Monday, April 6, 2015

Quick Take on LA Times' Report on Restructuring the Delta Tunnel Plan

Some highlights from Bettina Boxall's extremely interesting and important article.

"Sources familiar with the state discussions said that it is likely the department will separate the habitat restoration component from the tunnel proposal and pursue shorter-term operating permits for the new diversion facilities and existing pumping operations. Although the Bay Delta plan included restoration money, it is unclear how the separate restoration effort would be funded or carried out.

While the changes would not affect construction of the tunnels, they have raised concerns that the restoration work could fall by the wayside. And the revisions, expected to be released in coming weeks, could also make the project less attractive to the urban water and agricultural irrigation districts that have promised to pick up the roughly $15-billion construction tab....

The plan revisions would represent more than just a bureaucratic change. The agricultural and urban water districts that are the major drivers of the long-planned project were betting that a 50-year permit would stabilize delta deliveries that have been restricted by increasingly stringent protections for endangered fish. 

Reverting to shorter-term approvals would leave future water deliveries vulnerable to cuts associated with a change in permit conditions. And that raises questions of whether the project is still worth the money to the districts that have promised to pay for the tunnels. 

"We don't really know what the permitting will be 10 years from now, 15 years from now," said Jeffrey Kightlinger, general manager of the Metropolitan Water District of Southern California, which would cover a portion of the tunnels' cost. "That's the challenge in making sure it's a sound investment. Does it pencil out and still make sense?"

I am in rare agreement with Mr. Kightlinger, this change has huge implications for the economics of the tunnels.  As I have discussed on this blog and a variety of other issues, the value of reducing regulatory uncertainty is the majority of the economic benefit attributed to the tunnels in the BDCP economic studies.  According to this article, the level of regulatory assurance will be massively reduced under the revised plan.

I wrote this blog in 2012 right after Dr. Sunding unveiled the regulatory certainty argument in a BDCP meeting. That post still looks good to me this morning, and it looks like my environmental sources were right on target when they told me the regulatory certainty scenario was not accurate. http://valleyecon.blogspot.com/2012/06/is-bdcp-good-deal-for-water-agencies.html

The argument was later repackaged by changing the no-tunnel baseline to the "Existing Conveyance Scenario" where exports are assumed to plummet in the future without the tunnels, but remain near current levels with them.  Even with this reframing, the economic benefits of BDCP drop substantially with the impending change to short-term approvals, and risk of significant drops in water deliveries even with the tunnels.

Faced with that heightened risk even with the tunnels, it is reasonable to expect that water agencies will make more investment in expensive, less risky water supply alternatives.  Thus, another economic justification that has been made for the tunnels - that it will avoid the cost of these investments - is also weakened by this change.

The other big change described in Boxall's article is separating the habitat restoration component.  This will really help clarify the economic analysis, as the incorrect packaging of the restoration with the tunnels (restoration does not require the tunnels), was a major analytical shortcoming.

As for environmentalists worries that restoration will fall by the wayside without this packaging, they shouldn't worry.  The BDCP/tunnels were not creating any new funding for habitat restoration, it was diverting public environmental funding from other uses to the BDCP.  Good projects like the Yolo Bypass enhancements do not depend on the BDCP for funding and will go forward anyway with or without the tunnels.  And as we learned with last years water bond, environmental funding is more likely to be approved when it is detached from BDCP.  I would also argue that this is a good time to bring up again my argument for a no-tunnel BDCP, which is a more conventional approach to a Habitat Conservation Plan under the ESA, in which the regulated entities provide new resources for habitat restoration in return for some level of regulatory certainty.  I discussed that in an October 6, 2013 op-ed in the Sacramento Bee (can't find a link), and in this old blog post, http://valleyecon.blogspot.com/2012/07/does-regulatory-assurance-for-delta.html

P.S.
A bit unrelated, but I read an interesting new article last night in Businessweek about Seattle's troubled tunnel project.  The on-line version has fun graphics too and is worth a look by those interested in the Delta tunnels proposal.
http://www.bloomberg.com/graphics/2015-bertha/


Thursday, March 19, 2015

New Data Shows Surprisingly Small Impacts of Drought on Farm Employment

While I have a long record of saying that drought impacts on the economy tend to be overblown, even I was surprised by the minimal drought impacts in the data released this morning.

The Bureau of Labor Statistics' Quarterly Census of Employment and Wages is the most reliable data on employment (it is a census of quarterly tax filings).  Data for the 3rd quarter of 2014 was released this morning, representing the peak season for farm employment when drought impacts should be most evident.  As shown in the table I compiled below, there is virtually no difference in farm employment between 2014 and 2013 in the 3 counties that are thought to be most devastated by the drought. (Jobs are listed under each month in the table, NAICS sector 11 is 99+% agriculture in these counties, the increase in total wages suggest decreased hours is not a big part of the explanation even though the minimum wage increased on July 1, 2014.)


