ETF Trends
ETF Trends

On the last day of October, the headline from Ignites blared: “$32M Haircut for Franklin in Stockton Bankruptcy.” Under the newly approved bankruptcy plan, bond holders will receive only approximately 1% in repayment for a $32 million loan to the city of Stockton in California.

Two Franklin Templeton municipal bond mutual funds were the lone holdouts fighting the city’s proposed payouts. They had argued that Stockton could afford a larger debt repayment by reducing payments to the California Public Employees’ Retirement System.

Their arguments, however, were not enough to sway the U.S. Bankruptcy Court in Sacramento as it ruled that “Stockton retirees had sacrificed enough in the form of concessions to their medical coverage as a result of the bankruptcy.”

Although the net impact to a fund complex like Franklin is relatively minor, I believe this judgment has significance to the municipal marketplace perhaps far beyond the loss those funds stand to incur.

Such a ruling, which preserves pensions and lowers the boom on bond holders, could set a precedent for future municipal bankruptcy expectations and negotiations going forward.

The recovery rate for municipal impairments has, in the past, been significantly higher than that experienced in the taxable bond markets.

Although there still needs to be further examination of the bankruptcy plan, I believe pensions and their unfunded liabilities are a weak link for many municipalities/issuers, and, down the road, may play a significantly larger role in the attempt to preserve credit quality and payment obligations.