Tuesday, April 2, 2013

Stockton Ruling Saves Cities and Pensions?

Jim Christie of Reuters reports, Stockton ruling seen key to U.S. cities' bankruptcy options:
A federal judge on Monday is expected to rule on whether the city of Stockton, California is eligible for bankruptcy protection, a key milestone in a case likely to set critical precedents for cash-strapped U.S. cities, their employees and their bondholders.

The decision follows a three-day trial last week in which the city argued it had no choice but to file for bankruptcy after the financial meltdown devastated local tax revenues and harsh budget cuts still left the city with a $26 million shortfall.

Municipal bankruptcies have historically been rare, but troubled American cities increasingly see it as an option as they struggle with big debt loads, shrinking tax bases and massive pension and healthcare obligations. The California city of San Bernardino has also filed for bankruptcy, and some expect the city of Detroit, Michigan eventually to surpass Stockton as the biggest U.S. city to file for bankruptcy.

In the Stockton case, attorneys for bond insurers, who could potentially be forced to absorb major losses in a bankruptcy, argued the city could have done more to cut costs and raise revenues. The bondholders, who are not being paid in full under the city's interim operating plan, have also argued that pension payments made to the California Public Employees Retirement System (Calpers) should be slashed.

Bankruptcy experts expect U.S. Bankruptcy Judge Christopher Klein to find the city eligible for bankruptcy.

Michael Sweet, a lawyer at Fox Rothschild who helps local governments on bankruptcy issues but is not directly involved in the Stockton case, said the city had proven even before last week's trial that it was truly broke when it filed for bankruptcy protection last June. A municipality must be insolvent to be eligible.

"It will be hard for the judge to conclude that they weren't insolvent," Sweet said.

Stockton, a city of 300,000 residents in California's Central Valley, aims to use the Chapter 9 bankruptcy process to right the city's finances with a number of drastic measures. The city has already defaulted on some debt and allowed creditors to seize the assets - including a parking garage and a city building - and has cut payments to other municipal bondholders.

The city slashed the police department by 25% and cut other departments even more before it filed for bankruptcy. It has moved to eliminate a generous retiree healthcare plan - a major hit for many former city employees - but has not challenged pension payments to Calpers.

The retirement fund argues that under state law, pension payments cannot be reduced even in bankruptcy - an issue that is also front-and-center in the San Bernardino bankruptcy and one that could eventually find its way to the U.S. Supreme Court.

KEEPING TRADITION INTACT

Bondholders in major U.S. municipal bankruptcies have been repaid all of their principal since at least the 1930s - and Stockton's creditors don't want to see that change.

Bond insurers Assured Guaranty Corp, Assured Guaranty Municipal Corp and National Public Finance Guarantee Corp were joined by Wells Fargo Bank, the Franklin California High Yield Municipal Fund and Franklin High Yield Tax-Free Income Fund in contesting Stockton's bid for bankruptcy eligibility.

Assured's net exposure to Stockton's general fund-backed debt is $158 million. A spokesman for National said the MBIA Inc unit's Stockton-related exposure is $224 million, $89 million of it tied to the city's general fund. Franklin Advisers Inc, holds $35 million of uninsured Stockton lease revenue bonds.

Lawyers for the creditors argued to U.S. Bankruptcy Judge Christopher Klein that Stockton did not meet requirements to be eligible for bankruptcy court protection.

They claimed Stockton officials did not do enough to mend the city's finances and acted in bad faith by exempting the city's largest creditor - Calpers - from concessions in a mandatory pre-bankruptcy mediation.

They also said Stockton is not really broke, and that city officials are conflicted because they have accounts with the pension fund.

James Spiotto, a municipal law specialist at the Chapman and Cutler law firm, said that attack fell flat, noting that a finding of bad faith is a high bar.

CITY FINANCES A MESS

Stockton's legal team, which includes lawyers who worked for Vallejo, California in its 2008 bankruptcy, said the city needs to maintain pensions to retain and recruit employees, especially police officers who patrol a city with one of the highest crime rates in the country.

Stockton's officials note they have slashed $90 million in spending over three years, and say that deeper cuts would threaten public safety.

Ahead of the filing, Stockton won concessions from its unions and implemented the retiree healthcare cuts but has remained at odds with all but one of its capital markets creditors.

