Fri 05/07/2021 12:52 PM
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Relevant Documents:
Amended Recovery Plan
Audited Financials (2017)
Issuer Homepage
Chester Receivership (Website)

Michael Doweary, as the receiver for the city of Chester, Pa., this week disclosed to the municipal markets his amended recovery plan, dated April 7. Among the options being explored by Doweary is the pursuit of a bankruptcy filing as well as refinancing of debt. To read more of our Americas Municipals' coverage of Chester, PA as well as our coverage of  other timely, objective and actionable intelligence covering higher yielding and liquid municipal issuers request a trial here

Chester, with 34,000 residents, has been subject to commonwealth oversight under the Municipalities Financial Recovery Act (Act 47 of 1987) since 1995 and is only the second Pennsylvania city to enter into receivership. After the commonwealth’s governor declared a state of fiscal emergency for the city in 2020, the Pennsylvania Secretary of the Department of Community and Economic Development nominated Doweary, who subsequently proposed and executed on an initial recovery plan.

Although the city of Chester has not submitted audited financials for periods after 2017 (which were submitted in 2020), the last auditor’s report includes a going concern qualification stating that the municipality has experienced substantial recurring expenses in excess of revenue and a net unrestricted deficit of $234.46 million, as of Dec. 31, 2017. Further, the auditor’s report states the city has “limited funding available” to meet its financial obligations without additional funding sources or a reduction of expenses and continues to be delinquent in certain required pension payments.

The governor declared the fiscal emergency on the basis that the city is projected to be insolvent within 180 days due to ongoing fiscal challenges and the enhanced financial distress caused by the Covid-19 pandemic. The governor’s statement of facts highlights that Chester “regularly” finishes the year with barely enough cash to cover payroll, the police pension fund is nearly bankrupt, and there is “no capacity” to address mounting capital needs.

The statement says that in early 2017, the city had about $28 million of unpaid obligations and a cash shortfall that led to a default on its 2016 Tax and Revenue Anticipation Note. The city obtained a $2 million loan from the Department of Community and Economic Development, or DCED, to cover the shortfall and arranged an advance on gaming host revenues to the city to repay the note and provide immediate liquidity.

In August 2017, the city closed an unfunded debt issuance to eliminate a portion of its outstanding liabilities. However, even after the borrowing, unpaid obligations remained, including over $17 million of past due pension minimum municipal obligations, or MMO. The unpaid balance for one pension accrues interest at 7.5% and, as of 2020, totals over $25 million. The city’s pensions are grossly unfunded, with the city failing to make MMO payments for fiscal years 2014 to 2019.

Among the potential exit options the city explored was a monetization of assets. The city’s two “significant business-type” assets are the water system, owned by Chester Water Authority, or CWA, and the parking system owned by Chester. If the city monetized these assets, they would generate millions of dollars for the city. However, since 2019 the city has been mired in lawsuits related to the sale of the CWA. Similarly, the parking system is embroiled in a lawsuit with a third-party operator and manager. Both lawsuits remain ongoing.

The onset of Covid-19 further added to the city’s financial crisis, with business activity having slowed dramatically. For example, Harrah’s Racetrack and Casino was shuttered, costing the city $500,000 per month in general fund revenue. The declaration of emergency notes that as of April 8, 2020, the city had about $775,000 cash on hand, with a $590,000 April 17, 2020 payroll coming due.

According to the amended recovery plan, the 2020 cash crises the initial plan focused on - a lack of funds in the general fund and cash that supports the police pension fund - have been averted in the near term “but are nowhere near being fully resolved.” However, additional issues have been identified regarding employee pension funds and their “true financial status,” discussed more below.

The report says that Chester finished 2020 with $900,000 of cash, did not incur any additional debt and held a minimal backlog of bills, while failing to make full contributions to pension funds. Additionally, the report states that “preliminary indications” show the city is to receive $32.8 million under the newly enacted American Recovery Plan Act, with the first half arriving in 2021 and second at least a year after that. Nevertheless, for 2021 the report cautions that cash will be “very tight” again, hitting a low point of $722,000 or five days’ worth of expenditures in October.

The proposed recovery plan requires an overview of the most problematic areas identified by the receiver, which are detailed below.

Legacy Costs

The city allocates almost 30% of its 2021 general funds budget to three legacy costs: (i) its employee pension plans; (ii) principal and interest payments on debt; and (iii) retired employee health insurance. The report notes that the city budgets almost as much for these legacy costs as it does for the police department, the fire department and the public works department combined.

Debt Service

The city’s debt burden is not extremely high, but the report underlines that the debt is largely unrelated to the purposes for which municipalities should issue debt - to fund cost of capital projects. Instead, the city is repaying debt it needed to cover operating deficits or specific projects unrelated to city-owned infrastructure, the receiver says.

The debt shown above includes a DCED Act 47 emergency loan, which was issued to help with the city’s immediate cash flow needs. The loan is interest-free and matures in 2027.

The $12 million Series 2017A bonds were issued for the purposes of paying certain unfunded general fund liabilities and creating required reserve funds. These bonds essentially take the city’s deficient and unpaid liabilities in 2017 and spread the costs of partially repaying them over 10 years, the receiver says.

A second issuance in 2017 - the Series 2017B bonds - were used to finance the acquisition of certain property leased by the city and to fund required reserves. The report states that in effect, these bonds were refinancing debt originally issued by the Chester Economic Development Authority.

