Who Will Take Responsibility for Detroit’s Future?

January 19, 2016. Share on Twitter

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

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

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

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

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

Ethics & Their Role in Municipal Fiscal Distress

October 15, 2015. Share on Twitter

Unravelling SWAPs & Paying the Windy City’s Pipers. In a new report, the Chicago Civic Federation rendered its support for Mayor Rahm Emanuel’s City of Chicago proposed FY2016 budget of $7.8 billion—applauding the Mayor’s proposals to take on the Windy City’s public safety pension funding crisis, but expressing apprehension that perhaps the largest municipal property tax increase in U.S. history, by itself, might be insufficient to stabilize Chicago finances, especially given continued legal uncertainty with regard to the city’s public pension and retiree health care reforms. The big kahuna in the Mayor’s proposed FY2016 budget is a $1.26 billion property tax levy, an increase of more than 33% from the originally adopted FY2015 budget, rising in subsequent years to $544.2 million between FY2015 (payable in 2016) and FY2018 (payable in 2019) with those proceeds dedicated entirely to fund the city’s Police and Fire pension funds, with the always insightful federation leader Laurence Msall noting: “Mayor Emanuel and his team deserve credit for transparently outlining a plan to address one of the City’s most urgent financial crises,” adding, however, that “[G]reater sacrifice will be needed to address the pension funding crises for non-public safety funds, the liquidity crises at Chicago Public Schools (please see below for the criminal, ethical, and fiscal challenges to CPS), and Chicago’s ongoing structural deficit, urging the city to consider greater cost savings and efficiencies, “especially in public safety operations that have largely avoided budgetary scrutiny in recent years.” Mr. Msall noted that the Mayor’s FY’2016 budget reduces Chicago’s reliance on what the Federation terms “scoop and toss,” or what he notes is “an expensive practice which extends the life of existing [municipal] bonds and dramatically increases the cost of providing government services—” a practice Mayor Emanuel pledged to the Association he would phase out by FY2019, beginning with a $100 million reduction in FY2016. {Please note next item, “Gambling,” with regard to this prohibitive municipal finance process.] Nevertheless, Mr. Msall expressed apprehension with regard to the as yet unreleased portion of the city’s proposed budget on its plans for how to fund two significant potential expenses in its upcoming fiscal year: an additional $220 million pension contribution and an increase in retiree health care costs. In its proposal, the city’s budget assumes the state will act to adopt the Mayor’s proposed changes to the City’s pension funding schedule. Indeed, such legislation has passed both houses of the Illinois legislature; however, the bill has not been released for Governor Rauner’s signature, nor has Gov. Rauner indicated that he will sign it: without such a signature Chicago will be required to contribute an additional $220 million to its pension funds in the new fiscal year. Moreover, the city still faces uncertainty with regard to the ongoing litigation over its proposed phase-out of its retiree health care benefits—where an adverse court ruling could significantly increase retiree health care costs.

