Stockton Gorged on Debt for City Amenities Before Crash

(Corrects spelling of the name of former City Manager Dwane Milnes in 11th paragraph.)

In 2005, Stockton (3654MF), California, unveiled a gleaming new arena and ballpark on its riverfront, part of a $145 million plan to draw people downtown. The city east of San Francisco, a shipping hub for wine and almonds, is now negotiating with creditors to stave off bankruptcy.

The 10,000-seat arena, a glass-walled symbol of the city’s fight against a soaring crime rate and downtown blight, was one piece of a redevelopment boom that also saw the addition of a 5,000-seat minor league ballfield, a 650-space parking garage, a 66-slip marina and the purchase of an eight-story City Hall.

“This is the project that’s going to bring folks home, and it’s going to bring people from around the region to Stockton,” then-Council Member Leslie Martin said in 2004 when the waterfront revival was approved.

Today the new City Hall stands empty because the government can’t afford to move in. The parking garage may be seized by creditors because the city defaulted on $32.8 million in bonds.

The shopping spree contributed to the $319 million in debt, financed mostly with seven bond issues from 2003 to 2009, tied to its general fund -- the pool of money used for most day-to- day operations, equivalent to having loans backed by the contents of a checking account.

By the end of this February, Stockton found itself on the verge of insolvency from mounting retiree costs, the recession and accounting errors, City Manager Bob Deis told reporters.

Municipal Bankruptcy

The city, about 80 miles (130 kilometers) east of San Francisco, said it would default on $2 million in bond payments and begin negotiations with creditors, the first hurdle under an untested state law restricting municipal bankruptcy.

If negotiations fail, Stockton, with a population of about 292,000, stands to become the largest U.S. city to seek Chapter 9 protection. It would join Central Falls, Rhode Island, which filed in August after failing to win union concessions, and Jefferson County, Alabama, which turned in the biggest municipal bankruptcy in U.S. history in November, with $4.2 billion in debt.

State Controller John Chiang informed Stockton officials yesterday that his staff would begin an investigation into the city’s financial practices as early as May. The city’s ability to provide reliable and accurate financial data “is questionable,” Chiang said in a letter to Deis.

Downtown Redevelopment

Since the 1980s, the city had struggled to draw people downtown as homicides, which hit a record of 55 in 1992, emptied the streets and prompted stores to move to suburban malls. The record was surpassed last year when killings rose to 58, or more than one a week.

“Redeveloping downtown was a big political deal for the city,” Dwane Milnes, Stockton’s city manager from 1991 to 2001, said in a telephone interview. “Downtown was deteriorating, businesses had left.”

Then Stockton hit the radar of San Francisco Bay Area homebuyers, in search of affordable alternatives to escalating home prices. The city’s population grew 20 percent in a decade. Tax revenue rose on a burst of homebuilding. The city began pouring funds and debt into sprucing up the downtown and developing the waterfront in an ambitious plan to spur economic activity.

“Our leaders were dazzled by rosy projections and their desire to jumpstart downtown revitalization projects,” David Renison, president of the San Joaquin County Taxpayer’s Association in Stockton, said in a telephone interview. “We’re going to be paying the price for a long time.”

Financial Risks

In March 2004, the council agreed to issue $37 million in bonds to fund a $114 million plan to develop the waterfront. While acknowledging the financial risks, the lawmakers said the plan would draw people to return to the downtown and millions in private investment. Lawmakers said they were satisfied that the risks of the project, which eventually grew to $145 million, would be contained.

“We’re putting two-thirds down,” then-Council Member Larry Ruhstaller said in debating the issue. “We’re financing a third. That’s a pretty acceptable risk in my eyes and that’s why I’m for it.”

Then-Council Member Richard Nickerson, the sole dissenting vote, expressed doubts and said he’d prefer to build the venues one at a time.

“We’ve strained everything we’ve got to get to a place where we can finance this project,” Nickerson said during the meeting. “And if it doesn’t go perfect, if the state is in trouble, if the federal government is in trouble, if we in this city are in trouble, heaven help us.”

Diamond’s Million

The ballpark and arena were completed the following year. In 2006, the city paid singer Neil Diamond, whose last Top 10 hit was in 1983, $1 million to perform at the arena. In 2007, the city bought the 8-story Washington Mutual building for $35 million with the intent of making it the new City Hall.

While the city borrowed for buildings, it also ran up compensation and retiree-health liabilities it now can’t afford.

In the 1990s, city officials approved a retiree-health benefit that allowed a worker employed as little as a month to qualify for city-paid retirement health care for the retiree and his or her spouse for life, Deis has said.

“We now have the tail end of a legal but mismanaged program that feels similar to a Ponzi scheme that has ballooned to a $434.8 million unfunded liability that would require 31.58 percent of the payroll to adequately fund it,” Deis said in a Feb. 28 report to the City Council.

Automatic Increases

The city agreed to automatic salary increases regardless of whether it had the revenue to support them. The contract with the fire union required Stockton to compare its pay with that of 16 cities including Huntington Beach, Anaheim and Torrance. Stockton firefighters’ salaries were required to rank fifth- highest, according to the city’s May 2011 emergency declaration document.

By June 2011, the city had accumulated $977 million in debt on bonds, notes and long-term leases, according to a February report by Management Partners Inc., a Cincinnati-based firm the city hired in December to assess its financial condition.

About $319 million of the city’s debt is secured by the general fund, according to the report. That includes $303.9 million in outstanding debt on seven bonds issued from 2003 to 2009, nearly double the city’s $163 million general-fund budget for the fiscal year ending June 30.

“It assumed that the growth the city was experiencing was going to continue forever,” Deis, the city manager, said at the Feb. 28 city council meeting. “So not only did the city leverage the funds that were coming in during the first decade, it assumed and committed future growth for the next 20 years.”

Dedicated Revenue

The bonds were sold with the understanding that there was a dedicated revenue source outside the general fund that would pay the debt, Deis said.

“The bond market wasn’t convinced that the special dedicated revenue will be there for the next 30 years so they said, ‘We want you to put the general fund as security,’” Deis said. “The dedicated revenues dried up so now the general fund is having to pay the shortfall.”

Securities issued in 2004, 2006, 2007 and 2009 increased debt service payments linked to the general fund by 600 percent by fiscal 2013 from fiscal 2007. That created “major cash flow demands” after revenues and reserves fell, according to the Management Partners report.

Missed Payments

Wells Fargo & Co. (WFC), the fourth-largest U.S. bank by assets, sued Stockton for failure to make payments on $32.8 million in bonds for parking garages. The city missed a $779,935 payment due Feb. 25 on the revenue bonds issued in 2004, the bank said in documents filed March 7 in San Joaquin County Superior Court.

“One has to assume that the fathers of Stockton thought they could borrow to create infrastructure which in turn would attract more people,” John Ellwood, a public policy professor at the University of California, Berkeley, said in a telephone interview. “And that would lead to more building, which would lead to more revenues, which would lead to a richer, better community.”

“All of this presumed that the value of real estate would go up and up,” Ellwood said. “And they were wrong.”

To contact the reporter on this story: Alison Vekshin in San Francisco at avekshin@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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