There is more data that needs to be compiled before jumping to conclusions, but I think it is important to get this information out there since the rhetoric on jobs, unemployment and water shortages is heating up again.

In my view, the impacts of drought are much larger in environmental data such as plummeting fish abundance, than in jobs.  I surprised a reporter earlier this week when I said that I thought the drought was a bigger environmental crisis than an economic one, and the recent data about 6 delta smelt found in the recent survey compared to virtually no change in agricultural jobs is an example.

How to explain this?  

As I said, there is more data to sift through, but it is important to recognize that this drought is coming in the midst of a strong expansion period of Valley agriculture.  The total number of acres irrigated and harvested has been growing every year for most of the past decade, even in the face of scarce surface water.  Thus, in the absence of drought, I suspect 2014 employment would have been even higher.  The drought is causing significant fallowing of relatively low value, and non-labor intensive field crops, while new acreage is coming into production by tapping groundwater.  Thus, there are farmers laying people off, I don't think the farmers in news reports are lying.  But clearly, there are others that were hiring.  In other words, the baseline for agriculture activity is rising, as I discussed last spring in this post.  

Friday, March 13, 2015

The Center for Business and Policy Research opened today.

Today, the Business Forecasting Center was renamed the Center for Business and Policy Research and my main office has moved to the Center's second office in Sacramento.  The new name and second locations has been in the works for a while.  It better describes the scope of what we do and gives us a base to build on it.

It also allows the Center to align with new academic programs that the University of the Pacific will be introducing to its Sacramento campus over the next few years in partnership with Pacific's McGeorge School of Law which was the only program on that campus until recently.

See our new website here.


Which California Metro Areas Are Still Below Pre-Recession Employment Levels?

The latest revised payroll data shows big differences across the State's regions.  The tables below show the percentage change in payrolls (seasonally adjusted) since June 2007.

Among the 10 largest metro areas in California, Sacramento is the furthest behind and soon will be the only large metro area still below pre-recession levels.  The good news is that Sacramento is recovering nicely now, but the recovery started about two years late in this region.  However, the biggest outlier is on the positive side not negative.  Silicon Valley and San Francisco is in a league of its own.                                                                                                

Anaheim-Santa Ana-Irvine Metro Div

-0.25%
Bakersfield MSA

7.90%
Fresno MSA

1.77%
Los Angeles-Long Beach-Glendale Metro Div

1.66%
Oakland-Hayward-Berkeley Metro Div

2.17%
Riverside-San Bernardino-Ontario MSA

1.61%
Sacramento-Roseville-Arden Arcade MSA

-1.45%
San Diego-Carlsbad MSA

3.52%
San Francisco-Redwood City-South San Francisco Metro Div

13.40%
San Jose-Sunnyvale-Santa Clara MSA

12.06%

Focusing just on the Central Valley, there is a geographical pattern from north to south. The worst recovering areas are in the Sacramento Valley, while the strongest growth has been in the drought-stricken areas of the south Valley.  Stockton and Sacramento metro areas are virtually tied, and both should finally cross this job recovery threshold this summer.  While it has been a painfully slow process, it is actually two years sooner than we were predicting back in 2011.

Yuba City -4.72%
Redding -4.39%
Sacramento -1.45%
Stockton -1.44%
Modesto 0.06%
Chico 0.39%
Visalia 1.48%
Fresno 1.77%
Madera 3.65%
Merced 5.10%
Bakersfield 7.90%
Hanford 9.77%

Tuesday, March 10, 2015

Army Corps of Engineers leaves Lathrop and South Stockton levees out of a draft flood control plan.

The levee planning battles seem to be warming up again.

The Record has an extremely interesting story about the Army Corps of Engineers draft plan for upgrading Stockton area levees.  I have not had a chance to review the draft plan yet, but the article discusses an important issue surrounding RD 17.
The Corps eliminated from consideration any improvements to the San Joaquin River levee that protects Reclamation District 17, a vast area stretching from Weston Ranch to Lathrop. The government’s justification is a Carter-era executive order that forbids levee improvements that might encourage development in floodplains. If the improvements went forward, the population living behind the RD 17 levee could increase by 100,000 people or more, the Corps reports. 
While the Federal Emergency Management Agency does not consider RD 17 to be in a high-risk flood plain, the Corps does — and that’s the problem. “We can’t responsibly invest limited funds in levee improvements in areas that would induce or facilitate growth within an area highly prone to deep flooding,” said Stacy Samuelson, a water resources planner with the Corps. 
On the flip side, tens of thousands of people already live in RD 17, and the area is home to San Joaquin General Hospital, the county jail, Interstate 5 and other important infrastructure. All the more reason to provide better protection, advocates say. “We’re not happy, and we’re going to fight it,” said Dante Nomellini, a Stockton attorney representing the reclamation district. “The problem is there’s no (added) protection for the 43,000 residents and all the investments that are out there now. That’s the craziness of it.”
The other important infrastructure is about to include a nearly $200 million VA clinic to break ground soon next to SJ General.  I certainly believe in protecting floodplains, but there are other planning and public safety principals to consider as well, including the principal to concentrate development around existing infrastructure.

