MuniLand: Uncertainty and Expensive Bankruptcy

At the beginning of the October we wrote about the preliminary bankruptcy ruling for the City of Stockton, CA.  We highlighted the precedent being set between bondholders and pensioners.  In that preliminary ruling the bankruptcy court granted the City of Stockton an option to reduce payments to both bondholders and pensioners.  This would be the first time a state pension fund was vulnerable to cuts resulting from a bankruptcy.  However, the key word in the ruling is “option” because Stockton had a choice to reduce bond or pension liabilities, or both.  This week we found out which option was selected and approved by bankruptcy court. 

The decision was made to protect pension payments to retired workers and to further impair bondholders.  The ruling recognized that city employees had already accepted reduced salaries and the elimination of retiree health benefits. The bondholders, after secured payments, will receive less than 25 cents on the dollar. The pensioner will see a reduction of benefits in the amount of the underfunded pension liability. Nevertheless, the ruling still leaves the state pension system vulnerable to restructuring. Given the precedents set by the cities of Detroit, Stockton and San Bernardino, it is clear that the outcome of municipal bankruptcy is highly uncertain and expensive for bondholders, pensioners and municipalities.  This uncertainty is heightened by the large number of issuers and varying security pledges issued to the market.  It is critically important in the municipal market to know the credit you’re buying.  Those relying on income from municipal bonds need to open the official statement and understand who and what is pledged to pay back the bonds. 

Sources: Bond Buyer, LA Times, Bloomberg News