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.”

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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.”

The Hard Choices Forced by State or Local Fiscal Distress

eBlog

August 28, 2015

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

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

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

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

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

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

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).

Caught between Governance, Democracy, and Municipal Bankruptcy

August 3, 2015

Aching for a Fiscally Sustainable Tomorrow. Saturday marked the third anniversary of San Bernardino’s municipal bankruptcy filing—making it not only the longest period of any city in such a transition, but also a time of considerable public disruption. Because, in California, unlike Michigan or in a number of other states which authorize municipal bankruptcy, municipal elected officials remain in charge; only in the case of San Bernardino, even there—unlike Jefferson County—there has been significant change—a new Mayor, City Council, and City Attorney. Now even more could well be on the way. Candidates for the Third, Fifth, Sixth, and Seventh Ward Council Member positions, as well as for City Attorney, City Treasurer, and City Clerk, must file for election or re-election next November by the end of this week. For the bankrupt city’s voters and taxpayers, moreover, there is a tenuous balance between local control and the federal court. Almost as if in a twilight zone in a most disinterested state, San Bernardino is suspended not just in a time warp, but also in uncertainty as to critical decisions which will emerge not from their own elected leaders, but also U.S. Bankruptcy Judge Meredith Jury. That is, the city’s elected officials (and prospective challengers) bear not only their responsibility to their constituents and taxpayers, but also to be responsive to the federal court. Unsurprisingly, what might satisfy the federal bankruptcy court is less than likely to meet with citizens’/taxpayers’ hopes. Mayor Carey Davis provided his perspective: “I think there’s a fair amount of frustration on the part of residents with the protracted nature of this, but (bankruptcy) is a long and expensive process to move through…A lot of residents, I find, are surprised, because they saw filing the Plan of Adjustment as a completion. It required a considerable amount of effort to put together that Plan of Adjustment, and so the implementation of that, I think, is going to take just as much work — and I think it will be the most difficult time of the bankruptcy.” One of the terrible ironies of municipal bankruptcy is that a municipality that cannot meet its fiscal obligations is, after all, beset with very significant costs in bankruptcy: as of last February, San Bernardino had already more than doubled its budgeted costs for the municipal bankruptcy process from $4.1 to $9.3 million.

Pop Goes the Weasel. Sort of like the musical chairs game we played as kids, where when the music stopped—and one chair had been removed—someone was out. What is different is that in the case of Puerto Rico, with default now happening, and Puerto Rico’s government having suspended setting aside funds to meet its general obligation debt, the issue is rather which creditors will not be paid—especially in the wake of the Puerto Rico’s Treasury announcing that the government was not making the set asides—or, as Puerto Rico Secretary of the Treasury Juan Zaragoza put it in an interview: “We aren’t making the monthly deposits. But that does not mean in any way that we won’t pay our GO obligations.” Of course, it does not mean Puerto Rico will. As of today, the U.S. territory has moved into a fiscal Twilight Zone. Under legislation Governor Alejandro García Padilla signed, Puerto Rico is authorized to suspend set asides as long as it finds itself unable to borrow some $1.2 billion in intra-year funding or the Puerto Rico Infrastructure and Finance Authority cannot sell a $2.9 billion gas-tax supported bond. So, now the island—and its creditors—find themselves in a brave new fiscal world where—outside of municipal bankruptcy—there are few prescribed rules; moreover, unable to access federal bankruptcy, there is no federal bankruptcy judge to either ensure the protection of essential public services, much less to act as a referee amongst the clamoring creditors. Puerto Rico’s constitution prioritizes the payment of its guaranteed debt over any other financial need. The approved fiscal year 2015-2016 General Fund budget allocated $1.011 billion for general obligation debt, and a Treasury spokeswoman on Friday confirmed that the Government Development Bank had transferred about $170 million to the bond trustee for payments of its debts today.