Municipal Elections: Will They Provide a Platform for Fiscal Sustainability?

November 6, 2015. Share on Twitter

Voting for a City’s Post-Bankruptcy Future. In an election, where a majority, or four of the seven San Bernardino City Council seats were on the ballot, to determine half of the leaders who will shape whether and how San Bernardino might emerge from the longest municipal bankruptcy in U.S. history, only one-third of the city’s residents are even registered to vote. The greatest number of votes—in an election with an abysmal turnout of about 10 percent—came in the race for city Treasurer, where the incumbent, David Kennedy easily won reelection by a 2-1 margin. Or, as City Clerk Gigi Hanna, who was re-elected in an uncontested election, describes it: “It’s abysmal,” referring to the low turnout: “It’s a perennial problem in this area.” Councilman John Valdivia, who ran unopposed, was re-elected with 641 votes. In the 6th Ward, four candidates split a total of 983, while there were just over 1,500 votes cast in the 5th and 7th wards—where in the latter, 7th Ward Councilman Jim Mulvihill will face a runoff — albeit it remains uncertain who his opponent will be. Final, unofficial results appear to indicate that Bessine Littlefield Richard will face Roxanne Williams in a runoff for the 6th Ward. In the 5th Ward race, incumbent Henry Nickel won re-election with 66 percent of the vote, while incumbent San Bernardino Treasurer was easily reelected with 71 percent of the vote. In the city races where none of the candidates reach 50 percent, the top two vote-getters will advance to a February run-off. The runoff in the 7th – in the north end of the city, where the abysmal voter turnout was about 5% — centered on incumbent Councilmember Mulvihill, who had been elected two years ago in the wake of a recall election of Wendy McCammack. In the 6th Ward race to replace retiring Councilman Rikke Van Johnson, Littlefield Richard of San Bernardino County’s Workforce Development Department has been narrowly leading Roxanne Williams, a program specialist for the San Bernardino City Unified School District — 370 votes to 356 votes — reversing their order from the first round of results. However, both are assured placement on the runoff ballot, beating out Anthony Jones (156 votes) and Rafael Rawls (101 votes). Challenger Karmel Roe failed to dislodge the long-term hold of incumbent City Treasurer David Kennedy, who has served for some 24 years. A mortgage broker who ran for Mayor two years ago and the 5th Ward City Council in 2014, Mr. Roe attacked Treasurer Kennedy for not having done more to help a bankrupt city. The specific commitments Ms. Roe campaigned on that said she would do to change the office — demanding audits, taking control of the Finance Department, encouraging economic development in the city — are, however, not issues in the city which the treasurer is authorized to handle under the current city charter. Incumbent City Attorney Gary Saenz, City Clerk Gigi Hanna and 3rd Ward Councilman John Valdivia all, successfully—and unopposed, were re-elected.

Waiting for Godot. S&P yesterday reported it was keeping Atlantic City on credit watch negative as the credit rating agency awaits both an updated report by Emergency Manager Kevin Lavin and an expected decision by New Jersey Governor and aspiring GOP Presidential candidate Chris Christie whether and when he might sign into law a financial assistance package approved by the New Jersey State Legislature. Atlantic City Revenue Director Michael Stinson said he expects resolution on the fate of the legislature-approved rescue package by next week before the state Assembly and Senate return to session. If Gov. Christie takes no action before the new session, the five bills automatically become law, according to Mr. Stinson: “If the bills are passed than we are going to get revenue…The uncertainty of the bills should be resolved by next week.” Atlantic City, which is in a fiscal and governance Twilight Zone, with its municipal finances overseen by a state-appointed overseer and Mayor Don Guardian, is closing a $101 million budget deficit this year by firing employees, and crossing its fingers for a state assistance package approval. The city’s proposed budget, approved by the state’s Local Finance Board at the end of last month, depends on Governor and Presidential candidate Chris Christie’s approval of bills that would allow the city to spend $33.5 million of revenue from casinos that now goes to redevelopment projects and marketing. The Atlantic City budget was adopted nine months late, but came in time to mail fourth quarter tax bills and also fully funds its annual requirements for settled tax appeals. Emergency Manager Lavin, testifying before the legislature in Trenton, told state lawmakers the budget was an initial step to ease a fiscal crisis in the city, while Mayor Guardian testified: “We understand that we can’t get out of this by ourselves.” The unique partnership between Mayor Guardian and state-appointed emergency manager Lavin has led to the dismissal of more than 100 employees, reducing the city’s workforce by nearly a third, and deferring payments for employee pensions and health-care benefits, while continuing to meet Atlantic City’s obligations to its municipal bondholders. Nevertheless, S&P last month cut the city’s credit rating deeper into junk, because it had yet to lay out detailed plans for dealing with its fiscal distress. S&P ranks the debt B, five levels below investment grade. Moody’s Investors Service grades it two steps lower at Caa1.

S&P analysts Timothy Little and Lisa Schroeer noted in a report yesterday that while the state’s Local Finance Board approved a balanced Atlantic City 2015 budget in late September, that budget relies on anticipated revenues of $33.5 million in redirected casino taxes and $38.9 million in deferred pension and health care expenses. The pending assistance package adopted by the legislature last June of five bills would allow the redirection of casino taxes to pay debt service. S&P said the city reported it will be able to make an $11 million December 2015 debt service payment even the anticipated redirected casino tax revenue is not received. S&P dropped Atlantic City’s credit rating three notches by S&P in August due to uncertainty over whether it could meet its 2015 fiscal obligations. Now the city awaits both the decision of the peripatetic Gov. Christie as well as a second report from Emergency Manager Lavin which is expected anon. The city is rated Caa1 by Moody’s Investors Service.

Unaccountability? The road to municipal bankruptcy can be paved by inattention and unaccountability. Thus, a California audit of the City of Beaumont, an LA suburb, found that the city failed to properly account for nearly three quarters of a billion dollars’ worth of municipal bond transactions and that the municipality was unable to provide the State Controller’s office with any accounting records for the bond transactions—and that neither the current city management nor its employees were able to provide any information or records of bond transactions, according to the audit. Beaumont officials say they are already taking steps to address what the report called pervasive shortcomings resulting in non-existent accounting controls for the city: the state report found that 95% of the city’s internal control elements reviewed in an audit of fiscal years 2012-13 and 2012-14 were inadequate—or, as California Controller Betty Yee stated: “These kinds of deficiencies are of great concern,” adding: “However, I am encouraged that city leaders recognize the need to implement major improvements.” The audit uncovered widespread deficiencies that rendered them effectively non-existent, with 75 of 79 internal control elements determined to be inadequate, or, as Ms. Yee explained: “These kinds of deficiencies are of great concern, especially to the citizens of Beaumont, who rightly expect their city government to safeguard their tax dollars.” The state fiscal investigation came in the wake of an FBI and Riverside County District Attorney’s Office search conducted at Beaumont City Hall. Controller Yee launched her audit last May, a month after the Riverside County District Attorney’s office and the FBI executed warrants at City Hall, former City Manager Alan Kapanicas’ house, and the Beaumont offices of Urban Logic Consultants, a firm which had provided many of the city’s top managers on a contract basis. No charges have been filed, but the investigation is ongoing; the audit found improper accounting by three city agencies for bonds issued between 1993 and 2014.

