Originally posted at www.calpensions.com

UPDATE — A federal judge today ruled that Stockton is eligible for bankruptcy, leaving the question of whether CalPERS debt should be cut to negotiations on a debt-reduction plan allowing the city to emerge from bankruptcy.

U.S. Bankruptcy Judge Christopher Klein was sharply critical of bond insurers for walking away from pre-bankruptcy negotiations when Stockton refused to discuss cutting CalPERS debt.

The bond insurers argued that Stockton failed to negotiate with creditors in “good faith“ as required by law. The judge said it was the bond insurers who failed to negotiate in good faith when they “voted with their feet” to “stonewall” negotiations.

If a federal judge rules today that Stockton is eligible for bankruptcy, bond insurers facing big losses may wonder if they should have taken a harder look at how the city’s CalPERS debt could be cut.

The insurers, including the backer of a $125 million pension bond, would have to pay bondholders millions under a city proposal to cut general fund bond payments and continue making full payments to its largest creditor, CalPERS.

Assured Guaranty and National Public Finance Guarantee argued during a three-day trial last week that Stockton failed to meet the requirement for “good faith” negotiations with creditors before filing for bankruptcy last June, temporarily staying debt collection.

The city argued that pensions are needed to remain competitive in the job marketplace and retain police, that labor has been hit by cuts in pay and retiree health car and that not paying CalPERS would trigger termination and a $1 billion payment.

Ironically, said a city attorney, the insurers provided no legal basis under California law for cutting pensions in pre-bankruptcy negotiations, but also oppose eligibility for the bankruptcy that might allow pension cuts.

“What good would dismissal of the Chapter 9 (bankruptcy) case do for them?” said Marc Levinson, an attorney for Stockton.

The financially “broke” city would still need debt relief, Levinson said, and file for bankruptcy again — this time without the 90-day mediation with creditors prior to filing bankruptcy under a new state law, using the emergency “off ramp” instead.

He said the bond insurers used extensive sworn testimony and document requests in a nine-month delay, seeking “leverage” with the “perceived threat” of heavy city spending on a “plan of adjustment” to cut debt after the “inevitable” ruling of eligibility.

The bond insurers focused on the city failure to seek debt relief from CalPERS or explore alternatives, such as withdrawing city assets from the pension fund without triggering a $1 billion termination penalty.

“The city never tried,” said Matthew Walsh, an attorney for National Public Finance Guarantee. The insurers argued that they were targeted for “disproportionate” cuts before Stockton began the 90-day mediation.

The city did not ask the California Public Employees Retirement System for a “hardship” rate reduction until Dec. 4, after the insurers had raised the issue of lowering pension costs by extending the debt payment period.

CalPERS said Stockton did not meet the criteria. In a followup telephone call, an official said the city was told, among other things, that it did not qualify for an exception due to potential inability to “provide continuation of funding at termination.”

A hardship rate would save an estimated $4.5 million over three years, far short of closing a $26 million general fund budget gap. Stockton considered a hardship request early but decided to wait until after filing for bankruptcy, said Bob Deis, the city manager.

CalPERS also rejected a city request made on June 7 to lower its unusually generous annual inflation adjustment for most pensions (up to 5 percent if actual inflation goes that that high) to the 2 percent limit for police pensions.

Stockton said the 5 percent limit is not an additional cost for the city unless inflation is higher than the CalPERS long-term estimate, 3 percent. But 5 percent is above market, said the city, and an “uncertainty“ for budget forecasting.

Since the city chose to make the optional 5 percent limit an amendment to its contract with CalPERS, the big pension fund told Stockton, state law only allows the cost-of-living adjustment to be reduced if the contract is terminated.

The CalPERS rejection letter also mentioned the state law that Stockton officials said prevents the negotiation of cuts in CalPERS debt outside of bankruptcy.

“In addition, a modification of the benefits (which includes the COLA) promised by the city to its current and retired employees is not permitted under the vested rights doctrine in California without a comparable new advantage to these employees,” said the CalPERS rejection letter.

A bond insurer attorney briefly mentioned a way that the CalPERS debt might be cut, at least in theory, without cutting pension benefits protected as vested rights under state contract law under a series of court rulings.

A Stockton attorney had said CalPERS is technically not a creditor, but only a trustee of funds held for retirees. He said there is no big pool of city funds CalPERS could dip into to “backfill” a cut in Stockton’s pension debt.

U.S. Bankruptcy Judge Christopher Klein asked if that meant every $1 taken from CalPERS would be a $1 taken from actual pensions. “Exactly right,” said Norman Hile, the Stockton attorney.

The bond insurer attorney, Walsh, disagreed. He said CalPERS debt is based on actuarial projections “years and years” into the future, and with a small change “millions of dollars can be freed up.”

If the bond insurers, with deep financial pockets and talent from two global law firms, had pursued this line of inquiry they might have taken revealing testimony from CalPERS officials and outside actuaries about how pension debt can be manipulated.

It’s not a fixed amount like bonds and mortgages. Instead, pension debt varies with earnings forecasts, the actuarial or market value of assets, amortization periods for paying off debt, pay and inflation forecasts, demographic assumptions and other factors.

Would the bond insurers have discovered an acceptable actuarial change that would lower Stockton pension costs? Would the inquiry help the judge make a decision about accepting a “plan of adjustment” if Stockton is eligible for bankruptcy?

Another issue not explored in the trial is whether upcoming CalPERS decisions in the San Bernardino bankruptcy might apply to Stockton. After filing in August, San Bernardino stopped payments to CalPERS and owed about $13 million by Dec. 31.

How will CalPERS handle the San Bernardino non-payment — refinance the debt over a much longer period of time, go along with unprecedented pension cuts made through bankruptcy, terminate the plan and put a lien on city assets?

CalPERS opposes San Bernardino’s eligibility for bankruptcy. So CalPERS presumably wants to deal with the San Bernardino debt outside of bankruptcy and might have been asked about its plans during the Stockton trial.

The CalPERS board was told last November state law does allow pension cuts or aid from other funds when plans are terminated and lack the assets needed to cover liabilities.

“The law prescribes should that be the case the members’ benefits will be reduced until such a point basically as it is fully funded,” said Alan Milligan, the chief actuary.

“There is an out. The law does permit the board to bring them into the terminated agency pool without reduction in benefits if certain criteria are met,” Milligan said. “The two main criteria are that all reasonable steps have been taken to collect the funds and that doing so would not adversely impact the funding status of the terminated agency pool.”

Are these measures available in bankruptcy? It’s another issue not explored in the Stockton trial.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com/ Posted 1 Apr 13