MUNI NATION invited Kathleen McNamara, CFA, CFP, Senior Municipal Bond Strategist at UBS CIO Wealth Management Research, to provide her commentary on the Stockton, California bankruptcy plan.
MCNAMARA: Stockton’s bout with bankruptcy will be the subject of much debate — and a lot of second guessing — in the months ahead.
After warning the City of Stockton (CA) that pension obligations did not enjoy a privileged position in federal bankruptcy court, U.S. Bankruptcy Judge Christopher Klein confirmed the City’s plan of adjustment last week. Judge Klein’s decision to overlook the disparate treatment accorded pensioners and capital market creditors disappointed municipal bond investors, who had hoped for better treatment in the wake of his decision on October 1 that pensions should be given no more protection than other contractual obligations.
The court’s approval of the city’s bankruptcy plan reinforces the importance of choosing municipal credits carefully at the outset. In the rare instance when a municipality seeks court protection from its creditors, Chapter 9 grants the municipal petitioner extraordinary latitude in choosing whom to pay in full and whom to haircut. The court’s decision is also likely to highlight the stark difference between enterprise revenue bonds and structurally weaker securities such as local government lease revenue bonds and pension obligation bonds (POBs). The City of Stockton left its enterprise revenue debt unimpaired while targeting its leases and POBs for payment reductions.
In a general sense, municipal credit conditions are likely to improve in the next two years on the heels of continued growth in the U.S. economy. Bankruptcies should remain infrequent events. However, when they do occur, the examples of Stockton and Detroit remind us of the political risk associated with Chapter 9 proceedings. Unlike corporate reorganizations, creditors in a municipal bankruptcy are not permitted to offer an alternative plan to the court. Judge Klein’s ruling a month ago may yet have an enduring impact on public employee unions by asserting that pensions are a contract, like any other, and entail some risk of reduction in bankruptcy. But on a more practical level, municipal bond investors holding general fund obligations are still more likely to take a bigger hit in those rare occurrences when the two competing creditor classes find themselves facing off in court. Therefore, we expect bond-specific credit analysis to be increasingly important for performance.
Please note that the information in this post represents the opinions of Kathleen McNamara and not necessarily those of Van Eck Global. These opinions may change at any time and from time to time. Not intended to be a forecast of future events, a guarantee of future results, or investment advice. Current market conditions may not continue. Non-Van Eck Global proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Global. MUNI NATION is a trademark of Van Eck Associates Corporation. Please note that Van Eck Global offers municipal bond exchange-traded funds. Please see the prospectus and summary prospectus for more information.