Gambling on a City’s Future. At the exceptional conference, Bankruptcy and Beyond, hosted by Professor Juliet Moringiello of the Widener Law School in Harrisburg, Pennsylvania last year, there was substantive focus on the dangers of municipal involvement with so-called swaps—or municipal instruments packaged by Wall Street to make bets on interest rates—bets which Bloomberg this week insightfully noted are “costing [Chicago] taxpayers at least $270 million since Moody’s Investors Service cut its rating to junk in May,” noting that while traditionally, the exchange of one kind of municipal security for another to change the maturity (bonds), quality of issues (stocks or bonds), or because investment objectives have changed has been a more or less regular practice—one which has left all too many municipalities susceptible to significant fees and risk; more recently, so-called swaps have expanded to include currency and interest rate swaps—all leading to increased payouts to Wall Street banks, but coming, as noted above, as the Windy City considers a record tax increase to cover its public pension liabilities—swap costs in this case that are more than the city spends annually for the collection of garbage at 613,000 homes, or the equivalent of hiring more than 2,000 police officers. And that is before the city is forced to pay the piper to unwind municipal derivatives as it considers still another round of municipal debt restructuring—a round which could cost the debt-stressed city $110 million to unwind derivatives on its water debt—or, as the ever prescient Richard Ciccarone, the CEO of Merritt Research Services: “I don’t think the public should be gambling with its funds…Save the speculation for people who risk their own money, not for taxpayers.” Indeed, as can be seen from Bloomberg’s chart, Chicago confronts enormous debts to banks—not to teach in its troubled schools or to protect it citizens, but almost as a penalty for failing for too many years to address its rising pensions and borrowings to cover debt service. Instead of such critical investments, the city—and other cities and counties, as Bloomberg noted, “and other municipal borrowers in the past decade made bets on the future direction of interest rates through agreements with banks to swap interest payments. But when rates fell under the Federal Reserve’s attempt to stimulate the economy after the financial crisis, many issuers ended up on the wrong side of the bets. Since then [municipal] issuers have paid at least $5 billion to unwind the agreements.” Indeed, the city was scheduled to sell $439 million worth of municipal of bonds yesterday—with nearly 20 percent set aside to cover some $70.2 million to end an interest-rate swap tied to variable-rate debt for the city’s sewer system—and that, as Bloomberg adds, is “on top of $185 million paid to unwind swaps on general-obligation and sales tax debt since May.”The estimated $270 million total also includes the cost to banks and other professionals to restructure, according to data Bloomberg compiled from city documents. Chicago owed as much as $396 million to banks in March, before the city started terminating the swap agreements, according to market values at the time. Saqib Bhatti, a Chicago-based fellow at the Roosevelt Institute, told Bloomberg: “We’re paying these fees at the same time the city is looking at the biggest tax increase in its history,” adding that he has been recommending that governments with swaps should push to cut the fees rather than pay Wall Street banks: “Working residents of the city are going to have to sacrifice for the city to pay these fees to the banks.”

Aiding & Abetting Municipal Fiscal Distress. While they might teach math in Michigan’s schools, it might be that ethics ought also to be mandatory there and in Chicago—both places of exceptional fiscal challenges, but with, seemingly, one common denominator: unethical behavior from the top with abhorrent fiscal consequences. Thus it was Tuesday that former Chicago Public Schools (CPS) head Barbara Byrd-Bennett pled guilty to her role in a scheme to steer $23 million in no-bid contracts to education firms for $2.3 million in bribes and kickbacks. As part of her agreement, prosecutors recommended that Ms. Byrd-Bennett serve 7.5 years in prison for one count of fraud—an agreement under which prosecutors said in return they would drop the 19 other fraud counts, each of which carried a maximum 20-year term. The disservice by which Ms. Byrd-Bennett harmed Chicago’s fiscal sustainability and its children’s future came from her own past disservice to Detroit, where, as the former Detroit Public Schools chief academic officer, she had stepped down in the wake of a federal investigation into a contract between the district and SUPES Academy, a training academy where she once worked.—an investigation in which prosecutors allege the scheme started in 2012 — the year Mayor Rahm Emanuel hired her to become Chicago’s school district CEO. The indictment alleged that the owners of the two education service and training firms offered her a job and a hefty one-time payment, a payment purported to be a lucrative signing bonus — once she left CPS. The indictment alleges Ms. Byrd-Bennett expected to receive kickbacks worth 10 percent of the value of the contracts, or close to $2.3 million—or enough as Ms. Byrd-Bennett emailed to executives more than three years’ ago so that she could make money, writing: “I have tuition to pay and casinos to visit.” Her untimely departure comes in the wake of leaving the Detroit Public Schools system with what, today, is $327 million in debt with no visible means of repayment, and contemplating municipal bankruptcy, even as its debt insurer, Assured Guaranty Ltd., is pressing the Michigan legislature to bar the system from such a filing. Without the agreement, the insurer has threatened to accelerate long-term debt payments, raising the annual payment amount from $21 million to $45 million. In some sense, Ms. Byrd-Bennett brought her unethical and criminal fiscal legacy with her: SUPES Academy and Synesi Associates LLC owners Gary Soloman and Thomas Vranas have been accused of offering Ms. Byrd-Bennett money, along with sporting-event tickets and other kickbacks, in exchange for the contracts. Synesi Associates, which trains principals and school administrators—one shudders to imagine what kind of training they offer, was awarded contracts with Detroit Public Schools under Ms. Byrd-Bennett’s tenure, according to records posted on DPS’ website.