The Series 2017 bonds are limited obligations of the city, payable from pledged revenue, which consists of fees for hosting Covanta’s incinerator facility and “gaming-related revenues and additional city considerations between the City and Harrah’s that are directly deposited with the trustee as pledged revenues under the indenture.” In addition, “the timely payment of principal and interest is guaranteed by the City for which the City pledges its full faith, credit, and taxing power.”

The $3.985 million Series 2010B bonds were issued in connection with obligations related to the Chester Upland School District becoming a sponsoring district for Delaware County Community College. The $4 million upfront payment is secured by 1% of table gaming revenue guaranteed to the city as a casino host community, as well as a general obligation pledge.

Employee Pension Obligations

Identified as the “largest and most urgent problem,” the recovery plan states that the police pension plan is almost entirely depleted. Moreover, Chester has the lowest funding levels of any Pennsylvania city, as shown below:

The city has three “defined benefit pension plans” to its employees, meaning the monthly benefit payments the employees receive during retirement are set at a specific level, regardless of the pension plan’s funding status.

Under this construct, the employer and employees both contribute to the pension plan during the employee’s career, the city shoulders most of the financial burden and all of the risk that the pension plan will have enough money to make monthly benefit payments at the “defined” level. If pension benefits cost more than projected or plan investments lose their value, the city government covers the shortfall.

The three pension plans are the Police Pension Plan, the Paid Firemen’s Pension Plan and the Officers and Employees Pension Plan. The chart below shows the funding status of each pension plan:

Based on an “actuarial quirk” that allocates contributions that the city did not make in prior years as “receivables,” the PPP (Police) funding percentage is largely overstated at 33% and, instead, is more likely closer to 3% funded.

Under Pennsylvania law, the city is required to make the full minimum municipal obligation payment for each plan by the end of the year. The MMO comprises the sum of the normal cost, amortization cost and administrative cost, minus the employee contributions. Pennsylvania provides the city with pension aid that funds a portion of the MMO. The remainder is paid by the city from the same revenues that fund daily operations, debt payments and other needs. Failure to do so results in interest penalties calculated using the same interest rate that the city assumes pension investments will earn.

The recovery plan notes that Chester has not made its full MMO contribution to all three pension plans since 2013, relying only upon the state-funded portions between 2013 and 2016, and making partial contributions below the MMO since 2017.

Chester’s pension crisis was so dire that the police pension had $1.75 million in total assets at the end of July 2020, and entered 2021 with $2.1 million. As part of the Act 47 2018 Exit Plan, the city began levying a 1% distressed pension earned income tax on commuters in January 2019. The report notes that Chester failed to follow the requirement that this tax is levied on its own residents as well, which has been remedied.

The city’s outstanding MMO for each plan with estimated interest penalties applied as of March 2021 is below. The report notes that the police pension fund will not make monthly payments if it runs out of money, so the city has to make its full contribution, including using the distressed pension tax revenue for its intended purpose. Still, interest penalties will consume a large part of the city’s annual contributions, which will make it almost impossible for Chester to catch up on this obligation, absent a large infusion of money, the receiver concludes.

Other Post-Employment Benefits

The city’s other post-employment benefits, or OPEB, liabilities as of 2018, as calculated by the city’s actuary, were $232.9 million.

Chester uses a self-insured arrangement in addition to a Medicare Supplemental plan. Through these self insured plans, the total estimated premium costs about $5.5 million for the “POS” plan and $5.1 million for the EPO plan. The large enrollment and high cost explains why the city spent 3.2% more than its 2020 budget on medical insurance, despite furloughing employees for much of the year. As part of the receiver's work, the city will move certain retired employees to the other lower-cost Medicaid plan.

Recovery Efforts

Debt Refinancing

As part of the ongoing recovery efforts, the recovery plan proposes refinancing the city’s 2017 debt, which accounts for most of the debt service payments through 2027. The receiver explains that the city could redistribute the remaining portion of the outstanding debt service payments to require lower payments in the near term, with higher payments in the future. Ultimately, this would result in higher total debt payments than under the bonds. The report states that the receiver reviewed an initial proposal in 2020 and determined “while the concept is worthy of closer review,” the terms of the proposal were not “sufficiently beneficial” to the city. The report indicates that these efforts to obtain a satisfactory debt refinancing proposal continue.

The report also suggests exploring the possibility of a federal bankruptcy filing to address the reduction of retiree benefit costs if other options are not successful.

Pension and OPEB

The process of righting the pension system in the city has already begun, with the receiver attacking this issue from multiple fronts. First, the report notes the proper implementation of the distressed pension tax, and eliminating the compliance issues by applying it equally to commuters and noncommuters.

The budget has also been adopted for 2021 that includes the city contributing the full MMO payments for all three pension plans. Further, any financial windfalls will be directed toward a paydown of the pensions.

The receiver says that a one-time contribution to the pension funds, either backed by asset monetization or pension bonds will be part of the overall solution. However, this must accompany an amelioration of the underlying structural issues in the system in order to avoid ending up in the same situation later.

With respect to the police pension plan’s funding status, which the receiver says is “critical,” the receiver suggests taking steps “not seen before” for Pennsylvania public sector plans, but which are common for ERISA plans. For example, there will be no enhancements to pensions or OPEB, including retiree health insurance. This includes changes in collective bargaining agreements, side letters or other individual agreements. Such changes would be extended to all three plans and all employees.

Additionally, the city will engage in evaluating those employees on disability to ensure there is no fraud or abuse, as well as enter into negotiations with stakeholders in the police pension plan and OPEB to implement “meaningful” changes to the program. Among these include the elimination of retiree healthcare for new hires.

The report also notes the benefit of leveraging public-private partnerships in the city to help revitalize the community once the city shores up its financial positions better.

--Alix Brozman
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