Providence drowns while Brown thrives
Municipalities across the country are looking to local non-profits to pay for their share of community services. These payments, known as PILOTs, or “payments in lieu of taxes,” are voluntarily contributed by private schools, hospitals and other non-profits as an alternative to paying property taxes. As cities come under more fiscal stress, this will be a growing trend.
The mayor of Providence, Rhode Island, Angel Taveras, is in a wrestling match with Brown University over increasing the school’s annual payments to the city. Taveras is angling to get a bigger sum from Brown, but if he is unsuccessful, then his only option to balance his city’s budget would be to get public unions to agree to concessions. Others, including Robert Flanders, the receiver of nearby Central Falls, believe that Providence’s only option is bankruptcy:
“I don’t see how [Providence] can get out of it without going there,” said Flanders, a former state Supreme Court justice and a partner at Hinckley, Allen & Snyder LLP in Providence. He put Central Falls into bankruptcy in August and has since torn up contracts with city workers and cut pension benefits.
The situation Flanders faced in Central Falls is significantly different from that of Providence. Although Central Falls has some churches and small non-profits in the community, its only major institution, the Wyatt Correctional Facility, refuses to pay the city a monthly $25,000 “impact fee” until its bondholders are paid off. On the other hand, Taveras is hamstrung by a 2003 agreement that requires small payments from the local universities. The best report on PILOTS, from the Lincoln Institute (page 25), describes the arrangement:
In 2003 the City of Providence reached an agreement with its four private colleges for payments in lieu of property taxes totaling $48 million over 20 years. At the time Mayor David Cicilline argued, “With total annual budgets of $750 million, combined endowments of $2 billion, and over 25,000 students – the vast majority of them from outside of Providence – these institutions are thriving in our city. Yet for all the annual police, fire, public-works, and other services these enormous institutions consume, they pay virtually no compensation to the city”
The $2.4 million Providence receives annually from its four private colleges is pretty small – less than 1 percent of the city’s budget. Consider how much revenue the city would have received last year if it collected full property taxes on Brown instead of the previously agreed upon PILOTs. According to its annual report (page 7), Brown had a 2011 university plant value of $897 million, or about 7 percent of the accessed property in the city. If property taxes were levied on the full value of Brown’s 241 buildings, then the university’s payment to the city would be about $19 million per year. Coincidentally, this equals almost the exact amount of the current Providence deficit.
Taveras, however, isn’t pushing for Brown to pay that whole sum. Rather, he is looking for about $7 million in PILOTs from all Providence non-profits. Nor is his request without its supporters at Brown: A small group of Brown students held a protest in February to encourage the university to provide bigger payments to the city.
A municipal bankruptcy does not ruin a state
Chart source: Bonddesk
State politicians in Alabama, Pennsylvania and Rhode Island have lambasted municipalities within their borders that have either declared, or attempted to declare, bankruptcy. The politicians gripe that when a municipality in their state goes into Chapter 9 bankruptcy, it affects the cost of borrowing for the state and other issuers located there. But this rests on the false assumption that markets do not discriminate between different borrowers. Municipal bond issuers, like public companies, are looked at individually because every entity has its own story. After all, when American Airlines went bankrupt, it was not as if all airlines suffered.
Alabama Governor Robert Bentley explicitly used the increased cost of borrowing for other Alabama towns as a bludgeon against Jefferson County officials who declared bankruptcy last November. The Birmingham News wrote:
He [Governor Robert Bentley] said the county’s situation already has affected borrowing throughout the state and he expects the bankruptcy to increase the cost of borrowing even more. “The credit rating of Jefferson County is terrible already so it can’t get much worse, but certainly filing bankruptcy does not help,” he said. “I know they were frustrated but at some point, you have to step up and have to be a leader and have to be a statesman and you have to do what’s right. Bankruptcy is not right.”
I remember thinking at the time that the governor seemed to be exaggerating the effect Jefferson County’s bankruptcy filing would have on the state. In discussions with Chris Shayne, the senior market strategist at Bonddesk, the leading alternative trading platform, I asked if it would be possible to compare the yields of a bankrupt municipality with those of its state. Chris and his team were able to pull six years of trade data and construct the chart above. Some amount of Jefferson County bonds and warrants are floating rate, so they have been excluded from the analysis. But you can still see that yields for the bankrupt county spiked way over the state’s borrowing cost. In his analysis Bonddesk’s Shayne said:
The main reason that the JeffCo bankruptcy was a non-event outside of Alabama is that it was not a surprise. The county has had well-documented financial troubles going back to the Great Recession of 2008. They were afflicted with a combination of serious problems, including heavy exposure to derivatives, fraudulent city officials, and difficulty raising new taxes. By the time they finally filed for bankruptcy protection last month, most observers were expecting the announcement. (It is also worth pointing out that neither JeffCo nor Harrisburg is large enough to roil the markets by themselves.)
