How Lenders, Restructuring Pros Can Transform Public Sector Financing

Post-Election Thaw May Melt Political Gridlock

By Robert Himmel
Featured in the October 2012 Issue of  the Journal of Corporate Renewal

Among the many factors weighing on state and municipal government entities in the current environment is the political gridlock in Washington, D.C., and elsewhere. Legislative processes have ground nearly to a halt as Congress focuses on the November election and lenders, businesses and consumers wait to see which party will control the White House and the two branches of Congress next year.

This gridlock at the federal level continues to weigh heavily on municipalities, which are already feeling the pinch from a continuing poor economic environment, compounded by cuts in spending and, more importantly, the earmark restrictions on how local government entities can deploy the federal funding they receive. In California alone, three cities have declared bankruptcy this year: Mammoth Lakes, San Bernardino and Stockton. Fears abound that many more cities will be forced to follow suit if conditions do not improve.

The good news is that the election results, regardless of the outcome, will almost certainly provide clarity on a path forward for public spending projects. In a best-case scenario, there will also be greater awareness among legislators on both sides of the aisle and up and down Pennsylvania Avenue that further gridlock – particularly vis-à-vis federal funding to local governments – is almost universally unacceptable to their constituents. At a minimum, it is likely that extreme political partisanship will subside temporarily, and politicians, fresh off reelection, will feel more comfortable drafting and passing bipartisan legislation and begin to alleviate the legislative gridlock that has been the rule for most of the past two years.

Post-election, a relaxation of restrictions and a release of federal funds and rules of use for municipalities, and at least a slightly improved economic climate are expected. For lenders to municipalities and restructuring professionals, this potential thaw in the political atmosphere may introduce several crucial developments:

  • Many struggling public / municipal entities – and the private industries that support them – could begin to see a significant improvement in the flow of funds after November.
  • For many of these municipal entities, improvements in the political and business climates alone will not be enough to facilitate a full recovery from their current dire positions. Indeed, many of these municipal entities have amassed debt burdens that threaten their ongoing viability, while their revenue and operating cash flow positions have deteriorated to crisis levels.
  • With the anticipated relaxation of the gridlock in Washington, many of these entities would greatly benefit from an infusion of operating expertise from the private sector in order to re-position themselves as viable concerns in the immediate future. The alternative, in some cases, could be bankruptcy.

All of this means that there are a number of municipal entities and related industries currently stagnating or in decline that could see a rebound after the 1st legislative session, with funds being released between fiscal quarters two and four of next year.

Now may be the time for asset-based lenders with relationships in the municipal sector, in concert with restructuring professionals, to position themselves to collectively benefit from the potential upside of a post-election rebound. They should work together to identify public and private entities that could experience a lift in an environment in which local governments have greater discretion in how they allocate federal funds. Lenders may see opportunities in the following areas:

  • Energy: During the 2008 election there was considerable talk about government support for alternative energy, whether wind, solar or hydro. But with the failure of Solyndra, a solar company that was a recipient of federal loan guarantees, much of that talk was tabled. Lawmakers from both parties seem committed – at least on some level – to re-visiting the debate about government funding of green and traditional energy projects in the not-too-distant future.
  • High-Speed Rail: Florida, for instance, had plans to begin building a high-speed rail system in 2011 connecting Tampa, Orlando and Miami. Though Gov. Rick Scott rejected the plan as too costly, and construction never began, it is not unreasonable to assume that many high-speed rail plans will be revisited post-November.
  • Public Works: Even in cities and states where the economy is outperforming national trends, funding for public works projects remains sparse. For example, although the unemployment rate in North Dakota is only 3 percent, Rapid City is $12 million short of the $24 million it needs to complete much-needed street infrastructure projects, according to the state’s Department of Public Works.
  • Schools: To save money, public school districts nationwide have been forced to increase class sizes, squeeze into less than ideal physical plants and implement wage and hiring freezes, in addition to other staffing changes as infrastructure spending on education has plummeted. This is a situation that, with a softening in how funds can be deployed (absent of earmark restrictions), could change in the near future.