The ABC’s of Municipal Fiscal Challenges. The Holland, Michigan, School District, more than 100 years old—as may be observed from one of its oldest photos—is, like many Michigan school districts, confronting sharp and unexpected enrollment declines—declines adversely affecting their bottom lines; or, as Moody’s yesterday moodily opined, Holland illustrates not the place to skate all Winter, but rather the kinds of severe fiscal challenges of too many Michigan school districts—districts facing declining enrollments, stagnant state aid, and limited ability to raise additional revenues. Holland, a city of about 33,000 in the southwestern part of the lower peninsula, not unlike Detroit, is confronting a severe fiscal, as opposed to scholastic challenge in its K-12 system—or, as Moody’s this week reported, the A-1 credit-rated school district, has experienced a 174-student drop in enrollment—a drop nearly double what the district had anticipated and budgeted for in its current fiscal year—an enrollment drop which translates into a revenue loss of $591,000 in state aid, or, as Moody’s moodily explains: “The enrollment decline is not only credit negative for the district, but reflects the widespread credit challenges that continue to face Michigan school districts.” Moody analyst David Levett wrote: “Such pressures have led us to downgrade 44 Michigan school districts this year.” Holland’s six consecutive general fund operating deficits have been driven primarily by declining enrollment and the ensuing reduction in state aid under Michigan’s per-pupil funding system. As Mr. Levett notes: “Although officials are still analyzing this year’s enrollment figures, the district’s long-term trend of enrollment declines is attributable to significant competition from charter schools and an aging population,” effectively a fiscal one-two punch—two trends, however, which appear to be schooling Michigan’s elementary and secondary school fiscal sustainability, albeit with a potential steepening of the downward curve—or, as Mr. Levett added: “Even [school] districts that plan for declines may miss the mark on the magnitude of those declines.” Demographics are contributing to the fiscal python squeeze; the Census Bureau reports Michigan’s under-18 population is projected to decline an estimated 13% from 2000 to 2012, so that, as Mr. Levett further writes, “The state’s funding structure, demographic trends and liberal enrollment policies create an unpredictable and competitive environment for districts.” Indeed, close to 80 percent of Michigan’s school districts with more than $25 million in outstanding municipal debt experienced enrollment declines between 2009 and 2013—creating not just arithmetic opportunities for the system’s students, but math problems for the state’s school fiscal officers.

Restructuring Municipal Debt & Supermunis. Treasury Department and Puerto Rico officials are negotiating options for restructuring the U.S. commonwealth’s $72 billion in debts, especially with it becoming increasingly clear that the absentee U.S. Congress is unlikely to take any action to ensure Puerto Rico can avoid insolvency and be unable to provide essential public services. Under the evolving plan, the Treasury, or an agreed upon third party, would be in charge of an account which held a significant portion of Puerto Rico’s tax revenues—which would, effectively, be designated to pay holders of so -called super municipal bonds—municipal bonds, in this instance, held by bond owners in Puerto Rico and every state in the country who agreed to trade in their existing bonds for the new hybrid—albeit, a post “haircut” hybrid which, as in the case of a municipal bankruptcy, would be worth less than before the exchange, but which would be backed by employment and other taxes that the U.S. Treasury would collect for the territory, as well as possibly some of Puerto Rico’s own Treasury revenues. Under the evolving proposal, Treasury would act as a kind of intermediary; it would not be providing the territory with any kind of direct financial assistance or any guarantee; rather its role would be to serve as a quasi-trusted third party in a financial arrangement under which the new super municipal bonds would not only be backed by a much broader range of taxes than those that back the individual bonds of the territory and its authorities currently, but also indirectly through the unprecedented role of the U.S. Treasury—protecting and providing greater assurance to Puerto Rico’s bondholders of repayment. The discussions have not resolved whether any Congressional legislation would be needed, albeit, it is clear that the U.S. territory’s elected leaders would have to agree to potential debt exchange.