Among the state findings:

• The city failed to properly account for bond transactions by three of its units, including financing and utility authorities and a community facilities district that together issued $626 million in bonds. As a result, the Controller’s team could not determine whether the bond proceeds were used for the intended purposes.
• The former city manager and former public works director, both principals of outside consultants that provided city staff, received fees from bond proceeds for their services. In the absence of any written agreements, it was unclear whether these services were separate from their responsibilities as city officials. These two officials approved payments to the consulting companies where they were principals, creating conflicts of interests.
• In 2008, Beaumont obtained a reseller’s permit from the state Board of Equalization, allowing it to purchase items outside the city without paying sales tax, even though the city did not appear to be in the business of selling goods. Beaumont also allowed one of its vendors to use the permit. The arrangement allowed the city to shift sales tax revenues from other jurisdictions by moving the supposed point of sale within its boundaries.
• The city did not consistently follow its competitive bidding laws. City staff bought equipment or let contracts for public works without competitive bidding, arguing that the vendor was the only source, yet failed to provide documents supporting this claim. In 2013, the city entered into a no-bid contract with Urban Logic Consultants that allowed engineering projects to be approved through “job cards” rather than open, competitive bidding.
• The city lacked receipts and descriptions for credit card purchases, supporting documentation for loans made to employees, and sufficient records for a loan to a private business. Invoices were missing, including purchases from a construction company totaling more than $1 million.
• For five years in a row, the city ended the fiscal year with material deficits of as much as $10 million in its General Fund. It did not have sufficient revenue to fund existing levels of service. The city said it would cover these deficits with $21.5 million owed by its redevelopment agency. However, the redevelopment agency has been dissolved and it is highly uncertain that amount can be collected.
• Beaumont failed to do timely bank reconciliations and did not segregate staff duties.

According to acting City Manager Elizabeth Gibbs-Urtiaga, the findings of the Controller’s office confirm what the City Council and the new city management team uncovered last summer, in the wake of which, last month, the former city manager signed a separation agreement valued at $213,702.75 to terminate his contract, according to city documents—or, as Beaumont Mayor Brenda Knight said in a statement: “We have been very busy correcting the business practices going forward.”

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

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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 Rocky Road to Insolvency

September 18, 2015

The Road to Insolvency. Moody’s yesterday cut Ferguson, Missouri’s credit rating by four notches, a downgrade the credit rating agency said reflected the “severe and rapid deterioration of the city’s financial position, possible deletion of fund balances in the near term, and limited options for restoring fiscal stability…” adding the municipality could be headed for insolvency as early as 2017. [In Missouri, any municipality or political subdivision may file for municipal bankruptcy protection (six cities have previously]. The downgrade for the municipality of 21,000—one of 116 municipalities in the St. Louis metro area—came in the wake of the release of the Ferguson Commission report, which was released this week–more than a year after we began in this blog looking at the fiscal complexity of hundreds of municipalities operating in metropolitan areas (there are, for instance, over 280 in the Chicago metropolitan region). The downgrade was a sign of the fiscal fallout from the fatal 2014 police shooting of Michael Brown. The Ferguson report concludes:
• the State of Missouri should establish a publicly accessible database tracking incidents when police use force;
• Missouri’s Attorney General should step in as a special prosecutor in those cases which lead to a death;
• Municipal and county police should be trained with regard to the “implicit bias” which shapes decisions by people who had never consider themselves racist;
• The court system should stop jailing residents for non-violent offenses, locking them away from the jobs they would need to pay off their fines and speeding tickets in the first place, noting, pointedly: “When someone is jailed for failure to pay tickets, the justice system has not removed a dangerous criminal from the streets. In many cases, it has simply removed a poor person from the streets.”

The report, commissioned last fall by Missouri Governor Jay Nixon to dissect to roots of Ferguson’s unrest, also calls for the state of Missouri to expand Medicaid coverage (Missouri is one of 19 states which has refused to do so; it also urges adoption of a $15 minimum wage (the current floor in Missouri is $7.65 an hour). It calls for a cap on the interest predatory payday lenders demand of the poor, and an end to childhood hunger. It recommends smarter transportation investments, a commitment to early childhood education, and disciplinary reform in elementary schools. It even demands “inclusionary zoning” policies to ensure more low-income housing gets built-in neighborhoods with good schools and opportunity. The report, nearly 200 pages long, seeks to weave and connect every interlocking policy problem — in education, housing, transportation, the courts, employment, law enforcement, public health — implicated in the racial inequality at the heart of Ferguson’s unrest. A March report from the U.S. Justice’s Civil Rights Division found the Ferguson police department engaged in unlawful and discriminatory practices partially driven by the city’s reliance on court fine revenue to support its budget. Advocacy groups have filed a series of lawsuits challenging municipal ticketing operations. Between draws in fiscal 2015 which ended June 30, and fiscal 2016 projections, city reserves are expected to fall by 70% compared to audited fiscal 2014 levels.

Moody’s downgrade impacts $6.7 million of outstanding Ferguson general obligation municipal bonds, $8.4 million of certificates of participation from a 2013 issue, and $1.5 million of 2012 certificates or COPs, with the agency noting its downgrade “reflects severe and rapid deterioration of the city’s financial position, possible depletion of fund balances in the near term, and limited options for restoring fiscal stability: “Key drivers of this precipitous drop are declining key revenues, unbudgeted expenditures, and escalating expenses related to ongoing litigation and the Department of Justice consent decree currently under negotiation…”We believe fiscal ramifications from these items could be significant and could result in insolvency…We expect additional detail within the next few months as to the city’s final audited fiscal 2015 results as well as options and financial strategies for addressing these looming costs.”

Ferguson Mayor James Knowles III yesterday responded to the Justice Department report, saying he appreciated the hard work and dedication of the Commission by interviewing hundreds of community stakeholders throughout the metropolitan area, which included Ferguson residents and many of its business owners.

One outcome of the fiscal deterioration and the killing of Michael Brown in the wake of the subsequent rioting focused attention on aggressive policing tactics and the heavy reliance on court fines to prop up local government budgets. Critics note that stiff court fines imposed by local governments like Ferguson’s result in aggressive policing tactics which disproportionally target low-income and minority residents. Along with taxes and other revenue streams in 2010, the city collected over $1.3 million in fines and fees collected by its court. For FY2015, Ferguson’s budget anticipates fine revenues to exceed $3 million – more than double the total from just five years earlier, according to the report. The increase was not tied to crime figures. Ferguson responds that the city has taken action to with new ordinances to limit the use of revenue generated by court fines and fees to 15% of its budget. The city has also revised various policies on collections. The Missouri State Auditor’s office launched probes into 10 local governments’ use of court fines to ensure they comply with the law and plans more. Most Missouri local governments face new restrictions on the use of municipal court fines under legislation signed in July by Gov. Jay Nixon—especially in the wake of the new state commission’s recommendation of a sweeping overhaul of police tactics and court fine practices.

Bankruptcy Protection? Senate Finance Committee Chairman Orrin Hatch (R-Utah) reports his Committee will “have to have a hearing” on whether Puerto Rico’s agencies should be able to use bankruptcy to reorganize their finances. Interestingly, Chairman Hatch is in a very unique position to act—as it is the Senate Judiciary Committee which has jurisdiction over municipal bankruptcy legislation—and where Mr. Hatch is not only a member, but also a former Chairman. A staff member on the Finance Committee indicated it likely such a hearing would occur the week after next. For his part, Chairman Hatch, who spoke with Puerto Rico Governor Padilla this week, said “I always intended to have a hearing, because it’s a serious problem and we need to resolve it,” adding that the U.S. citizens of Puerto Rico are in “real trouble.” Chairman Hatch reports that legislation extending chapter 9 municipal bankruptcy protection to Puerto Rico, co-sponsored by Sens. Charles Schumer (D-N.Y.) and Richard Blumenthal (D-Conn.) will be discussed when panel meets.

