F ISC AL E ME NCIES , , AB506 AB506 ISCAL MERGE RGENCIE AND M EDIATION AND EDIATION November 13, 2018 10:00 – 11:30 a.m. (PT)
Agenda 1. Introduction and Overview: Karol Denniston 2. Lessons Learned from San Bernardino: Michael Busch 3. Update from the League of California Cities: Dane Hutchings 4. Declaration of Fiscal Emergency: Sonia Carvalho 5. Out-of-Court Restructuring Process: Peter Morrison and Karol Denniston 6. Closing and Q&A squirepattonboggs.com 2
L ES SONS L EARNE ESSON EARNED FROM FROM S AN AN B ERNARDINO ERNARDINO Michael Busch
Why Did San Bernardino Need Chapter 9 Protection? The simple answer, a combination of poor accounting and high structural spending (labor costs, public safety commitments, inefficient service delivery models, etc.) lead to multiple years of deficit spending, and the City’s Charter provided no one with the power to assert control and facilitate much needed fiscal policy changes. In 2007, the City was first put on notice that continuing existing fiscal policies and practices could lead to insolvency, despite recent passage of ¼ cent sales tax measure. City declared a fiscal emergency on July 18, 2012, and filed for Chapter 9 protection on August 12, 2012. As an emergency filing, the AB 506 process approved in March 2011 was not used. City was able to avoid running out of cash. squirepattonboggs.com 4
Why Did San Bernardino Need Chapter 9 Protection? While a number of factors contributed to the crisis, by far the most significant was increasing operating costs (primarily due to City Charter approved salary and benefit increases) at a time when City revenues continued to decline. As the chart below depicts, over two years (from fiscal years 2009-2010 to 2011-2012), the City’s “ fund balance ” declined to negative $1.2 million. Cash balances were negative $15 million. Without substantial and immediate restructuring of the organization, both operationally and financially, the City was not be able to provide basic services. 5 Year Budget and Fund Balance Estimates 2008-092009-102010-112011-122012-132013-142014-152015-162016-17 200.00 Millions 100.00 Expenditures - Revenue (100.00) Fund Balance (200.00) (300.00) squirepattonboggs.com 5
Cash Flow – All Funds FY 12-13 $60,000,000 Expenditures $50,000,000 Revenue Ending Cash $40,000,000 $30,000,000 $20,000,000 $10,000,000 $0 ($10,000,000) squirepattonboggs.com 6
Meeting Chapter 9 Eligibility The City’s petition for bankruptcy eligibility ( i.e. , proof of insolvency) was structured around its inability to provide essential services without the court- ordered fiscal relief from various obligations. The City’s position comports with the definition of “financial condition” adopted by the International City/County Management Association (ICMA). Specifically, ICMA defines a municipality’s financial condition as the ability to (1) maintain existing service levels, (2) withstand local/regional economic disruptions, and (3) meet the demands of natural growth, decline, and change. ICMA also categorizes financial solvency in 4 distinct ways: Cash solvency : government’s ability to generate enough cash over a 30 to 60 day period to 1. meet its obligations. Budgetary solvency : government’s ability to generate enough revenues over its normal 2. budgetary process to meet its expenditures and not incur deficits. Long-run solvency : government’s ability to meet expenditures that may not be addressed as 3. part of the normal recurring annual budgetary process. Service-level solvency : government’s ability to provide services at the level and quality that 4. are required for the health, safety, and welfare of the community and to meet its citizens’ desires. squirepattonboggs.com 7
Meeting Eligibility: On to Mediation One contributing factor to the City’s year long fight for bankruptcy eligibility was the lack of time to complete AB 506 process negotiations with its creditors due the City’s cash flow insolvency – the City needed protection ASAP. The City’s major creditors included CalPERS, police and fire unions, bond holders and bond insurers, and individual claimants (wrongful death & excessive force). Judge Jury ordered the City into mediation in Reno, Nevada with Judge Zive. Judge Zive ordered the City’s major creditors to attend a mediation kick-off meeting. Attendees included the police and fire labor groups, CalPERs, bond holders and insurers, City staff, Chapter 9 counsel, bankruptcy consultants, and a few elected officials (Mayor and Mayor pro-tem ). The City learned the significant data required to support its eligibility petition and to validate specific creditor treatment ( i.e. , impairment) was deficient. squirepattonboggs.com 8
