Bond insurer contests Stockton bankruptcy over pensions

SAN FRANCISCO Thu Aug 9, 2012 4:51pm EDT

Crumbling sidewalks and shuttered businesses line a downtown street in Stockton, California, June 27, 2012. REUTERS/Kevin Bartram

Crumbling sidewalks and shuttered businesses line a downtown street in Stockton, California, June 27, 2012.

Credit: Reuters/Kevin Bartram

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SAN FRANCISCO (Reuters) - A unit of bond insurer MBIA Inc challenged the California city of Stockton's eligibility for bankruptcy, making an argument -- that the city can cut pension benefits -- with potentially profound implications for the state.

The bond insurer in a court filing said the city's failure to ask for concessions from the California Public Employees' Retirement System pension fund showed that it had not negotiated with creditors in good faith, and it argued that the city's plan for recovery was doomed because it did not touch pensions.

The filing sets a roadmap for a battle, in or out of bankruptcy court, in which Wall Street takes on the largest public U.S. pension fund, Calpers, as troubled cities and counties watch the outcome closely.

Calpers has used warnings of court battles to dissuade municipalities from considering pension benefit cuts, but retiree benefits are constricting many cities. San Bernardino, California also faces major pension obligations and is following Stockton's bankruptcy path.

"It's the equivalent of a declaration of war (on pensions)," said Karol Denniston, a San Francisco lawyer who helped draft California' bankruptcy process law, said of the filing. "It affects every municipality looking to restructure."

The city of Stockton did not immediately respond to requests for comment. A lawyer for Stockton previously had said that bond insurers had not even made counterproposals to the city during pre-bankruptcy negotiations as mandated by state law.

Calpers provided information to the city during the talks, spokesman Brad Pacheco said by email. "We remain committed to safeguarding the constitutionally protected pension benefits of the city's employees and retirees," he added.

A federal judge must approve Stockton's eligibility for Chapter 9 protection before the city can reorganize its debts under court protection, and a primary criterion is whether the city made a real effort to avoid a bankruptcy filing.

"The city has not presented evidence that it negotiated with its creditors equitably and thus, in good faith," National Public Finance Guarantee Corp, a unit of MBIA, wrote in the filing. (link.reuters.com/zyv89s)

The company, which insured nearly $94 million of the city's revenue bonds, said Stockton had not negotiated with Calpers at all, and that its initial proposal to creditors, called 'the Ask,' showed a financial shortfall for 2013-14, even after bond payments were cut.

The insurer said that was because of plans to keep making full pension fund payments. Those pension payments represent a financial liability, like debt service payments, and should be treated equally, it said.

"The protection of Calpers benefits for the mayor, city council and other city employees is clearly not in good faith," it added.

Debt service savings of $11.3 million account for 44 percent of concessions in 2012-13, it said. Calpers obligations amount to $17 million that year and rise to over $30 million by 2020.

National also insures $18 million of bonds backed by San Bernardino's general fund, the main budget, and it is represented in that case by the same law firm that filed the Stockton objection, Winston & Strawn. A lawyer declined to comment further on San Bernardino, which went straight into federal bankruptcy court without negotiations, saying it did not have enough resources to last during the negotiating period.

Credit ratings agency Moody's Investors Service said the rush to bankruptcy by San Bernardino, following on the heels of Stockton and another city -- Mammoth Lakes -- could signal a major change in city governments' attitudes.

"Historically, U.S. cities have considered bankruptcy as the very last resort to managing fiscal problems. The recent uptick in bankruptcy filings in California could signify not only a lack of ability, but a lack of willingness to pay debt service at the expense of other financial obligations," the agency said in a Thursday note.

While Stockton is not touching pensions, its retired employees face deep cuts to their health-care benefits, which many pensioners say they cannot afford on their own.

The city of nearly 300,000 is a traditionally agricultural area on the edge of San Francisco Bay, which burst at the seams with new houses a decade ago.

Its growth outstripped that of the state and now its foreclosure and unemployment rates are among the worst in California, while infrastructure deals like a new city hall and riverfront development have failed.

Bond insurer Assured Guaranty Ltd has also questioned Stockton's eligibility for bankruptcy in public statements and has until the end of the day on Thursday to file a motion with the court.

The case is In re: City of Stockton, California, debtor, U.S. Bankruptcy Court, Eastern District of California, No. 12-32118.

(Additional reporting by Hilary Russ; editing by Padraic Cassidy, Gary Crosse)

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