The Hard Choices Forced by State or Local Fiscal Distress

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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.

Can Default be Contagious?

August 7, 2015

Default & Its Consequences. Puerto Rico, in uncharted fiscal, and public health territory in the wake of its default and its current drought, confronts increased borrowing costs and greater public demands. The U.S. territory’s decision, last month, to cease setting aside funds to meet its general obligation bonds now raises constitutional and legal questions with regard to how and whether Puerto Rico will make payments to its general obligation bondholders next New Year’s Day, when a $375 million payment to GO bondholders is due. Because such obligations have a superior claim on revenues, that could force the government to syphon off fiscal resources from public services, including infrastructure, schools, health care, and other authorities in order to make the payment: that is, the Solomon’s Choice between essential public services and critical access to capital is looming. Article VI, §8 of the Puerto Rico constitution provides that “In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made in accordance with the order of priorities established by law.” Nevertheless, on Monday, Puerto Rico posted a statement on EMMA that it had “temporarily suspended” the set asides. Last month, Luis Cruz Batista, Puerto Rico’s Director of the Office of Management and Budget told El Vocero that the GO payment was not assured—an uncertainty confirmed this week by Government Development Bank President Melba Acosta Febo, who stated she could not guarantee the general obligation payment to bondholders would be made, albeit she made clear Puerto Rico working to improve the central government’s liquidity so that it would be able to make the payment, noting to El Vocero: “We recognize the GO’s priority over other debts and its difference from other debts, but we must also recognize that there is a duty of the state to maintain health services, education services, and some security to our people – we must look at those things.” Indeed, the island’s general obligation debt holds a superior claim to revenues compared with other government debts and claims, meaning that, for instance, motor vehicle fuel taxes, crude oil, and derivative products excise taxes, cigarette excise taxes and license fees allocated to the Puerto Rico Highways and Transportation Authority can be diverted to meet the island’s general obligation debt, at least according to the official statement for its March 2014 Puerto Rico GO bond sale. Moreover, there is authority to divert some rum tax payments allocated to the Puerto Rico Infrastructure and Finance Authority, as well as hotel occupancy tax revenues currently flowing to the Puerto Rico Convention Center District Authority in order to meet general obligation debt; however neither Puerto Rico’s constitution, nor its applicable laws specifically mandate funds to revert to the central government “even if other available resources of the commonwealth are insufficient for the payment of public debt.”

Promises, Promises…Could Puerto Rico Be Contagious? Just as Chicken Pox can be contagious, so too there can be apprehension that political promises to pay—when perceived to be welshed upon, can create contagion fears and higher costs to cities, counties, and states in other places—especially on state or local debt supported only by a legislature’s, county or city council’s promise to pay. Thus it is that S&P this week abruptly downgraded Chicago’s Metropolitan Pier and Exposition Authority’s rating from its stellar AAA status to near junk: why? Because Gov. Bruce Rauner and the Illinois legislature are in a stalemate: the state has yet to appropriate funds to meet its promises to pay the bondholders. It is unsurprising that state and local bondholders in other states, counties, and cities—observing an inability to make a promised payment—might insist upon a higher interest rate to reflect the political risk. Whereas a general obligation or revenue bond issued by a state, local government, or authority provides the municipal bondholders with claims to designated revenues, so-called appropriation bonds might be perceived to give bondholders claims only to promises to pay. Moody’s unmoodily this week illustrated the extreme distinctions: examining the Motor City’s municipal bankruptcy, the credit rating agency wrote that holders of Detroit’s certificates of participation, which had neither the city’s taxing power nor dedicated specific revenue streams, received only twelve percent of what they were owed—some 16 percent of what Detroit’s general obligation bond holders received under the city’s federally approved plan of debt adjustment. Under San Bernardino’s proposed plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury, the California municipality has proposed paying its pension-obligation bondholders only one cent on the dollar. Already the Puerto Rican contagion seems to be giving potential Jayhawk development finance authority bond investors the eeby-jeebies. With Kansas collecting $3.7 million less in taxes than anticipated this month, potential investors in the $1 billion of debt it is seeking to sell next week through its development finance authority to shore up its underfunded workers’ retirement system are almost certain to be affected—especially as the prospectus circulated to potential buyers warns that if Kansas does not allocate cash to pay investors, the agency “has no obligation to seek or obtain any source of moneys for deposit to the Revenue Account, other than State appropriations.”

Advice and Consent. The Wayne County Board yesterday voted 12-2 to enter into a consent agreement with the state to handle its financial emergency and avoid insolvency. The strong vote means Wayne County and Michigan Treasurer Nick Khouri have started the clock ticking over the next 30 days during which to negotiate a draft of an agreement—one which the County hopes would enhance its authority vis-à-vis labor contracts as well as allow the county to continue to maintain local control over its restructuring. Wayne County Executive Warren Evans noted: “Today Wayne County continues on its road to financial recovery…We have already made significant strides towards getting Wayne County back on the right fiscal path. The consent agreement will ensure our ability to fully implement our recovery plan and stabilize the county for the future.” The next steps are to negotiate with the state over the terms of a consent agreement, or, as Executive Evans noted: “As we finalize the terms of the consent agreement with the state Treasurer, we will continue in our commitment to negotiate in good faith with our unions…Although a consent agreement will eventually give the county the ability to set the terms of employment, our preference is to reach agreements at the bargaining table.” Any final consent decree will affect Detroit—the County seat in the middle of Wayne County—thus one might imagine a double helix with the city and county interlinked in their fiscal fates.

Heard It Through the Grapevine. First recorded 49 years ago in Detroit by producer Norman Whitfield with various Motown artists by the Miracles on August 6th, yesterday’s anniversary marked a miracle of a different kind: Detroit posted preliminary bond documents for what will be its first public sale of municipal bonds since its historic municipal bankruptcy: sale through the Michigan Finance Authority is tentatively set for a week from Wednesday, marking the city’s first public market access since it received the rhythm guitar playing U.S. Bankruptcy Judge Steven Rhodes’ approval of its plan of debt adjustment of the largest municipal bankruptcy in U.S. history last December. In contrast to the kinds of appropriation bonds which have both worried investors and driven up the cost of borrowing for states and local governments, this new issuance is expected to benefit from a remarkable state role through which Michigan makes use of a statutory lien on income-tax revenue and an intercept feature by means of which the income-tax revenue is first routed to a bond trustee before the rest is sent back to the city—meaning that S&P has already assigned an A rating to the deal. In addition to the relatively unique statutory lien and intercept feature, the sale also provides that about 8 percent of the income-tax revenue, will first be sent to the police budget, a pledge that is senior to bondholders’ under the deal. The Motor City is issuing the debt to repay Barclays for a $275 million loan, the proceeds of which the city used to help finance its exit from municipal bankruptcy. Notwithstanding the nice rating and excitement about the city’s return to the bond market, Detroit’s preliminary municipal bond documents hint at the uncertainty of how the liens might be interpreted in a U.S. bankruptcy court: “The bankruptcy court would not be bound by legal opinions other than binding precedent, and there currently is no binding precedent regarding these matters…Thus, the opinion of bond counsel to the city is not (and cannot be) a guaranty that the pledged income tax revenues would be treated as subject to a statutory trust or lien.” The documents note other potential risks, including the possibility of another bankruptcy filing; the uncertainty of future income tax revenue; limitation on rate of income tax; and Detroit’s economic and fiscal condition.