It reminds me of Natomas in the Sacramento area.  Talk about federally funded levee upgrades that will induce or facilitate development.   

Thursday, March 5, 2015

Drexel Closes in Sacramento. What about Warwick?

In recent weeks, many conversations I have had in Sacramento have turned to the University of Warwick's announcement that they are going to establish a campus in south Placer County.  There are a mix of views but I would say the Warwick skeptics slightly outnumber the believers in my informal conversations.

Undoubtedly, today's news that Drexel is closing its Sacramento campus bolsters the skeptical view. After all, Warwick's plan is very similar, and based on the same gift of property, as Drexel's abandoned plan.  And the national higher ed headline this week is that Sweet Briar College in Virginia is closing despite a beautiful campus and a $93 million endowment adds more evidence that private, residential colleges are in financial trouble across the country and supports the view that it would be foolish to consider starting a new one.

Personally, I remain very positive about the potential for higher education growth in Sacramento in spite of the well-documented challenges in the sector.  I think one or more new campuses can succeed in Sacramento or Northern California, even if a hundred small private colleges close in the East and Midwest over the next decade.  And I think Warwick can be very successful in south Placer County, although there is a chance they could pull out like Drexel as their phased plan has several points for them to reevaluate before significant investment is made in the physical campus.

The memory of Drexel's closure is undoubtedly going to create challenges for Warwick's planned start-up phase of offering graduate programs in leased space.  Potential students may be reluctant to enroll in a University that they aren't sure will still be there in 5 years, and given Drexel's history and confusion with troubled for-profits in leased office buildings around the area, those doubts will persist until Warwick can show tangible investment in the campus.

Successful private universities in the Sacramento area will need to have a compelling non-monetary reason to be here, solid and patient financial backing, some visibility and connection with the Bay Area, and have the ability and desire to attract students from outside the local area.  Drexel had no compelling reason to be here and sensibly closed, but I still think Warwick and others have an opportunity to succeed.

Tuesday, February 3, 2015

Treasurer's Report on Delta Tunnels' "Affordability and Financing Considerations"

This report was released in November, but I only managed to take a second look yesterday.  I still don't find it convincing, and it doesn't appear to have done much to quell growing financial doubts about the $25 billion BDCP twin tunnels plan.

The report attempts to estimate whether the twin tunnels' are financially feasible.  In other words, do the water agencies that would pay for the tunnels have the financial capacity to successfully issue and repay its construction bonds?

I have no doubt in the capacity of the urban water agencies to pay their share.  These agencies have tremendous ability to recover their costs through rates and property taxes - even for a bad multi-billion dollar project like the tunnels.  However, these urban agencies are the minority players in the tunnels' financing, the majority of the water and the costs are allocated to agricultural contractors, and most questions about financial capacity have been targeted at these farmers.

The majority of the agricultural water contractors are part of the Federal Central Valley Project (CVP), not the State Water Project.  The executive summary of the Treasurer's report summarizes its findings on the CVP contractors as follows (page 8).
Even if the CVP contractors develop a new credit with a take-or-pay obligation and similar credit features of DWR bonds, it is not clear at this point whether $10.25 billion of bonds (assuming a 50/50 split) in the Base Case could reasonably be issued without a large rate stabilization fund or other credit enhancement or subsidy from the federal government, state government, or SWP contractors.
Not very reassuring.  The first part of the sentence assumes CVP contractors will agree to unfavorable changes from their current contracts, and the second part concludes that subsidies are still likely to be needed even if they do.

Specifically, it assumes CVP contractors will change to a take-or-pay system where they would be obligated to pay debt service for capital costs even in dry years when they receive little water.  It seems unlikely that these farmers would be willing to give up one of the most favorable terms in their current CVP contracts.  It also assumes additional unfavorable provisions to CVP farmers to secure repayment such as "step-up" provisions to pay their neighbors' costs if they default, and the ability to levy property taxes or assessments to guarantee payments.  Finally, it assumes that the CVP contractors will be able to establish a new credit sufficient for a mammoth $10 billion bond issue with a AA rating, even though half of these agencies have no history of issuing muni bonds and thus no credit rating, and even the larger AA rated agencies have relatively small bonds.

