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California’s Stockton Strives to Avoid Bankruptcy Court

California’s Stockton Seeks to Avoid Vallejo Path
Richard La Frentz, chief executive officer and owner of Best PC Value, stands for a photograph at the back gate of his shop in Stockton California. Photographer: David Paul Morris/Bloomberg

After a man with a laptop walked into Best PC Value computer repair in Stockton, California, owner Richard La Frentz telephoned the police. Hours before, the same man had been recorded by a security camera hopping a locked gate behind the store and stealing the computer.

The police didn’t come. They told La Frentz to call his insurance company, he said.

“It is the Wild West out here,” said La Frentz, 47, who keeps two handguns at his store in Stockton’s Miracle Mile shopping district. “When I call the police department, I don’t get help. The city can’t help me because of the condition that it’s in.”

Stockton, an agricultural center of about 292,000, is fighting to avert California biggest bankruptcy since Vallejo’s in 2008. The city has shrunk its payroll, including a quarter of the roughly 425-member police force. Twice since 2010 it has declared a state of fiscal emergency to force cuts on public employees.

Stockton’s City Council will be asked to vote to take the first steps toward bankruptcy and default on bonds at a Feb. 28 meeting, according to a person familiar with the council’s agenda who wasn’t authorized to speak about the matter. The issue isn’t on the agenda, which will be updated tomorrow. Connie Cochran, a City Hall spokeswoman, didn’t respond to telephone calls and an e-mail seeking comment on the potential bankruptcy filing and interviews with officials.

Fiscal Status Briefing

City Manager Bob Deis will brief reporters tomorrow to “provide background information and answer questions from the media related to the city’s fiscal status,” according to a statement distributed today.

“I do not believe bankruptcy is a better option but it is an equitable approach because it is judicially supervised,” David P. Mastagni, a partner at Mastagni, Holstedt, Amick, Miller & Johnsen, the Sacramento-based law firm representing Stockton’s police union in a lawsuit against the city, said today by telephone. “It will take the politics out of balancing the budget.”

The San Joaquin and Calaveras Counties Central Labor Council, representing Stockton-area workers, circulated an e-mail to its members announcing a meeting to “discuss the plan for Tuesday,” the day the City Council meets.

A state law passed last year requires the city to work with a “neutral evaluator” for at least 60 days before seeking bankruptcy court protection. The process is similar to mediation and gives creditors a right to participate. It can be bypassed if the city declares a fiscal emergency, according to the law.

Sidestepping Vallejo Fate

A deepwater port on the San Joaquin River, 75 miles (120 kilometers) east of the Golden Gate Bridge, Stockton is trying to sidestep the fate of Vallejo, its neighbor about a 90-minute drive away. Half the size of Stockton, Vallejo in 2008 became the biggest California city and at the time, the second-biggest local government after Orange County to file for bankruptcy.

Vallejo turned into a national symbol for distressed municipal finances after it failed to win pay cuts from its unions. It emerged from court protection in 2011 with a skeletal workforce, about 20 new medical-marijuana dispensaries and a surge in prostitution, while forfeiting its ability to issue debt for five years.

“We truly want to avoid that,” Stockton Mayor Ann Johnston, 69, said in a Jan. 19 interview at City Hall. “We’re not moving in that direction whatsoever. Our focus is to balance our budget, to continue to provide services, to continue laying the foundation for our future recovery.”

A Stockton sewer bond maturing in April 2022 traded Feb. 21 at an average yield of about 6.2 percent. The bond is rated A, sixth-highest, by Standard & Poor’s.

Worse Than Vallejo

Stockton is already worse off than Vallejo. It had the eighth-highest violent crime rate in the country in 2010; the second-highest foreclosure rate in the U.S., behind Las Vegas; and the eighth-highest unemployment, at 15.9 percent in December, almost double the national average.

Such factors helped earn Stockton the title of “most miserable city” in the U.S. twice in the past four years by, out of the 200 largest metropolitan statistical areas. In November, Moody’s Investors Service downgraded about $137.7 million of its debt to Baa1, the third-lowest investment grade, citing Stockton’s “precarious financial position.”

Only a few years earlier, the city was flush with cash from property and sales taxes, development fees and permits in the midst of a housing boom, Kathy Miller, Stockton’s vice mayor, said in a telephone interview.

“They couldn’t build housing fast enough,” Miller said. “People from the Bay Area were pouring into the valley, snapping up houses.”

Urban Flight

Buyers fleeing the San Francisco Bay Area’s soaring prices, and willing to drive two hours, looked on Stockton as an affordable alternative. The population jumped almost 20 percent from 2000 to 2010, according to U.S. Census Bureau data.

Single-family home construction, which had averaged 2,500 units a year from 1991 and 1997, tripled to 7,500 units annually from 2003 and 2005, according to Robert Denk, senior economist at the Washington-based National Association of Home Builders.

Buyers who paid an average of 3.5 times their annual salaries for a Stockton home in the 1990s were paying a ratio of 7.5 times in 2006, as measured by median house price to household income, Denk said.