The Desperate Price of Fiscal Unaccountability

October 14, 2015

Municipal 9-1-1. As U.S. District Court Judge Bernard Friedman noted late last month, the importance of Chapter 9 municipal bankruptcy is to ensure “the resources to provide [its] residents with basic police, fire, and emergency medical services that its residents need for their basic health and safety.” It is that very apprehension about such essential, lifesaving services that has been at the heart of the municipal bankruptcy turmoil of Rhode Island’s Coventry Fire District—one of four fire districts in a municipality of 36,000 people—and where each district has its own governing authority—and where, currently, a private ambulance company had been negotiating with local officials to provide “temporary/emergency” coverage in the Coventry Fire District during its fiscal crisis—but has backed out after several of its employees threatened to resign. Kent County Superior Court Judge Brian P. Stern presided last week as the district remains essentially paralyzed—its bank account is frozen; its firefighters have not been paid for about 45 days; and Fire Board Chairman Frank Palin had contacted a private fire service, Coastline, in the event the court orders the board to hire a private ambulance company. Judge Stern has issued a stern [yes, a pun] warning that the Coventry Fire District is approaching a public safety crisis and residents could be without fire protection in the imminent future. The judge issued an order that state emergency and revenue officials be notified that fire and rescue protection might end soon.

Indeed, the district has been in crisis mode for years: In May 2013, Judge Stern had ordered the Central district liquidated after the board and the union representing firefighters failed to reach a contract agreement, directing the board to sell off property and lay off employees to pay off its debts. The board sold off equipment, shrunk staff, and closed three of five fire stations; however, before the job was completed, former Rhode Island Gov. Lincoln Chafee stepped in and appointed the first of two receivers in May of 2014 to reorganize the department, and, if deemed necessary, to take the fire district into chapter 9 municipal bankruptcy—as former Rhode Island Supreme Court Judge Robert Flanders had done after his appointment as a state Receiver with Central Falls or Chocolateville in August, 2011. Ergo, by the New Year, the Governor had named a receiver, Mark Pfeiffer, appointed by Governor Gina Raimondo, directing a municipal bankruptcy reorganization through the state Department of Revenue.

The duration, however, was short-lived: last month, Mr. Pfeiffer and state revenue officials announced they were giving up trying to reorganize in the face of fierce opposition to his proposed plans of seeking chapter 9 bankruptcy for the fire district—fiery opposition from both the town’s elected leaders and fire district’s leaders. That adamant opposition appeared to be inflamed by Mr. Pfeiffer’s proposed five-year plan of debt adjustment’s inclusion of major contract concessions from the firefighters’ union; but also its proposal of tax increases.

Thus, U.S. U.S. Bankruptcy Court Judge Diane Finkle has granted the state’s request to withdraw the Central Coventry Fire District from chapter 9 municipal bankruptcy, effectively restoring control of the district back to the district’s fire board, noting: “Face it, the taxpayers want a different model,” adding it was time for the courts to get out of the way and the parties to resolve their issues through a “political or legislative” process. Judge Finkle’s decision puts control of the fire district back into the hands of its board, some of whom have made no secret that they want more affordable fire protection and rescue services, possibly even using volunteers and private ambulance service. But how to get there is uncertain: the District’s board of directors has just a week left in which to come up with a plan and put it before district voters at an annual budget meeting on Oct. 19th: the board will have to decide if it wants to return to the idea of liquidating the district — as voters in the neighboring Coventry Fire District did recently — or negotiate another contract with local firefighters.

Ergo, with an accumulating debt to Coventry Credit Union of about $465,000, and an accrued deficit of more than $600,000, the fire district is in a fiscal Twilight Zone amid a broader governance question with regard to whether the current system of fire districts ought to be replaced by town-wide fire departments and the elimination of fire districts. Yet, to date, the Coventry Town Council has proved unwilling to become involved in the fire district’s seeming insolvency—notwithstanding its ultimate responsibility for public safety or the town’s citizen, non-binding referendum last June to liquidate the fire district. Indeed, the town’s inaction appeared to provoke, last July, a letter from the Rhode Island Department of Revenue to warn Coventry’s elected leaders, in which the acting Director wrote: “[T]he Department of Revenue is operating under the premise that the Town of Coventry will assume responsibility for the safety and well-being of its residents…We fully expect the town to be taking the necessary steps to ensure that it will be able to provide fire protection services to the area covered by the Coventry Fire District in the event the district suspends its operations.” Noting the state was ready to help under Rhode Island’s Fiscal Stability Act, which makes it clear that “any and all costs incurred pursuant to the state’s involvement under the Fiscal Stability Act become obligations that must be paid by the locality.” In fact, that appears to be part of the hot potato problem: were the town’s fire district to dissolve, the town’s taxpayers would be forced to finance their services.