And even if CVP contractors agree to all these changes, the Report still casts doubts on the ability of the CVP farmers' to issue the bonds without a large rate stabilization fund (who would pay for this? the financial analysis in the report does not include costs for a rate stabilization fund) or subsidies from federal and state taxpayers or urban ratepayers; even though BDCP proponents have repeatedly denied that any such subsidies would be necessary or acceptable.

In contrast to the caveat-riddled report conclusions, tunnel proponents have been quoting this sentence in the news release  that puts a rosier spin on the results than any sentence I could find in the report itself.
The Treasurer’s report illustrates that the cost of the Delta conveyance facility is within the range of urban and agricultural users’ capacity to pay.
Specifically, the report estimates the cost of water with the tunnels is $213 to $278 per acre foot for Kern and $253 to $301 per af for Westlands, and that the "capacity to pay" of Kern farmers is $277 af and Westlands' farmers capacity to pay is $291 af.  The estimated "capacity to pay" is within the range of costs, so BDCP proponents state that the tunnels are "affordable."  I don't think falling within this range is going to be very reassuring to potential bond investors.  I reviewed the calculations in the report and see a few significant problems:

1. The analysis uses average values.  It does not account for variation in hydrology or markets.
2. Capacity to pay is overestimated. The return to owner/management is implausibly low.
3. Costs are likely underestimated, relying on optimistic assumptions about ratings and bond covenants.

With respect to the first issue, using average values, financing the tunnels requires these farmers to make payments in every year - they can't skip dry years or years when markets are unfavorable.  In a dry year like the current one, the cost per af of water shoots up under take-or-pay contracts, and net revenues drop if you are fallowing land or paying high prices for supplemental water.  The Report correctly notes this risk, and even proposes a solution - a large rate stabilization fund.  But it does not include the costs of establishing such a fund - which would most likely come from increasing the initial amount borrowed - and include the cost of this insurance into the cost of water.

Second, the capacity to pay is overestimated.  To estimate capacity to pay, the Report uses average per acre revenue for 5 years, 2008-12, and subtracts an estimate of per acre costs from UC Cost/Return studies excluding cost for water and a return to owner/management (i.e. profit).  The Report then allows for a miniscule return of $90 to $94 per acre (Figure 20-21, page 37-38), and defines the remaining net revenue as the "capacity to pay for water."  The low value for a return is because the report used 10% of net revenue as an allowance for profit, rather than the more commonly used approach of a percentage of gross.

I don't think there are any farmers out there that would consider $90 per acre a reasonable return, especially when more than half the land is in vegetables or permanent crops.  According to USDA, the rental rate of irrigated cropland in California in 2012 was $340 per acre. My relatives in Michigan and Ohio have rented farmland for almost $200 an acre in the frosty and unirrigated Midwest.  Rental rates are reasonable to use for a return on bare land, but they do not include a return on investment in permanent crops (like the nearly $10,000 acre investment in establishing an orchard) or a return to management effort.  So what is reasonable value?

According to the BEA farm income data, the average net return to farming in Fresno County since 1969 is 25% of gross revenue with a range from 9% to 37%.  Profits have been strong in recent years, with margins over 30% of gross revenue since 2011 and over 20% in every year since 2002.  In light of this, I would argue that 10% of gross revenues would represent the minimum return to ownership/management to use for payment capacity.

Another approach could be a return on investment necessary to attract capital to a business with the risk profile of farming.  An example of this kind of allowance would be the 11-11.5% return on investment the Public Utilities Commission uses in determining allowable rates for investor owned utilities.  A 10% ROI to estimate a fair profit for farmland would be even more than 10% of gross revenue - but I will use the 10% of gross revenues to be conservative.

Using 10% of gross revenue, the return to management in the Report for Kern would increase from $94 acre to $439 acre and increase from $90 acre to $363 acre for Westlands which reduces the net revenue available to pay for water.  $400 per acre is not a lot of profit for running a farm, but it is a little bit higher than the rental rate of land and seems a reasonable estimate of the minimum necessary to keep the land in ag. production which I think is the spirit of the payment capacity calculation.

If you make this adjustment to a minimal profit margin, the calculated payment capacity for Kern drops to $164 af of water, and for Westlands it drops to $192 af.  Both of these values are well below the estimated cost range, and thus one should conclude that farmers do not have the capacity to pay for the tunnels and make a minimal profit.  

Finally, on the cost side, the Report's estimate of costs do not appear to account for any coverage ratio that is common in bond covenants.  Typically, bond covenants would require the debt issuer to ensure that net revenues after operating expenses are at least 1.25x annual debt service payments.  The new credit entity for CVP farmers will not only need revenue in excess of its debt service payments, it will undoubtedly need its own general manager, lawyers, lobbyist, office, etc.  Farmers will have to pay those costs, the costs of establishing and maintaining a rate mitigation account, and keep their annual net revenues at least at 1.25 times the debt service if they have any hope of the credit ratings and borrowing costs assumed in this report.  I haven't made an estimate of all this, but I think it would boost the cost range of water by at least $50 af, maybe closer to $100 af.

