Bond Insurer May Contest Stockton Bankruptcy

A potential big loser in the bankruptcy filed by Stockton last week, an insurer backing a $121 million Stockton pension bond issue, is warning that it may contest the city’s eligibility for bankruptcy.

The leading municipal bond insurer, Assured Guaranty, said three Stockton bond issues totaling $161 million “remain fully protected by our unconditional and irrevocable guaranty to pay scheduled principal and interest in full and on time.”

But in a statement posted on its website Friday, the insurer said it will “vigorously enforce” its rights for fair treatment as a creditor, including the right to contest Stockton’s eligibility for bankruptcy under federal law.

“Since the City Council has not engaged in any meaningful effort to initiate revenue enhancement, asset sales or pension reform, it is questionable whether the City has taken all steps necessary and available to meet the stringent eligibility criteria for filing a bankruptcy petition under chapter 9,” the Assured Guaranty statement said.

The insurer said its offer of “turnaround experts” to help develop a plan for Stockton to avoid bankruptcy was rejected by the city. Bankruptcy seemed to be the “only option” seriously considered to solve long-term structural budget problems.

Other cities facing similar problems have chosen “difficult decisions” rather than bankruptcy, said the insurer, citing voter approval of cost-cutting pension reforms in San Diego and San Jose last month and a tax increase in the small town of Hercules.

Stockton, a Central Valley agricultural hub and inland port with 290,000 residents, is located about 54 miles from Vallejo, a San Francisco Bay Area city of 116,000 that declared bankruptcy in May 2008, finally emerging last November.

As in Vallejo, much of the savings sought in the Stockton bankruptcy plan would come through eliminating bond payments and deep cuts in retiree health care promised city employees.

And as in Vallejo, the Stockton plan does not cut the pensions promised city employees. Vallejo officials discussed a pension cut, but backed off after the California Public Employees Retirement system threatened a lengthy and expensive legal battle.

It seems possible that the statement from the presumably deep-pocketed Assured Guaranty, which said it had $13 billion in “claims-paying resources,” may be intended to be read as a CalPERS-like warning of a costly and time-consuming legal battle.

There was no saber rattling last week from an insurer backing $89 million in Stockton bonds, the troubled National Public Finance Guarantee, which also said bondholders will receive “scheduled interest and principle payments on time and in full.”

A Wall Street credit rating firm, Moody’s, has mentioned an apparent trend causing “distressed municipalities to contemplate a strategic default or bankruptcy on insured debt, knowing that bondholders will not suffer losses.”

Stockton has $700 million in outstanding bonds, but most are being paid off by restricted sewer and water funds. A half dozen bond issues totaling about $325 million are being paid off by the deficit-ridden general fund.

The Stockton general fund bonds are insured and are not voter-approved bonds secured by the taxpayers. Several major municipal bond insurers expanded into mortgage-backed securities and were crippled by huge payouts during the financial crisis.

A former market leader, the Municipal Bond Insurance Association, split off its municipal bond arm, National Public Finance Guarantee, which reportedly is not writing new policies because of lawsuits over the restructuring.

“The carnage left one bond insurer standing, Assured Guaranty,” Reuters reported in March. The insurer was said to be “threatening to pull out of some states without tight bankruptcy controls.”

The Assured Guaranty statement on Stockton said its insurance allowed the city to save “millions of dollars” in interest payments. But now the city bankruptcy plan treats the bonds in an “unfair and disproportionate manner relative to its personnel costs.”

The biggest part of the bankruptcy plan to close a $26 million general fund deficit eliminates $12 million in annual debt payments — among them $5.8 million for the pension bonds and $2.6 million for a $36.5 million bond issue for a new city hall.

In an ill-timed move, Stockton issued the $121 million in insured pension bonds in 2007 and gave the money to CalPERS, which suffered a 24 percent investment loss in the following fiscal year when the stock market crashed.

A government employer can profit if money borrowed at a lower interest rate is put into CalPERS and the giant pension fund’s investments hit its earnings target, 7.5 percent lowered from 7.75 percent last year.

Critics say pension earnings forecasts are too optimistic, concealing the need for higher contributions or lower pension benefits. Employers not employees are responsible for pension fund shortfalls, making pension bonds a gamble with taxpayer money.

It’s a stark example of the casino-like nature of modern public pensions, which expect to get two-thirds of their revenue from investment earnings. Proposition 21 in 1984 lifted a requirement that most pension funds be invested in predictable bonds.

Now most pension fund money is in stocks and other higher-yielding but risky investments. No one can say for sure whether pension funds will hit or miss their earnings targets in the decades ahead, but taxpayers are on the hook if there is a major shortfall.

In the Stockton bankruptcy, another big part of the plan to close a $26 million general fund deficit in the new fiscal year that began this month is a $7 million cut in retiree health care paid by the general fund.

All retiree health care benefits would be eliminated next fiscal year. Retirees would be allowed to enroll in the city’s self-funded medical plan if they choose, but they would have to pay all of the cost.

Retiree health care may be a tempting target for cuts in the Vallejo and Stockton bankruptcies because there is no deep pocket to pay for a legal challenge. But unlike pensions, no money has been invested to help pay for retiree health care.

Most state and local government retiree health care is pay-as-you-go. Retiree health care promised current state workers will cost an estimated $62 billion over the next 30 years. Last year it cost $1.5 billion, up 60 percent in five years.

Stockton’s retiree health care covers less than half of the 2,400 city retirees, and the average recipients have pensions twice as high as retirees without health care. There is no cap on premiums, and some are said to become eligible after just a month on the job.

The city owes an estimated $417 million for promised retiree health care. The annual cost, $13.8 million all funds ($9.2 million in the deficit-ridden general fund), is projected to double in 10 years.

Stockton filed for bankruptcy in the U.S. Bankruptcy Court in Sacramento last Thursday, listing estimated assets of more than $1 billion and liabilities of $500 million to $1 billion. A hearing on three procedural motions is set for 10 a.m. Friday.

(Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. Originally posted on CalPensions.)

Speak Your Mind

*