Commentaries

APA May 2013 Commentary

By: admin / May 16th, 2013

Pension Payments in Stockton Case Could Have Ramifications in Muni Market

As we rep orted in the April 2013 AP A commenta ry, a California Judge has granted per mission to the City of Stockt on to remain under court ordered Chapter 9 bankruptcy protection. As part of the bankruptcy protection, Stockton has begun working on a retructuring plan for its various debt obligations. The California Public Employees Retirement System (CalPERS) has raised questions regarding what constitutes a debt obligation in Cha pter 9. Stockton is arguing that CalPER S is a creditor and therefore the City may reduce o suspend payments while working through its bankruptcy. CalPERS argues that the California State Constitution and various court rulings forbid any state or local government from being able to lower the pensions or payments to retirees or current employees once t hey are enrolled in CalPERS. Additionally, CalPERS argues that federal bankruptcy law, which allows a judge to end contracts, should trump state law. City officials have stated that they do not intend to reduce pension benefits, but they have reduced health benefits for retirees. The California State Supreme Court will decide the issue in the next few months, with many legal analysts believing the Stockt on case may end up in the U.S. Supreme Court. Should the Courts rule in favor of CalPERS, this would be unprecedented as in recent Chapter 9 cases courts have forced cuts to pensioners while honoring payments to bond holders.

In yet another California city bankruptcy, San Bernardino is in state court arguing that its CalPERS obligations should be treated as debt and therefore the city should be allowed to make reduced payments to CalPERS in the same way they may be able to force haircuts to bondholders and other stakeholders. A judge has yet to rule on the petition. In January 2013, the Florida Supreme Court ruled that public employees’ pension contracts can be adjusted. In that case, the Florida Education Association had sued the state arguing that required contributions to the pension system equated to a pay cut and thus should be subject to negotiations as part of the Association’s collective bargaining agreements. The court ruled that a ny restriction on the state’s pension structure by subjecting contributions to labor negotiations could lead to fiscal irresponsibility. In August 2011 , the city of Central Falls, R.I. declared bankruptcy after failing to renegotiate various pension and labor contracts that would have prevented insolvency. The city then filed for bankruptcy and went to court to reduce the amount owed on its various debt, eventually reducing its pension obligations by 55 %. Both case s illustrate that legal precedent provided state and local governments the right to modify any obligations during bankruptcy.

Chapter 9 Bankruptcy: How Common?

The three California bankruptcies last summer leads to the question of how common a bankruptcy filing is by municipalities. Currently, municipalities can file for Chappter 9 bankruptcy protection under the federal bankruptcy code. However, states cannot file for bankruptcy. According to the Pew Charitable Trusts, a municipality is legally eligible for Chapter 9 bankruptcy if it is:

• Insolvent.
• Has made a good-faith attempt at negotiating a settlement with its creditors.
• Is willing to devise a plan to resolve its debts.

Additionally, municipalities must also have permission to file for Chapter 9 from their state governments. Currently, only 15 states have specific laws granting their respective municipalities the legal right to file for bankruptcy. They are Alabama, Arizona, Arkansas, California, Idaho, Kentucky, Minnesota, Missouri, Montana, Nebraska, New York, Oklahoma, South Carolina, Texas and Washington. The remaining states required some sort of stat e oversight in the bankruptcy process, with only the State of Georgia not allowing a municipality the legal right to file. Filing for bankruptcy by a municipality still remains a rare occurrence. The Pew Charitable Trusts reports that since 1937, when Congress added Chapter 9 to the federal bankruptcy code, approximately 620 municipalities have filed for protection. In comparison, there w ere 12,000 corporate bankruptcy filings in 2012.

A Chapter 9 filing can have short term advantages by giving a municipality a reprieve from creditors and the ability to renegotiate its collective bargaining agreement s. But it often has long term ramifications as well. Vallejo, California, filed for Chapter 9 in May 2008 and spent three and a half yea rs in legal proceedings. The City has not been able to issue any municipal debt since filing Chapter 9 due to lack of market access. After emerging from bankruptcy the City still faces a structural deficit of $3.8 million in its 2012 budget. Furthermore, the city reports it has been unable to maintain its infra structure and has reduced its police and fire protection personnel by half. This is an example as to why APA believes municipaities will use Chapter 9 only as a last resort.

Defaults and Downgrade Trends

Despite predictions of “Armageddon” and “hundreds of billions of defaults”, the actual number of Municipal defaults and downgrade s reported fr om January through April 2013 remain ed at historic levels. Municipal Market Advisors (MMA) reports that through April, there have been a total of 19 muni issuers reported to have defaulted with a total outstanding debt of $4.97 B. According to MMA, this is down fro m the 22 first time defaults recorded for the same time period in 2012, with a total outstanding debt of $41 billion. There were 30 first time defaulters for the comparable period in 2011 with total debt of $62 billion. The increase in the actual dollar amount in debt outstanding for 2013 was the result of the large defaults of San Bernardino and Stockton, CA. Standard & Poors rated muni portfolios shows there were eleven defaults (non-housing) in 201 2, which was higher than S&P’s annual mean of 2.1 and median of 1 since 1986. Only four of the eleven defaulted issues in 2012 held an investment grade rating prior to defaulting while seven had speculative grade ratings . APA does not typically trade speculative rated issues. Bank of America Merrill Lynch reported $573 million in missed payments for quarter 1 of 2013 or approximately 0.6% of the $3.7 trillion of munis outstanding, compared with 1 .01% for all of 2012.

Moody’s Investors Service reports that in the first quarter of 2013, downgrades comprised 87% of its public finance rating actions. While downgrades may not necessarily predict default, they are considered an early indicator of issuer performance. The total amount of downgraded debt declined from $95 b in 4Q2012 o $27B 1Q20 13. This was the lowest amount of defaulted debt since 4Q2011 .