The chart [above] shows that JeffCo yields increased substantially as soon as the trouble began to leak into the market. You can also see that prior to the distress in 2008 Jefferson County actually had lower bond yields than both the national median and the statewide median. Following the first sign of trouble, however, yields crossed over and remained elevated till they declared bankruptcy.
Rhode Island’s awful investment returns
It’s getting a little tiresome to hear all the adulation that’s being heaped on Gina Raimondo, the Rhode Island General Treasurer. She’s been praised in the Wall Street Journal, Time, and now CNBC as some sort of fiscal Joan of Arc who rescued the state’s public pension system from insolvency. I’ll give Raimondo credit for leading the charge to reduce benefits to Rhode Island public workers and increasing their retirement age, but she’s far from a pioneer in making tweaks to state pension plans – 17 other states have also made changes recently.
More importantly, the problems Raimondo addressed were not the biggest that the state faced. The main problem with Rhode Island’s pension system is that it has very poor investment returns on its $6.5 billion portfolio of assets. Over the past ten years the state’s investments returned 2.47 percent compared with the national median of 3.4 percent (page 6). These returns are in the lowest tier of state pension plans, and this chronic underperformance is causing a substantial shortage of assets to pay retirees.
A national clearinghouse for public pension fund data, the Public Fund Survey, wrote in its report for FY2010:
Over time, investment earnings have a major effect on the cost and funding condition of a public pension plan: from 1982 through 2009, investment earnings accounted for 60 percent of all public pension revenue.
So the major source of pension plan funding, investment returns on plan assets, has been terrible in Rhode Island. I’m not aware of any discussion or changes in the law to address this issue. Instead, state workers and retirees are carrying the load of getting the pension plan in better shape. The latest pension reform only addressed state worker conditions. Check out this list from WPRI.com:
Dear Ms Long,
Thanks so much for providing this information as well as your analysis. The Treasurer’s response to these dismal returns was that she’s “keeping an eye on risk.” Even with a risk averse portfolio, I find it hard to believe that she can’t do better for the state retirees, especially given her expertise in investing.
Please continue to monitor the situation.
Mary Williams Walsh, asleep in Rhode Island
In her 2,500 word feature on the pension reform process in Rhode Island, New York Times reporter Mary Williams Walsh seems to have found more color than facts. The piece reads more like a campaign profile of Treasurer Gina Raimondo than an assessment of the gritty fight over public pensions in the nation’s sixth smallest state:
Ms. Raimondo also learned early on about economic forces at work in her state. When she was in sixth grade, the Bulova watch factory, where her father worked, shut its doors. He was forced to retire early, on a sharply reduced pension; he then juggled part-time jobs.
“You can’t let people think that something’s going to be there if it’s not,” Ms. Raimondo said in an interview in her office in the pillared Statehouse, atop a hill in Providence. No one should be blindsided, she said. If pensions are in trouble, it’s better to deliver the news and give people time to make other plans.
Treasurer Raimondo did not initiate Rhode Island’s pension reform fight. We can give her credit for being a politician who is doing her job to rein in a plan that, for structural reasons, will consume a growing portion of state general fund revenues. But this fight began under the administration that preceded Raimondo and Governor Lincoln Chafee. Walsh buries this deep in the article when she says:
Rhode Island has been trying to fix its pension system for years; it has announced four “reform” plans since 2005, each of which has claimed to reduce costs for the state and cities.
Moreover, the numbers reported in the article seem inflated and poorly sourced. The article says that pension costs will grow very rapidly to consume 20 cents of every tax dollar. Moody’s, however, published a report yesterday showing that pension payments would not consume 20 percent of the budget until 2021, and even that assumes that general revenues remain at the 2011 level. This fiscal hysteria is overblown.
Mary Williams Walsh and the NY Times are poor sources for financial information. Walsh seems more motivated to write stories which capture imaginations more than facts. She has misrepresented the municipal bond issues for a couple of years now and helped publicize that hack Meredith Whitney and her special form of mythology.
This Class is Unimpaired by the Plan
@tednesi Ted Nesi The Dow is down 4% as I write this. But I’m sure the market will turn around once Central Falls releases its Ch9 plan at 3.
Central Falls, Rhode Island is a down on the heel community that has become the epicenter of the battle to preference municipal bondholders over retired municipal workers in bankruptcy proceedings. This is a tale of the state of Rhode Island turning federal bankruptcy law and pension law upside down.
