Vallejo’s Bankruptcy Sojourn Sets Example Others May Want to Skip

SAN FRANCISCO — Vallejo, Calif.’s bankruptcy ordeal has served as a harsh, precedent-setting example that will keep other cities from filing despite rising fiscal pressures, officials said Friday.

Industry experts said during The Bond Buyer’s California Public Finance Conference here that Vallejo has established helpful law even as it has shown the enormous disruptions and costs piled on municipalities that file for Chapter 9 bankruptcy.

“We have established that just the threat of [bankruptcy] will keep many, many cities out,” said Robert Stout, Vallejo’s finance director. “If I could just get a small percentage from the finance directors that have threatened to pull a Vallejo unless they get concessions from their unions, I would be fine.”

He cited calls from some cities asking him about bankruptcy and said some smaller cities may end up in default.

Stout said the big reason why most cities will not have to go into bankruptcy is that Vallejo’s case established that unions cannot keep cities that file from renegotiating benefits. He said the unions’ argument that city assets extend past the general fund no longer holds water as a result of the litigation.

Stout said the bankruptcy will now make cities search harder for agreements with unions and alternative financing routes and give them leverage. He said Vallejo saved $25 million to $30 million because of the concessions they were able to get from the employee unions after filing.

However, the city’s budget this year calls for withholding payments to bondholders for four years and no interest accrued for three years, Stout said.

Vallejo filed for Chapter 9 in May 2008, citing labor contracts that rendered it unable to meet its obligations. It defaulted on its certificates of participation principal and interest payments a year later. It has renegotiated some public safety labor contracts since then and has been trying to work out the problems with creditors.

The city is also in a prolonged court battle with bond insurer National Public Finance Guarantee Corp., which has asked a federal bankruptcy court to allow some California state payments to flow to bondholders instead of to the city.

The high costs and big impact on city services demonstrated by the Vallejo case will also make other cities think twice.

“It is a howitzer that you are really taking to city operations,” said Eric Tashman, an attorney and partner at Sidley Austin LLP. “It is really a last resort.”

Vallejo has had to spend two and a half years and more than $9 million on lawyer fees, Stout said.

The bankruptcy “is a tremendous argument for every city in the state to think twice, three times, four times, maybe two dozen times, maybe eight or nine million times for why would you consider going this route unless you have no other choice,” said Mark Curran of Piper Jaffray & Co.

Stout also noted that Vallejo case is unique for several reasons. He said the city, known as a union-friendly, blue-collar town, gave large pension and retirement benefit increases to public safety employees without negotiations, and has had seven city managers since he started in 2004. He said the city was lucky: most of the bonds were secured by a letter of credit and it only had to deal with one bondholder.

But even though many aspects of the bankruptcy may be unique, rising pension cost are affecting others. Curran said he recently surveyed several city finance directors and found that long-term contributions to the California Public Employees’ Retirement System are expected to rise.

“There is nothing apocalyptic here, but it is discouraging to some of the financing directors that rates are going up this much,” he said.

Bradley Gewehr, director in the municipal products group at Bank of America Merrill Lynch, said pension obligations and contributions tend to be very “pro-cyclical.” As a result, he said demand for contributions is rising at the exact time revenues and budgets are most strained.

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