Joseph Krist

Municipal Credit Consultant

THE GAMES BEGIN IN ILLINOIS

Before Gov. Bruce Rauner could even officially begin his term, the games have begun in Illinois. The Illinois General Assembly approved legislation last week establishing a special election in two years’ time for state comptroller in a move that clearly defies the wishes of the Gov.-elect. The Senate approved the measure by a 37-15 vote, with the House voting 66-40.  The move is the first indicator of the partisan divide that overhangs Illinois as it attempts to deal with its financial and pension predicament. Democrats said the legislation was in the spirit of democracy and good government, while Republicans called it a political power grab.

Rauner’s spokesman released a statement saying Democrats in the General Assembly “refused to take bipartisan steps” and “proceeded instead with a constitutionally dubious election bill.”  Outgoing Gov. Quinn had called a special session following Republican comptroller Judy Baar Topinka’s death in early December. Topinka was reelected to a second term in November, but died six weeks before taking the oath. A legal opinion from Attorney General Lisa Madigan determined that Quinn could appoint a replacement to serve until Jan. 12, when the current term expired, but that Rauner could name someone to serve the upcoming term.

In addition to the comptroller position, the bill also would apply to other vacancies that might occur in statewide constitutional offices going forward, except the governor’s office. Still, Republicans complained the move was designed to strip Rauner of his executive authority and an attempt to better place Democrats for the post in 2016. They also called it a purely partisan maneuver with one GOP state Sen. saying approval of the legislation “sets a new day in Springfield off on a disappointing foot. It poisons the well.”

GOV. BROWN PROPOSES FY 16 CA BUDGET

Governor Edmund G. Brown Jr.  proposed a budget last week that injects billions of dollars more into schools and health care coverage, holds college tuition steady and delivers on Propositions 1 and 2 by investing in long overdue water projects and saving money, while continuing to chip away at the state’s other long-term liabilities – debt, infrastructure, retiree health care and climate change.  “This carefully balanced budget builds for the future by saving money, paying down debt and investing in our state’s core needs,” said Governor Brown. “Our long-term fiscal health depends on the wise and prudent actions we take today.”

When Governor Brown took office in 2011, the state faced a $26.6 billion budget deficit and estimated annual shortfalls of roughly $20 billion. Since then, the state has eliminated these deficits with billions of dollars in cuts, an improving economy and new temporary revenue approved by California voters.

The Budget includes the first $532 million in expenditures from the Proposition 1 water bond to continue the implementation of the Water Action Plan, the administration’s five-year roadmap towards sustainable water management. Additionally, the Budget includes the last $1.1 billion in spending from the 2006 flood bond to bolster the state’s protection from floods. It also proposes $1 billion in cap-and-trade expenditures for the state’s continuing investments in low-carbon transportation, sustainable communities, energy efficiency, urban forests and high-speed rail.
Under the Budget, the state’s Rainy Day Fund plans for a total balance of $2.8 billion by the end of the fiscal year. The Budget spends an additional $1.2 billion from Proposition 2 funds on paying off loans from special funds and past liabilities from Proposition 98. In addition, the Budget repays the remaining $1 billion in deferrals to schools and community colleges, makes the last payment on the $15 billion in Economic Recovery Bonds that was borrowed to cover budget deficits from as far back as 2002 and repays local governments $533 million in mandate reimbursements.

In positive credit news for local school districts, K-12 school funding levels will increase by more than $2,600 per student in 2015-16 over 2011-12 levels. This reinvestment provides the opportunity to continue implementation of the Local Control Funding Formula. Rising state revenues mean that the state can continue implementing the formula well ahead of schedule. When the formula was adopted in 2013-14, funding was expected to be $47 billion in 2015-16. The Budget provides almost $4 billion more – with the formula instead allocating $50.7 billion this coming year.

University tuition almost doubled during the recession. The Budget commits $762 million to each of the university systems that is directly attributable to the passage of Proposition 30. This increased funding is provided contingent on tuition remaining flat. All cost containment strategies must be explored before asking for higher tuition.

