California Seeks Muni Bankruptcy Warnings, Lockyer Says

California, where three municipalities have filed for bankruptcy since June, is working on an early-warning system to prevent more by detecting signs of financial trouble, state Treasurer Bill Lockyer said.

He compared the goal to stress testing, “where we try to determine what are the right metrics to cause red flags, alarm, some form of friendly discussions with experts, external advisers about what might be done to avoid a potential crisis.”

Stockton, San Bernardino and Mammoth Lakes have sought Chapter 9 protection, stoking investor concerns that more will follow as municipal finances worsen and bankruptcy’s stigma fades. Lockyer, speaking yesterday at a Bond Buyer conference in San Francisco, said he doesn’t expect the trend to continue.

“I agree with those who have said probably not, there may be some, not very many,” Lockyer said.

The early-detection system is a collaboration among the treasurer’s office, the controller, the Legislature and officials in Los Angeles and San Diego, Lockyer said in an interview. Lawmakers would have to approve the plan, he said.

Analysts at the conference said they’re taking a closer look at the willingness of California cities to repay their debt in light of the bankruptcies.

‘Difficult to Assess’

“It is difficult to assess a city just based on the numbers,” said Melanie Tung, senior municipal research analyst at Wells Capital Management.

“Management, the willingness and ability to pay -- those are measurements that we have looked at and are trying to examine more closely as we look at credits now in this environment,” she said.

Stockton, the largest U.S. city to enter bankruptcy, had the underlying rating on its taxable pension-obligation debt cut by Standard & Poor’s to the lowest non-investment grade last month after skipping a payment.

Willingness to pay can be evaluated by whether the municipality has and follows its fiscal policies, performs long-term forecasting and respond to the results, and monitors its financial condition “so that they have as quick as possible an idea of when they’re in trouble,” Bill Statler, former director of finance and information technology for the City of San Luis Obispo, said in a session at the conference.

Lockyer said he didn’t believe California municipalities are becoming less willing to repay their debt. “Just the opposite,” he said in the interview.

Rating Companies Differ

Credit-rating companies Moody’s Investors Service and Standard & Poor’s differ in their predictions of further municipal bankruptcies in California.

Gabriel Petek, an S&P analyst in San Francisco, said he doesn’t anticipate a “tsunami” to follow the recent filings.

The communities in bankruptcy are a fraction of the 482 cities in the most-populous state, Petek said Oct. 16 in a conference session. Among the 201 communities that S&P rates, “we believe that those that are at most risk of encountering this level of financial distress are already at the very low end of the rating spectrum,” he said.

Moody’s, in a report last week, said that while it doesn’t expect many cities to follow those already in bankruptcy, “as long as the economic recovery remains sluggish, the risk has increased that some California cities will make this choice.”

Willingness to Pay

The decisions by San Bernardino and Stockton to seek court protection “provide some indication that willingness to pay debt obligations may be eroding in the U.S. municipal market,” Moody’s said. While the Stockton and San Bernardino fiscal troubles are tied to declines in tax revenue and rising employee costs, Mammoth Lakes sought protection because of an adverse legal judgment.

California can offer guidance to municipalities that need it, said James Spiotto, a partner who leads the bankruptcy practice at Chapman & Cutler LLP in Chicago.

“If a municipality is in trouble, this is the first time, more likely than not, they are facing that issue,” he said. “The people there are struggling with first-time issues, how to handle it.”

“Oversight and assistance can help the municipality avoid the last resort such as Chapter 9 and address the issues earlier and provide the background that a lot of municipal officers wish they had,” Spiotto said.

While Lockyer said he’d like to see the state offer some modest help, he’s opposed to the state picking up the costs.

“I agree with the credit-rating agency that said it actually helps the state’s credit to not be on the hook for those local liabilities,” Lockyer said.

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