The bottom line is that I think a more reasonable estimate of maximum payment capacity for farmers is about $175 af, and their average cost of water will be at least $300 af with the tunnels.  Even for permanent crops, the adjusted maximum payment capacity is about $325 af and the water supply is not nearly reliable enough to shift to 100% permanent crops.

As frustrating as current conditions are to south-of-Delta farmers, they are still very profitable today. If they are paying for the tunnels, they have little chance of being profitable.

Like Hydrowonk Rodney Smith, the Treasurer's Report has left me more convinced than ever that the tunnels are not a doable deal.

P.S.  It should also be emphasized that the Treasurers' report only looks at financial feasibility, it is not a benefit-cost analysis or policy analysis.  The first page of the Report states this clearly,
The report does not address the merits of the BDCP per se or the question of whether the state and other parties involved in the project should proceed with this project.
That hasn't stopped tunnel boosters like the Metropolitan Water District from misrepresenting the report.  Clearly Jeff Kightlinger didn't read the first page of the report when he issued a statement that said "this independent review finds that BDCP is a prudent investment."

This post is too long already, so I recommend this post from the Hydrowonk for a good explanation of why the average cost analysis in this Report does not show that the tunnels are a prudent investment.

Thursday, January 22, 2015

Stockton wins first part of its bankruptcy appeal. Plan implementation begins next month.

According to the Stockton Record, Judge Klein has rejected a stay in the bankruptcy plan implementation, and the City will move forward with implementing the plan in February.  These excerpts from Roger Philips' article in the Record, featuring comments from the Judge, are very informative about his reasoning and what lies ahead.

In announcing his ruling, Klein took into account Stockton’s success at negotiating settlements with all of its creditors other than Franklin before the city’s trial began last May.
“The nature of the plan has involved a lot of hard work and hard-fought matters involving compromise by virtually all of the parties of interest,” Klein said. “My ultimate rationale … was everybody with the exception of Franklin had come to the table and given up quite a bit. They elected not to come to the table and deal, and they chose instead to challenge confirmation and to appeal.” 
In refusing to stay confirmation of Stockton’s plan pending the appeal’s outcome, Klein noted that Franklin’s appeal solely concerns the amount of money the firm will receive. As a result, Klein said, he saw no reason to delay implementation of the bulk of the restructuring plan and no cause to risk scuttling what has already been accomplished. If the case is returned to him by the appellate panel, Klein said, “I think I can (handle it) without tearing up the existing plan and throwing it away and having to abandon all the difficult compromises that were achieved.” 
Klein said the appeal could take as many as five years to resolve, and that to delay Stockton’s exit from bankruptcy over a money issue involving one creditor was against the public interest. The judge also said he does not think it is likely Franklin’s appeal will succeed. “The public interest is served by actually being able to implement a plan upon which people can rely,” Klein said. “When I add up those aspects in the analysis, I’m seeing little likelihood of success on appeal. I’m not seeing significant harm to (Franklin).”
As I have discussed before, Franklin's recovery is extremely low compared to other unsecured creditors - whether they are the other bondholders who settled - or even the retirees who lost health coverage but retained pensions.  So Franklin has some arguments, but there is also the argument that creditors who didn't negotiate and settle and who loaned the city money in 2009 once the downward spiral in the City's economy and finances was extremely obvious should take a larger loss.

The Judge is right, the City needs to be able to move forward.  Franklin is a relatively small creditor, and if they win the right to greater payment on appeal - it would almost certainly amount to less than a million dollars a year.  That would hurt the City's efforts to restore services, but it is not enough to upend the whole plan.  So while there is still some lingering uncertainty regarding the Franklin appeal, it is just going to be a footnote to the bankruptcy story.

The more important questions are how the City will move forward from here financially?  Is there enough revenue in Measure A (and will it be managed properly) so that the City can live up to the promise of 120 more police in Measure B?  Will the City maintain fiscal discipline with future employee contracts and budgets?  How much will the CalPers burden grow in the future?  Can it come up with creative ways to start restoring some of the non-safety services given its budget constraints?  Many challenges still lie ahead for City leaders, but at least Stockton can move forward with more certainty and confidence now.

Friday, November 14, 2014

Franklin Appeals Stockton Bankruptcy Confirmation

Franklin filed an appeal of Stockton's bankruptcy confirmation this week.  I hope that my previous prediction that Stockton's plan would be rejected in Court will continue to be wrong. 
Franklin claims that Judge Klein's ruling included 4 errors:
1. It incorrectly interpreted the Best Interest of Creditors Test.
2. The classification of Creditors was discriminatory and unlawful.  [The City's plan grouped Franklin's claim "class 12" with the retiree health plan claim.]
3. The plan was proposed in Bad Faith.
4.  The City has not adequately disclosed payments and fees related to the case.
 
