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Central Falls Aims to Protect GOs

AUG 1, 2011 4:05pm ET
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Central Falls’ bankruptcy shouldn’t directly impact bondholders carrying $20.8 million of the city’s general obligation debt, according to Monday’s Chapter 9 filing.

Justice Robert Flanders, a state-appointed receiver who has been overseeing the troubled Rhode Island city’s precarious financial situation since January, makes it clear in the bankruptcy filing that bondholders will benefit from a first lien on ad valorem taxes and the city’s general funds.

Flanders blamed “overwhelming pension obligations and the slowing economy” for the filing.

“They are trying to make sure, at least by intent, that their $20 million of GO debt is not adversely affected,” said James Spiotto, a partner at Chapman & Cutler and widely regarded as one of the country’s foremost experts on Chapter 9.

Late last year, Central Falls’ fiscal problems prompted a change in Rhode Island law to establish a statutory lien that would protect bond and note holder interests in the event of bankruptcy. It gives general obligation bonds priority over all other municipal obligations.

“They are prioritizing bondholders to assure access to the market and not to affect rate or cost, and at the same time they are using Chapter 9 to deal with other creditor relations that obviously are ones they want to focus on,” Spiotto said.

Municipalities considering bankruptcy protection often fear market discipline that could affect their borrowing costs for years or even decades to come.

Rhode Island’s solution, Spiotto said, is to avoid the stigma by making it clear from the start that bondholders will not be affected. In this way the case resembles the San Jose School District, which in 1983 filed for bankruptcy to renegotiate teacher salaries. The district said from the start that outstanding debt would in no way be impaired, despite a general prohibition for paying interest during a proceeding where a debtor is insolvent.

A pact reached one year later cut promised future income raises to teachers by 60%, but full payments to bondholders were never delayed.

“Because the pledge was a statutory lien, as the county tax collector collected taxes he had to pay the bondholders the day he collected, so bonds were unaffected,” Spiotto recounted. “Special revenues and statutory liens are to be unaffected in Chapter 9. And that’s what they did in Rhode Island. They gave a statutory lien to all bondholders to cover them.”

Vallejo, Calif. — which only emerged from bankruptcy proceedings last week after filing in May 2008 with a legal cost of roughly $10 million — set a strong precedent that Chapter 9 was far from a cure-all solution. But Spiotto said Rhode Island’s surgical approach could prove more successful and potentially start a trend.

“The interesting issue is, could this become a trend which makes Chapter 9 more socially acceptable?” he asked. “It really should be the last resort even if bondholders are well taken care of and protected. This could be a new trend, but the proof is in the pudding.”

Chapter 9 filings to date have been rare. Central Falls is only the 625th filing since the vehicle was created in 1937 and the 254th since 1980, according to Spiotto. In data only involving counties,  cities, villages and towns, it is the 47th filing since 1980, he said.

Central Falls has been struggling for some time.

In Monday’s Chapter 9 filing, Flanders and Gov. Lincoln Chafee said “everything reasonable and feasible” was done to avoid bankruptcy, including cutting services “to the bone” and raising taxes “to the maximum level allowable,” but negotiations with unions and retirees regarding voluntary concessions and reductions in benefits were unsuccessful.

The city’s estimated revenue in fiscal 2011, which ended June 30, was $14.8 million, versus estimated expenditures of $21.1 million.

For fiscal 2012, estimated revenue is $16.3 million, versus projected expenditures of $22 million. It also has unfunded pension obligations of $80 million and a structural deficit of $5 million.

Flanders filed a motion Monday to reject collective bargaining agreements with the police and fire unions that expire June 30, 2012. The receiver also rejected agreements with the municipal workers union, which expired June 30.

Higher deductibles, changes in co-payments, and a 20% co-share of premiums for active employees and retirees are effective immediately. The next payments, which will be paid out at the end of August, will reflect reductions that Flanders laid out on July 19, including $1.75 million in pension cuts and $725,000 in benefits concessions.

The struggling city faces $25 million of pension and benefit deficits over the next five years.

According to the fiscal 2012 budget, employee benefits and police and firefighter retirement costs make up 19% of total expenditures and 17% of the budget gap.

Retirement and benefit costs are estimated to cost $4.3 million out of $22 million in expenditures. Of the $5.7 million budget gap, almost $1 million comes from retirement and benefit payments.

Another problem for the city is the Donald W. Wyatt Detention Facility. In December 2008, the U.S. Immigration and Customs Enforcement agency withdrew all of its 152 immigrant detainees from the lockup.

The Central Falls Detention Corp., which runs Wyatt, was supposed to pay the city $500,000 annually in lieu of taxes, but hasn’t done so in the past two budget years. The facility had been getting $100 per prisoner per day from the federal government.

Central Falls has been under receivership since May 2010, when the Fiscal Stability Act was established. It received yet another blow from the state last month when the 2012 budget eliminated $6.7 million in aid. The city’s school system has been funded by the state since 1990.

Moody’s Investors Service downgraded the city’s outstanding GO debt to a rating of Caa1 on June 17. Standard & Poor’s downgraded the bonds in May 2010 to C.

Debt maturing in 2014, originally priced in 2007 with a 3.625% yield, traded last week at about 90 cents on the dollar for a yield of 7.45%, according to Bloomberg LP.

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