Yet, as Motown singer Ted Nugent, in his “Motor City Madhouse Lyrics” sings:

Who! Welcome to my town
High energy is all around tonight
Who! You best beware
Well, Detroit city, she’s the place to be.

Municipal Default & Consequences

August 6, 2015

Default & Its Consequences. Puerto Rico is in uncharted fiscal and physical territory in the wake of its default, and now faces a severe physical and fiscal drought. Lacking the protections to ensure the ability to provide essential public services under municipal bankruptcy, the drought threatens to syphon off already insufficient resources—almost certainly forcing further defaults—a fiscal situation which will make the island’s cost of borrowing increasingly prohibitive. Put another way, further credit downgrades could pose a serious challenge to Puerto Rico’s post-crisis recovery. With nearly 13 percent of the island under an extreme drought, the U.S. territory’s public utility will be providing water only every third day, raising the total facing 48-hour cuts in service to 400,000, as Puerto Rico’s main reservoirs continue to shrink, according to the island’s water and sewer company. Last month was the fourth-driest month on record in San Juan since 1898. Now the drought has forced some businesses in Puerto Rico to temporarily close—closures which will further erode critical tax revenues, including recently increased sales and use tax revenues. But the island’s travails will have widespread fiscal reverberations: if Puerto Rico fails to make interest payments on its $72 billion public debt, pension funds across the U.S. could find themselves unable to meet their own payment obligations. Thus, even as Congress has slipped out of town without any consideration of what threatens to become a much more national financial crisis, tens of thousands of Americans in Puerto Rico are facing an immediate issue—one with potential serious health and safety consequences—and one which even a simple debt restructuring, were Puerto Rico’s bondholders to agree to it — would not resolve the fiscal and increasingly physical challenge. Absent some intervention, the U.S. territory, with a population of 3.6 million, assumes that each and every person on the island would need to pay $1,400 a year — 9 percent of Puerto Rico’s per-capita income — just to cover this year’s $5 billion principal and interest payments on the debt.

Advice and Consent. Wayne County Executive Warren Evans told his fellow commissioners yesterday that agreeing to a consent agreement is Wayne County’s only option for resolving its financial emergency: “It’s the only rational option…It keeps power in the county’s hands.” Mr. Evans’ remarks came as he and his colleagues must opt for one of four options under Michigan law: a consent agreement, mediation, appointment of an emergency manager, or Chapter 9 municipal bankruptcy. Mr. Evans added, yesterday, that Michigan State Treasurer Nick Khouri had told him earlier in the day that the county could be released from a consent agreement as early as next April. Commissioner Burton Leland, D-Detroit, said the panel’s realistic choices are limited. “There are really only a couple of options,” he said. “Bankruptcy and emergency manager aren’t really options.” Commissioners have until 5 p.m. today to make their decision—with the most radical to, in effect, remove themselves and hand over power and governance authority to an unelected emergency manager. For his part, the County Executive made clear he would prefer a consent agreement: such an agreement, he said, would spell out specific budgetary reforms the county would have to meet, adding that power is only a tool—and one he would not necessarily need to use if cost-saving contracts with Wayne County’s labor unions could be negotiated, noting: “I would much rather negotiate contracts with our unions than impose them…Because I have the hammer doesn’t mean I drop it.” Leaders of Wayne County’s public unions asked commissioners to consider how their decision might impact workers before they vote, with Edward McNeil of AFSCME testifying: “You commissioners were asking (Executive Evans) if the consent agreement would take away your power…If you go with a consent agreement, you take away our power to sit down and negotiate (a contract) on equal footing.” The issue confronting the elected leaders is how they can address a $52 million annual structural deficit—a deficit caught between the Scylla of a $100 million drop in annual property tax revenue since 2008 and the Charybdis of the county’s desperately underfunded pension system: Wayne County’s primary pension plan is 45 percent funded and has a liability of $910.5 million, based on the latest actuarial valuation. Officials currently project Wayne County’s deficit could reach $171.4 million by FY2019 absent immediate fiscal steps.

Rolling the Fiscal Dice. Standard & Poor’s Monday cut Atlantic City’s general obligation credit rating three notches to BB, citing uncertainty over whether the fiscally stressed municipality can meet its fiscal obligations this year, with S&P analyst Timothy Little commenting that Atlantic City confronts short-term fiscal risks from the “lack of a clear plan” to plug an estimated 2015 deficit of $101 million, adopting a 2016 fiscal budget and achieving tax collection projections. Mr. Littler noted: “The downgrade reflects continued uncertainty regarding the long-term fiscal stability and recovery of the city as it responds to increasing liabilities from tax appeals and an eroding tax base… [it] reflects our view that the city is more vulnerable to nonpayment since our last review given that three months have passed without additional clarity on how the city will propose to resolve its long-term financial challenges.” The downgrade came as the city—rather than awaiting tonight’s GOP debate—instead is frustrated by the delay in action by Gov. Chris Christie. Atlantic City Revenue Director Michael Stinson made clear that Atlantic City not only has met its August debt payments, but also that he expects a balanced budget to be achieved in early September, provided Gov. Christie signs legislation to implement a state fiscal package which would provide the city with additional revenue. Mr. Stinson added that Atlantic City was successful in selling some $40.5 million in Municipal Qualified Bond Act (MQBA) bonds last May to pay off a state loan and that tourism has been up this summer, noting: “There has been nothing negative happening to the city since we issued those bonds in May…A downgrade at this point is unwarranted.” But S&P’s Little wrote that although Atlantic City was able to address immediate financial and liquidity pressures through the MQBA bonds, the future ability of Atlantic City to the municipal bond market remained more of a gamble, adding that since the release last March of a 60-day report from the city’s emergency manager Kevin Lavin, there has been no clarity on potential payment deferrals. Indeed, on July 1st, Mr. Lavin said that all options are on the table with a potential municipal bankruptcy filing not ruled out—in effect reemphasizing the confused governance situation with regard to his role and relationship with Mayor Don Guardian, leading Mr. Little to note: “The lack of clear and implementable reforms to restore fiscal solvency without payment deferrals or debt restructuring remains uncertain as the city continues to operate in a difficult fiscal environment.”

