Thursday, 3 October 2013

Wow, Assured Guaranty and Stockton Reach a Settlement. The Deal Improves the Case to Voters for Measure A (sales tax increase).

The City was hinting at a deal, but I guess I didn’t believe it given how antagonistic Assured Guaranty has been with the City.  I will reserve final judgement until seeing the fine print, but the outlines of the deal seem reasonable.  I don’t think the City would have been able to get anything substantially better in court, as their original ask on the pension bonds of an 84% loss was highly inequitable.  In other posts and writings, I have suggested an appropriate loss for the Pension Bonds would be about 40% whether viewed from the perspective of equity with retirees or the damage the pension bond deal did to the City’s finances.  This deal appears to be in that ballpark.

The City will start making small payments on the pension bonds from the general fund in 2023 and extend those payments an additional 15 years out to 2052.  Combined with the portion of the bonds paid from sources outside the general fund, that puts the haircut from the fixed payments at around 50% in net present value basis. However, Assured will do better than that because they will keep a share of Stockton tax revenue over current projections - and Stockton will definitely exceed their projections for at least the next couple of years.  It’s hard to know exactly where it will turn out in the end, but the deal definitely gives Stockton’s general fund significant short-run relief and the scale of the loss and shift of risk to Assured seems fair and roughly proportional to the loss to retirees.

All these creditor deals have definitely been made easier by the recovering real estate market.  Several of the bonds had pledges of property tax increment, and the loss of property tax increment is why they fell back on the general fund in the first place.  Improving property values and tax increment is making some of the deals possible, such as the settlement on the Arena bonds.  The improving market also helped the deal on the 400 E. Main building as Assured will take title to that office building and sell it.  My rough math says they will break even if they can sell it for about $165 per square foot, and my understanding is that office buildings are selling for $125-150 per square foot in the Stockton area.  With the City leasing up more of the building’s space and the market improving, the creditors loss won’t be too enormous from taking over the building.  Finally, the improving market makes it very likely that tax revenue will exceed the City’s projection over the next few years, and thus will help improve Assured Guaranty’s payments on the pension bond deal as well.

With all of these deals, the City can make a strong case that the judge will likely accept the settlements, and thus avoid a protracted bankruptcy.  The creditor deals depend on Measure A.  I would say that exiting bankruptcy in a timely fashion and saving millions in additional legal costs seems like another tangible benefit to passing Measure A that did not seem likely to me a few days ago.  The City definitely strengthened its case for the sales tax to voters tonight.

As discussed in the previous post, I still have significant concerns about the City’s long-range financial projections that showed deficits in 8 of the next 10 years despite passing the sales tax and bankruptcy savings.  This was driven by the high growth rate of costs (mostly employee compensation).  Given the extremely low levels of non-police services for projected for decades to come, and the suggestion that Measure A revenues could sunset in 10 years, the City needs to control costs more than this projection suggests.  However, I was assured today by the City’s consultants that the growth in employee compensation is not in contracts, it is just a planning assumption they have been using.  (They defended the assumption and why they thought those raises are needed, but I wasn’t convinced.)  The bottom line is that the City can’t afford to put 2% COLAs (cost of living adjustments) back into employee contracts in 2015 like its financial projections do if it plans to let Measure A expire or start restoring any non-Safety services in the next 20 years.  Since this financial plan of adjustment does not represent a commitment to those costs, this debate can be postponed for a short while.

Update 10/7:  I have had a chance to review the details.  I was concerned about the "contingent" payment formula that is based on whether and how much city revenues exceed a forecast, but it looks o.k.  I am comfortable that the ultimate loss on the pension bonds will be in the range of 30-50% and thus be proportional to the loss of benefits to retirees.

I did have one item wrong, there are more general fund payments on these bonds than I stated above.  General fund payments start at about $1.3 million annually in 2018, and will increase to about $2.9 million per year in 2023, and $3 million from 2042 to 2052.  There will also be the payments allocated to restricted funds (i.e. water and wastewater) for their share of costs, and the potential for additional contingent payments if the City’s revenues are high.  For the next 5 years, this will save the City’s general fund about $7 million per year, and about $3-5 million per year for the next 20 years.  Then there is 15 years of additional payments because the term has been extended.


About the Author

Ethan Jacob

Author & Editor

I am Ethan Jacob Executive Director of the Center for Business and Policy Research at the University of the Pacific, where I have a joint faculty appointment in the Eberhardt School of Business and the Public Policy Program in the McGeorge School of Law..


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