San Bernardino’s Introduction to Mediation Judge Zive asked all creditors, including City staff and consultants, for ideas the City should consider for restructuring (A total of 38 options were put on the table). The process to meet a good faith effort to evaluate the options represented an organizational challenge. The City needed a structure to evaluate each option as well as a realistic expectation for fiscal & operational change. We defined the study areas into two (2) basic categories: Cost Containment : Process of maintaining organizational costs within a specified budget; restraining expenditures to meet organizational or project financial targets. Cost Recovery : Recoupment of the purchase price of a capital or qualified asset or service provided through depreciation, user fees and taxes over a prescribed period. Our analysis further assumed the City would return to the basics of governmental services. squirepattonboggs.com 9
Fiscal and Operational Change Where Do We Begin? Guiding Principles ORGANIZATIONAL INTEGRITY: We agree to the adherence of moral and ethical principles placing emphasis on the betterment of the organization over individual results. SOCIAL RESPONSIBILITY: We agree to the principle that the organization serves the betterment of the community and not be solely devoted to interests of the organization. TRANSPARENCY: Transparency permits employees, elected officials, and the community a greater understanding of a City’s operations, including the parts of the organization that are most and least efficient. This, in turn, places greater pressure on the organization to communicate openly and to produce acceptable results in all facets of the City’s operations and negotiations. squirepattonboggs.com 10
Meeting the Mediation Challenge Evaluation Process How do we measure organizational priorities and provide a good faith evaluation of the 38 options presented in mediation? The City developed an evaluation criteria based on the adopted guiding principles: each option was ranked and evaluated on how well the option minimized impacts to community while maximized savings to the general fund. Because the 38 recovery options included a variety of options, the options were separated into “study areas. ” Three study areas were developed: Policy Opportunities 1. • Contracting Out for City Services (Refuse and Fire). Administrative Opportunities 2. • Service Consolidation and Reduction in Workforce. Voter Approved Opportunities 3. • Charter Reform and Voter Approved Revenue Measures. squirepattonboggs.com 11 Cost Containment (Contracting For Services)
Meeting the Mediation Challenge (con’t) Strategic Planning Structure We made a decision to use a familiar process to help the City understand its options and to evaluate / defend its future. The typical stages of a strategic plan include: Readiness Phase – This includes interviews with internal and external stakeholders and leaders leading to assess the City’s readiness to develop and implement a transformative plan. Self Assessment – This is a comprehensive assessment of the strengths and weaknesses of the current City environment – both internal to the organization an external within the community. This phase evaluates, at a high level, various attributes such as the organizational culture, level of accountability, capacity and performance, and what is supporting or getting in the way of high performance and/or achieving the goals of the Council and Mayor. squirepattonboggs.com 12
Meeting the Mediation Challenge (con’t) Strategic Planning Structure (con’t.) Examining The Future – This stage describes the City’s future assuming no change-of-effort from the status quo. It not only describes the internal organization but also the community, in terms of how both will look and feel if the current course is stayed. Creating The Future – This stage involves the organization (Council, Mayor and City Manager) and possibly community leaders and describes a realistic vision on what San Bernardino can be in 2 years, 5 years or more. This shared vision is then compared to the previous phase, the status quo future. Where there are unacceptable differences between the two, we then propose specific new strategic initiatives that optimize the strengths and remove obstacles. squirepattonboggs.com 13
Measuring the Options and Defending Our Position Policy Opportunities Franchise Refuse Services / Contracting or Selling Sanitation Impact Low Medium High Department x Organization x Ward x Community x Financial Savings x squirepattonboggs.com 14
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