The case law surrounding municipal bankruptcy and restructuring is thin. The recent bankruptcy proceeding from the City of Detroit, expected rulings in Stockton and San Bernardino, CA and new debt legislation in Puerto Rico are, literally, writing the rules on how municipal debt is secured, who gets payment priority and how liabilities can be restructured. Cases in point are the comments, and preliminary assessments that came out last week from the U.S. Bankruptcy Court overseeing the City of Stockton bankruptcy case. In the coming months we will continue to get more clarity on:
(1) Can a state’s constitutionally protected pension benefits be curtailed;
(2) Does the California pension system (CALPERS) get priority over bondholders when a municipality seeks protection from creditors;
(3) And a potential new question arises about who is actually impaired – the pension system or the retiree.
These are critical issues because they will inform whether stressed municipalities can seek bankruptcy as a viable route to curtail pension benefits and restructure debt. In Detroit’s preliminary bankruptcy proceedings we saw that City pensioners are not immune to restructuring even if a state’s constitution safeguards benefits. The unique factor in the Detroit case is the support from the State of Michigan and local foundations that have helped pensioners recoup some of their losses. In the Stockton example we do not have the same outside players pledging support. Furthermore, if the much anticipated ruling places equal priority of payment between pension plan and bondholders we can infer that pension liabilities are hard liabilities and need to be accounted for in credit analysis, which is a practice we have adhered to for some time. Lastly, the question of who is actually impaired arises – the pension system and all of the participants administered by it or just the subset of retiree participants of the bankrupt entity. The outcome of the ruling will have implications for California’s financial health and potentially the wider municipal market.
It is valuable to remember that when SNWAM reviews municipal credits we are not asking ourselves “What is the entity’s willingness to pay bondholders?” because we believe that all credits are willing to repay their debts, at least until they cannot. We are asking ourselves “Does the entity have the economic resources to pay the bondholders in full and are our payments high in priority?” The difference between these questions is what separates us from other shops that are currently dealing with the fallout from Detroit, Stockton and Puerto Rico.