Is Municipal Bankruptcy a Dirty Word? Moody’s, in a decidedly unmoody examination, today wrote that the nation’s city and county leaders no longer consider municipal bankruptcy to be taboo; rather, they said, fiscally distressed cities and counties in those states which authorize chapter 9 municipal bankruptcy are increasingly likely to consider it a viable option, based upon their examination of recent municipal bankruptcies, adding that “The number of general government bankruptcies following the recession remains low, but is still remarkable compared to the long-term experience of the U.S. municipal market since World War II.” They noted that four of the five largest municipal bankruptcy filings in U.S. history have been made in a little more than three years, a record they attributed to a slow recovery from the Great Recession, but also to changing attitudes about debt. But they also noted that the successful recovery from municipal bankruptcy by municipalities such as Central Falls, Jefferson County, and Detroit—in addition to the willingness of investors to come back to defaulting cities like Wenatchee, Washington could further help change municipal investors’ perceptions with regard to default and bankruptcy: “In the apparent absence of a severe or prolonged capital markets penalty, it is not surprising that various governors, mayors, and other local government officials have come to consider bankruptcy as a potentially realistic and effective option for restructuring liabilities.” The magnificent seven also noted that while these municipal bankruptcies have gained wider acceptance and appear—at least so far—to have worked; they have been less friendly to municipal bondholders, noting especially that pensions have been largely protected, whilst municipal bondholders have taken steep cuts, adding: “A more frequent use of bankruptcy by distressed credits does not in and of itself alter our overall stable outlooks for the state and local government sectors, but it does underscore how the recent recession has resulted in significant pockets of pressure, ongoing challenges of balancing rising fixed costs against anti-tax sentiment and a tighter budgetary ‘new normal’ that is less resistant to new shocks…We expect that bankruptcy and default will remain infrequent among rated local governments and consequently expect no change to our broad distribution of municipal ratings.”

Public Service Delivery Insolvency

July 30, 2015

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

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

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

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

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

Puerto Rico & Greece: A Disparity

eBlog

July 6, 2015
Is Puerto Rico at the Tipping Point? Almost like an old hour clock, the sand is running out for Puerto Rico—defaults could occur as early as September—when an exchange of notes may be needed in order to maintain liquidity at the Government Development Bank (GDB) of Puerto Rico. With Puerto Rico running low on cash and Governor Padilla making clear the U.S. territory has no viable option but to restructure its debt, it remains to be seen if the rating agencies or other observers would see any exchange as voluntary. Last month, El Vocero reported that GDB leaders were meeting with investors about possible exchanges of up to $4 billion of GDB notes—an exchange, which, were it to happen—could avert the triggering of such note exchanges in September: the critical challenge, in effect, is to reorganize its debts without access to the U.S. Bankruptcy Courts, so Gov. Padilla has few options but to try and work with the government’s creditors. The government, in the financial report it released last week, at the end of its fiscal year, estimated it would end with a General Fund deficit between $705 million and $740 million, or 7.4 percent. Viewed from the perspective, however, of the report Gov. Padilla released last week, “Puerto Rico – A Way Forward,” which provided a far more comprehensive perspective and analysis, Puerto Rico’s General Fund government deficit in the just-ended fiscal year would be almost $2 billion—meaning the government now believes its FY2014 the General Fund ended with a $1.1 billion deficit—more than 30 percent greater than its initially announced $783 million.

An American Challenge. A swirl of events puts Puerto Rico’s looming insolvency in some context: Greek voters, by a significant margin, yesterday voted to reject the harsh conditions proposed by the European Union as a condition of a bailout. Mayhap ironically, the rejection came almost simultaneously with the award to the CEO’s of federally bailed out Fannie Mae and Freddie Mac CEO’s of annual salaries of $4 million, effective Wednesday. These two quasi federal agencies, which claim to be exempt from most state and local taxes, received a $187 billion federal bailout in 2008 to rescue them from insolvency. In contrast, of course, there has been no federal bailout of Detroit, Vallejo, Jefferson County, or Stockton—nor has one ever been contemplated for either San Bernardino or Puerto Rico. But what can strike one as perhaps odder is to contrast the significant efforts of the European union to reach out and help Greece compared to the seeming disinterest and unwillingness of the U.S. Congress to even provide a judicial process or access to a means to protect the health and safety of the U.S. citizens of Puerto Rico without any bailout. That is, while Europe is offering a conditional bailout to Greece with, admittedly, harsh terms; Puerto Rico has never requested a bailout: what it would like would be a federally, judicially overseen process to ensure continuity in its essential public services and a process overseen by a federal bankruptcy court to adjust its debts. 

Emergency Support. Gov. Rick Snyder last Thursday appointed a team to review Wayne County’s finances, a day after state officials determined the County is in probable financial distress, stating: “The individuals appointed today bring diverse and extensive experience to the review process…And given the county executive’s request for an expedited review, I have directed this review team to work as quickly and efficiently as possible, to establish a solid baseline of facts on the county’s finances and a report which we can collectively work from.” Gov. Snyder said members of the team include: Clarence Stone, director of Legal Affairs for the State Housing Development Authority; Jeffrey Bankowski, chief internal auditor, State Budget Office; Tom Davis, deputy director at the Senate Majority Policy Office; Sharon Madison, owner of design and construction firm Madison International, and Frederick Headen, legal adviser for the Michigan Department of Treasury. Mr. Headen brings experience as a former member of the financial review team for the city of Detroit that was appointed in December 2011. The review team will have up to 60 days to report to Gov. Snyder whether a financial emergency exists in Wayne County—albeit State Treasurer Nick Khouri, a member of the Local Emergency Financial Assistance Loan Board, said he expects the review to be completed within “weeks, not months.” The Michigan Board’s preliminary review found troubling conditions in Wayne, including:
• Deficits in the General Fund began in fiscal year 2008, with a deficit of $10.6 million. Without taking corrective steps, the county is projecting a $171.4 million deficit by fiscal year 2019;
• County officials had not filed an adequate or approved deficit elimination plan with the Department of Treasury since fiscal year 2010. No plan has been submitted for fiscal year 2014, which was due when the audit was submitted in March;
• During the past several years, the county’s taxable property values declined about 24 percent, reducing the amount of property taxes received. Since 2007, General Fund property tax revenues dropped more than $156 million, while total expenditures increased more than $50 million.
• The county’s primary pension plan is 45-percent funded and has a liability of $910.5 million based on the latest actuarial valuation in September 2013. In the past 10 years, the county’s underfunding of its pension plan has accelerated and its unfunded liability has increased to more than 18 times its 2004 balance.

Burning Issues in San Bernardino. The city of San Bernardino’s firefighters—even as the city is in municipal bankruptcy—are scheduled to receive a raise today—nearly a year after the city charter guaranteed it to them. The nearly $500,000 in base pay, overtime, pension, and post-retirement healthcare benefits from the bankrupt city will likely complicate the city’s trial—but reflect a separate reality: the severe drought in California and excessive heat have unleashed two major brush fires, both erupting just before the July 4th celebrations. The larger one, the Lake Fire, has consumed more than 31,000 acres in and around the San Gorgonio wilderness and southeast of Big Bear and has destroyed one home in the Burns Canyon area along with three outbuildings; the other fire threat, the Sterling Fire, came from the base of the hill east of Del Rosa Avenue in the City of San Bernardino. There is no way in putting together a plan of debt adjustment to anticipate the kinds of costly, essential services a city in bankruptcy might be called upon to provide. The fiery situation, however, is further complicated by apprehension by the city’s police union that it has still not received its COLA, which it claims is guaranteed by the same charter section (Please see box below for description of charter requirements.). Nevertheless, the City Council is not scheduled to approve that raise today. For their part, the city’s firefighters, apparently unaware of today’s council schedule, had issued a statement noting: “Judge Jury has made it clear that bankruptcy does not give city leaders license to ignore our Charter. The City’s decision to single out Firefighters for discriminatory treatment was both an inappropriate political act and a violation of law.” City Manager Allen Parker, who apparently was under the impression late last week that public safety units had already received raises, claimed the delay was another casualty of what he said was the fire union’s refusal to negotiate — a step technically required by the city’s charter. Mr. Parker added that he had forgotten about the raises until the firefighters told him at a recent meeting, adding that in most years, San Bernardino approves the salary change several months in August, and then retroactively pays the difference.

