U.S. bankruptcy court: because the island is not a state, there is no state to grant the territory—or its municipalities—authority to file for municipal bankruptcy and work out its debts through a plan of recovery under a federal court’s supervision. Thus, absent the kinds of legal and fiduciary protections available to all other Americans, the elected state and local leaders—and their citizens—increasingly confront a process likely to be far more uncertain and expensive: lawyers for all the different parties—bond holders, banks, bond insurance companies, and government entities—will probably have to rack up lots of billable hours as they seek the best outcome for their clients. Unsurprisingly, the territory’s many municipalities can hardly afford comparable legal representation, so that, absent Congressional action, there is a signal risk of municipal harm. In contrast, a group of 35 hedge funds have retained Morrison & Foerster, as well as Washington-based Robbins Russell Englert Orseck Untereiner & Sauber. That is, hedge funds and distressed-debt buyers, rather than the public, appear to have the upper hand. Indeed, for nearly two years, hedge funds and investors in riskier municipal debt have been purchasing Puerto Rico securities at distressed levels. There is no indication such purchases have anything to do with public purposes or the interests of the U.S. citizens. A group of 35 hedge funds, led by Fir Tree Partners and others, holds $4.5 billion of Puerto Rico debt: that is, these are businesses which purchased public debt at a discount, hoping to make a profit on Puerto Rico municipalities that can either avoid a default or that offer recover rates higher than what the hedge funds originally paid to own the bonds. Prices on Puerto Rico’s GO bonds maturing in July 2041 fell to as low at 55 cents on the dollar back in July 2014: now they are trading at about 66 cents, according to data compiled by Bloomberg.