Stockton Battle With Bondholders Begins This Week

Stockton, California, which last week became the biggest U.S. city to seek court protection, will begin a historic effort this week to be the first American city to use bankruptcy to successfully impose losses on bondholders.

Lawyers for Stockton are to appear in U.S. bankruptcy court in Sacramento July 6 for the initial hearing in the case. City council members have set aside more than $3 million for the first year of a bankruptcy court fight with bondholders and labor unions over how to divide a smaller budget.

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

“We’re trying to spread the pain, unfortunately, to others besides employees,” Stockton City Manager Bob Deis told council members at a June 26 hearing. Before the June 28 bankruptcy filing, Stockton officials said they would try to impose cuts on all creditors.

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. “What’s the stigma for it? What’s the price? Do you trade a short term gain for a long term pain?”

Municipal Bankruptcies

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.

“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 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.

First Municipality

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.

Stockton listed assets of more than $1 billion and debt of $500 million to $1 billion in court filings. The Chapter 9 petition allows Stockton, a city of 292,000, to suspend payments to creditors while it seeks court approval for a plan that balances revenue with 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.

‘Active Role’

Wells Fargo “expects to take an active role in the bankruptcy proceedings,” Elise Wilkinson, a spokeswoman for the San Francisco-based bank, the nation’s biggest home lender, 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.

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 is trying to force bondholders to take less.

Jefferson County

Unlike Stockton, Jefferson County’s bonds are tainted by claims of 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.

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

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.

Housing Market

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.

Stockton began negotiations with creditors March 27. They were extended to June 25. Calpers, Wells Fargo and bond insurer Assured Guaranty Ltd. were among at least 18 creditors involved in the failed talks.

Assured Guaranty has insured $161.4 million worth of Stockton’s bonds, the company said in a statement. Insured bondholders “remain fully protected,” the company said.

“Assured Guaranty intends to vigorously enforce its rights as a creditor in any Chapter 9 proceeding, including the right to contest eligibility and confirmation of any plan of adjustment proposed by the city,” the company said in a statement e-mailed by Ashweeta Durani, a company spokesman.

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

*T 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 2001 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 2011 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 *T Source: Federal court records.

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