Rhode Island Setting Standard for Bondholders’ Love: Muni Credit

Rhode Island Setting Standard for Bondholders’ Love
Cars pass a welcome sign at an entrance to Central Falls, Rhode Island, on Jan. 12, 2012. Photographer: Steven Senne/AP

Central Falls, the first city in Rhode Island’s 222-year history to go bankrupt, is preparing to exit court protection after 13 months by keeping bondholders whole while raising taxes and cutting workers and pensions.

The financial and political support Central Falls got from state officials makes the case unique among municipal bankruptcies in the past year from Alabama to California.

Yet “there are great lessons to be learned here,” said Theodore Orson, who represented the state-appointed receiver overseeing the bankruptcy and is a lawyer with Orson & Brusini in Providence. Chapter 9 of the U.S. Bankruptcy Code, which localities can use to cut debt as companies use Chapter 11, “can be effectively utilized to fix what appeared to be a broken city,” Orson said.

A proposed resolution is set for review in federal bankruptcy court in Providence Sept. 6. The city’s plan to cut debt doesn’t impose losses on bondholders and may let them recover legal fees. State lawmakers also put investors ahead of other creditors by letting them put liens on city tax revenue. Rhode Island helped ease the pain of retirees and workers, providing $2.6 million to cushion pension cuts.

‘Good Sign’

By contrast, Alabama state lawmakers refused to let Jefferson County raise taxes, prolonging the biggest U.S. municipal bankruptcy by months. California took away redevelopment tax money, contributing to two cities’ insolvency.

The Central Falls approach “is a good sign for bondholders of Rhode Island bonds compared to, say, California,” said Alan Schankel, head of fixed-income research at Janney Montgomery Scott LLC, an investment bank in Philadelphia.

Stockton, California, targeted lenders including bondholders when it sought court protection in June for the community of 296,000. It was one of three such filings in the state since June. Last year, there were 14 local-government insolvencies nationwide, including special tax districts, compared with six in 2010, data compiled by Bloomberg show.

Rhode Island has labored under the lingering effects of the longest recession since World War II, with one of the nation’s highest jobless rates. For Central Falls, the difficulties date to at least 1991, when the state took over its school district’s finances.

Cocaine Capital

Dubbed the Cocaine Capital of New England by Rolling Stone magazine in 1986, it is the state’s smallest city, at 1.2 square miles (3.1 square kilometers) and a population of about 19,400, according to U.S. Census Bureau data. A quarter of the population lives in poverty, double the state average.

Residents resent that $3 million has been spent on lawyers while their community center was closed and the public library turned over to a nonprofit group, said state Senator Elizabeth Crowley, a Central Falls Democrat. The city remains in a state of disrepair with potholed streets, she said, while bondholders have continued to be paid.

“I will never be able to retire because they had to protect their precious bond rating,” said Don Cardin, 47, a former fire department battalion chief. His monthly pension fell to $2,100 from $2,800 and is set to drop to $1,250 in five years. Like many government workers, firefighters in the city don’t participate in the federal Social Security system.

Market Access

The approach to resolving the bankruptcy will help the city regain access to the $3.7 trillion municipal bond market, said Janney’s Schankel.

“Central Falls will be penalized by the market going forward for awhile, but they have a shot at crawling their way back,” Schankel said. “They will be able to borrow because the process worked out OK for bondholders.”

Central Falls securities maturing in May 2015 traded on Aug. 9 at an average of about 92 cents on the dollar to yield 9.33 percent, or about nine percentage points more than top-rated debt with a similar maturity, Bloomberg Valuation data show. On Dec. 20, the securities traded at about seven percentage points above a AAA index.

In the broader muni market yesterday, yields fell in most maturities, tracking gains in Treasuries. Yields on top-rated tax-exempts due in 10 years fell 0.02 percentage point to 1.80 percent, the lowest in about two weeks, Bloomberg Valuation data show.

Less Complex

The city’s case differs from the bankruptcies in California, according to Marc Levinson, an Orrick Herrington & Sutcliffe LLP lawyer in Sacramento who represents Stockton.

“Central Falls is a much smaller city than San Bernardino, Vallejo or Stockton,” Levinson said by e-mail. “Its debt structure was not nearly as complex.”

Levinson also worked for Vallejo, the California city that has spent about $11 million over three years to exit a Chapter 9 case that began in 2008. San Bernardino, with 213,000 residents, filed for bankruptcy this month.

Central Falls is asking citizens and retirees to absorb higher taxes and reduced benefits after Rhode Island Treasurer Gina Raimondo last year spearheaded an overhaul of the state’s pensions. The revamp included measures such as delaying retirement and offering workers 401(k)-type plans.

Under the Central Falls plan, the city’s payroll will fall to 121 jobs from 174 in May, according to Rosemary Booth Gallogly, the state’s revenue director who oversaw negotiations with creditors. Pensions will be cut as much as 55 percent for 133 municipal retirees, while no one will get less than $10,000 a year, court documents show. They will also be required to pay 20 percent of their health-care costs until they turn 65 and become eligible for the federal Medicare program.

State Promises

Retirees accepted the proposal after the state promised to supplement pensions for five years. After an earlier receiver put the city in bankruptcy, municipal workers agreed to new contracts with lower benefits, helping expedite the Chapter 9 process, said Orson.

“I would consider it a model,” Gallogly said. “I don’t want to make it sound like this was easy and anybody could go through this process. It’s an unfortunate chapter, and I hope all Rhode Island cities and towns will learn by it.”

The plan also includes annual 4 percent property-tax increases through 2017. It closes almost $26 million in deficits projected over six years in annual budgets averaging about $18 million. Rhode Island covered more than $3 million in legal fees, which the city will have to repay starting in 2017, Gallogly said.

Payments Priority

Last year, Governor Lincoln Chafee, an independent, ensured investors holding $27 million of Central Falls debt would be protected when he signed a law giving them a lien on tax and general revenue.

“We don’t want Central Falls to become a contagion that spreads around the state,” Gallogly said in September. “We want to show very clearly that our priority is to pay these obligations.”

Moody’s Investors Service in June said the city’s credit rating, seven steps below investment grade at Caa1, might be raised.

“You take the bonds being held hostage out of the equation,” said James Spiotto, a bankruptcy lawyer in Chicago with Chapman & Cutler LLP.

The case is In re City of Central Falls, 11-13105, U.S. Bankruptcy Court, District of Rhode Island (Providence).

Following are pending sales:

ARKANSAS is set to issue $225 million of general-obligation bonds as soon as next month, data compiled by Bloomberg show. The bonds are secured by Federal Highway Grant Anticipation and Tax Revenue and will help finance interstate highways, according to bond documents. (Added Aug. 29)

FLORIDA MUNICIPAL POWER AGENCY plans to sell a combined $140 million of debt as soon as today, according to data compiled by Bloomberg. The issuance will refund debt and finance capital projects, according to sale documents. (Updated Aug. 29)

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