Wed 05/19/2021 11:32 AM
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During a City Council meeting on Tuesday night, advisors to the city of Long Beach - O’Melveny & Myers and M3 Partners - provided an update on early efforts toward a restructuring of nearly $500 million in long-term liabilities that include legacy bond debt, pensions and other post-employment benefits, or OPEB. To read more of our Americas Municipals' coverage of the Long Beach restructuring as well as our coverage of  other timely, objective and actionable intelligence covering higher yielding and liquid municipal issuers request a trial here.

Having largely completed the initial legal and financial diligence phase of the engagement, O'Melveny partner Maria DiConza said the advisors are “starting to formulate options available to the city and the pros and cons and the risks and benefits of those options.”

During the meeting, the City Council also adopted a five-year capital plan, approved an override of the tax levy limit and targeted certification of a fiscal 2022 budget for next week that incorporates recent recommendations from the Office of the New York State Comptroller.

Restructuring Update

While concurring that the city is trending in the right direction in terms of budget controls and operating spending, DiConza and M3 Partners Managing Director Brian Griffith both signaled that the legacy obligations would have to be dealt with sooner rather than later.

DiConza touted the input of City Manager Donna Gayden and Comptroller Inna Reznik during the diligence phase and the expertise of other outside advisors, including legal counsel and Capital Markets Advisors.

“As we mentioned at the outset, our goal is to pull all that expertise together along with our own to try to put together some comprehensive strategy for the city. And that is what we are working on,” DiConza said. “While our work is still ongoing, it is clear that the city cannot just borrow their way out of this.”

DiConza noted that the city needs to be in a position to pay back any money it borrows and to be able to service its debt on an annual basis while still paying for its operating expenses.

“There’s no silver bullet here,” she said, stressing the importance of continuing to identify and work to “reduce or eliminate the structural issues and the legacy liabilities” that the city faces. “And it is extremely important to do it today because it will only get worse,” she added.

In addition to the legacy liabilities, DiConza also pointed to the roughly $132 million awarded judgement against the city in January in the marathon Haberman zoning case that dates back to 1989. The city has stated that financial consultants and legal counsel are examining all potential options to mitigate the financial impact to the city and its taxpayers from the damages award. These options include appeal of such judgment, settlement negotiations, state legislation to provide the city with flexibility in financing the ultimate liability and mitigating the annual cost to the city; and restructuring the city’s budget and services to augment such options.

Both DiConza and Griffith concurred that the city’s financial problems predate the current administration, which they credited with important strides to improve budgeting processes and control spending. DiConza touted moves made by the city to understand “what money is coming in and coming out” as a foundational step toward fixing its finances.

“But we do need to deal with the legacy liabilities as well,” Griffith said. “But you guys are tending in the right direction.”

The M3 Partners and O’Melveny representatives also pointed to an arbitration cap amid ongoing collective bargaining agreement negotiations that should have a positive impact on the city’s finances. Interest arbitration was the city’s largest payout last year at more than $600,000 for separation payments when people are retiring. Under the new award, the interest arbitration on the collective bargaining agreement would be capped at $275,000.

“The city can’t sustain those kinds of payments year after year without a corresponding increase in revenues. And so these structural issues are what create these liabilities,” DiConza said. “It is really addressing these issues today that this administration is working to do. And it is extremely important to do it today because it will only get worse.”

Griffith said M3 Partners preliminary analysis showed that the actual true operating expenses of the city have come down over the past five years “as belts have been tightened and folks have done a pretty good job” of managing ongoing expenses.

“Where we are seeing some pretty material increases are in the debt and the legacy expenditures,” Griffith said, highlighting that “deficiencies” have driven principal amortization and interest payments on bonds up over the past decade. “That is kind of coming home to roost and it’s causing the dollars going out the door to go up at a higher rate than the operating expenses are coming down,” he said, adding the “same is true” on OPEB and pensions.

“Those are contractual so those are things that will have to be dealt with as part of a bigger process. If there are opportunities to reduce it, I think that is what we are going to be looking at,” he said. “I just want to make it clear it is not total operating expenses. It is total dollars going out the door and a lot of that does have to do with the legacy portion - you know, the debt and the kind of contractual obligations.”

“In effect, we are paying for money that was borrowed quite a ways back and is catching up to us now. That’s why we need to right the ship,” City Council President John Bendo said.

