Not willing to accept a negative fiscal analysis and reduced bond rating by Moody’s, I requested a meeting to discuss the report with Moody’s.
My request was granted, and on August 13, 2015, City Manager Bill Lindsay, Bond Counsel John Knox, Mayor’s Office staff member Alex Knox and I met with representatives of Moody’s Investor Service in their San Francisco office to discuss the recent bond rating downgrade by Moody’s. Present for Moody’s was Managing Director Leonard Jones rom New York, Western Regional Office Senior Vice-president Eric Hoffman and Analyst Lori Trevino.
We presented information indicating that there were both factual errors and unfounded opinions in the Moody’s report supporting the downgrade.
Some examples of what we discussed included:
- The Moody’s August report stated that Richmond’s “tax base remains 11% below its pre-recession level.” (Tax base means real estate property taxes). In fact, Richmond’s property tax base is now only 6.6% below pre-recession levels, a 40% improvement over what Moody’s reported.
- The report stated that Richmond had a $3.3 million operating deficit for FY 2014-15, when in fact Richmond actually finished FY 2104-2015 with a $1.4 surplus.
- The report speculated that costs for remaining successor agency projects might not be reimbursed by the State Department of Finance when in fact such costs are required to be reimbursed by Health & safety Code Section 34171(b), and Richmond has never been denied a reimbursement.
- The Moody’s report speculated that enterprise funds, particularly the healthy wastewater enterprise fund might be raided by the general fund. Such a loan not repaid during the same fiscal year would not only be illegal but Richmond has no history of ever making such an illegal loan.
To their credit, the Moody’s representatives agreed that they were open to continuing to discuss, and correct if necessary, any errors in the report, and even to consider revisiting the rating by their rating committee.
To my knowledge, this is the first time that a Richmond mayor has taken the initiative to directly engage a bond rating service in an effort to correct errors and improve the City’s rating.
See the letter below from John Knox that was featured on the front page of today’s edition of The Bond Buyer.
Richmond, Calif., Fights Back After Junk Downgrade
by Kyle Glazier
AUG 13, 2015 1:15pm ET
PHOENIX - Richmond, Calif., is fighting to avoid being perceived as the next California issuer in distress after Moody's Investors Service downgraded the city to junk.
Richmond officials and the city's bond counsel responded strongly to Moody's three-notch downgrade Aug. 4, which brought the city's implied general obligation rating to Ba1.
Moody's also dropped San Francisco Bay Area city's pension obligation bonds to Ba2 from Baa2, and its wastewater revenue bonds to Baa2 from A2.
The rating agency cited the city's long-term structural budget imbalance, narrow liquidity, significant general fund support of poorly performing enterprise funds, and high exposure to variable-rate debt and derivatives as reasons for the downgrades.
John Knox, a partner in the San Francisco office of Orrick, Herrington & Sutcliffe who is bond counsel to the city of more than 100,000, said Moody's acted rashly in downgrading his client's ratings.
"I personally think they went completely overboard," Knox said.
Knox has deep ties to the city, having grown up there and served as its bond counsel for nearly three decades. He acknowledged that the city has struggled in the past decade, but said it is really on the upswing now after austerity measures. The city grew explosively during World War II when a major ship building yard was established and the population shot to more than 93,000 in 1943 from fewer than 24,000 in 1940. The population dwindled significantly in the postwar years before recovering during the last 20.
"There are some financial challenges," Knox said, pointing to home values that declined sharply during the recession and a major August 2012 fire at the Chevron refinery that is a major economic driver for the city. Knox said the city has been working to cut expenses in its latest budgets.
"The city has been trying to work its way through that," Knox said. "For whatever reason, Moody's felt it wasn't enough."
Moody's had already downgraded Richmond three notches in May when it initiated a downgrade review process. Before then, it assigned Richmond its A1 issuer rating.
The rating agency concluded that the city's expenditure reductions have been insufficient to match declining revenues.
Richmond city manager Bill Lindsay fired off an Aug. 6 email to the mayor and members of the city council blasting the decision by Moody's and attacking the validity of the agency's criticisms.
