The Steep Road to Recovery from Municipal Bankruptcy

October 7, 2015

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

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

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

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

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

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

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Exiting Municipal Bankruptcy Does Not Necessarily End a Municipality’s Fiscal Challenges

eBlog

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

Sewer & Suer Rats. In a federal filing on which U.S. District Judge Abdul Kallon has scheduled trial to commence this July, the Securities and Exchange Commission (SEC) has filed a motion for summary judgment in its securities fraud case against two former JPMorgan bankers who were involved in Jefferson County’s more than $3.2 billion in sewer deals and swaps, [SEC v. Charles LeCroy & Douglas MacFaddin], writing that its case proves that Messieurs LeCroy and MacFaddin violated the securities act by failing to disclose payments to others who did no work on swaps between the county and JPMorgan―swaps which imposed higher fees on Jefferson County, and imposed higher rates on Jefferson County sewer system customers. The SEC wrote that Messiers LeCroy and MacFaddin also failed to disclose information about payments that would have been material to bond investors―even if the payments did not increase the county’s costs: “Any reasonable investor would have wanted to know that bonds in which he or she was investing were being offered by an underwriter who had procured the county’s business through a corrupt process of paying off friends and associates of [county] commissioners.” The swaps at issue were a key driver that forced what was, at the time, the largest municipal bankruptcy in U.S. history.

Will Hillview Have to Bite the Bullitt? S&P has downgraded Hillview, a 4th-class city in Bullitt County, Kentucky, with a population of approximately 8,172, from A- four notches to BB-plus, with S&P credit analyst Scott Nees noting: “The downgrade to ‘BB+’ reflects, in part, our view of the going concern opinion in the fiscal 2014 audit, in which the city’s auditor expressed doubts regarding Hillview’s ability to continue as a going concern.” Mr. Nees wrote that the circumstances reflect the unsuccessful appeal of a legal judgment where a jury determined that Hillview was in breach of contract (the breach involved a land purchase contract with a local trucking school, with damages of $11.4 million assessed against the city). Subsequently, a year ago, the state of Kentucky Court of Appeals delivered a decision affirming the Bullitt County Circuit Court’s prior decision dating back to 2012 that the city breached a land purchase contract with a local trucking school. The $11.4 million is currently accumulating interest at 12% per year and is not covered by the city’s insurance policy, but it represents nearly 1,000% of the small city’s cash on hand of $960,713 at the end of its most recent fiscal year (June 30, 2014). Mr. Nees added: “The negative outlook reflects our view of the potential for the deterioration in credit quality that could accompany a court decision against the city, the auditor’s going concern opinion in the city’s most recent audit report, and management’s inability to articulate a plan should Hillview be required to pay the settlement.” If the Kentucky Supreme Court sides against the city, S&P notes any subsequent rating will depend largely on the city leadership’s response—a response which could involve a settlement through the issuance of long-term debt—or a filing for chapter 9 municipal bankruptcy protection—an option which S&P understands the city’s leaders are considering. Under Kentucky law (Ky.Rev.Stat.Ann. §66.400), any taxing instrumentality may file a petition for municipal bankruptcy.

The Critical Role of Leadership

February 3, 2014
Visit the project blog: The Municipal Sustainability Project

Getting Ready to Roll. Today is not just scheduled to be frigid in Atlantic City, but also a critical day for the city to test the credit markets—as it seeks to refinance $12.8 million in debt due today—a task made more challenging with its quasi two headed leadership uncertainty between Mayor Don Guardian and the State of New Jersey. The Mayor has scheduled a special Atlantic City Council meeting for this morning to vote on repayment of the $12.8 million, which has a 1.75 percent interest rate and was used to pay for repairs after Hurricane Sandy in 2012. With Gov. Christie in the United Kingdom, it will be Mayor Guardian who reports he will be arranging an agreement to sell $12 million in short-term notes—after reporting at a statewide Republican convention that his city had been unable to sell the debt until receiving three offers last Friday―one in which the interest rate was too high, another which required the city to pledge state aid, and the winner—albeit he declined to give specifics of the offer or say which banks were involved. Of the three lenders who had expressed interest in making the loan, one wanted to charge 12 percent interest, another was willing to lend at a lower rate but wanted a state guarantee, which the state rejected, according to Mayor Guardian. The Mayor reported the City Council will vote today on a separate plan by which the city would come up with $800,000 to cover the final portion of the one-year notes that have come due, adding that Atlantic City could have repaid the full loan with cash—and was unwilling to accept loan terms deemed too expensive, adding: “It’s a great interest rate given our situation…We had a verbal agreement on Saturday and it should be coming through tonight or tomorrow morning and we’ll sign it.” The last minute refinancing comes in the wake of last week’s downgrading by Moody’s of $344 million in Atlantic City debt to Caa1 from Ba1, with the credit rating agency citing Governor Christie’s decision to install an emergency-management team that includes Kevin Lavin and Kevyn Orr.