I find the second argument most compelling, and it is a big reason why I originally thought the Court would reject the plan.  Of course, I am not a lawyer.  According to Judge Klein, Stockton's classification scheme does not discriminate illegally, and the appellate court may agree.
 
Below is an excerpt on this topic from Franklin's appeal.
 
"Disparate And Discriminatory Classification And Treatment. Franklin also established that
the Plan’s classification scheme – in which Franklin’s unsecured claim was classified together with
part of the claims of City retirees (health benefit claims but not pension claims) and separately from
the claims of all of the City’s other bondholders – had only one purpose: to enable the City to avoid
the “cramdown” requirements of section 1129(b)(1) of the Bankruptcy Code. By improperly
gerrymandering Franklin’s unsecured claim into a class whose other members (the retirees) had
committed to vote to accept the Plan due to the promise of unimpaired pensions, the Plan violates the
strictures of section 1122(a) of the Bankruptcy Code. In re Barakat, 99 F.3d 1520, 1525 (9th
Cir. 1996) (plan violates section 1122 where “the classifications are designed to manipulate class
voting”) (quoting In re Holywell Corp., 913 F.2d 873, 880 (11th Cir. 1990)). The Court erred in
concluding otherwise.
The Court also erred in disregarding the disparate treatment of Class 12 claims and creditors
holding Class 12 claims. Specifically, the Court turned a blind eye to the direct linkage under the
Retirees Settlement between the retirees’ recovery in Class 12 and the City’s agreement to leave the
retirees’ pensions unimpaired. While nominally providing a sub-1% recovery to all claims within
Class 12, the Plan actually provides retirees with a recovery of somewhere between 53% and 70%
 

due to the fact that, as quid pro quo for the sub-1% “settlement” of Retiree Health Benefit Claims,
the City agreed to pay pensions in full. As many cases cited by Franklin establish, that treatment
violates section 1123(a)(4), which requires that claims and creditors in the same class receive the
same treatment. The Court erred by disregarding that authority.
Finally, the Court erred by failing to consider the undeniably unfair discrimination against
Franklin’s unsecured claim. Had the Court properly rejected the City’s gerrymandered classification
and disparate treatment of Franklin’s unsecured claim, it would have concluded that the sub-1%
payment on that claim unfairly discriminated against Franklin in comparison to the Plan’s 50%-70%
payment of retiree claims and 52% to 100% payment of other City bonds, including the wholly unsecured Pension Obligation Bonds. This legal error is likely to lead independently to reversal."

Monday, November 10, 2014

North San Joaquin Valley Regional Assessment Conference, November 19 in Modesto

On Wednesday November 19, the Business Forecasting Center is organizing a forum in Modesto to share the results of a project we have been working on for the past year with regional leaders and the general public.  In addition, to Dr. Pogue and myself with Powerpoints of data on the regional economic system, there will be panel discussions with leaders from inside the region, and some guests from the Bay Area and Sacramento to discuss how the North San Joaquin Valley fits within the mega-region and how collaboration between counties can work for economic development.

The half day event is free, but you must pre-register.  Click here for more information and registration.

Also, the Modesto Bee published a Q&A with me this morning related to the event.

Regional Differences in Valley Air Pollution Could Drive Changes in Regulatory Approach

The Fresno Bee article linked below features an important regional environmental-economic issue that is often under the radar.
Clovis and Bakersfield, with dirtiest of dirty air, complicate Valley’s pollution battle

Read more here: http://www.fresnobee.com/2014/11/08/4223458_clovis-and-bakerfield-with-dirtiest.html?rh=1#storylink=cpy
The article talks about air pollution hot spots that cause the entire Valley to be out of attainment with federal standards, and how air pollution regulators are looking to focus on pollution "hot spots".   The graph below, borrowed from a regional data brief from California Forward, illustrates the regional disparities.



Overall, the North San Joaquin Valley (San Joaquin, Stanislaus, Merced) has less than 1/3 the number of unhealthy air days as Fresno, Tulare, and Kern, and is actually better than Sacramento, and far better than LA and the Inland Empire.

The NSJV complains about the regulatory costs and poor image that comes from being associated being grouped with the South.  The South Valley complains that much of their pollution isn't local, but is blown in from the North.

