Although we have no exposure to Stockton, California debt, we thought it would be useful to comment on the city’s financial plight in the wake of the recent bankruptcy court ruling allowing the city to file a “plan of adjustment” or the equivalent of Chapter 11 reorganization. We, and other municipal bond participants, will be watching this process closely to see how the court treats various creditors. Of particular interest will be the treatment of obligations owed to the California Public Employees Retirement System (CalPERS). Given the large size and budgetary importance of Stockton’s CalPERS payments, the court’s ruling could have widespread ramifications for other distressed municipalities in California and elsewhere across the country. The resolution of whether or not federal bankruptcy law trumps state law (which protects pension payments to CalPERS) may influence the expected level of recovery in any other bankruptcy case. However, we do not believe that Stockton’s bankruptcy or future rulings in this case, will, in and of themselves, cause a wave of bankruptcy filings in California or elsewhere. While Stockton’s financial and economic plight is not entirely unique in California — there are several other very distressed cities in California — we believe the number of bankruptcies will remain relatively small and not significant in the context of the overall municipal bond market.
For those in the media and other market pundits, it is important to remember that Stockton is hardly representative of a typical issuer in the municipal market. Stockton’s problems of weak socio-economics, high debt burden and badly underfunded pension have long been known to astute municipal market participants. The city’s financial demise stems from several factors: aggressive capital spending during the mid-2000s, a lack of effective accounting controls, overly generous employee salaries and benefits, and significant future pension and health care liabilities that cannot be realistically paid from a declining revenue base. Stockton’s relatively affordable housing stock located near San Francisco and Sacramento led to a housing bubble that temporarily hid some of the underlying budgetary problems. With housing prices down close to 70% since 2007, Stockton now has to deal with an above average debt burden and increasing expense demands. At its peak, Stockton had the second highest foreclosure rate of cities with populations greater than 200,000, trailing only Las Vegas. Many of these issues have manifested themselves in a poor quality of life in the city: Stockton was recently deemed the eighth most violent in the country and twice in the past five years was name the most miserable city to live in.
As noted in the past, we do not believe Stockton is an omen or the beginning of an impending wave of local government bankruptcies across the country. However, with various cities in California in similar fiscal straights, Stockton’s path through the travails of bankruptcy and, particularly, the treatment of its future pension contributions will be instructive for creditors and bondholders of other distressed California cities.
The views expressed are as of 4/8/13, may change as market or other conditions change, and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts are accurate.
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