Section 186 of the city’s charter sets police and firefighter salaries as the average of 10 California cities with a population between 100,000 and 250,000. Each year, unions representing firefighters and fire management — and their counterparts in the Police Department — strike out the lowest-paying cities in the state, while city negotiators eliminate the highest-paying, until only 10 remain. In practice, that means the 10 cities represent the state average in pay for mid-sized cities. But critics of the charter section — which more than 55 percent of voters chose to retain in 2014, when presented with a ballot measure that would have set public safety salaries by collective bargaining as every other city in the state does — point out that San Bernardino, even before its bankruptcy, had median income far below the average mid-sized city. Among the 10 Southern California cities selected this year are Costa Mesa, Garden Grove, Irvine, Pasadena and Torrance. Collectively, for all of 115 of the city’s fire safety employees (firefighters, paramedic/firefighters, engineers and captains), the salary increase is nearly $258,000, and with overtime and related costs such as pension increases it adds, according to the city, $517,776 to the budget for 2014-15, the fiscal year that ended this week. The percent increase that individual employees will get varies by rank, ranging from 1.84 percent to 3.01 percent, and means monthly pay — before the overtime that tends to form a huge portion of firefighter salaries — begins at $5,679 for the least-experienced firefighters and reaches $9,349 for fire captains. That will be paid retroactively, as though it had gone into effect Aug. 1. No interest is paid.

July 2, 2015
Is Puerto Rico at the Tipping Point? Gov. Alejandro García Padilla of Puerto Rico has made clear the commonwealth cannot pay its full $72 billion in accumulated debt, a position backed up by this week’s report; rather the issue is how to come up with a credible plan to put the island’s finances and economy on sound footing, e.g. how to ensure the continuity of essential services while putting together a credible plan of debt adjustment—but, so far, without either the protection of municipal bankruptcy and its freeze of debts until such a plan is approved by a federal bankruptcy court, or any seeming possibility to come to an agreement with the island’s thousands of creditors. Thus, even though Gov. Padilla has made clear he is prepared to implement even deeper cuts in spending—on top of the 70,000 or nearly 25 percent cut in commonwealth jobs since 2009—he also recognizes that straight insolvency would have significant, life threatening consequences for thousands of his citizens. Thus, he is seeking some understanding from the commonwealth’s lenders, including mutual funds, hedge funds and other investors, to reduce the principal owed on some loans and allow more time to pay back other debts—even as it seems to have become increasingly clear that absent federal action to provide a time out in order for the island’s public corporations, such as its electric utility (PREPA) and highway authority, to restructure their $25 billion in debt in bankruptcy court (as every other corporation in the U.S. can), there is a growing risk to the Commonwealth’s future. To address its $47 billion in debt, the Gov. is asking creditors, voluntarily, to give Puerto Rico more time to pay back interest on its outstanding municipal bonds—bonds held by mutual funds and U.S. citizens in virtually every state in the U.S. With Congress not even in session this week, the Puerto Rico Electric Power Authority, PREPA, averted the most immediate fiscal threat when the public utility made its principal and interest payments on time—and reached agreement to continue negotiations with creditors to restructure its $9 billion of debt. Its bonds rallied. The utility also borrowed $128 million from bond insurers, including Assured Guaranty Ltd., with the provision that it will have to pay that debt back in December—an action that marked the first cliff and key step to avert default—and, maybe, a hint that its negotiations with its creditors may make some progress, not to mention free up some fiscal resources to modernize a public utility whose high electricity costs have left it saddled with unpaid bills. As part of the yesterday’s agreements, PREPA extended a forbearance pact with creditors until Sept. 15th, which will keep discussions out of court: that triggers a September 1st deadline by which the utility must negotiate a plan to overhaul its debts.

Help from the Capitol? Sens. Richard Blumenthal (D-Conn.) and Charles Schumer (D-N.Y) have announced they intend to introduce legislation to grant Chapter 9 bankruptcy authority to public entities in Puerto Rico—a companion bill to pending House legislation, albeit it remains somewhat uncertain whether a Senate version would be modified to give Puerto Rico itself authority to seek municipal bankruptcy. Under current law, unlike every state, Puerto Rico and other U.S. territories lack access to Chapter 9 bankruptcy authority to authorize municipalities to file for chapter 9 bankruptcy—a provision which allows a U.S. bankruptcy court to temporarily effectively freeze such city’s debt obligations to ensure that there is no interruption in essential public and life-saving services while negotiating with all its classes of creditors a plan of debt adjustment which would have to be approved by the federal court. That is, the House version of the bill would, if enacted, permit Puerto Rico to authorize its 147 municipalities access to federal bankruptcy—under whatever mechanisms the territory chose to impose, similar to the 36 states that have so acted; it would not, however, apply to Puerto Rico. Despite the introduction of the House version of the bill—introduced last February—the House Judiciary Committee has demonstrated no interest to date in acting. Its author, Rep. Pierluisi (D-P.R.) yesterday expressed his hope the bill would receive “careful consideration” in the Senate: “H.R. 870 does not require the federal government to spend a single dollar. It would simply grant the government of Puerto Rico a power that all state governments have, namely the ability to authorize one or more of its insolvent public enterprises to work out a path forward with its creditors under the supervision of a federal bankruptcy judge based on federal substantive and procedural law…It is clearly the best course of action for both Puerto Rico and its creditors. The alternative is a legal no-man’s land that benefits neither Puerto Rico nor those who have loaned the territory money.” Sen. Blumenthal responded to Politico that he and Sen. Schumer have received “strong interest” on the bill from both Democrats and Republicans. In perhaps a key change, the White House this week also expressed support for Congressional consideration of granting municipal bankruptcy authority to Puerto Rico, when White House press secretary Josh Earnest Monday told reporters there were “strong merits to having an orderly mechanism for Puerto Rico to manage the financial challenges of its public corporations if needed…We’ve urged Congress to take a close look at this particular issue…A Chapter 9 scenario that would be available to all of the 50 states is not one that’s currently available to Puerto Rico, and that’s something that only Congress can change.”

