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Stockton, Calif., City Council May Take First Step to Chap. 9

LOS ANGELES — Stockton, Calif., City Council members will be asked Tuesday to stop making general fund payments toward several bond issues and to take the first step toward a Chapter 9 bankruptcy filing, according to a disclosure statement filed Friday morning on the Municipal Securities Rulemaking Board’s EMMA website.

If council members approve the resolution, the city of 290,000 will suspend payments toward seven general-fund-backed bond issues and enter a mediation process that is the first step toward bankruptcy under California’s recently enacted AB 506.

“The new law establishes a framework for troubled public entities to attack their challenges by providing for a guided mediation process,” said Lisa Quateman, a Los Angeles-based bond attorney and managing partner with Polsinelli Shughart. “The hope is that an actual bankruptcy proceeding can be avoided.”

Quateman’s firm is not representing Stockton, but based on the details in the 156-page filing, she said, it appears the city is on the road to bankruptcy.

“I’m not saying this is a prepackaged bankruptcy, but this is a complete package the city manager has apparently been working overtime on to prepare the suggested path in compliance with the state law,” Quateman said.

The new process will challenge bondholders even before a bankruptcy filing, though cash reserve funds or surety policies mean no investors will immediately miss their March 1 payment, according to a staff report city manager Bob Deis prepared for the City Council.

“The providers of bond insurance for the city’s general fund obligations (National Public Finance Guarantee, Assured Guaranty and Ambac), and the trustee (Wells Fargo), will be invited to participate in the AB 506 confidential neutral-evaluation process,” the report said. “ It is likely that they will be asked to make significant concessions.”

Holders of Stockton Public Finance Authority 2007 variable-rate bonds are likely to tender them to liquidity provider Dexia, the staff report said, “which would result in a significant increase in the interest rate on those bonds.” Assured Guaranty also wraps that issue.

Bonds issued by the city of Stockton and the Stockton Redevelopment Agency would also be affected by the payment stop.

According to a report by Management Partners, a consulting firm hired to review the city’s finances, the city is in dire financial condition and must take immediate steps to resolve its financial crisis.

Stockton has yet to file its financial statements for fiscal 2011, according to the filing. The City Council has twice — in mid-2010 and mid-2011 — declared a fiscal emergency.

“I don’t know if the earlier declaration made that far back, in May 2011, will apply to the AB506 qualifications,” Quateman said.

The resolution also asks the city manager and city attorney to investigate whether the financial crisis was caused by any “wrongful, unauthorized or illegal acts” and if the city has any recourse against such parties, if that is the case.

If Stockton, located 80 miles east of San Francisco, files for Chapter 9 protection from creditors, it would follow in the steps of Vallejo, located about 70 miles away, which emerged last year from three years in bankruptcy.

California Treasurer Bill Lockyer expressed concern about the city’s proposed strategy.

“The reputational stain can bleed onto other local issuers and the state, and that can hurt taxpayers in the bond market,” Lockyer said. “So we hope a Chapter 9 filing is not the final outcome.”

Moody’s Investors Service placed all the city’s rated bonds on review for a possible downgrade Friday morning.

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