Daily Journal Considers Municipal Bankruptcy

The San Francisco Daily Journal, a sister publication to the Los Angeles Daily Journal, contacted me a couple of weeks ago.  This publication caters to the legal profession and its website appears to be available only to subscribers.  The reporter was kind enough to e-mail me a copy of her piece.

The editors of the Daily Journal decided that potential municipality bankruptcies was worth doing some research on.  Time will tell if Chapter 9 will be a new practice niche for California attorneys.  When the ball starts rolling, remember you heard it here first.  In the meantime, Jill Redhage provides a reasonable update on the subject at this moment in time.

MUNICIPALITIES FLIRT WITH BANKRUPTCY
Cities Flirt With Bankruptcy as Revenue and Spending Diverge

By Jill Redhage
Daily Journal Staff Writer

Are fat union contracts, relics from flusher times, going to send more California cities into bankruptcy this year?

City officials have been hiring insolvency lawyers across the state to help them answer that question, keeping those lawyers busy for the first time in years on the rarely tested issues unique to municipal bankruptcy. But experts say cities in shaky financial health can muddle along for as long as a decade without resorting to the last-gasp tactic of filing for bankruptcy.

That means the string of municipal bankruptcies forecasted for 2009 isn’t likely to materialize, although bets are still on for the next few years. Employee unions, for one, are pushing to take the tactic off the table – and with good financial reason, for them at least.

As much as 70 percent of many city budgets go to pay employees, and cities that sprang for more generous employee raises and pension spikes, when tax revenue was high and market returns were strong, are finding themselves in trouble now that their fortunes have plummeted.

One such city was Vallejo, which filed for bankruptcy protection last year under Chapter 9, the section of the bankruptcy code reserved for municipalities like counties, cities and other public entities. That city has rejected its collective bargaining agreements with its city employee unions, and a federal bankruptcy judge tasked it with striking new accords on an expedited basis. Pacific Grove, meanwhile, is mulling bankruptcy because of its pension debt to the California Public Employees Retirement System (CalPERS).

Some California cities appear poised for the same fate, while others are struggling mightily to balance their budgets. Stockton, Sacramento, Corte Madera, Victorville and Mammoth Lakes, to name a few, saw their bond ratings downgraded over the last year, making it more difficult for them to borrow money and attract investors. The San Francisco Chronicle reported this summer that Oakland was discussing Chapter 9 amid its $100 million budget deficit.

But for all the stresses that pension plans and salary increases can put on city budgets, experts say the reasons cities contemplate bankruptcy vary widely by city. Rio Vista, for one, has suffered expensive sewer problems for many years. Mammoth Lakes has said it will contemplate bankruptcy if it loses its appeal of a $30 million trial court judgment in a lawsuit with a developer. Desert Hot Springs, which filed for bankruptcy in 2001, couldn’t pay $3.1 million for a housing discrimination lawsuit it lost. Half Moon Bay’s Chapter 9 discussions were similarly inspired by an adverse court judgment. Isleton, home to 840 people, still faces $950,000 in unpaid debt, which accumulated due to years of inattention to its budget.

Standard & Poor’s California credit analyst Gabriel Petek said, on the whole, it’s good financial management that keeps cities solvent.

During the boom years from 2003 to 2006, property tax and sales tax revenues, which respectively constitute about 40 percent and 30 percent of a typical city’s revenue, were way up. Construction and development were bustling, and the employment rate was high.

Financial managers at some cities chose to amplify their spending apace with rising revenues, which jumped as much as 15 percent for some local governments, Petek said. But those decisions didn’t take into account that economic growth only tends to support annual spending increases of 3-5 percent.

“The cities in financial trouble are the ones that have committed themselves to generous salary increases and have committed themselves to [other] higher spending that are not supported by revenue growth,” Petek said.

Although he wouldn’t speculate on whether more cities were likely to declare bankruptcy, he did note that credit analysts tend to rank cities higher than corporations on creditworthiness.

“They have the advantage of being perpetual entities,” Petek said. “Even when they go through a period of stress or severe financial challenge, they generally continue to operate.”

Although a handful of cities have admitted to exploring Chapter 9 as an option, industry observers were split on whether California will soon see city bankruptcies en masse.

Bruce Bennett, the Los Angeles lawyer who was lead counsel to Orange County during its 1994 bankruptcy, dismissed expectations of a near-term wave of local bankruptcies.

“Do I expect an upsurge in municipal bankruptcies?” he said. “No. I think that the municipalities just got through their first moderately rough fiscal year. They’re in the middle of their worst fiscal year this year. If next year is fine, we’re not going to see an upswing in municipal bankruptcies.

“If we have another year of really distressed revenues? They’re more likely to have a problem,” Bennett said.

John Moorlach, who sits on the Orange County Board of Supervisors and foresaw the county’s bankruptcy back when he was an accountant, predicted four California municipal bankruptcies for 2009 in a December interview with Bloomberg News. He changed his tune slightly in a recent interview with the Daily Journal, forecasting that the wave will come instead over the next few years.

But the uncertainty surrounding whether Chapter 9 bankruptcies will soon rain down has inspired city employee unions, especially firefighters, to push hard in the state legislature to pass a bill that discourages and complicates the Chapter 9 bankruptcy filing process.

Senate Bill 88, an amended version of Assembly Bill 155, would require municipalities to gain approval from a state panel, the California Debt and Investment Advisory Commission, before it could file in federal bankruptcy court for Chapter 9 protection. Sponsored by Sen. Mark DeSaulnier, D-Concord, the bill hasn’t been passed by the legislature and is expected to resurface in the next legislative session.

