TAHOMA, Calif. –  A reduction of Stockton’s obligations to the California Employees’ Retirement System debts in the city’s bankruptcy reorganization would have major ramifications for bondholders as well as California municipalities, Moody’s Investors Service said in a report Wednesday.

Such an outcome if far from certain, but would set an important precedent, Moody’s said. 

“Bondholders may have greater recoveries if CalPERS is forced to share in any reorganization of fixed costs payments,” Moody’s said in the note. “Such an outcome may encourage other distressed California to bring CalPERS to the negotiating table.”

Stockton, a city of 300,000 in the state’s Central Valley, became the largest city in the country to enter bankruptcy after a federal judge on Monday approved the city’s eligibility for Chapter 9 protection, nine months after it filed for relief and following a three-day trial over challenges from its bond market creditors.

The ratings firm said the eligibility benchmark established by Stockton will likely be evaluated by other financial troubled local governments.

Moody’s said how much Stockton bondholders may have to give up during the reorganization of the city’s debt remains uncertain as very little clear information is available.

The city recently settled with Ambac Assurance, which insures a 2003 series of bonds. According to the proposal, which still needs court approval, the city would pay 81% of debt service with the rest offset by tax increment revenue Stockton is pledging to bondholders, Moody’s said.

The deal with Ambac, the city’s smallest bond creditor, addresses $22 million in debt payments, according to the city.

As part of that settlement, the firm said the city is also pledging $12 million in additional payments to Ambac, which could result in zero present value losses to the insurer.

The Ambac settlement is a far cry from the proposals Stockton made to bond market creditors during mediation sessions before its bankruptcy filing; it asked  bond firms to take a $350 million hit in interest and principal, including permanently ceasing payments from the general fund toward $124 million in outstanding Assured Guaranty-insured pension obligation bonds.

“The proposed settlement between Ambac and Stockton leaves unanswered the question of how much Stockton’s other creditors should expect as recovery,” Moody’s said. “If the court determines that the Ambac settlement is fair, it may raise the possibility that the city’s other creditors will demand – and obtain – similar treatment.”

The city has already missed $231 million of payments on four outstanding series of bonds, all of which are insured, according to Moody’s.

Moody’s said Stockton offered pension obligation bondholders the equivalent of just 17% of future debt service payments.

The rating agency noted that neither Stockton, nor San Bernardino, which is also petitioning for bankruptcy protection, have outstanding general obligation debt, adding that will leave unresolved the question of the treatment of GO debt versus unsecured general fund obligations.

“Resolution of the outstanding issues for the city’s creditors will take months, if not years,” the firm said in the report.

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