Thursday, December 20, 2012

Differentiating Between Stockton's Creditors

The bond insurers protesting Stockton's bankruptcy have filed their protests to the City's eligibility in court.  I have read their documents and don't find their case compelling.  For every good point, the creditors offset it with several ridiculous arguments and omit, ignore or distort a lot of other highly relevant information.  I think they have a case that the city's initial ask and pendency budget is inequitable towards them and is not an acceptable blueprint for a final plan of adjustment, but the case isn't there yet, it is still determining eligibility. 

As the case proceeds past eligibility, as I expect, the amount of concessions required of various bondholders will be a key issue.  Some criteria and principals are necessary for determining the level of repayment.  (Note: I am not a lawyer, and I can't say whether this a sound legal argument)

In its initial ask, the City used two criteria:
1.  Secured vs. Unsecured Debt. (the pension bonds were the major unsecured debt)
2.  Essentiality of Assets (for secured debt):  bond collateral varies from essential police stations to non-essential parking garages

These are reasonable criteria, but I would suggest two additional basis for distinguishing between the bonds:

3. the date of issue.  For bonds issued in 2007 and 2009, it was already been clear that the City was in the midst of a collapsing housing bubble and recession, already had high debt, had just cut the utility users tax, and the excessive employee contracts were already in place.  These lenders were taking a huge risk and were facillitating the City's excessive risk taking.  I would argue should take higher losses than 2004 bonds when the City's financial and economic outlook was stronger and it had lower levels of debt.

4.  whether bond underwriters proactively gave the City bad financial advice to convince them to issue ill-advised debt.  As far as I know, this criteria would only apply to the pension bonds, and it gets to my earlier posts and press stories about the pension bonds, and how the bond underwriters had a special meeting to present "Pension Bonds 101" to the City Council in which they gave a deceptive and misleading presentation that did not accurately describe the enormous risk of the pension bonds (not just the probability of losses, but that those losses are correlated with times of general budget distress), encouraged bad financial practices such as deferring initial principal payments for short-run budget savings, and did not discuss that in a period of financial distress that they expected that the City would be obligated to pay the bonds first and thereby cut services and employee compensation more during tough times.  Most importantly, the bond underwriters actively advised the city council not to make the pension benefit cuts, the very same cuts that their bond insurance partners now demand of the city and say the city should have done at that time.  Wall Street sold the pension bonds to the city specifically as a substitute for tough budget choices and benefit cuts, and now they say the City is ineligible for failing to make the cuts that they told them they didn't need to do back in 2006-07. 

So if you look at the City's 5 big ($30 million or more bonds) in this way, I think there is a strong case that the pension bonds take the largest loss.

Stockton's 5 biggest bond issues by purpose and date of issue:
1.  2004 Events Center and Arena:  $45 million outstanding, secured by events center and arena, insured by National Public Finance Guaranty (NPFG)

2.  2004 Parking Facilities:  $32 million outstanding, secured by parking garages, insured by NPFG, garages were already taken over by creditors prior to bankruptcy filing when City defaulted on payment.

3.  2007 Pension Obligation Bonds:  $124 million outstanding, unsecured obligation, insured by Assured Guaranty.

4.  2007 400 E. Main St (former Washington Mutual building, intended to be new city hall):  $40 million outstanding, insured by Assured Guaranty, building already taken over by creditors prior to bankruptcy filing when City defaulted on payment.

5.  2009 Public Facility Bonds.  $35 million outstanding, secured by 2 golf courses and Oak Park property, no bond insurance.

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