Stockton, California, to File for Bankruptcy Protection

Stockton, California, to File for Bankruptcy as Talks Fail
People ride bicycles along the street in Stockton, California. Photographer: David Paul Morris/Bloomberg

Stockton, California, said it will file for bankruptcy after talks with bondholders and labor unions failed, making the agricultural center the biggest U.S. city to seek court protection from creditors.

“The city is fiscally insolvent and must seek Chapter 9 bankruptcy protection,” Stockton said in a statement released yesterday after its council voted 6-1 to adopt a spending plan for operating under bankruptcy protection. “In addition to the bankruptcy petition, the city will file a motion with the courts to share information from the confidential mediation.”

The budget for the fiscal year beginning July 1 calls for defaulting on $10.2 million in debt payments and cutting $11.2 million in employee pay and benefits under union contracts that could be voided by the bankruptcy court. The city of 292,000 may file its petition as soon as today.

“It’s a sad day in the city of Stockton,” Mayor Ann Johnston said before the budget vote. “I see no other solution to this.”

Municipal bankruptcies in the U.S., while still rare compared to corporate filings, became more common after the housing and financial crisis began. Ten of 42 cases filed since 1981 came in the past four years, according to court records.

The biggest municipal bankruptcy was filed last year by Jefferson County, Alabama, which is trying to restructure $4.2 billion in debt, most of which is tied to sewer bond deals tainted by corruption.

Vallejo Bankruptcy

Stockton’s bankruptcy will probably resemble the 2008 case of another California city, Vallejo, which exited court protection last year, bankruptcy attorney Dale Ginter said. Both cities have been hurt by high labor costs, particularly health insurance for retirees, he said.

“Retirees are not going to be happy,” said Ginter, who represented retired Vallejo workers in that city’s bankruptcy. “My prediction is that retiree health care is cut. I wouldn’t be surprised to see it cut to zero.”

Bondholders and current employees will probably also have to take less, said Ginter, who has reviewed city financial reports.

“We think Chapter 9 protection is the only choice left,” City Manager Bob Deis told the City Council, referring to the section of the federal bankruptcy code that applies to municipalities.

Municipal Bonds

Stockton’s expected bankruptcy filing won’t create a sell-off in the $3.7 trillion municipal-bond market because investors of tax-exempt debt have known about the city’s budget deficit and rising health-care expenses, Matt Fabian, managing director at Concord, Massachusetts-based Municipal Market Advisors, said in a telephone interview.

“There’s been enough talk about municipal bankruptcy and worries about it that when one actually happens, it’s a little beside the point,” Fabian said. “It’s hard to see one city’s faltering pushing the market weaker.”

Investors will buy municipal debt for its relative safety and low default rate, said Chris Ryon, who helps manage $8.25 billion of municipals, including a $367 million California fund, at Thornburg Investment Management. The average cumulative default rate in the past four decades was 0.13 percent for municipal bonds versus 11.2 percent for corporate debt, Moody’s Investors Service data show.

‘Extremely Low’

“The overall default rates in municipal bonds are extremely low and Stockton is a small participant in the $3.7 trillion market,” Ryon said in a telephone interview.

A taxable Stockton pension bond sold in 2007 and due September 2037 traded June 25 as high as 80.68 cents on the dollar, down from when it traded as high as 102.03 cents on the dollar on Feb. 15, according to data compiled by Bloomberg.

The City Council’s approval paves the way for Deis to proceed with the bankruptcy filing. Stockton, a river port about 80 miles (130 kilometers) east of San Francisco, ran out of options after three months of negotiations with creditors ended June 25 without enough concessions to close a $26 million deficit.

“We’ve worked really hard with our creditors and we’ve been unable to close the gap,” Deis said. “If we get any agreements in the near future, then those will be honored in Chapter 9.”

Break Contracts

Bankruptcy would allow the city to break contracts with creditors without the threat of lawsuits, though it won’t assure the city’s recovery, he said.

“This basically is the equivalent of the pause button,” Deis told the council. “It provides you a breather to adopt a budget and maintain services during this next year. It doesn’t guarantee success in the long term. That’s going to require some negotiating and some give-and-take.”

Dale Fritchen, the only one of seven council members to vote against the plan, said he wasn’t convinced there was no alternative.

“I think it’s going to hurt Stockton more than it will help Stockton,” Fritchen said. “For heaven’s sake, I hope I’m wrong.”

In February, the city began a process during which it is required by state law to review its finances with help from a “neutral observer” who is picked in cooperation with creditors. That review is similar to a mediation process in which creditors have a right to participate, according to the law, passed last year at the request of California labor unions.

Salaries for current workers and benefits for them and former employees account for about 68 percent of the city’s general fund, the city said.

Service Cuts

The city has cut services so much the past two years that “public safety is at a crisis level,” officials said in a June 5 fiscal report. Unemployment, at 15.4 percent in April, was almost double the national average, according to the U.S. Department of Labor.

Stockton ranked third in murders last year among large California cities, behind Los Angeles and Oakland, according to FBI data.

The collapse of the housing market left Stockton to contend with mounting retiree health-care costs and eroding tax dollars in the wake of the recession, amid accounting errors that overstated municipal revenues. One in every 195 homes in Stockton’s metropolitan area received a foreclosure filing in May, the fifth-highest rate in the U.S., according to RealtyTrac Inc.

Creditor Talks

Negotiations with creditors began on March 27 and were extended to June 25. The California Public Employees’ Retirement System, the largest U.S. pension fund, and San Francisco-based Wells Fargo & Co., the nation’s biggest home lender, and bond insurer Assured Guaranty were among at least 18 creditors involved in the talks.

Last year, three municipalities entered bankruptcy, including Jefferson County.

Chapter 9 of the U.S. Bankruptcy Code is reserved for cities, counties and quasi-governmental bodies, such as special water or tax districts. It offers more protection from creditors than Chapter 11, which is used by companies and wealthy individuals.