Bondholders, Insurers Challenge San Bernardino Bankruptcy

By Tim Reid | August 20, 2012

Bondholders and bond insurers are challenging the eligibility of San Bernardino, California, to file for bankruptcy protection, claiming the city provided no financial information to its creditors.

Their court filings follow one by the city’s firefighters this week that asked for more time to decide whether they will fight San Bernardino’s request for bankruptcy protection.

The court filings by some of San Bernardino’s biggest bondholders and bond insurers is part of the rapidly expanding battle between Wall Street and California as the state, and some of its cities, look at ways to reduce debt payments to alleviate an ongoing budget crisis.

San Bernardino filed for bankruptcy on Aug. 1, becoming the third California city to seek bankruptcy protection since June, following filings by Stockton and Mammoth Lakes. Analysts say the state’s budget crisis is so acute that more cities could follow.

Richard Larkin, senior vice president and director of credit analysis at bond underwriting firm HJ Sims, concluded in a recent study that “because of the fiscal environment in California … many of those defaults yet to come this year are likely to be in California.”

Unlike the other two cities, San Bernardino declared a fiscal emergency on July 18, before filing for bankruptcy protection. Under California bankruptcy law, a city does not have to negotiate with creditors if its finances are in a state of emergency.

San Bernardino is seeking an aggressively quick schedule for the bankruptcy proceedings. It asked the court to set a deadline of Sept. 21 for its creditors to file objections.

Bond insurer National Public Finance Guarantee Corporation, a unit of MBIA, argued in a filing on Wednesday t hat San Bernardino provided no financial information to its creditors and had not proved it was eligible to declare a fiscal emergency or to seek municipal bankruptcy protection under Chapter 9 of the bankruptcy code.

“To date, the city has not provided its creditors with any information which would enable them to determine whether the city is eligible to be a Chapter 9 debtor,” National Public Finance Guarantee’s attorneys wrote in its filing.

San Bernardino’s request for a short deadline for its creditors to file objections was “patently unfair and unreasonable,” the filing added. The bond insurer demanded documents and witnesses so creditors could analyze the city’s finances.

In a separate filing on Wednesday, Ambac Assurance Company, which insured $50 million of pension bonds issued by San Bernardino in 2005, and the bondholder Erste Europaische Pfandbrief-und Kommunalkreditbank AG, challenged the city’s bankruptcy filing and its deadline for creditors.

“The city has not provided its creditors with the information necessary to evaluate its chapter 9 eligibility,” the filing states.

The filing also questioned San Bernardino’s declaration of a fiscal emergency as a way to avoid negotiating with its creditors before it declared bankruptcy.

“If it is shown that the City precipitated a fiscal emergency by unreasonably delaying taking necessary action and then relied on a declaration of that emergency to avoid the negotiation requirement, its petition should be dismissed,” it states.

In a reply filed in court on Thursday by San Bernardino’s attorneys, the city suggested that it will file evidence in support of its bankruptcy by August 31, and that creditors be given until October 5 to file any objections.

The filing states that the city declared a fiscal emergency due to “a dire liquidity crisis and certain creditor actions that threatened to exacerbate the City’s cash flow problems.”

The escalating battle between San Bernardino and its creditors mirrors similar moves in Stockton. Last week two bond insurers, including National Public Finance Guarantee Corp., challenged Stockton’s eligibility for bankruptcy.

In a move that could have profound implications for California, the bond insurers essentially also took on the largest U.S. pension fund, the California Public Employees’ Retirement System (Calpers).

They argued that Stockton’s failure to ask for concessions from Calpers, its largest creditor, showed the city had not negotiated in good faith and that its request for bankruptcy should not be granted because it did not touch pensions.

On August 1, the bond insurer Syncora Guarantee filed a lawsuit challenging California’s move to eliminate the state’s 400 local redevelopment agencies, claiming the plan unfairly deprives bondholders of money they are owed.

The San Bernardino case is City of San Bernardino, Debtor, Central District of California, Riverside Division, No. 6:12-bk-28006-MJ.

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