Some clips from the Fresno Bee article
“If those places do not attain the standard, the Valley won’t attain,” district executive director Seyed Sadredin said. “We’re not talking about backing off on the pollution reduction in other parts of the Valley. But we’re seeing that these two hot spots need more attention.”To focus on Clovis and Bakersfield, officials will need to deal with regional politics, doubts from air activists and probably state and federal air agencies...
Historically, the politics have involved the Valley’s northern tier of counties — San Joaquin, Stanislaus and Merced. Their air is cleaner than counties to the south, but they feel they need to speak up for their share of the $150 million in federal and state grants the district gets each year.
The money helps replace diesel engines, fireplace inserts, gasoline-powered lawnmowers and pay for many other incentive-based cleanup programs. Thousands of old diesel engines and diesel-powered vehicles have been replaced with this kind of money.
Stanislaus County Supervisor Bill O’Brien, an air district board member, defends the northern counties.
“We can’t just take the money from one area and give it another,” said O’Brien, whose family owns O’Brien’s Market, based in Modesto. “If the hot spot is around Fresno or Bakersfield, then we might want to talk about different rules and different ways of raising money in those areas to spend there.”

Friday, October 31, 2014

Stockton Bankruptcy Plan Approved!

I can't recall the last time I was this happy to be wrong.  I should stick to predicting the economy as I have a poor track record predicting judges.

It seems the judge was being very practical, and recognized the precarious public safety situation in Stockton and the risk of some very negative outcomes, especially in the short-run, if he were to reject the plan.

I am still a little surprised that he approved a plan that treated Franklin so severely (12% overall repayment, less than 1% on unsecured debt) - not just when compared to the City's retirees - but the other unsecured bond creditors who had settled.  That doesn't mean I am sympathetic to Franklin, they loaned the City money in 2009 without adequate collateral when the economic and financial crisis of the City was obvious.

It's time to move forward.  I am very happy for Stockton today.

Wednesday, October 29, 2014

Stockton's Bankruptcy Ruling Is Tomorrow: I expect the judge will reject Stockton's plan

According to today's Stockton Record article, it appears that there is no imminent settlement between the City of Stockton and Franklin Investment.  In addition, the City spokesman said they have not amended their plan that pays Franklin less than 1% on their more than $30 million in unsecured debt.

Thus, I expect the Judge will reject Stockton's plan, as I discussed in my earlier post reacting to the October 1st ruling.

It seems to me that Judge Klein has been doing everything he can to nudge the sides to settle over the past few months.  I believe delaying the confirmation ruling from October 1 to October 30 was to give them one last chance for a deal or for Stockton to come forward with an amended plan.

I hope I am wrong about this.

Wednesday, October 1, 2014

Bankruptcy Judge Delays Stockton's Decision until October 30. If City does not improve its offer to Franklin, rejection of its exit plan seems likely.

I expected the Judge to reject Stockton's bankruptcy plan of adjustment today, because it unfairly discriminates against Franklin.  However, he delayed a ruling on the plan until October 30th and reportedly said it was still "open season" on a negotiated settlement or for Stockton to amend their plan's treatment of Franklin.

While the delays in this case have been painful and costly for the City, I think he did them a favor here by giving them one last chance to avoid a rejection of their plan.  I think the Judge recognizes that rejecting the plan will be destabilizing to the City, but I doubt he is willing to confirm a plan that pays Franklin less than 1% on its unsecured debt and about 12% on its total debt when other creditors - both retirees and bondholders - are receiving so much more.

I also expected the Judge to make some sort of finding that CalPers pensions could be impaired by the City, and he did.  Since the City does not want to impair pensions, the ruling may seem to be of little practical importance to Stockton.  However, I do think that finding turns up the pressure for the City to improve its offer to Franklin and potentially make a last minute deal.

Below is an excerpt from what I wrote about the case in the most recent California and Metro Forecast.  I did not predict a rejection of the plan, but speculated at what the City would do if he does.
Judge Klein may confirm Stockton’s plan on October 1, but what happens if he does not?  The Judge could find that the City’s plan discriminates unfairly against Franklin, and he may also reach a conclusion that opens the door for Stockton to reduce pensions but he can’t compel the City to go through that door.  Even if the Judge gives Stockton an opening to impair pensions, City leaders have made it clear that they have no desire to go in that direction.  It is most likely that the City would simply amend its plan to offer Franklin a repayment of around 50%, roughly proportional to the recovery from fixed payments in the City’s settlement on its over $100 million in unsecured pension bonds.  The City would have a strong case that such an offer is fair, and would hopefully be able to still avoid a long and costly court battle over the pension issue.
While the judge did not reject the plan today, I expect he will unless the City produces something that is reasonably close to the settlement on the unsecured pension bonds announced last October. (The terms of the pension bond settlement essentially precludes the City from offering anything better.) Franklin also said today that it wants to be a "partner" in the City's recovery, which I believe is the same language that Assured Guaranty and the City used in describing their pension bond settlement last fall, because that deal provides a higher repayment if the City's future revenues exceed their current projections.

