History may be against Stockton, California, which last 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. “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.
“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 Friday 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.
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.
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 Friday.
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).
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