Emergency Support. Wayne County, one of the nation’s largest counties—and one which encompasses Detroit and other municipalities, as well as the insolvent Detroit Public Schools, and which is projecting a $171.4 million deficit by 2019 absent remedial actions—yesterday received some positive response to its request to the state: Michigan’s three-member Local Emergency Financial Assistance Loan Board approved a resolution of probable financial stress in Wayne County—a finding which triggers Gov. Rick Snyder’s authority to appoint a review team to take a deeper look at county finances. It could also, however, be a first step towards a state takeover or appointment of an emergency manager. The emergency loan board’s declaration is the first step in the process of declaring a financial emergency. Gov. Rick Snyder will now appoint a review team to delve deeper into the county’s finances. The team will then make a recommendation to Gov. Snyder, who will make the final decision. If the Governor agrees to declare a financial emergency, there would be four options for the county: municipal bankruptcy, and/or an emergency manager, a consent agreement, or a neutral evaluator.
The response came in the wake of County Executive Warren Evans’ request two week ago for Michigan to declare a financial emergency in the county; Executive Warren hopes to develop a consent agreement to address Wayne County’s financial crisis—a plan which would surely have repercussions for continuity in Detroit’s implementation of its federally approved plan of debt adjustment. After the Board’s unanimous vote, Michigan State Treasurer Nick Khouri noted that one of Wayne County’s biggest issues is its unfunded pension obligations, emphasizing the importance of speed in the state’s response: “The sooner we can get to solutions, the easier (it will be) for all residents of Wayne County…We want to move as quickly as we can,” adding that he thought it would be “weeks, not months,” before he is able to submit Gov. Snyder with the review team’s finding and recommendations. A spokesperson for Gov. Snyder noted: “We appreciate the hard work of County Executive Evans and his team and their seriousness and diligence in addressing some longstanding financial issues. We stand ready to work with them.” The Michigan loan board, composed of Treasurer Khouri, Mike Zimmer, director of the Michigan Department of Licensing and Regulatory Affairs, and Michigan Budget Director John Roberts, voted after a treasury official read highlights from the state’s final preliminary review report, which cited Wayne County’s unfinished jail, its $4.5 billion in long-term obligations, its failure to file an adequate deficit elimination plan since 2010, and other issues. The county is projecting a $171.4 million deficit by 2019 absent remedial actions. Both the Wayne County Commission and the County Executive’s Office were represented at the session: Dwayne Seals, Wayne’s Chief Fiscal Adviser and budget director, stressed the positives: he testified that the county deficit had increased, but at a lower rate than in the past; he added that the most current data demonstrates that the pension funding level is at 47% rather than 45%, and he predicted that the level would rise to 50% because of changes the county is undertaking—noting: “It’s a huge hole that we’re looking at, but we’re gradually climbing out of it.” Nevertheless, Jay Rising, who was representing the Snyder administration, warned id the positive changes were not “indicative” of a long-term recovery: “I think of some of these legacy cost issues are not something that can be handled without a consent agreement.”

Nevertheless, it was clear that fiscal stress also creates political and intergovernmental stress: Wayne County Commission Chairman Gary Woronchak (D-Dearborn), as he addressed commissioners during their scheduled full board meeting yesterday, noted that the commission submitted comments on the state’s interim report only a few hours before the state issued its final report of the preliminary review, but he was concerned and said that the commission felt the report contained certain financial data that was inaccurate and a “description of certain events that was, in our opinion, incomplete or mischaracterized.” Chairman Woronchak, who issued a revised estimate that the governor could declare a financial emergency within the next two weeks, took issue with claims by the state that the commission had not submitted any evidence or information, which would have caused the Treasury to amend its final report: “Rest assured,” he stated, “that if they had expressed interest in receiving ‘evidence,’ the form of our response would have been different. In any event, I strongly disagree with their conclusion, as we did our best to submit detailed financial and other information, and made extensive legal argument.” In fact, the commission took issue with several of the state’s findings, including a reference to the recent judgment levy facing county property taxpayers, noting that County Executive Evans had vetoed the commission’s attempt to pay the $49 million court judgment in a pension case without assessing the one-time tax. After the commission meeting, Commissioner Raymond Basham, D-Taylor, said that based on the speed of the review “The only way the Commission is going to have a role in this is if it’s a dinner roll.”

Rolling the Dice on a City’s Fiscal Future. Three months after an interim fiscal report urged “shared sacrifice” to turn severely fiscally distressed Atlantic City around, former (and, ergo exceptionally experienced) spokesperson for Detroit Emergency Manager Kevyn Orr, Bill Nowling—now the spokesman for Atlantic City’s emergency manager Kevin Lavin reports that all options remain on the table, noting yesterday that a negotiated solution with Atlantic City stakeholders would be the most ideal way to stabilize the city’s finances. Nevertheless, Mr. Nowling did not rule out a potential municipal bankruptcy filing as the city grapples with a $101 million budget gap, making clear that for Mr. Lavin: “All options are on the table.” Referring to Mr. Lavin’s March 22 report, which included suggestions for the city’s municipal bondholders, such as extending maturities, exploring refinancing opportunities that may reduce interest rates, and rearranging the amortization schedule of bonds to delay principal repayments—and included the appointment of mediators to work with union leadership and casino representatives on possible solutions in an effort to cut city expenses by $10 million this year, Mr. Nowling said: “The March plan the emergency manager put forward was crafted as the best way his team saw to reach a negotiated restructuring of Atlantic City’s financial issues for 2015 and beyond…A mutually agreed to resolution of the city’s financial emergency is the surest and most efficient way to long-term financial stability.” The statements and continued governance stress of having Mayor Guardian and a state-imposed emergency manager thus continues—even as Mayor Guardian and the City Council await to see if Gov. and now announced Presidential candidate Chris Christie will sign the legislation approved by the New Jersey Legislature, which Mayor Guardian cited as vital to Atlantic City’s fiscal sustainability at our session at the New York Federal Reserve, which would reallocate the casino alternative tax to pay debt service on Atlantic City-issued municipal debt: the New Jersey Legislature approved a package of bills on June 25 aimed at stabilizing Atlantic City finances that authorizes casinos to make payments in lieu of taxes over the next 15 years.

Protecting the Ability to Provide Essential Public Services

eBlog

July 1, 2015

Is Puerto Rico at the Tipping Point? As Puerto Rico nears insolvency, the White House and key members of Congress, perhaps observing events in Greece, appear to recognize that any reorganization of the U.S. territory’s debt outside of the U.S. judicial system would be chaotic and prohibitively expensive. Nevertheless, with Congress in recess, some of the island’s creditors are threatening they will continue to oppose any effort by Puerto Rico to have access to federal bankruptcy courts. Oppenheimer Funds, the largest holder of Puerto Rico debt among U.S. municipal bond funds, yesterday warned Puerto Rico it stands ready to defend the terms of the municipal bonds it holds, challenging Gov. Alejandro Padilla’s proposal to begin restructuring Puerto Rico’s debt and to postpone interest payments on outstanding Puerto Rican municipal bonds. Oppenheimer’s fierce denunciation came in the wake of Gov. Padilla’s proposal Monday to create a Working Group for the Economic Recovery of Puerto Rico, led by Chief of Staff Victor Suárez, Government Development Bank President Melba Acosta, Secretary of Justice César Miranda, and the Presidents of the Senate and House, Eduardo Bhatia and Jaime Perelló: with the group charged to develop a consensus on the restructuring of Puerto Rico’s public debt—or, as Gov. Padilla put it: “The ultimate goal is a negotiated moratorium with bondholders to postpone debt payments a number of years, so that the money can be invested here in Puerto Rico.” .That is, absent the kind of neutral referee created under the U.S. bankruptcy laws and courts, chaos could reign as Gov. Padilla seeks to restructure the island’s $73 billion debt to relieve its fiscal problems. Retired U.S. Bankruptcy Judge Steven Rhodes, who presided over Detroit’s 18 month municipal bankruptcy trial before approving its unprecedented plan of debt adjustment—a plan under which Detroit’s municipal bondholders took significant reductions—and who has been retained to assist Puerto Rico as it seeks to restructure its debts in a way that preserves the island’s abilities to provide essential public services, such as 9-1-1, water, street lights, etc. yesterday told Reuters it would be impractical to expect Puerto Rico to restructure its $72 billion of obligations outside the court system: “I just don’t think that an out-of-court negotiation process is feasible here…There are too many creditors, too many different kinds of creditors. They’re all over the place,” adding Puerto Rico will need access to federal bankruptcy courts for more than just its public agencies, which would be allowed under H.R. 870, a bill introduced by Rep. Pedro Pierluisi, Puerto Rico’s non-voting member of Congress: “The commonwealth itself needs access to Chapter 9 relief as well…Puerto Rico is not a state. It’s not a sovereign in the same sense that Michigan or Pennsylvania or Illinois is. Congress has complete and plenary authority over it. Without violating any of our constitutional principles, it could grant the commonwealth that relief, if it chose.”