Judge Klein said at the close of the trial on Wednesday that a verbal ruling on eligibility would likely come on Monday. A written opinion would follow, and if the judge affirms its eligibility for bankruptcy, the city could then begin drafting a so-called plan of adjustment for its debts. At the same time, the capital markets creditors would be able to appeal to U.S. District Court or a bankruptcy appellate panel.

If the city is ineligible it could operate under its current budget while seeking concessions from creditors, who could press claims against the city in state or federal court.

Stockton's spokeswoman said a plan of adjustment would largely be guided by the city's so-called pendency plan, essentially the city's $155 million budget. Because it leaves pension payments intact, Stockton's capital markets creditors could strike at them again as a plan of adjustment takes shape.

"They'll still have the point unless the judge rules on it, which I doubt he will. That will be an issue for later on," Spiotto said, adding the eligibility trial was "a battle, not the war. The real game is coming up with a plan that works."
Tracie Cone of The Associated Press also reports, Pension issue in Stockton, Calif., bankruptcy:
On its first official day in bankruptcy, the city of Stockton now must grapple with the hard part of reorganizing its financial affairs — how to share the financial burden equitably among creditors while meeting its massive state pension obligations.

At the conclusion of a three-day trial, a judge on Monday formally granted the city Chapter 9 protection, over the objections of creditors who questioned whether it was fair for the city to fully meet its obligations to the state pension system while other debt holders go partly paid.

The issue — whether federal bankruptcy law trumps the California law that requires pension fund debts to be honored — could have huge implications across the state and the rest of the nation, experts say.

"The fear is that there is going to be a run on the bank," said bankruptcy attorney Michael Sweet, who has been monitoring the Stockton trial. "Everyone is going to be cutting CalPERS" payments if Stockton is allowed to do it.

California's $225 billion Public Employees Retirement System already is underfunded by $87 billion, which means there are more payments due to retirees than there is money in the system.

Stockton's biggest creditors insured $165 million in bonds the city issued in 2007 to keep up with CalPERS payments as property taxes plummeted during the recession. Stockton now owes CalPERS about $900 million to cover pension promises — by far the city's largest financial obligation.

Nearly two dozen California cities, from San Jose and Watsonville to San Bernardino and Compton, either are facing bankruptcy or financial emergencies — and their hefty pension costs are getting heightened scrutiny.

"This is just the beginning of a multi-dimensional.... well, I can't say chess game because it's not a game," said attorney Karol Denniston, a municipal restructuring expert. "There's not one thing that will fix the pension system. The net message is you can't see a restructuring when the largest creditor isn't being restructured."

Last year, the Congressional Joint Economic Committee reported that unfunded pension obligations across the nation amount to more than $2.8 trillion and may be as high as $4.4 trillion. Illinois lacks funds for nearly 72 percent of the pensions it guarantees, while California and Texas are short by more than half. North Carolina's debt is lowest but is still more than a third short of what its system has promised to pay out.

Experts say that state pension funds are acting like the banking industry before the financial collapse by engaging in risky behavior and racking up unsustainable obligations.

"In the private sector there is insurance," said Sweet. "CalPERS is working without a net. If they fail and if Stockton is allowed to impair the CalPERS payments, then who knows who's next?"

A major focus in the next phase of Stockton's bankruptcy proceedings will be whether pensions negotiated in good economic times can be cut.

"I don't know whether spiked pensions can be reeled back in," U.S. Bankruptcy Judge Christopher Klein said during his ruling on Monday. "There are very complex and difficult questions of law that I can see out there on the horizon."

Attorneys for CalPERS at times attempted to speak to the creditors' assertions that the pension fund should share any pain in Stockton's recovery plan, but the judge said their time would soon come during proceedings.

"It's no secret (creditors) have CalPERS in the crosshairs of the dispute," Klein said.

The city of nearly 300,000 has tried to restructure some debt by slashing employment, renegotiating labor contracts, and cutting health benefits for workers. Library and recreation funding have been halved, and the scaled-down Police Department only responds to emergencies in progress. The city crime rate is among the highest in the nation.

Since cities can't liquidate assets, those that declare bankruptcy must come up with a plan for creditors to forgive some of the debt.

So far, Stockton has kept up with pension payments while reneging on other debts, maintaining it needs a strong pension plan to retain its pared-down workforce.

Legal observers of the first-ever Chapter 9 bankruptcy case questioning state pension obligations expect an appeal to decide whether the 10th Amendment that gives rights to states is more powerful than federal bankruptcy code.