In this uncertain municipal governance and fiscally distressed environment, the fire district board has one week in which to complete and present a plan to voters about how fire and rescue services will be financed and provided to residents of the district.

In a state half the size of many counties, the multiplicity of governing districts and municipalities raises grave questions of not just fiscal accountability, but also the seemingly intractable nature of the fire district’s own charter—a charter which provides that only fire district voters have the authority to determine whether and how to tax district residents – a power apparently greater than even a state-appointed receiver’s, despite legislation passed last year to clear the way. Indeed, it was just that charter provision which imposed such a wrinkle in Rhode Island’s efforts to step in: U.S. Bankruptcy Court Judge Diane Finkle last July, during a municipal bankruptcy status conference, warned that portions of the state’s proposed five-year plan of debt adjustment would likely need voter approval—especially for the last four years of the plan wherein the plan called for tax increases once the state receiver had stepped aside and decision-making powers reverted to the fire district’s board—one of four in a town of about 35,000—and one where the Coventry Town Council has repeatedly refused to extend any further fiscal assistance to the district which already is in debt to the town for $300,000.

The Steep Road to Recovery from Municipal Bankruptcy

October 7, 2015

The Hard, but Critical Road to Recovery & Fiscal Sustainability. Few municipalities, especially compared to other corporations, go into bankruptcy. But for those that do, they do not disappear, as is the outcome in many corporate bankruptcies; rather they do not miss a beat with regard to providing essential services, even as they began the long and expensive process of putting Humpty Dumpty back together again by means of assembling a plan of debt adjustment in negotiations with their thousands upon thousands of creditors. While each of those plans must receive approval from a federal bankruptcy court—and the respected and respective judges do look to see that such proposed plans incorporate long-term fiscal sustainability provisions; nevertheless, those municipalities are not starting on a level playing field. So the question with regard to their ability to fully recover remains a story to be learned—because never before in American history has there been such a spate of major municipal bankruptcies. Ergo, unsurprisingly, Detroit—with its plan approved and the Mayor and Council restored to governance authority—in effect starts at a disadvantage compared to other municipalities: its road to climb is steep.

There is good news, however: a new report, “Estimating Home Equity Impacts from Rapid, Targeted Residential Demolition in Detroit, Michigan: Application of a Spatially-Dynamic Data System for Decision Support,” from the Skillman Foundation, Rock Ventures LLC, and Dynamo Metrics has found that the valuations of homes within 500 feet of a demolition funded by the U.S. Department of Treasury’s $100 million in Hardest Hit Funds have increased by an estimated 2.4 percent between December 2014 and May 2015. Indeed, blight removal has been a core element of any route to Motor City recovery: in May of 2014, the Detroit Blight Removal Task Force — which includes representatives from Detroit Public Schools, U-SNAP-BAC Inc. and Rock Ventures — identified more than 78,000 properties in need of sales, repair, or demolition. That is, federal help seems to have sparked a critical revival of affected assessed property values and, ergo, the Motor City’s revenues: the report found demolitions have increased the value of surrounding homes within 500 feet by 4.2 percent, or an average of $1,106. Citywide, that amounts to an increase in home values of more than $209 million. The bad news is that even as this innovative federal program is beginning to demonstrate its ability to contribute to Detroit’s comeback, the assistance in financing the demolition is drying up.