The U.S. House Judiciary Committee has, to date, refused to take the bill up for consideration—especially in the face of a well-financed campaign by hedge funds lobbying against any Congressional action. Support from Congressional leaders for providing Puerto Rico access to U.S. bankruptcy began to build this week, however. Sen. Charles Schumer (D-NY), the third-highest ranking Democrat will sponsor a companion of H.R. 870. In addition, Josh Earnest, a spokesman for the White House, said that Congress should “take a look” at the bill. In addition, a spokeswoman for House Minority Leader Nancy Pelosi (D-Ca.) said the legislation should be voted on when the House of Representatives returns to work later this month.

The inaction in Congress follows rejection last year by a U.S. District Court of proposed Puerto Rican legislation which would have enabled Puerto Rico’s public corporations to file for federal bankruptcy protection: U.S. District Judge Francisco A. Besosa last February held that the proposed legislation, the Public Corporation Debt Enforcement and Recovery Act, violated the U.S. Constitution in a suit brought in federal court by municipal bond funds affiliated with Franklin Resources Inc., Oppenheimer Rochester Funds, and Blue Mountain Capital Management—firms which had sued Puerto Rico, arguing the law was unconstitutional and that, if enacted, would have depressed the value of the $2 billion in Puerto Rico power utility municipal bonds they held. Puerto Rico has appealed.

Oppenheimer Funds, which has an estimated $4.5 billion exposure on municipal bonds on behalf of its clients according to Morningstar, claims it believes Puerto Rico could repay municipal bondholders even while providing essential services to its citizens and taking steps to revitalize the island’s economy, adding that it stands ready “to defend the previously agreed to terms in each and every bond indenture,”—and that it is “disheartened that Governor Padilla, in a public forum, has called for negotiations with other creditors, representing and including the millions of individual Americans that hold Puerto Rico municipal bonds.” Oppenheimer’s statement came in the wake of Gov. Padilla’s statement Monday that his goal was to come up with a negotiated moratorium with the territory’s municipal bondholders to postpone debt payments for a number of years. No doubt, the fierceness of Oppenheimer and other of the island’s municipal bondholder servicers is related to recognition that in the resolutions of plan of adjustment approvals granted by the U.S. Bankruptcy courts in the Stockton and Detroit cases, the respective cities’ municipal bondholders took very steep haircuts—an outcome that clearly affected Puerto Rican bonds yesterday, which fell sharply for the second consecutive day, with general obligation 8 percent bonds maturing in 2035 as low as $64.50 versus a low of $68.75 on Monday. A Moody’s chart reflects the significant cuts bondholders took in the Vallejo, Detroit, and Stockton chapter 9 municipal bankruptcies—as well as the reductions proposed in San Bernardino’s proposed plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury. Almost 10 percent of municipal bonds that traded Monday were Puerto Rico-related, according to Janney Capital Markets. A key part of the drop, no doubt, came from downgrades by S&P and Fitch, with S&P warning that a default, distressed exchange, or redemption of Puerto Rico’s debt within the next six months seemed inevitable. Nevertheless, S&P reported it expects Puerto Rico to make its scheduled payment today of $655 million on general obligation debt; while Puerto Rico’s public utility corporation, PREPA, which has a current estimated debt in the range of $9 billion, is in discussions with creditors with regard to its own $400 million payment due today. One gets an appreciation of how fiercely municipal bond funds have been opposing giving access to the federal courts by Puerto Rico or any of its 147 municipalities: U.S. open-ended municipal bond funds have $11 billion of Puerto Rico bonds and nearly 53 percent of such funds have exposure to the commonwealth—with the biggest exposure including Franklin Templeton, which already was thoroughly bloodied in the Stockton federally approved resolution to its emergence from municipal bankruptcy.

Gov. Padilla, earlier this week, in the wake of the release of the Puerto Rico “Way Forward” report, made clear the U.S. territory could not pay all of its debt, even if it took strong measures to cut spending and increase revenues: “All the measures we have taken in the last two years reflect our willingness to pay and, had we not taken them, we would not be in a position today to request restructuring…We have done all that was within our power, but, as the report makes clear, the next step must be to ensure more favorable terms for the repayment of our debt.” That same day, the redoubtable Natalie Cohen of Wells Fargo Securities noted: “I agree that Puerto Rico’s current trajectory is unsustainable and lack of immediate action will only make its situation more painful to resolve. I thought the report was balanced and shows that without action, there is a financing gap of $3.7 billion in 2016, growing substantially in future years as Affordable Care Act reductions and loss of Act 154 benefits disappear (about 20% of General Fund revenues).”

• According to Gov. Padilla, the Working Group formed this week will create a long-term fiscal agenda by Aug. 30 aimed at:
  • Establishing the parameters for a five-year fiscal plan; proposing additional cuts in spending — including cuts in some services — to avoid an increase in taxes; * *Restructuring the Department of Treasury to increase the efficiency of income gathering;
• promoting alliances with the private sector to provide some of the services that are today provided by the public sector, such as the successful projects like the Moscoso Bridge, the airport, and the highway to Arecibo;
• radically changing the way in which we work with government finances and economic statistics, to establish greater transparency and credibility;
• guaranteeing our citizens’ essential services and our pensioners a just income; [and] creating a fiscal board which, outside political considerations, will guarantee the continuity and honor of the commitments agreed upon by us during the restructuring process.
• Seeking passage in Washington of Chapter 9 eligibility for Puerto Rico’s public corporations, a more equitable distribution of Medicare payments, and the end of the Jones Act, which increases costs of shipping to and from the island.

Retirees v. Municipal Bondholders. The incredible Boston Federal Reserve report, “Walking a Tightrope: Are U.S. State & Local Governments on a Fiscally Sustainable Path?” by Bo Shao and David Coyne came as increasing data makes clear that municipalities have never recovered in terms of employees from pre-recession levels—so there are fewer employees paying into municipal pensions—even as retirees appear to have the gall to live much longer than any previous generations: the teeter-totter is fiscally teetering. Thus, when Chicago Public School system, last week, announced it intended to issue some $1 billion in new debt to finance its $600 million-plus pension payment due yesterday; it created still another battlefront between firms like Oppenheimer and states and municipalities. It also appears to have been a key factor in Moody’s sharp downgrade of the Windy City’s credit rating—a downgrade Moody’s attributed almost entirely to Chicago’s pension issues—adding to apprehensions that should the Illinois legislature grant Chicago and other Illinois municipalities access to municipal bankruptcy, the municipalities’ constitutional and political inabilities to reign in pension liabilities could trigger future U.S. Bankruptcy court decisions that, as in Puerto Rico, would have signal repercussions for municipal bondholders. . In the bankruptcies of Detroit, Vallejo, Stockton and San Bernardino, bondholders have faced losses of up to 99% of their holdings, according to a Moody’s report dated May 18. Meanwhile all three California cities chose to preserve full pensions for their employees, while Detroit only cut pensions by approximately 18%.

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

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

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

Fighting over the Dregs

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