The Role of Leadership in Recovering from Municipal Bankruptcy. Motor City Mayor Duggan, who is scheduled to deliver his State of the City address a week from this evening, was left to skipper a ship he had neither built nor set the course for when U.S. Bankruptcy Judge Steven Rhodes approved former emergency manager Kevyn Orr’s plan of debt adjustment early this winter. A key difference among the states which have enacted legislation permitting municipalities to file for federal bankruptcy protection is with regard to whether—as in, say Alabama or California―the municipal elected leaders remain in command, or, as in say Michigan or Rhode Island―where the Governor designates a receiver (Rhode Island) or emergency manager, as in Michigan. Thus, for Mayor Duggan, he has been thrust into the unique position of implementing a recovery plan of debt adjustment—under state oversight—on which he—as the chief elected official—was given no role. That is a remarkable challenge. Nevertheless, as Amy Haimerl of Crain’s this week writes, Mayor Duggan has already earned high marks—even as the challenges now turn more complex. She writes:
Mike Duggan has juice. In his first year as Detroit mayor, he has shown that he’s got the power to move the intractable, to make the impossible possible. He’s got a way to make people believe, to step in line. When he stood up at his invocation last January and told the gathered crowd “we are not going to tolerate this kind of service in the city of Detroit,” it stood in ovation, agreeing and believing. One week in, the mayor had already impressed by getting trash picked up and roads plowed during a polar vortex. That required classic Duggan: a tactical mind, a no-nonsense demeanor and a willingness to play enforcer. He assumes anything can get done, and holds those around him to the same exacting standards he sets for himself.
He is also a man who lionizes the underdog, the one who speaks truth to power. But now he is the mayor. He is the power. And he doesn’t always appreciate truth-telling.

Ms. Hammerl beautifully quotes one executive who, understandably, was unwilling to be named, writing: “‘The mayor gets the highest marks from me…But he’s a tough S.O.B., and I wouldn’t want to be on the wrong side of him,’” noting that the Mayor “arguably has more to deal with than any mayor in America and, so far, he’s excelling at triaging the problems and pushing forward on solutions. But with speed comes the risk of haste and missteps.” Unsurprisingly, there is considerable anticipation – now that his feet are snow-broken—about what his long-term vision for the Motor City is—and, critically, how he will take on the still intractable problems. At the same time, Ms. Hammerl noted another integral part of municipal crisis leadership, quoting the CEO of the Kresge Foundation, Rip Rapson, referring to the Mayor: “He has rebalanced the machinery of democratic governance…The fact that we now take for granted the relationship between the mayor and council is nothing short of astounding. There was so much residual bitterness, and he navigated us to a place where it seems normal and right. If he’d accomplished nothing but that in his first year, it would have been a success.”

It is amazing, really, to think about. In Washington, where dysfunction is the rule of the day and where, notwithstanding the threat of ISIS, Congress appears ready to allow the U.S. Department of Homeland Security funding to expire this month, Mayor Duggan has had to deal with more than 500 water main breaks in the dead of winter; the Detroit Water & Sewerage Department shutting off the taps at thousands of homes; a devastating flood; and the snowiest winter on record. Part of it, of course, as former Cleveland Mayor, Ohio Governor, and U.S. Senator George Voinovich once said: ‘I have never been able to distinguish between a Republican versus a Democratic pothole: it’s just something that has to be fixed.” Nevertheless, for Mayor Duggan the list “to be fixed” is long, complex, and withering―or as Ms. Hammerl describes it: “If year one for Duggan was about speed and solving tactical problems, year two is about complexity and long-range thinking. The projects to be tackled are of a higher order and require nuanced solutions and collaboration. That doesn’t happen just with speed and determination, the two traits that served him well in year one.”

Selling Rats. The Securities and Exchange Commission has filed a motion for summary judgment in its securities fraud case against two former JPMorgan bankers who were involved in Jefferson County’s sewer deals and swaps. In its 50-page filing filed at the end of last week, the agency wrote that that its evidence is sufficient to prove that Charles LeCroy and Douglas MacFaddin, former directors of JP Morgan Securities, violated the securities act by failing to disclose payments to others who did no work on swaps between the county and JPMorgan―swaps which imposed significantly higher fees, and cost sewer system customers higher rates. The SEC also determined that the pair failed to disclose information about payments which would have been material to bond investors even if the payments did not increase the Jefferson County’s costs: “Any reasonable investor would have wanted to know that bonds in which he or she was investing were being offered by an underwriter who had procured the county’s business through a corrupt process of paying off friends and associates of [county] commissioners.” The approximately $3.2 billion in odoriferous sewer deals are viewed by most as at the heart of the complex municipal bankruptcy – indeed, described by many as a crime perpetrated against the county and its tax and ratepayers. In its motion, the SEC also wrote the bankers had a duty to disclose the improper payments, and that there are numerous undisputed facts upon which the court should also rule affirmatively. U.S. District Judge Abdul Kallon, who is scheduled to preside, has set an opening date for the trial of Bastille Day, July 14th. The scheduled trial comes in the wake of an SEC civil suit filed against the former bankers in November of 2009, alleging they made more than $8 million in undisclosed payments to close friends of certain county commissioners and broker-dealers to obtain Jefferson County’s business for JPMorgan. The case was delayed several years because the men sought to depose Douglas Goldberg, the senior vice president of CDR Financial Products Inc., and Jefferson County’s swap advisor. Mr. Goldberg was charged with conspiracy and wire fraud in a lengthy Department of Justice investigation into muni bid-rigging unrelated to Jefferson County; he was not allowed to give any statements under oath while the case against him was pending; and he was sentenced in May.