CalPERS, Bondholders Square off Over Stockton Assets

(March 26, 2013) - A trial began in Sacramento, California on Monday over the City of Stockton's eligibility for bankruptcy protection—and repayment priority of its creditors.

The California Public Employees' Retirement System (CalPERS) holds the single largest claim to Stockton's remaining assets and future cashflow: $147.5 million for unpaid pension contributions, according to court documents.

If Stockton succeeds, it will be the largest American municipality ever to be under bankruptcy protection. The city has more than $300 million in debt at issue in the trial, which is being held in Sacramento, and presided over by Chief Judge Christopher Klein.

Stockton's creditors are contesting the city's eligibility for Chapter 9 protection, and the case has aroused unprecedented legal issues as numerous counties and municipalities struggle with solvency and pension obligations.  

"The cty has been grappling with massive budget deficits for the past several years," Stockton attorneys wrote in documentation accompanying the original filing in July 2012. "Confronted with this fundamental imbalance, in late February 2012, the city entered the new state-mandated 'neutral evolution process in an attempt to resolve the outstanding debts consensually, without the need for a Chapter 9 case. …However, the city and its creditors were unable to reach either a short or longer-term agreement, Faced again with insolvency, and out of time to reach a deal before fiscal year 2012-2013 started, the city had no option other than to seek bankruptcy relief."

One of these creditors, for instance (and a party in the case), insurer Assured Guaranty backed a $125 million pension-obligation bond issuance for the city, and now holds $161 million in exposure to the Stockton paper. According to Assured Guaranty, wiping the debt payments would constitute an 83% haircut on the bonds' principal.

The city has said, however, it intends to maintain its pension contributions to CalPERS while reducing or eliminating debt service some of its other bonds. In August, Assured Guaranty made its claims as an equal-priority creditor public with a press release lashing CalPERS' "investment underperformance, since it will further increase the City's unfunded pension liability." Assured Guaranty suggested that Stockton "should be taking that up with CalPERS rather than reneging on the City's obligation to holders of the pension bonds."

CalPERS shot back, pitting Assured Guaranty against retired police and firefighters. "As a successful long-term investor with an average annual return rate of 9% over the past 30 years, CalPERS is committed to working with the City of Stockton and other public agencies during these turbulent economic times," said pension system's General Counsel Peter Mixon in the statement. "The obligations owed to the public workers of the City have priority over those of general unsecured creditors including bondholders. Unlike insurance companies, policemen, firefighters and other public employees are not in a position to evaluate credit risk of their employers. Assured Guaranty is in the business of evaluating these risks. CalPERS is committed to working within the legal system to reach resolution of these difficult issues." 

CalPERS has submitted $147.5 million in unsecured claims to city assets, according to court documents. The next largest claim, Wells Fargo bank, is seeking $124.3 million for pension obligation bonds alone, in addition to repayment for other municipal credit offerings.  

Other creditors named in the suit include various subsidiaries of Assured Guaranty, Wells Fargo Bank, the Franklin California High Yield Municipal Fund, and Franklin High Yield Tax-Free Income Fund.

The Eastern District of California Bankruptcy Court has hearings for the case scheduled through Tuesday.

The case is number 2012-32118.