SAN FRANCISCO — A decision that would allow Stockton, Calif. to reduce its pension liabilities, something the judge in the city's bankruptcy case indicated is a possibility, would be a positive development for bondholders in ongoing municipal bankruptcies, according to Moody's Investors Service.
However, such ruling could make it more likely that other California local governments file for bankruptcy, Moody's analysts said in a report Tuesday.
"A ruling in favor of pension adjustments would incentivize some distressed California local governments to file under Chapter 9, but local governments would still have to fulfill the requirements of the bankruptcy code for becoming a Chapter 9 debtor," they wrote. "These requirements, combined with the high legal costs and protracted process of a bankruptcy filing, would still make additional filings rare."
Another possible outcome is that, if reducing pension liabilities in bankruptcy appears to be more feasible, the threat of a Chapter 9 filing could change the negotiating posture between municipal employees and local governments.
If municipalities could ultimately reduce pension liabilities in bankruptcy, municipal employees may be more willing to concede enough on compensation and benefits to protect pensions and avoid a filing, Moody's said.
"Ultimately, this would be a positive development for bondholders if issuers are better able to target compensation expenses, rather than filing for bankruptcy and cutting debt principal," the report said.
The report follows a July 8 hearing during which U.S. Bankruptcy Judge Christopher Klein indicated that he could reject Stockton's proposed exit plan and rule that the city's pension obligations are no different from other contracts that local governments can modify in Chapter 9 bankruptcy.
Specifically, Klein said that he could decide that the California Public Employees' Retirement System is a fiduciary, rather than a creditor, and that it does not have the right to place a lien on Stockton's assets in the event of a pension payment delinquency or plan termination.
"Such a ruling would provide Stockton with the opportunity to significantly reduce its pension liability and annual pension payments — an opportunity that it may still decline," Moody's said. "Alternatively, Judge Klein could confirm the city's proposed plan of adjustment as constituted, even if he decides that the city's pension liabilities are vulnerable to adjustment in bankruptcy."
Under Stockton's current plan, its bondholders' recoveries would be around 50%, on average, while pensions receive no haircut. The city argues that providing a CalPERS pension with the current benefit levels is integral to recruiting public safety workers.
While Judge Klein indicated he could rule that pension obligations can be treated like other contracts, he also said he could confirm the plan, leaving pensions untouched.
The judge is expected to give his decision on whether or not the city can exit bankruptcy under its current plan of adjustment during the city's next hearing in federal bankruptcy court in October.
Stockton, a city of 298,000 about 80 miles east of San Francisco, filed for bankruptcy in June 2012.