Housing construction collapsed in 2009, when less than 1,000 homes were built, Denk said.

In 2011, Stockton had the second-highest foreclosure rate in the U.S. among cities with a population of more than 200,000, trailing only Las Vegas. One in every 18 Stockton homes had foreclosure filings, according to RealtyTrac Inc., an Irvine, California-based data provider.

Falling Revenue

A drop in property-tax and program-fee collections shrank the city’s revenue 20 percent to a projected $161.8 million in fiscal 2012 from $203.1 million in 2009. At the same time, union contracts drove employee pay and benefits higher.

Public-safety costs represent 77 percent of the city’s general fund, Susan Mayer, who was Stockton’s chief financial officer until her retirement Feb. 15, said in a telephone interview. The situation has fueled talk of bankruptcy in recent years.

City Council member Dale Fritchen, at a February 2009 budget committee meeting, asked the city attorney’s office to lay out the pros and cons of bankruptcy protection.

In the 2011 spending plan, City Manager Bob Deis said Stockton “is near insolvency.” He cited depleted reserves, debt that puts the general fund at risk and “multi-year labor contracts with escalating costs that simply cannot be paid within anticipated revenues in the foreseeable future.”

Fiscal Emergencies

The city declared a fiscal emergency in May 2010 when it faced a $23 million deficit and extended the declaration last year when the gap widened to $37 million. The moves, which let city officials force changes on existing labor contracts to balance the budget, prompted the police union to sue.

“They simply don’t want to share the pain that all the rest of the city’s employees have shared,” Johnston said of the police union.

“We need to continue to evaluate how we do business, the kind of employee compensation and benefits, to bring them in line with the marketplace,” said the mayor, who is paid $82,099 a year, according to the city’s website. She also runs a party and balloon-supply store.

In October, the city warned it may default on redevelopment agency debt issued in 2006, citing a shortfall in tax-increment revenue. Debt service will exceed available revenue by about $858,000 in the North Stockton project area, the city said.

Closely Watched

“People are watching closely to see what they do,” Matt Fabian, a managing director at Concord, Massachusetts-based Municipal Market Advisors, said in a telephone interview. “The Stockton bonds have been trading fairly cheaply, at 88 cents on the dollar. Bond holders are buying Stockton cheaply to insulate themselves against potential problems and further credit deterioration in Stockton.”

Among large nongovernment employers in the city are San Diego Chargers owner Alex Spanos’s A.G. Spanos Construction Co. and Duraflame Inc., the closely-held firelog manufacturer.

Stockton ranked eighth in the U.S. in violent crime per 100,000 residents in 2010, according to FBI data on metropolitan statistical areas. This includes murder, non-negligent manslaughter, rape, robbery and aggravated assault.

The police department is down to about 310 officers. It has lost its community-policing, narcotics and auto-theft units in the last two years, Steve Leonesio, president of the Stockton Police Officers’ Association, said in a telephone interview.

Empty Patrol Cars

“Because we’ve lost so many officers, we are basically a reactive department,” Leonesio said. “There’s a lot of empty desks, a lot of empty police cars, very few police officers in the street.”

Stockton hired some Vallejo veterans to help it steer clear of bankruptcy. Mayer joined the city about a year ago, after serving as Vallejo’s assistant finance director.

It also retained John Knox, a partner at Orrick, Herrington & Sutcliffe LLP in San Francisco who helped represent Vallejo in bankruptcy court. He was hired “to advise the city in various financing and litigation-related matters,” according to a City Council agenda item. Knox declined to comment on his work for Stockton, responding to an e-mailed inquiry.

In December, the city agreed to pay $79,900 to Management Partners Inc. to assess Stockton’s financial condition. The Cincinnati, Ohio-based firm lists Vallejo, Harrisburg, Pennsylvania, and Orange County among its clients. Harrisburg’s City Council sought court protection for the state’s capital city last year and was rejected.

Preparation for Restructuring

“If we have to seek protection to restructure our debts and to reorganize, we want to be able to know fully what our financial position is, be able to craft a recovery plan and to get the city back on the road to recovery,” said Miller, the vice mayor.

Stockton has cut its workforce to about 1,200 from about 1,700 in 2007, Johnston said.

“Just walk down the hall -- empty offices, empty desks,” Johnston said. “It just makes it more difficult for us to respond quickly to the public when they need certain services.”

The emptiness extended to the nearby Pacific Avenue shopping district. Retailers there tell of armed robberies and break-ins. A jeweler said his wife won’t go to the grocery store without him.

La Frentz, the computer-repair shop owner who had another break-in at his business on Jan. 30, said he’s sure the city will end up seeking bankruptcy protection.

“It’s coming,” La Frentz said. “I almost guarantee it.”

-- With assistance from Michael B. Marois in Sacramento and Steven Church in Wilmington, Delaware. Editors: Pete Young, Ted Bunker, Paul Tighe.

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