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April 2, 2013 12:25 am
A federal judge ruled to allow Stockton to enter bankruptcy on Monday, rejecting the pleas of Wall Street creditors who say they will shoulder the burden of the Californian city’s unpaid debts.
With a population of nearly 300,000, Stockton is the largest US municipality in decades to declare bankruptcy. Years of borrowing against projected tax revenues to make improvements and offer generous employee benefits and pensions culminated in a massive debt the city could no longer afford when the housing bubble burst.
Assured Guaranty and National Public Finance Guaranty, Stockton bondholders, had argued during a three-day trial that the city should not qualify for bankruptcy because it had not negotiated with them in good faith because it did not try to reduce its pension obligations.
However, Judge Christopher Klein said in his verdict that it was the bondholders who refused to negotiate. “They absented themselves from all discussions,” he said, adding that Stockton had made a reasonable effort to resolve its debt with bondholders, but was met with “nothing but a stonewall on the other side”.
Creditors made no indication they would attempt to appeal against the judge’s ruling. Assured Guaranty, the lead objector in the case, instead asserted its commitment to working with the city on a “productive path” to address its debt.
Various legal experts surmised that the creditors knew their objection would not succeed in stopping the bankruptcy, but that they planned to use the trial as a way to establish their position for future proceedings.
The main question going into the formal proceedings is whether the judge will allow Stockton to reduce the debt it owes to Calpers, the California Public Employees’ Retirement System.
The city owes the system at least $147.5m in pension obligations. It made no attempt to cut that obligation in its initial restructuring plan. The city owes capital market creditors $165m, for bonds issued to pay for a sports arena, a city hall building and a car park. It offered to pay those bondholders 17 or 18 cents for every dollar owed.
California state law prohibits Calpers from changing the terms of existing contracts, which is one of the reasons Stockton officials did not negotiate with it. The Stockton bankruptcy trial will be the first to address the question of whether federal bankruptcy law trumps the state law governing Calpers.
Bondholders will continue to watch for any signs that the judge is willing to allow a challenge to Calpers’ immunity from renegotiation. Several other cities in California with obligations to Calpers have either declared bankruptcy or are in such financial distress that they are considering it.
“Calpers has been bullying around municipalities and cities in arguing for a more favourable creditor status,” said Anthony Valeri, a fixed-income strategist at LPL Financial in San Diego. “But if the judge throws that in to question and allows them to take a haircut along with the bondholders, that would ultimately be a victory for bondholders.”
Either way, the case is likely to work its way through appeals courts, possibly as far as the Supreme Court, with bondholders challenging any deal that does not force Calpers to share the burden of restructuring, and Calpers objecting to any deal that does.
That is, unless the California legislature acts first to change the laws governing Calpers, said Karol Denniston, a partner in the municipal restructuring group at Schiff Hardin.
“When you have municipalities with 60 to 70 per cent of their operating budgets going to pension obligations, you have a tension of being able to deliver services to their constituencies,” she said. “Where California is with the conversation with Calpers is a growing recognition that it is not sustainable.”
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