Griffith said the work that the city has been doing over the past couple of years is “paying off in terms of figuring how to best balance the budgets without having to borrow.” Between 2014 and 2018, the city was borrowing on average about $6 million annually more or less to balance the budget between interfund transfers and bond issuances. “And over the last two or three years that number has come down significantly,” he said, noting that about $3 million would need to be borrowed to bridge gaps in the fiscal 2022 budget in part to cover payouts that were accelerated as part of arbitration.

“But in the long term that is going to pay off because you’ve capped these payments,” Griffith said. “So we’re going to have a little bit of pain in this current year, but the trend is obviously very encouraging.”

Reznik, the city comptroller, noted that pension plan payments are set to surge to $8 million in fiscal 2022, a $1 million increase over the current budget based on estimated bills from the New York State and Local Retirement System. She said the city has yet to receive “any good indicators” from the state health system on adjustments to health insurance costs. The health system operates on a calendar-year basis so current rates are locked in though December, she said.

Seeking to put an “interesting data point in simple terms,” Bendo said that about two-thirds of the city’s budget is salary and benefits and 15% is debt service. “So 83% or 84% is going to stuff the city in effect doesn't have much control over,” he said, noting that pension costs and medical costs come from the state and that the city has contractual obligations with the employees covered under collective bargaining agreements that give them contractual pay raises in a given year. “That’s not just something we can say you’re not getting it.”

Bendo said that “talk about slashing the budget is really talking about cutting heads. That’s the only thing to cut.” Such cuts would necessarily mean reduced quality and quantity of services, he said.

Fiscal 2022 Budget Process

The City Council set a special meeting for Monday, May 24, to adopt a fiscal year 2022 budget that contemplates $93.64 million in general fund spending as part of a broader operating fund budget that includes a $5.46 million water fund spending plan and $6.59 million sewer funding plan. Approval of the budget was pushed out in part to give the city time to evaluate, and ultimately incorporate, recommendations issued by the Office of the New York State Comptroller, including approving the override of the tax cap and adopting water rate increases before passing the budget.

In a budget review issued on May 12, the Office of the New York State Comptroller found that the city's financial condition “remains in significant fiscal stress” and that the proposed general fund budget of $93.6 million is structurally imbalanced because the city continues to issue debt to finance recurring operating expenditures. “The continued reliance on proceeds of long-term debt to finance recurring operating expenditures will further diminish the city's ability to finance needed services in future budgets,” according to the report.

Among its key recommendations, the report called on the city to discontinue its reliance on proceeds of long-term debt to finance recurring operating expenditures. The report notes that the city has been authorized to issue debt not to exceed $12 million to liquidate the accumulated deficit in the general fund and certain other funds as of June 30, 2012. Local finance law requires all municipalities that have been authorized to issue obligations to fund operating deficits to submit their proposed budgets for the next fiscal year to the state comptroller for review while the deficit obligations are outstanding.

Among other things, the report also called for the city to include cash flow projections in the budget to identify and address cash shortfalls and to implement overtime controls.

As part of the budget process, the City Council also voted to override the tax levy limit. Reznik stated that to balance the fiscal 2022 budget structurally, the city would need to “pierce the tax levy limit or cut services drastically.” Reznik noted that an initial budget gap projection of $3.9 million had been reduced to $2.3 million, as reflected in an errata document, in large part as beach revenue targets were revised upward in light of easing of Covid-19-related capacity restrictions.

Gayden, the city manager, said the nearly.$106 million proposed combined budget had been “scrubbed” as far as possible, echoing that piercing the tax cap was needed to avoid service reductions and public layoffs. “Remember, payroll is our biggest expense,” she said.

The City Council also approved a five-year capital plan following a presentation by Public Works Commissioner Joe Febrizio, who noted that approval for related bonded borrowing will be considered at a future stage. Febrizio said he met with representatives from M3 Partners and O’Melveny this week to discuss the capital plan. “They had a lot of questions and will probably have a lot more. They are interested in that, and I’m sure we are going to have more dialogue in terms of the impact to the city,” he said.

DiConza, of O’Melveny, signaled that the legal and financial diligence will be subject to some adjustments once the fiscal 2022 budget and capital plan are approved.

The plan states that while Long Beach will potentially add $9.7 million in new debt in fiscal 2022, it will pay down $9.6 million in existing long-term debt and capital lease payments (inclusive of $1.1 million to be paid on the debt issued by the risk retention fund to provide for legal settlements). Because the bond anticipation notes issued in 2021 was all new money, a principal payment is not required next year, according to the plan.
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