Either the judge will decide that CalPERS obligations must be cut and the state will appeal, or he will say state law forbids CalPERS from negotiating and the creditors likely will appeal.

"We're going to get new precedent no matter what happens," Denniston said.
And late yesterday, Jonathan Weber of Reuters reported, Stockton eligible for bankruptcy protection:
Stockton, California, is eligible for bankruptcy protection, a federal judge ruled on Monday, turning aside creditors' arguments the city was not truly insolvent when it sought protection and improperly failed to seek pension concessions.

U.S. Bankruptcy Court Judge Christopher Klein's ruling permits Stockton to proceed with a Chapter 9 municipal bankruptcy case after it became the largest U.S. city ever to file for bankruptcy.

The decision is likely to increase scrutiny of how the city will handle its pension obligations, managed by the California Public Employees Retirement System (Calpers).

Stockton is being closely watched by the $3.7 trillion municipal bond market and by other cash-strapped cities.

Creditors have claimed a lack of good faith by Stockton in its decision to fully pay its obligation to the $254 billion Calpers system but impose losses on bondholders and bond insurers.

The expected move by the California city of 300,000 - along with Jefferson County in Alabama and San Bernardino in California - breaks with a long-standing tradition to fully repay bondholders the principal in most major municipal bankruptcies.

CALPERS ISSUE LOOMS

In a lengthy preamble to his ruling, Klein delivered a stinging rebuke to the so-called capital market creditors - mainly the insurers for bondholders who own hundreds of millions of dollars of Stockton debt - who had opposed the bankruptcy filing.

Klein said capital market creditors had failed to negotiate in good faith in a pre-bankruptcy mediation, as required by law, and also criticized their refusal to foot part of the bill for mediation. He dismissed their arguments that the city wasn't really broke, stating that Stockton was "by any measure insolvent" prior to its filing.

The judge also rejected the argument that city had improperly exempted the $254 billion Calpers from concessions during the pre-bankruptcy mediation. He did, however, suggest that the issue of how pension payments are treated will be a central issue in the case going forward.

"This does not mean there is not potentially a serious issue involving Calpers," Judge Klein said in reference to his ruling. "But at this point I do not know what that is." He added that there were "very complex and difficult questions of law that I can see out there on the horizon," relating to Calpers.

But those issues are properly addressed as part of the effort to finalize a so-called "plan of adjustment" for emerging from bankruptcy.

"SCORCHED EARTH" TACTICS

Bob Deis, the Stockton city manager who is largely responsible for managing the bankruptcy process, called the judge's verdict a "vindication" of the city's position. He criticized the "scorched-earth" legal strategy of the bond creditors as a waste of time and money and said the city had already spent $6 million to $7 million on the mediation and legal costs.

Assured Guaranty Ltd., one of the bond insurers, said in a statement that it "disagrees" with the Judge's ruling but that it looked forward to working with the city on a "consensual approach" to resolving its debts.

Bond insurers Assured Guaranty Corp, Assured Guaranty Municipal Corp and National Public Finance Guarantee Corp were joined by Wells Fargo Bank, the Franklin California High Yield Municipal Fund and Franklin High Yield Tax-Free Income Fund in contesting Stockton's bid for bankruptcy eligibility.

They argued that the city could have done more to cut spending and raise taxes, and that it was unfair to demand concessions from bondholders without also demanding cuts in payments to Calpers.

But Judge Klein, citing crime statistics and the city's extensive cost-cutting pre-bankruptcy, agreed that further cuts in public safety and other services were not options.

He also rejected bondholder arguments that they were not required to negotiate in good faith in the mediation, noting that it was impossible to negotiate with a "stone wall."
I`ve already covered whether California bankruptcies will rock munis and whether pension bonds increase default risk. This is a huge decision with profound implications for municipal bond creditors and underfunded U.S. state pension plans.

In my opinion, judge Klein was right to allow Stockton to proceed with a Chapter 9 municipal bankruptcy but the ruling will open the door to other cities coping with their dire finances to follow suit. It also opens the door to complex legal issues which could mean future cuts to benefits and/or pension payments. All that remains to be sorted out in the future.

Below, Fox News' Claudia Cowan reports on why the Stockton ruling is seen as key to U.S. cities' bankruptcy options. Indeed, this ruling is a landmark decision for cities and their pension plans (click here to view).