Marc Levinson, Vallejo’s bankruptcy counsel, said the bankruptcy code has already built in a number of barriers to frivolous Chapter 9 filings, including that the municipality be insolvent – that is, cash poor and unable to pay its bills. The code also requires that entities prove they tried their best to stay out of bankruptcy and that the governing board, such as the city council, has passed a resolution to file for protection.

“[If the bill passes,] what have you accomplished?” Levinson asked. “You’ve basically put in a huge disincentive to file.”

DeSaulnier, on the other hand, said through a spokeswoman that Senate Bill 88 is meant to ensure that Chapter 9 filings are “truly used as a last resort, rather than a quick fix or negotiating tactic.” The bill is also meant to secure for the state a stake in the solvency of local governments. DeSaulnier’s office also pointed out that 26 states don’t allow municipal bankruptcies.

As to Chapter 9 being used willy-nilly: There have only been three municipal bankruptcies in California history – Vallejo in 2008, Desert Hot Springs in 2001, and Orange County in 1994. Local officials attest to steering clear of such filings to avoid the “career suicide” aspect of them. And bankruptcy lawyers call Chapter 9 pricey and inefficient.

“There shouldn’t be a panic about a rush to bankruptcy because there haven’t been any others,” Levinson said.

jill_redhage@dailyjournal.com

FIVE-YEAR LOOK BACKS

September 22

1999

The fall of 1999 would find me in a most unusual fund raising campaign for a very important Costa Mesa nonprofit organization.  The Daily Pilot’s Elise Gee’s “Senior Center kicks off fund-raising campaign—With help from the county’s tax collector, officials at the facility hope to raise $250,000,” announced our efforts.

The campaign was unique because the Costa Mesa Senior Center’s new executive director, Alan Myers, was not who his board of directors thought he was.  So much for checking references.  More on this in later editions.  And a neighboring and worthy senior center did not appreciate solicitations being directed in their area of influence.

It would make you wonder if you were living in novel, because the plot could not have been real.  But, I say this all too often.  Sometimes life is stranger than fiction.  Maybe some of the updates to come will also leave you scratching your head.

                Orange County’s tax collector wants your money – for a good cause, that is.  John Moorlach will head up the Costa Mesa Senior Center’s annual fund-raising campaign as the auxiliary committee’s honorary chairman, officials announced Tuesday at the campaign kickoff. 

    And he knows where you live.

                Moorlach has spearheaded a direct-mail campaign that will send 58,000 letters to the homes of Costa Mesa, Newport Beach and Corona del Mar residents.

                “Thirteen percent of the populations is over 65,” Moorlach said.  “That will double in a short time.  It will be busier here every year.  Someone like myself, who’s 40, should be planning ahead 20 years.”

September 23

1999

Andrea Figler of The Bond Buyer had a great headline:  “Orange Co. Upgraded By Moody’s—To Pre-Crisis Levels.”  This is the kind of headline you want to see.

By way of background, it was the County’s Pension Obligation Bonds that defaulted.  The relied on the largesse of the Bob Citron’s Orange County Investment Pool to satisfy any puts that were called, which could be done every week.  Not being able to honor the puts was cause for a technical default.

The county’s debt service in fiscal year 1998 was 10.4% of operating expenditures, nearly double the state metropolitan county median of 5.7%.  This perspective shows you what a burden the bankruptcy related debt put on the OC.  The upgrade in credit ratings was good news.

Here are the first few paragraphs:

                Moody’s Investors Service gave Orange County’s $1.5 billion of outstanding debt some of the largest upgrades in recent memory Wednesday afternoon, just five years after the county credit rating sank into a quagmire created by the largest municipal bankruptcy in history.

                The move, which included assigning the county an Aa3 issuer credit rating, restored the ratings on its pension debt to the level it enjoyed before the bankruptcy filing [lifted four notches, from Baa2 to A1].

                “We don’t think there was a kind of penalty box around the county because it was in bankruptcy,” said Ken Kurtz, who acknowledged that he could not recall another county upgrade as large.  “It’s a big upgrade.”

                Rather, he said, the major credit overhaul is due to a three-year management trend in fiscal prudence, evidenced by continued budget cuts, ongoing debt reduction, and a long-term pay-as-you-go capital improvement plan.

                County officials welcomed the move.  “I believe [the upgrade] is a real strong affirmation of the hard work . . . that we’ve all been pursuing at the County of Orange,” said County Treasurer-Tax Collector John Moorlach.

September 24

2004

On this day in history I made it to the Financial Times.  The title of the article held so much promise, “Schwarzenegger tackles ‘perfect storm’ of city pension plans – Problems with underfunded, over-generous California schemes are bringing action from the governor, reports Christopher Parkes.”  I guess London-based newspapers put the reporter’s name in the title.

We know now that all our current Governor does is form commissions to look at something.  But he doesn’t do anything.  That’s patronization, not tackling.  Oh well, maybe we’ll get some “action” out of our next Governor.  

My only quote made it to the box quote (the quote blown up within the article) in the article where the reporter discusses the recent vote by the Orange County Board of Supervisors to enhance benefits.

John Moorlach, the county treasurer, who forecast the county’s humiliating fiscal collapse in 1994 and was later hired to oversee recovery, knows where the trouble lies.  “It’s a political problem,” he told the Orange County Register.  “We have electeds who seem to believe the line that it doesn’t cost anything.”