San Bernardino Third California City to Choose Bankruptcy

San Bernardino’s City Council voted to become the third California municipality this year to seek bankruptcy protection after officials learned they may not have enough cash to pay workers.

The council last night voted 4 to 2, with one abstention, to authorize a filing under Chapter 9 of U.S. bankruptcy law. The city of 209,000, about 65 miles (105 kilometers) east of Los Angeles, is so broke it can’t cover its payroll, interim City Manager Andrea Travis-Miller said.

San Bernardino would follow Stockton, a community of 292,000 east of San Francisco, which on June 28 became the biggest U.S. city to enter bankruptcy. Mammoth Lakes, a mountain resort of 8,200, sought court protection from creditors July 3 saying it can’t pay $43 million owed on a legal judgment, more than twice its general-fund spending for the year.

Declining tax revenue, growing worker costs, accounting discrepancies and an unemployment rate in the metropolitan area of almost 12 percent helped propel San Bernardino toward court.

“If the employees are not paid on Aug. 15, on Aug. 16 there will be a mass exodus of city employees,” City Attorney James Penman told the council before the vote.

“People are not going to work when they don’t get paid,” he said. “Most of our employees will not show up to work. That would include police, fire, refuse, everybody. The city will virtually shut down.”

Payment Suspension

Under Chapter 9, San Bernardino could suspend payments to creditors while it seeks court approval for a plan that balances revenue with debt. Travis-Miller said a filing could take a month to prepare.

Taxable Build America Bonds sold by the San Bernardino Joint Powers Financing Authority in December 2010 and maturing in 2030 traded today at a record average yield of almost 11 percent, up from 7 percent yesterday, before falling back to average about 9.5 percent, data compiled by Bloomberg show.

General-obligation debt from state and local California issuers yielded 1.02 percentage points more than top-grade securities on average today, after reaching 1.04 percentage points yesterday, matching the most since Jan. 12, according to Bloomberg Fair Value indexes.

“When you’ve got headlines like this, it creates anxiety for investors,” Robert Miller, a senior portfolio manager in Menomonee Falls, Wisconsin, for Wells Capital Management, which oversees about $30 billion in munis, said today by telephone.

‘Higher Rates’

Buyers of bonds sold by California issuers “are going to require higher rates of return, especially at the local level,” he said.

Confronting a $45 million shortfall, San Bernardino also faces insolvency because of deficit spending, pension and debt costs, and a lack of revenue growth, according to a June 26 budget analysis posted on the city’s website. Officials have declared fiscal emergencies, negotiated for concessions from employees and reduced the workforce by 20 percent in four years.

“Reorganization may be the only way to keep the city of San Bernardino on life support,” said Wendy McCammack, one of the seven council members. “This is the hardest decision this councilwoman has ever had to make.”

A law signed by Governor Jerry Brown that took effect this year requires municipalities to pursue mediation or declare a fiscal emergency before seeking bankruptcy protection. Public-employee unions pressed for the law after Vallejo, a city of 120,000 in the San Francisco Bay area, went bankrupt in 2008 and asked the court to let it void labor contracts.

‘Economic Strains’

It isn’t clear whether San Bernardino would need to go through mediation.

“The specific municipalities that are pursuing Chapter 9 are the cases where longstanding economic strains, in many cases reaching back to early 1990s, created the underlying fiscal stress,” Trident Municipal Research, which tracks the $3.7 trillion muni market from New York, said today in a note to clients. Plunging home prices and the state’s fiscal challenges drove the communities “past the tipping point into crisis,” the firm said.

Penman, the city attorney, said during the council meeting that former municipal employees had understated the extent of San Bernardino’s fiscal woes in “falsified” reports over the past 16 years. He declined to name anyone.

Mayor Patrick Morris, who took office in 2006, said it was the first time he’d heard such allegations.

“This is a wholesale indictment of all of the officials who have served over a number of years,” Morris said in an interview. “It’s new information to me.”

Home Foreclosures

The city is the seat of San Bernardino County, which at more than 20,000 square miles is the largest, by area, in the contiguous U.S.

With neighboring Riverside County, the two form a metropolitan area that had the third-highest foreclosure rate in the U.S. in May, according to RealtyTrac Inc., an Irvine, California-based data provider. The area’s jobless rate was 11.8 percent that month, compared with 8.2 percent nationwide, according to U.S. Labor Department data.

The city and its agencies have $243 million of debt, including $48.6 million of taxable pension-obligation bonds, according to financial statements. Per-person debt was $1,506, or 5.4 percent of personal income.

Late today, Standard & Poor’s lowered its credit rating on the city’s lease revenue bonds 12 steps to CC, or “junk” status, from BBB+, third-lowest investment grade, saying San Bernardino has depleted its cash, which could impair its ability pay its bills. It put the credit on watch for future cuts.

“Cities are running out of options,” Michael Sweet, a bankruptcy specialist at the San Francisco office of law firm Fox Rothschild LLP, said by telephone. “As they see pension-contribution obligations and retiree health-care costs going through the roof, revenue is at best stable if not declining.”