The tug of war continues between pension plan participants and outside creditors. As a result, doing business with troubled municipalities may end up costing creditors time, money and headaches. Just a few days ago, Judge Christopher Klein with the United States Bankruptcy Court for the Eastern District of California ruled against Franklin Templeton Investments. By doing so, this asset manager will not be able to recoup the $32 million it sought from the City of Stockton as the municipality seeks to exit bankruptcy. Instead, as Reuters journalist Robin Respaut writes in "Holdout creditor in Stockton bankruptcy denied higher claim" (December 10, 2014) the city's plan would give Franklin "just over $4 million of the $36 million it said it is owed." This follows an October thumbs-up from the Court to reduce the payout to bond investors in order to maintain retirement and health care benefits and thereby (hopefully) prevent an exodus of badly needed city workers.
A topic not actively discussed but critically important to ignore is that once-burnt lenders are unlikely to come knocking again. If they do, they will charge a higher cost of capital and demand tighter collateral safeguards to reflect the bigger risk associated with exposure to struggling borrowers. After all, lenders are accountable to their customers. As Bond Buyer's Keeley Webster describes, investors in Franklin California High Yield Municipal Fund and Franklin High Yield Tax-Free Income Fund will suffer as the result of a low recovery rate in the neighborhood of twelve percent for loans made to Stockton.
As Attorney B. Summer Chandler discusses in "Is It 'Fair' to Discriminate in Favor of Pensioners in a chapter 9 Plan?" (American Bankruptcy Institute Journal, December 2014) putting pensioners ahead of other unsecured creditors may not seem right to some but could be supported by "limited case law assessing chapter 9 plans..." taking into account "the unique nature of a municipality, its relationship to its citizens (including pensioners and current employees) and the purposes of chapter 9..."
To reiterate, customer risk is real for organizations such as Franklin Templeton. Unless its higher costs can be passed along to customers, expect some lenders and suppliers to say "never mind" and look elsewhere for business. This would logically reduce the supply of capital and services and could mean higher costs for all municipalities, not just those seeking bankruptcy protection. As my co-authors and I discuss in "Muni Bonds, Pension Liabilities and Investment Due Diligence" by Dr. Susan Mangiero, Dr. Israel Shaked and Mr. Brad Orelowitz (American Bankruptcy Institute Journal, July 2014), the evolution of decision-making can reduce uncertainty. We add that "...legal, economic and political skirmishes associated with municipal bond distress now being played out are helping to set the stage for future clarity." We assert that future bond buyers may still lend to a municipality if they "are comfortable in their belief that large unfunded post-employment obligations can be compromised as part of a distressed-debt workout..." and that "fresh capital can be a lifeline for a municipality that has fallen on hard times, even if it comes with a higher service cost.'
The best outcome is that pension-plagued municipalities seeking to exit from bankruptcy get their financial house in order as quickly as possible. While retirement plan participants have received a reprieve in some situations such as what happened with Stockton, the overall funding crisis is likely to reverberate in ways that could lead to future skirmishes. Witness what is happening right now, courtesy of the U.S. Congress. According to "Pension Bill Seen as Model for Further Cuts" (December 14, 2014), Wall Street Journal reporter John D. McKinnon portends future diminutions in employee benefit payouts if such action is deemed to prevent the "failure of just a few" plans being able to destroy "the federal pension safety net" (i.e. the Pension Benefit Guaranty Corporation). While the focus of lawmakers right now is on corporate union plans, it is not much of a stretch to imagine certain reductions being allowed throughout the United States and in other countries, postured as protection for the "greater good."