SAN FRANCISCO - A federal judge's verbal ruling during Stockton, Calif.'s bankruptcy confirmation hearing could increase the appeal of bankruptcy for some distressed municipalities, but overall filings should remain rare, credit rating agencies say.
U.S. Bankruptcy Judge Christopher Klein ruled Wednesday, saying Stockton's payments to the California Public Employees' Retirement System could legally be impaired in its plan of adjustment to exit bankruptcy protection.
His decision is not binding on other municipal bankruptcy cases, but if established as a precedent, the ruling could increase incentives for distressed municipalities to seek pension cuts in bankruptcy court, according to Fitch Ratings.
"However, Fitch believes those seeking bankruptcy protection will do so whether or not they can be certain of their ability to impair pensions," analysts said in a report released Thursday. "More likely in Fitch's view is that the ruling may encourage labor and management to negotiate pension cuts to avoid the uncertainties of bankruptcy court."
The ratings agency added that the ruling is consistent with its view of pension liabilities in the bankruptcy of municipality.
"Payments to pensions may be protected by anti-impairment language in state law, but in a federal bankruptcy proceeding they are at risk for impairment like any other liability," analysts said. "The ability to impair otherwise protected obligations to reset a debtor's financial profile is a key premise of municipal bankruptcy law."
Fitch said its basic approach to Stockton's ratings are unaffected.
Standard & Poor's also released a report Thursday saying it does not believe the theoretical ability to reduce pension costs will induce a significantly large number of local governments to enter bankruptcy.
"However, [Klein's comments] could prove meaningful for a very small portion of distressed municipalities nationwide as they contemplate potential avenues to address mounting budget and liquidity pressures with little room to navigate," analysts said.
Any material benefits to a municipality's credit quality from Klein's ruling are likely to be muted, according to Standard & Poor's.
One reason is because a bankruptcy filing is necessary but not sufficient for a municipality to revoke employee contracts, analysts said. Another reason is that filing for bankruptcy shines a negative light on a municipality in terms of popular perception, market access, and viability of long-term provision of services.
"Although we have witnessed three California cities, including Stockton, file for bankruptcy protection in the past five years, we believe that credit quality in the state is stable overall, with most California cities having shown the ability to make difficult budget adjustments during the Great Recession to bring expenditures in line with revenues," the report said.
Moody's Investors Service earlier Thursday called the ruling a positive sign for investors. While it could encourage other financially stressed municipalities to consider bankruptcy as a way of addressing pension costs, the agency said it expects few, if any, filings in the near term.
Stockton's confirmation plan, which does not propose to cut pension contributions, has still not been approved or denied by Judge Klein. Another court date has been set for Oct. 30 to continue proceedings.