The report also suggests that combined with other efforts by the city—efforts which include code enforcement and sales of public assets such as side lots—have also begun to make telling fiscal differences: the value of homes nearby increased by 13.8 percent, or an average of $3,634. Citywide, that amounts to an increased assessed property value of about $410 million—or as Mayor Mike Duggan describes it: “The numbers are extraordinary,” noting that eliminating blight has allowed “good homes and good vacant homes” to increase in value: from January of last year until last, 5,812 blighted structures in the city were demolished thanks to funding from the federal “Hardest Hit” fund—a now drying up fund focusing nearly $8 billion in post Great Recession assistance foreclosure prevention in 18 states, including Michigan, with where Michigan’s share was over $498 million, of which Detroit received just over one fifth. Because those funds will be depleted this year, Mayor Duggan is planning to travel to Washington soon to meet with White House officials and others to lobby for the next round of money—especially since the demolitions to date have only addressed some 10 percent of the city’s blight.

Good Gnus. In its review of Chicago’s proposed FY2016 Budget, Kroll Bond Rating Agency (KBRA) reports it believes Mayor Rahm Emanuel’s budget includes “reasonable actions for closing the projected fiscal 2016 operating shortfall, and represents clear progress in confronting the challenges of unfunded pension liabilities.” The Budget closes the city’s FY2016 gap via proposed savings and reforms, efficiencies, and significantly increased property taxes from a four-year phased-in $543 million increase in the property tax levy, earmarked to specifically address rising police and fire pension liabilities. The rating agency wrote it believes the choice of a property tax levy increase demonstrates the Chicago’s political will to craft an effective and sustainable solution. Nevertheless, the agency noted there still remain numerous unresolved issues, which could potentially undermine budgetary goals: first, will the City Council, in an election year, approve the Mayor’s proposed budget? Second, the big shoulder city is relying on State action to increase the size of the home-owners property tax exemption, which would exempt homes valued at less than $250,000 from the increase—this a state legislature which is locked in a stalemate with the Governor. The phased-in property levy increases assume that Senate Bill 777, which reforms police and fire pension funding, will be enacted into law—and not be rejected by the Illinois Supreme Court. If not enacted, Chicago’s police and fire pension funding obligation would immediately rise from approximately $328 million to $550 million, and the city would have to identify and act on additional funding sources.

Not the Odor of Verbena. The Securities and Exchange Commission (SEC) has settled its almost six-year-old pay-to-pay case against two ex-JPMorgan bankers involved in hold-your-nose, soured sewer deals that thrust Jefferson County, Ala., into municipal bankruptcy. The SEC, according to a notice filed in federal court this week, reported it had reached agreement with Charles LeCroy and Douglas MacFaddin via mediation which resolves securities fraud charges against the two, albeit the actual terms of the settlement will not be made public until it is presented to the full commission for approval, with the independent federal securities agency advising the federal district court that, if the Commission approves the report, that would end litigation on the case. The long, simmering case dates back just about six years to when the SEC filed a civil suit alleging that Messieurs LeCroy and MacFaddin had improperly arranged payments to local broker-dealers in Alabama to assure that certain Jefferson County commissioners would award $5 billion in county sewer bond and swap deals to JPMorgan. The SEC suit, which charged that the two men “privately agreed with certain county commissioners to pay more than $8.2 million in 2002 and 2003 to close friends of the commissioners who either owned or worked at local broker-dealers,” sought declaratory and permanent injunctions against the two for federal securities law violations, as well as disgorgement of all profits they received as a result of their legal misbehavior, plus interest. The SEC had brought the suit simultaneously with its settlement of municipal securities fraud charges with the investment bank. Without admitting or denying the SEC’s charges, JPMorgan agreed to pay $75 million in penalties eventually turned over to Jefferson County, and to forfeit more than $647 million of claimed swap termination fees. In January, the SEC sought summary judgment in the case, leading U.S. District Court Judge Abdul Kallon to determine the five-year-old case was appropriate for mediation—this all in a case involving some nearly two dozen municipal elected officials, contractors, and county employees involved in Jefferson County’s sewer bond sales or construction of the sewer system who were jailed for bribery and fraud—and which led to what was, at the time, a filing for the largest municipal bankruptcy in U.S. history.

