San Bernardino would see little benefit from “Chapter 18” bankruptcy filing

This piece first published May 1, 2017 Debtwire Municipals
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San Bernardino, whose exit plan from Chapter 9 bankruptcy protection was approved earlier this year, still faces distress conditions, but sees no benefit in filing for bankruptcy a second time, said Mark Scott, city manager.

“If we went back into bankruptcy, what would be the point?” Scott said. “What debts do we have that we’d be trying to free ourselves of? We’ve done that already, bankruptcy is an awful process, it’s no fun to do that, but we’ve done what we can do in bankruptcy. Now our task is to make do with what we’ve got, we’ve slimmed our organization way down, gradually working on building our economy and getting enough resources so we can restore services.”

A report from Moody’s Investors Service said the city could head back to bankruptcy due to rising pension obligations, challenges with deferred maintenance and potential service shortfalls.

San Bernardino filed for bankruptcy in 2012, after a 44% drop in sales tax revenue in four years, said Toby Pegors, fixed income analyst at Western National Insurance. Similar economic downturn would put them in a similar position, he said.

“(Moody’s) didn’t take an extreme position at all – it will be interesting to see what happens to all of the recent pension-related bankruptcies,” said Pegors. “If we see a sizable downturn in the economy, time will tell how resilient they’ll be – we’ll see how they all pan out.”

Pensions could be the catalyst for San Bernardino. The plan to lower the California Public Employees’ Retirement System (CalPERS) discount rate to 7% from 7.5% will dramatically increase the pension burden of all California cities, Pegors said. CalPERS expects the change will increase municipal pension expenses between 30% and 40%, as reported.

But Scott said San Bernardino’s bankruptcy process leaves the city better prepared than any other in California to handle the increase.

San Bernardino’s pension costs in FY17 total USD 16.37m. In FY20, when the reduction of the CalPERS discount rate takes full affect, the city will contribute an estimated USD 31.4m, Scott said. The fiscal year begins 1 July.

“We’re prepared for CalPERS issues, that’s not the thing we’re most concerned about. We’re much more concerned about fixing infrastructure than that,” Scott said.

The California bankruptcies have left CalPERS’ obligations intact, while pensioners in Detroit received an 82% recovery. Tackling the pension burden in California cities is a “bigger can of worms” and any CalPERS reduction in one city could set a precedent for other cities, making it difficult to pursue, Pegors said.

Leaving CalPERS is not an option for the city – it would first have to pay off its unfunded liability and it’s an unattractive option for San Bernardino from a recruitment standpoint, Scott said. The move would make it difficult for the city to recruit employees, he said.

“We’d be unable to hire qualified staff, the pension liability is very complicated and expensive to get out of – I don’t see that as a solution, it’s not a solution at this point for going forward,” Scott said.

When the judge approves a plan of adjustment, it’s because it “checks the boxes,” including feasibility, said Juliet Moringiello, professor at Widener University Commonwealth Law School.

“The feasibility standard the judge is convinced the plan will succeed, but the feasibility standard (asks), ‘Are the financial assumptions of the underlying plan reasonable?’ Chapter 9 doesn’t fix the underlying problems of the city,” Moringiello said. “It can’t make the population or industry return, or restructure the way a city does business.”

But San Bernardino did change the way it does business, outside of the courtroom. In November 2016, voters approved Measure L, creating a council-manager form of government, empowering the city manager and reducing the day-to-day responsibilities of members of council, Moringiello said.

When people are weary of a second Chapter 9 filing, they must remember that bankruptcy exists to cut debt, Moringiello said.

“If the problems San Bernardino faces after Chapter 9 are structural government problems, Chapter 9 isn’t going to fix that anyway,” Moringiello said. “Nobody seems to be telling CalPERS to go away. This was the case in San Bernardino and other California cities – CalPERS may be too expensive in the long run, but (leaving) makes it harder to recruit good employees and so on and so forth. So even though pension obligations could be cut in bankruptcy, nobody’s doing that with respect to CalPERS.”

The city’s financials are sustainable, Scott said, saying the city is “not in danger” of heading back to bankruptcy court.

“I don’t see any reason in the world that would happen – we just have to work within the means we have and we can do that,” Scott said.

Looking forward

Rejuvenating a city after bankruptcy is difficult, Moringiello said.

“It’s interesting – coming out of bankruptcy, we are much better off than we were before, but we still have a long way to go,” Scott said. “We’re a rather poor city as it relates to resources, (but exiting bankruptcy) doesn’t put us in a situation where we’re able to immediately restore every service we’ve got.”

California’s recent transportation funding increase will send about USD 50m over ten years to San Bernardino for road improvements, Scott said. Energy efficiency improvements to streetlights will pay for themselves in cost savings, but the park system will struggle as the city emerges from bankruptcy.

Scott believes San Bernardino can grow its way economically through the revenue problem, though the bankruptcy, 2015 terrorist attack and school shooting earlier this month pose challenges to that strategy.

“Attracting investment, that’s the number one thing we’re doing,” Scott said. “But we’re in such a favorable place in southern California, a great location, wonderful transportation connections, in the heart of southern California and the lowest land values in southern California – we have opportunities. It’s our task to show people we’ll be a great place to invest in, and that’s foremost in our mind –developing a reputation that can be trusted. We’ve lost that and we’ll have to earn that.”

Pension obligation bondholders received 40 cents on the dollar and had maturities extended 30 years, reducing the city’s obligation by about USD 45m to USD 50m from USD 90m.

By Maria Amante


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