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Take Five: Muni mavin Ronald Bernardi on the tremors from Stockton

Trader says bankrupcty will likely shake up tax-exempt landscape in California

By Jeff Benjamin

Apr 9, 2013

Ronald Bernardi, a municipal bond trader and president of Bernardi Securities Inc., puts the Stockton, Calif. bankruptcy in perspective.

For investors, he said, there is an upside to the growing list of defaults, and he thinks that municipal employees will ultimately be forced to share in the pain alongside bondholders.

InvestmentNews: Does the Stockton bankruptcy represent the start of a tipping point for municipal bankruptcies?

Mr. Bernardi: In California, perhaps. But even on that score, there’s still much to be determined. Nationally, we don’t see a direct correlation with the precedent-setting decision in Stockton.

Clearly, the decision [last week by U.S. Bankruptcy Judge Christopher Klein approving Stockton’s petition for bankruptcy protection] gives California municipalities an option in terms of walking away from their debt, but nationally we don’t view it that way because bankruptcy is handled differently in different states.

InvestmentNews: The California Public Employees’ Retirement System is listed as Stockton’s largest creditor but has so far not been asked to make any concessions. What is the message being sent to muni bond investors?

Mr. Bernardi: Reading what the judge said about the kinds of nontransparent pension benefits that workers received for decades, I have to believe CalPERS will be asked to make some concessions. And that will make the reorganization more palatable to bondholders.  The plan that ultimately is approved will be the defining moment for this and future bankruptcies for municipalities in California.

InvestmentNews: What larger message should muni bond investors take away from the Stockton bankruptcy?

Mr. Bernardi: As it relates to unsecured California municipal debt, investors need to be very wary. The judge gave Stockton permission to use monies in its general fund to pay operating expenses.

The reorganization that Stockton ultimately presents to the judge will greatly determine how market makers and debt issuers view Stockton and other California municipalities.

InvestmentNews: Is there an upside for investors to be gleaned from a municipal bankruptcy?

Mr. Bernardi: Most definitely, because bad news creates opportunities. California muni debt is trading at higher yields and lower prices than it was 10 days ago. The legal right of municipalities in California to file for bankruptcy has now been confirmed by a judge’s ruling.

InvestmentNews: From 1970 through 2009, municipal defaults averaged less than two per year, but there have been 16 defaults over the past three years. What does the trend suggest?

Mr. Bernardi: From a 10,000-foot level, an increase in defaults is certainly consistent with the economic crisis we went through. And secondly, it shows that the chickens are coming home to roost, in that too many nonessential bond issues have come to market in the last several years.

If it doesn’t work out, elected officials are more likely to walk away, because typically the officials in office when the issue was approved are no longer there. And the new officials have inherited a problem that taxpayers don’t want to pay for.

When I started in the business in late 1980s, you didn’t default on debt, period. But what we’re seeing now is consistent with what you’re seeing across the country — people walking away from their mortgages. You’re seeing those same lower standards trickle down into the muni area.

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