Stockton Threatens to Bbe First City to Stiff Bondholders

History may be against Stockton, California, which this week became the biggest city to file bankruptcy in the U.S., saying it may try to impose losses on lenders.

Since at least 1981, and possibly as far back as the 1930s, no U.S. municipality has used bankruptcy to force bondholders to take less than the full principal due, according to experts and court records.

Before the June 28 court filing, Stockton officials said they will try to impose cuts on all creditors, not just employees.

“We’re trying to spread the pain, unfortunately, to others besides employees,” City Manager Bob Deis told City Council members at a June 26 hearing.

The municipal bond market will be watching to see if that goal is met, said Jim Spiotto, a bankruptcy attorney with Chapman and Cutler LLP who helped write a book about municipalities in financial distress.

“That’s what everybody is going to be watching,” Spiotto said in a telephone interview yesterday. “What’s the stigma for it? What’s the price? Do you trade a short term gain for a long term pain?”

Of the 43 municipal bankruptcies filed since 1981, 33 were either dismissed by a judge, or failed to win a court ruling discharging their debt. Court records for the remaining 10 did not list the disposition. Spiotto said none of those cases ended with a cut to the principal owed lenders.

Suffer Consequences

“Whenever there’s a bankruptcy or default, there’s a psychological twinge that goes through the issuer community and the market,” Tom Dresslar, a spokesman for California Treasurer Bill Lockyer, said yesterday in a telephone interview. “If other issuers, including the state, are stained as a result of Stockton’s bankruptcy then potentially when we go to market we suffer the consequences.”

During negotiations in the months leading up to the bankruptcy, bondholders “were grossly unhappy with the city’s proposal,” Joe Rose, an attorney for the city’s biggest labor union, said in an interview. Rose was part of the negotiations, which were required under a state law governing when cities can file bankruptcy.

The California City of Vallejo, about 65 miles west of Stockton, became the first municipality to use bankruptcy to cut the interest rate paid to its lender, Union Bank NA, Spiotto said.

Suspend Payments

Stockton listed assets of more than $1 billion and debt of $500 million to $1 billion in court filings June 28 in U.S. Bankruptcy Court in Sacramento, California. The Chapter 9 filing allows Stockton, a city of 292,000, to suspend payments to creditors while it seeks court approval for a plan that balances its revenue with its debt.

The two biggest creditors named in the filing reflect the groups most likely to face cuts imposed as part of the bankruptcy: bondholders and city employees.

Stockton said its biggest unsecured creditor is the California Public Employees’ Retirement System, or Calpers, the largest U.S. pension fund, owed $147.5 million, followed by Wells Fargo Bank NA, as trustee for $124.3 million in pension obligation bonds, and Wells Fargo as trustee for three other sets of bondholders owed $107 million, according to court papers.

Wells Fargo “expects to take an active role in the bankruptcy proceedings,” Elise Wilkinson, a spokeswoman for the San Francisco-based bank said in an e-mail the day Stockton filed bankruptcy.

The bank didn’t lend the city any money, she said. “All our efforts in the bankruptcy proceedings will be directed toward achieving a recovery for the holders of Stockton bonds,” she said.

Jefferson County

Stockton is the biggest city to file bankruptcy, by population. The biggest of all municipal bankruptcies, by debt, was filed by Jefferson County, Alabama, last year.

Jefferson County owes creditors about $4.2 billion, according to court records, and like Stockton it is trying to force bondholders to take less.

Unlike Stockton, Jefferson County’s bonds are tainted by political corruption. In 2009, JPMorgan Chase & Co. agreed to a $722 million settlement with the Securities and Exchange Commission over payments its bankers allegedly made to people tied to county politicians to win business.

Cities have avoided trying to force investors to take a loss in court, or out, because the bond market would punish any future borrowings with higher interest rates, or possibly by locking them out entirely, said Richard Ciccarone, Chief Research Officer at McDonnell Investment Management LLC in Oak Brook, Illinois, said in an interview yesterday.

Housing Crisis

Since the financial and housing crisis, the number of municipalities filing bankruptcy has increased. Eleven of the 43 to file since 1981 came after 2008.

Spiotto and Ciccarone said they cannot identify any large municipalities that haven’t fully repaid principal since the Great Depression in the 1930s. In that era, about 4,000 municipalities defaulted, with about 40 of those not fully repaying the debt.

The collapse of the housing market left Stockton to contend with mounting retiree health-care costs and an eroding tax base in the wake of the recession, amid accounting errors that overstated municipal revenues.

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.

The case is In re Stockton, 12-32118, U.S. Bankruptcy Court for the Eastern District of California (Sacramento).

Following is a list of municipal bankruptcy filings since 1988

Date                      Municipality

March 1988               City of Copperhill, Tennessee
April 1991               City of Lipscomb, Alabama
June 1991                City of Bridgeport, Connecticut
October 1991             City of North Bonneville, Washington
December 1992            Town of North Courtland, Alabama
June 1994                City of Kinloch, Missouri
December 1994            County of Orange, California
June 1995                Town of Ozan, Arkansas
September 1996           Greene County, Alabama
April 1997               Town of Winstonville, Mississippi
September 1998           City of Macks Creek, Missouri
July 1999                City of Camden, New Jersey
October 1999             City Of Prichard, Alabama
April 2000               City of Westminster, Texas
September 2000           Town of Tyrone, Oklahoma
November 2000            City of Macks Creek, Missouri
June 2001                City of Kendleton, Texas
November 2011            Village of Hillsdale, Missouri
December 2001            City Of Desert Hot Springs, California
June 2002                City of Rio Bravo, Texas
November 2002            City of Reeds Spring, Missouri
October 2003             Village of Brooklyn, Illinois
October 2003             City of Iron Mountain Lake, Missouri
April 2004               City of Westminster, Texas
May 2004                 Village of Washington Park, Illinois
December 2004            Town of Millport, Alabama
January 2005             Village of Alorton, Illinois
April 2005               Town of Muldrow, Oklahoma
August 2005              City of Camp Wood, Texas
January 2006             Town of Marshall Creek, Texas
December 2006            Town of Moffett, Oklahoma
February 2007            Town of Marion, Mississippi
April 2008               City of Gould, Arkansas
May 2008                 City of Vallejo, California
April 2009               Westfall Township, Pennsylvania
July 2009                Village of Washington Park, Illinois
October 2009             Town of Moffett, Oklahoma
October 2009             City of Prichard, Alabama
March 2001               Boise County, Idaho
August 2011              City of Central Falls, Rhode Island
October 2011             City of Harrisburg, Pennsylvania
November 2011            County of Jefferson, Alabama
June 2012                City of Stockton, California

Source: Public Access to Court Electronic Records, the system used by federal courts to file and view court documents.

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