In my view, the City's argument for its harsh treatment of Franklin is illogical and inconsistent with its treatment of other creditors.  Sticking to that argument until October 30 seems like it could be a losing strategy. The City's plan hinges critically on being able to classify retiree's claims against the city for medical benefits and pensions into separate classes. The City's plan defines the medical claims as unsecured and sticks them in the same class as Franklin's unsecured claim for its bond debt, and the City puts the pension claims into a separate class. Since the retiree health care benefits were essentially eliminated by the bankruptcy plan, the City argues that the 1% recovery for Franklin's unsecured claim is fair since it is proportional to the treatment of retiree healthcare that it has placed in the same class. However, in ruling today that the pensions could be impaired and the $1.6 billion termination liability could not be enforced, it seems that the Judge views pensions as an unsecured retiree claim as well - at least they are not as protected as the City and CalPers claims. And at least to my non-lawyer brain, that suggests to me that it is highly unlikely that the judge will accept the City's classification scheme and agree with Franklin's argument that they are unfairly defining the classifications in order to impose a low recovery on them. I would also point out that the City considered separate secured claims from the same creditor (Assured Guaranty's secured bonds on the 400E Main building and unsecured pension bonds) as a package in describing the fairness in the settlements, so it seems to me that they are not being consistent here either. So I expect a settlement or adjustment to the plan in the next few weeks. I haven't made any serious attempt to estimate the cost of an adjustment on the City's budget, but it seems that the worst case would be $1 million per year over the next 30-40 years. While that hurts, it is much less painful for the City than having their plan rejected by the judge.

Disclaimer:  I am not a lawyer, and this is my immediate reaction to today's hearing.  As a non-lawyer, my opinion is based on my personal view of the logic and fairness behind the arguments and whether the business case and economic analysis supporting the arguments is sound.  I have been following this class closely, and have read all the briefs submitted by both sides leading up to the case, and have reviewed the City's financial projections in the past.

Wednesday, September 3, 2014

Will the City of Stockton Ever Be Able to Hire the 120 Additional Police Officers Promised in the Measure A Tax Increase?

As pointed out in today's Stockton Record (also see Michael Fitzgerald blog post), the City of Stockton has yet to hire any additional police officers with Measure A funds.  Officer attrition is high, and hiring is slow.

I was a notorious fence-sitter during the Measure A debate, upsetting a lot of people because I was waffling for and against the tax.  It was a close call, and the City dropped blockbuster creditor settlements and a new bankruptcy exit plan in October that greatly changed the situation.  I ultimately gave Measure A a very tepid endorsement, but many of my concerns about the unrealistic promises made to promote Measure A are now being realized.

Since the City unveiled Measure A, I have warned that my review of the City's financial projections made me doubt whether the City could live up to all the promises made in the Measure A campaign: namely that it would a) finance a bankruptcy exit, b) add 120 new police officers, and c) sunset in 10 years.

The City broke its promise about the 10-year sunset even before the election by assuming a permanent tax increase in the bankruptcy exit plan it filed with the court.

After Measure A passed, I wrote in the January 2014 forecast "it is clear that the City will have extremely tight budgets for the foreseeable future and hiring all of the promised 120 police officers will prove difficult, especially if new employee contracts include restoration of raises and cost of living increases."

These news reports of the struggles in hiring and retaining police seems to be setting the stage for higher compensation in future contracts.  In addition, the bankruptcy exit is already costing the City more than it projected - the offer to Franklin has increased by $4 million and the City is still paying high-priced bankruptcy lawyers when it had projected it would leave bankruptcy before the middle of 2014 if Measure A passed.

Back in the May 2013 forecast, even before the City proposed Measure A, I projected that the city would need a 1/2 cent sales tax increase just to finance its bankruptcy exit if it didn't hire any additional cops, and that there would only be 1/4 cent available to increase police staffing, enough to perhaps hire 50-60 police officers.  This was in major part of my argument against the Mayor's "Safe Streets" half cent tax proposal dedicated to public safety because it was unrealistic and would make it impossible for the City to finance its bankruptcy exit.

Measure A proponents headed off the Safe Streets proposal by promising 1/2 cent to pay for cops and 1/4 cent to pay for bankruptcy exit, and even gave voters an advisory Measure B to express this desire.

Now, it appears that arithmetic will ultimately prevail and Stockton voters may only receive half the police they were promised as bankruptcy and pension costs mount, and pressure increases for employee raises.

I am not surprised or disappointed in these developments as it is where I thought things were inevitably headed all along, and there wasn't and isn't necessarily a better financial plan for the City.  I am disappointed in the process, although it is not unusual for government officials to promise more than they can deliver and passing Measure A may have prevented an even worse outcome.

But it will further erode Stockton voters' trust in City Hall, and the voters should hold City leaders accountable for keeping costs down and doing everything they can to deliver the services promised to them.