Due principally to the implementation of federal health care reform, Medi-Cal caseload has increased from 7.9 million in 2012-13 to an estimated 12.2 million this coming year. The program now covers 32 percent of the state’s population. The state’s unfunded liability for retiree health care benefits is currently estimated at $72 billion. State health care benefits for retired employees remain one of the fastest growing areas of the state budget: in 2001, retiree health benefits made up 0.6 percent of the General Fund budget ($458 million) but today absorb 1.6 percent ($1.9 billion). Without action, the state’s unfunded liability will grow to $100 billion by 2020-21 and $300 billion by 2047-48. The Budget proposes a plan to make these benefits more affordable by adopting various measures to lower the growth in premium costs. The Budget calls for the state and its employees to share equally in the prefunding of retiree health benefits, to be phased in as labor contracts come up for renewal. Under this plan, investment returns will help pay for future benefits, just as with the state’s pension plans, to eventually eliminate the unfunded liability by 2044-45. Over the next 50 years, this approach is estimated to save nearly $200 billion.

DETROIT’S WAKE

Last week the Municipal Analyst Group of NY (MAGNY) held a discussion on the meaning and impacts of the Detroit bankruptcy now that the final opinions have been issued as of yearend. The panel assembled included advisors to the bankruptcy judge, a bond insurer, and holders of the City’s pension COPs. A few key takeaways from the meeting are as follows. The consensus is that the pace and results of the bankruptcy resulted from its relative speed. The pace seemed to be driven by politics – the politics of the 2014 gubernatorial election, a possible desire for higher office on the part of the Governor, and fears as to reliance upon the political infrastructure of the City.

The plan of adjustment that resulted – especially its reliance on the Grand Bargain for funding pensions – was cited as an outlier relative to other Chapter 9 proceedings. The fact that the City’s best asset in terms of monetary value – the art collection at the DIA – was effectively ring fenced throughout the negotiations between the City and its creditors contrasts with the actions of many other municipalities facing insolvency or bankruptcy. The sale of assets by Allentown and Harrisburg, PA were specifically noted as contrasting with the lack of asset sales by the City.

The result is that the plan of adjustment only had a real impact on the City’s balance sheet. It did not truly address the City’s operating culture or resources over the long term. This concerned many analysts as the process unfolded as it is clear that a mere reduction in the City’s debt payment obligations was insufficient to deal with its long term operating and economic issues. A good example is the City’s well documented problem with blighted properties.

With nearly 85,000 such properties, the City faces a herculean task to address these conditions and provide a more realistic footprint for the City. This will impact the scope of infrastructure restoration, the ability to develop new resources whether for economic or residential development, and has real impacts both current and long-term on the scope of the City’s operating demands and resources. As an example, over 50% of police and fire incidents responded to involve these properties. Current budgeted resources are clearly insufficient to address the current state of these parcels.

The net result is that on many levels, the bankruptcy has many negative implications for tax backed bondholders across the municipal market. The relative standing of pensioners relative to debt holders in favor of pensions was reinforced while the value of a voter approved debt issuance and tax pledge was effectively limited. In addition, the failure to meaningfully address long-term operations meant that bond holders will continue to be subject to many of the same risks that led to the bankruptcy in the first place. These include dysfunctional politics, inefficient operations, a weak economy, and a poor environment to support future economic growth. Each of these issues are strikes against the bondholder.

DETROIT SCHOOLS STILL FACE HUGE PROBLEMS

Gov. Rick Snyder of Michigan appointed a new emergency manager on Tuesday for the Detroit Public Schools, the fourth since 2009. About 47,000 students in kindergarten through high school attend Detroit’s 97 schools now, compared with 96,000 in existing schools in 2009.  In 2009, the school system had a $327 million deficit; this year the deficit was estimated at $169.5 million. The intent of Michigan’s emergency manager law has always been to quickly move cities and schools systems out of financial distress and back on their own, but Mr. Snyder said the problems in the school system were so great that an emergency manager must remain. The term of the current EM was due to run out so a replacement had to be named. He is was the emergency manager for the city of Flint, and he worked as Saginaw’s city manager before that. The Governor has ruled out bankruptcy for the Detroit Public Schools, a distinct legal and financial entity from the City of Detroit.

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