When an entity becomes insolvent and seeks the protection of a bankruptcy court it throws itself within the processes and rules of the federal bankruptcy court. Cities are not liquidated in a Chapter 9 bankruptcy but outstanding claims against a community are reduced so that the community can pay them all. Traditionally in bankruptcy proceedings pensions are treated similarly to bondholders and other secured creditors.
In a new and surprising move the state of Rhode Island passed General Laws § 45-12-1 and enshrined in law that bonds are secured by a Rhode Island statutory lien on property taxes and general fund revenues. In essence the state created a post-facto super senior preference for bondholders. The state changed the rules after the game was underway.
The stated concern of state officials was that if Central Falls bondholders were “haircut” in bankruptcy court then bond market access for all cities in the state would close or be severely curtailed. In essence the state wanted to ring fence the assets of the bondholders assets against any harm that a bankruptcy proceeding would subject them to.
The state may feel that this is a clever way to protect their credit rating but they just created the mother of all municipal moral hazards. Bondholders now know that they can loan unlimited amounts of money to Rhode Island towns and cities and the state has guaranteed them 100% access to the tax revenues of a community. As a bond investor I’d go whole hog loaning money around Rhode Island because I would know that cities would cut all services and pensions to pay off my bonds. Winning by investing in Rhode Island!
This scenario has played out in the Chapter 9 bankruptcy plan and five year “recovery plan“. When I read through the documents I quickly realized that there was very little “recovery” for the town as funding for the library was eliminated, the community center would be sold off and trash collection outsourced. A dry husk of a community with the reduced level of services would remain. But bondholders will be repaid 100 cents on the dollar.
By the Obama Administration’s reasoning, Central Falls pensioners launching missiles at the Providence statehouse while the legislature is in session would be a legitimate act of fealty.
Also, I suspect that lynching the architects of the “recovery plan”–the people who decided not to challenge the unconstitutional law–is well within the “no jury of your peers would convict” standard, though.
Not that I would -ever- encourage either action, of course.
The Dummies Guide to the Pension Crisis
Hat tip to Ted Nesi of WPRI.com for pointing out this excellent union sponsored video that discusses the problems for the public pensions of Rhode Island. Although the details are specific to that state the structural problems apply to almost every state because public pensions across America are underfunded. Every state faces problems that are politically or financially difficult. Either taxpayers will be paying more to top pension plans or retirees will be receiving smaller pension payments. Pension reform is a complex topic and I hope we see more educational efforts like this video.
Further:
WPRI.com Judge Taft-Carter issues decision in pivotal RI pension case
Desperation costs are steep
Harrisburg, the state capital of Pennsylvania, has narrowly averted filing for Chapter 9 bankruptcy as their independent city Parking Authority has secured a loan to advance future payments to the city for use of city land. Unfortunately the unnamed lender will be charging the Authority 10.75% interest. The costs of desperation are steep. This one-off lease payment from the Parking Authority allows the city to make their September 15th bond payment on their crushing incinerator debt and avoid Chapter 9, but what about the next bond payment in 2012? They don’t seem to have any more assets to borrow against. So they’ve postponed the problem but not solved it. From Bloomberg:
The Parking Authority will borrow to make the payment, and some on the council balked at the interest rate of as much as 10.75 percent on the loan. About a third of the city’s 49,500 residents live below the federal poverty level. The lease covers land under several garages, and the loan costs may reduce the authority’s income, which provides revenue to the city.
Fitch gives USA its stamp of approval
Fitch leaves munis tied to U.S. rating at AAA, S&P downgrades
Fitch Ratings, one of the three major rating agencies and the one considered the most accurate by institutional investors, has affirmed the credit rating of the debt of the United States at AAA. As a follow-on to this action they have also maintained the AAA credit rating of municipal entities tied to U.S. Treasuries.
Going in the opposite direction, Standard & Poor’s downgraded the investment portfolio of the city of Los Angeles to AA+ because it holds 80% of its assets in U.S. Treasuries. This follows S&P’s recent downgrade of U.S. Treasuries to AA+. The Bond Buyer reports what happened next:
Los Angeles has dropped Standard & Poor’s from rating its $7 billion investment portfolio after the agency downgraded it along with the United States last week.
“Quite frankly, we just don’t want to be associated with [Standard & Poor’s] anymore based on that decision. We think it was irresponsible and just excessive,” Thomas Juarez, the city’s chief investment officer and assistant treasurer, told The Bond Buyer.