"I normally find the rating agencies' analytical approach in reviewing a city's finances to be helpful, and believe that their credit reports can provide a good financial management road map," Lindsay wrote. "I also do not want to discount the importance of sound financial management as a top priority for the city. However, I believe that this action by Moody's to further downgrade the city's credit is completely unwarranted. The conclusions contained in their Aug. 4, 2015 report are filled with inaccuracies, unsupported statements, and pure conjecture concerning Richmond's credit risks that do not reflect the city's debt management history."
The downgrade directly affects $11.2 million of POBs and $10.7 million of wastewater revenue bonds rated by Moody's; the city has $316.9 million of combined city and wastewater enterprise debt, according to the rating agency.
Lindsay's missive attacked the Moody's conclusions about what could cause further downgrades for the city's bonds.
Moody's said in its report that the city has shown signs of improving economically. The city's unemployment rate has declined from a high of 17.9% in 2010 to 5.4% in April, which is actually better than the California rate of 6.3%, Moody's noted. The agency said in its report that further downgrades could follow in response to "further deterioration" of the city's financial position or a decline in its tax base.
"These statements are axiomatic, and not unique to Richmond," Lindsay wrote. "Deterioration of financial position and a decline in the tax base are credit risks associated with any municipal debt issuer. Yet, when applied to Richmond, the statements are completely inconsistent with recent events showing improvements to the city's financial position (thus, misapplication of the term 'further'), and an expansion of the City's tax base, as noted above."
Lindsay was even more aggressive when it came to the wastewater bonds, which Moody's warned could be downgraded due to "significant depletion" of cash reserves or a decline in debt service coverage levels.
"In identifying the city's financial strengths, the August report cites 'very healthy wastewater enterprise reserves,' and 'moderately strong wastewater enterprise rate-setting record, including a recently approved program of 6.8% annual increases for five years.' Cash and liquidity in the wastewater enterprise are not only strong, but they are getting stronger," Lindsay wrote.
In its report, Moody's cited as a negative the city government's borrowing from the wastewater enterprise's "sizable reserves" for short-term liquidity purposes, as well as plans to issue additional debt in the near term for a substantial capital program.
Moody's said the wastewater enterprise's "high level of cash on hand" is largely offset by exposure to puttable variable rate debt and derivatives.
"In addition, it is important to note that city has never breached its debt service coverage levels," Lindsay said in his email.
The city manager further claimed that Moody's overestimated how much of a planned investment by Chevron that the city plans to use for city planning efforts, and that Moody's was made aware of the error but ignored it.
Moody's analyst Lori Trevino and senior vice president Eric Hoffmann told The Bond Buyer that the downgrades primarily came about as the result of the city's inability to bring its budget into structural balance, despite Lindsay's claim that the city passed a balanced budget earlier this year.
"They hadn't had a surplus in several years," Trevino said.
The most recent "balanced" budgets for fiscal 2015 and 2016 were the result of a one-time "swaption" payment the city received, Trevino said. The city received a $9.3 million payment from RBC in fiscal 2015 in exchange for the option to enter into a swap agreement in 2019.
"They were not really bringing it into structural balance," Trevino said.
Hoffmann said that the city's management had resulted in a huge decline in its liquidity, dropping from a cash reserve of $132 million in 2010 to just $31 million by the end of 2014.
The city has a "very complex debt portfolio," Hoffmann said, featuring many swaps that are now a drag on the city's finances.
"Nearly all of them are underwater," Hoffmann said.
One of those swaps is already nearly $30 million in the counterparty's favor, the Moody's report said, with several others also weighing against the city for millions of dollars. The city is also on the hook for pension and other post-employment benefit liabilities exceeding 21% of general fund expenditures.
"They have unusually high fixed costs," Trevino said.
Hoffmann warned that at some point, the city could run out of options to provide new infusions of cash and its now-narrow liquidity could become a more serious problem.
Knox said that despite the challenges the city faces, Richmond is not on the same track that led the city of Stockton, 70-some miles east, to declare bankruptcy.
"As someone who worked on the Stockton bankruptcy, I can tell you Stockton was in very much worse shape," Knox said. "I don't think they are comparable at all."
Reposted from Mayor Tom Butt's "E-Forum"
Photo: Richmond Confidential
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