Wither Its Future—and Who Decides? Facing decades of structural budget gaps and unsustainable legacy costs, the City of Pittsburgh entered two forms of state oversight in 2004. In the subsequent decade, that engagement appeared to have been key to a turnaround in the city’s structural deficits, leading to annual positive fund balances, as the then-partnership helped restructure its crushing debt load, streamline an outsized government, and earn a triple-notch bond rating upgrade. Nevertheless, the Steel City still carried a $380 million pension liability, leaving questions with regard to whether the city was ready to graduate from state oversight – especially given the extra relief from restrictive state laws that the state’s Act 47 provides to city officials. Now that state-local tension seems to be back, with the Pennsylvania Intergovernmental Cooperation Authority (ICA), the city’s overseer, an authority state lawmakers formed in 2004 to oversee Pittsburgh’s finances, at a time the city was on the precipice of municipal bankruptcy, claiming it is justified by state law in withholding Pennsylvania gambling revenue from the city (ICA is invoking Act 71 of 2004, a state statute which grants, according to ICA, has “exclusive control” of the gaming revenues dedicated for Pittsburgh, the only second-class city under the commonwealth’s system of categorizing cities.), because, as the Intergovernmental Cooperation Authority’s Henry Sciortino, reports: “They haven’t met certain benchmarks.” Indeed, the former amity is now gone: Pittsburgh is suing the state agency in the Allegheny County Court of Common Pleas, accusing it of illegally withholding $10 million in annual gambling host city revenue funds the past two years related to the Rivers Casino—a costly dispute triggered by state agency claims that Pittsburgh Mayor Bill Peduto is backing off his commitment of $86.4 million to fully fund current payments to retirees – separate from the city’s overall unfunded pension liability estimated in the hundreds of millions. In addition, Mayor Peduto requested that Pennsylvania Auditor General Eugene DePasquale conduct an audit of the ICA—a request putting Mr. DePasquale now in a most awkward position in the wake of the city’s decision to file suit. Moreover, the city-state dispute—itself now becoming a costly court battle—arises even as the city faces daunting pension challenges: returns on the city’s employee pension funds have, according to the State Auditor, deteriorated from 16.3% in fiscal 2013 to 5.5% this year, reflecting the slowdown in financial markets, who estimates the city’s funds’ assets to be $675 million versus liabilities of almost $1.2 billion. Indeed, the Public Employee Retirement Commission considers Pittsburgh’s pension fund “moderately distressed.” In a letter to Gov. Tom Wolf and top legislative leaders a week ago, ICA Chairman Nicholas Varischetti called pension underfunding “one of the most serious barriers to Pittsburgh’s fiscal stability.” That statement comes in the wake of Pittsburgh’s efforts just five years ago to avoid a state takeover of its pension funds by earmarking nearly $750 million in parking revenues over three decades to prop its funding level above a state-mandated 50%. Keeping this growing state-local dispute constructive could matter: over the last decade, Pittsburgh has received 11 upgrades, most recently in early 2014 when S&P elevated its general obligation rating to A-plus, and Moody’s, just a year ago, revised its outlook to positive on the steel city’s general obligation bonds. The city’s suit alleges the ICA has been illegally withholding $10 million in annual gambling host city revenue funds the past two years, whilst, for its part, ICA officials claim Mayor Peduto is backing off his commitment of $86.4 million to fully fund current payments to retirees. Indeed, in an epistle to Gov. Tom Wolf, ICA Chairman Nicholas Varischetti wrote that pension underfunding was “one of the most serious barriers to Pittsburgh’s fiscal stability.” The state-local tension over the city’s pension liabilities is hardly new–five years ago Pittsburgh avoided a state takeover of its pension funds by earmarking nearly $750 million in parking revenues over 30 years to prop its funding level above a state-mandated 50%; however, once again, state apprehension is on the uptick that the city is, as one expert, David Fiorenza, a Villanova School of Business professor and a former chief financial officer of Radnor Township, said: Pa., said “[O]nce again the municipality is only fixing the leak and not curing the flooding problem of pension debt and other unfunded liabilities looming around like an albatross,” adding that he believes the state ICA can be a force to persuade cities to devote gambling revenues to other areas of the budget, such as pensions.

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

eBlog

September 21, 2015

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

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

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

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

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

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

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

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

September 11, 2015

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

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

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

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

Municipal Bankruptcy Is Large, Complicated, & Seemingly Unending

September 10, 2015

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

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

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

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

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

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

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

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