S&P gave an honest opinion and is getting cut out of business. That is how the “paid for opinion” business works. If the entity paying for the rating doesn’t like it, then they don’t pay.
Rhode Island enhances financial disclosure for bond offerings
The Providence Journal reports that the Securities and Exchange Commission has been scrutinizing the state of Rhode Island about their financial disclosures associated with new municipal-bond offerings. As a consequence the state has expanded the level of detail that they are disclosing in their bond-offering documents. This increased transparency is critical for muniland. From the Providence Journal:
Bondholders have cut the line
Something doesn’t seem right in Central Falls, the Rhode Island city that declared municipal bankruptcy yesterday. Now that the state receiver has filed Chapter 9, all the town’s dirty laundry has been hung out in public, and, like any bankruptcy, it’s not pretty. Overspending and declining tax revenues doomed this poor town, along with liberal doses of alleged corruption.
Here is what doesn’t seem right in Central Falls. The city is dead broke and those they owe money to are lined up at City Hall to collect. But for some odd reason, the city’s bondholders have pushed ahead of all the others in line to claim full repayment of their debts; those later in line must settle for 50 cents on the dollar. Retired police officers and firemen will have their pensions cut by 50%.
It wasn’t Central Falls’s decision to give preferential treatment to bondholders. Last year legislators in the state capitol passed a law making the claims of bondholders superior to all other claims in bankruptcy. The Rhode Island General Assembly’s action flies in the the face of common bond market practice, which is that bondholders get in line with everyone else and a judge overseeing bankruptcy proceedings gives a fair resolution to all the creditors.
The law passed by the Rhode Island General Assembly upends the order of priority for payments in bankruptcy. Municipal bankruptcy is filed in federal court, and cities cast themselves at the mercy of the federal bankruptcy law. Because our federal constitution reserves all rights to the states that the federal government does not claim, it makes this area of the law a funny hash of competing jurisdictions. And it possibly encourages the Rhode Island legislators to try and change the rules.
The federal bankruptcy code does create some special protection for holders of “special revenue” bonds. The law firm Jones, Day characterizes the exemption:
Protection of Special Bond Revenues.
Chapter 9 of the Bankruptcy Code expressly provides protection to creditors holding liens on special project revenues of a municipal debtor. For example, municipalities often finance special projects, such as water and sewer plants, with bonds that are collateralized with the revenues and fees earned by such projects. Section 928 of the Bankruptcy Code states that the “special revenues” from these projects remain subject to the liens of the bondholders in the specific projects.
The bondholders of Central Falls hold “general obligation,” or GO, bonds. This type of bond has access to the revenues of the central taxing authority of the municipality. These are not “special revenue” bonds issued by a sewer or water entity that is legally separate from the municipal entity. So within Chapter 9 law, general obligation bondholders would not receive preferential treatment in bankruptcy proceedings.
Providence Journal: Central Falls bankruptcy a cautionary tale for R.I., state leaders say
http://www.projo.com/news/content/CF_POL ITICAL_REACTION_08-02-11_K0PGV39_v23.476 03.html
The smallest city in the smallest state
Central Falls, Rhode Island — the smallest city in the smallest state — filed for bankruptcy today after years of decline. It is the fifth U.S. municipality this year to seek protection from the courts under the bankruptcy law. The Governor of Rhode Island stood with city officials as the bankruptcy process commenced. Reuters quoted him as saying in a statement:
“The current situation is dire and it necessitates decisive steps to put the city back on a path to solid financial footing and future prosperity,” Rhode Island Governor Lincoln Chafee said in a statement.
Central Falls’s population peaked in 1930 and has declined ever since; it currently has only 19,000 inhabitants. The town is extremely poor with median household income of $22,628 and per-capita income of $10,825, according to the 2000 Census. Central Falls, like many hidden American towns, is at the end of municipal row.
The city was placed in state receivership last year as its pension problems spiraled out of control. The twin municipal demons of debt and pension obligations have burdened this community with unsustainable costs as the population and revenue bases shrank. Bloomberg reports:
The pension’s obligations were $48 million greater than the fair value of its assets as of June 30, 2010, according to data compiled by Bloomberg.
Central Falls has about $21 million of outstanding debt, New York-based Moody’s said. The city’s per-capita income is 50 percent of Rhode Island’s, according to the company.
Below in the chart are the largest city expenses. They exceed the city’s revenues and fail to show the expenses for 21 other departments, ranging from the mayor’s office to the library budget.
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Resident Muniland expert
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Nonprofits boosting Boston’s coffers
http://articles.boston.com/2012-01-21/me tro/30645986_1_nonprofits-contributions- property-taxes