Stockton bankruptcy sends chilly message to muni bondholders

If municipal bond investors aren’t already stressed out over the latest developments in the Stockton, Calif. bankruptcy dealing, they should be.
The city of nearly 300,000 was granted Chapter 9 bankruptcy protection on Monday after a federal judge berated creditors for not wanting to compromise with the debt-laden municipality.
It is not surprising that the two main insurers of Stockton’s roughly $500 million worth of debt issuance would try to prevent bondholders from taking a “haircut.”
For starters, the muni bonds are supposed to be senior debt obligations.
Obviously, Assured Guaranty Ltd. and National Public Finance Guarantee Corp. should be expected to do everything possible to avoid being left on the hook for Stockton’s financial mismanagement, even if compromise might look like the right thing to do.
But what is more alarming and potentially threatening to the muni bond market is that Stockton has shown no interest in trying to renegotiate its obligations to CalPERS, which collects nearly $30 million a year to fund the town’s municipal employees’ pension fund.
“If you’re an investor in California bonds, this sets a precedent for how California municipalities are treated in bankruptcy,” said Ronald Bernardi, president of Bernardi Securities Inc.
“They will have to somehow treat the current investors a little more favorably than what’s on the table,” he added. “If Stockton is dealing in good faith they will have to go to all of the creditors.”
Nobody ever said muni bonds were risk-free, particularly in California, but the bondholders should at least be able to maintain their status as holders of senior debt.
And, as for CalPERS?
“The contribution amounts are set, and the annual payments must be made in order to keep the pensions funded,” said CalPERS spokeswoman Amy Norris.
If this feels at all like the dealings around the 2009 General Motors bankruptcy that bailed out labor unions while forcing bondholders to take a haircut, it should.
“The judge (in Stockton) definitely didn’t do the muni market any favors,” said Daniel Toboja, vice president of municipal bond trading at Ziegler Capital Markets.
“Right now is not a time to panic, but it is a time to pay attention,” he added. “If the final bankruptcy plan comes through and CalPERS is made whole and the senior creditors get an 80% cram down, that will be an issue.”