Of course, complications will continue to arise even when state and local governments enjoy greater discretion over how they can spend the federal funds they receive. Financially distressed municipalities, in all probability, will continue to struggle in the short term. Perhaps even more problematic, however, are a series of untenable long-term obligations, such as pension and healthcare costs for public workers, exacerbated by the rapidly retiring Baby Boomer generation.

Municipal entities, therefore, would benefit from private market expertise to get back on a sustainable operating path, giving lenders and restructuring professionals who work in partnership the opportunity to help transform the public sector as it is structured today, while maximizing upside opportunities from a potential rebound.

Public-Private Partnerships

Municipal lenders and restructuring professionals should work together on a broad basis to develop and implement public-private partnership initiatives geared at working out current municipal government debt. This can be potentially achieved by taking some of the best features of the Municipal Assistance Corporation’s (MAC) bond initiative that was established in New York City in the 1970s, and broadly applying them throughout multiple municipalities.

The MAC initiative sought to address the economic environment in the nation’s largest city, which at the time was as precarious, if not more so, than anything we are witnessing today. The city of New York had over $14 billion of debt outstanding, almost $6 billion of which was short-term.

After getting frozen out of the credit markets and flirting with bankruptcy, the city, with the help of the state of New York, formed MAC in 1975. A collaborative effort by public institutions and private enterprise, MAC ultimately succeeded in restructuring New York City’s debt by issuing over $10 billion in bonds.

Not only did this help restore the solvency of the city, it established common-sense fiscal practices that are still in place today. These include requirements that the city balance its budget every year, institute five-year spending plans and eliminate poor accounting practices.

What is instructive for asset-based lenders and restructuring professionals is that when the city finally re-entered the credit markets in 1978, the banks that underwrote much of New York City’s debt through their partnership with MAC ended up being long-term beneficiaries. That model could be applied today through a restructuring process that includes new, ongoing operating partnerships with banks that provide assistance through dedicated restructuring professionals to municipalities attempting to rework their balance sheets.

Another approach that could be employed in tandem with the above solutions is to create more quasi-public corporations that assume responsibility for certain key public works with enhanced accountability to the various branches of government and ultimately the taxpayers. Two examples of such entities are Amtrak, the national railway company, and ConEdison, the New York utilities provider.

Such entities would be expected to operate as going concern companies. Lenders and restructuring professionals could join forces on a broad basis to introduce this concept to state and municipal governments, and then work closely with them to identify where they could reduce financial burdens and streamline operations by housing certain services and public works under such quasi-public entities.

Generally speaking, city managers and other government employees rarely have extensive and highly sophisticated financial engineering expertise, a skill set that is sorely needed at this time. Accordingly, restructuring professionals should approach lenders who work closely with municipalities. Restructuring professionals can offer a broad spectrum of private sector expertise, including cash and expense management, to public entities on a consultative basis. This would not only reduce risks in association with loans and bonds already made to municipalities, but would also solidify the financial underpinnings of states and municipalities going forward.

Equally important, lenders and restructuring professionals could explore opportunities to work together to develop a range of creative debt financing solutions for municipalities that involve public assets. The value of many types of public assets including land, buildings, and use rights over public areas, to name a few, are currently underutilized or perhaps even completely overlooked by local governments. Lenders and their restructuring partners, with their expertise in assessing and unlocking asset values, could help state and municipal governments use these assets to rework their balance sheets and find new debt financing solutions.

Transformative Force

After the nation’s votes are cast in November, the dialogue will almost certainly focus on what the electoral outcome means on a macroeconomic level. One thing is clear: With the prospects improving for an easing of the current political gridlock by next year, lenders and restructuring professionals that move now to work together and systematically target public sector clients could not only successfully protect lenders’ existing loan portfolios, but potentially open up a whole new universe of clients to serve.

In the process, there appears to be a clear opportunity for lenders and restructuring professionals, working in concert, to act as a positive transformative force within the public sector.