TAHOMA, Calif. — For Vallejo, Calif., it took more than three years. Central Falls, R.I., exited after just 13 months. Jefferson County, Ala., is still knee-deep in its case after 16 months. There’s no standard timeline for a Chapter 9 bankruptcy.
Now the question is how long will it take Stockton to exit bankruptcy? And how will Stockton reorganize its debts to put the city on a path to fiscal stability? There are no answers yet, only guesses, as the city continues its slog.
“We have gone through the war phase; I would like to go through the peace phase for a while. If necessary, we will go back to war,” Marc Levinson, Stockton’s bankruptcy attorney and a partner at Orrick, Herrington & Sutcliffe LLP, said in a phone interview. “I would much rather cut deals and move on. We will see when we actually start talking.”
Stockton, a city of 300,000 in California’s Central Valley, became the largest city in the country to enter bankruptcy after a federal judge on Monday approved the city’s eligibility for Chapter 9 protection, nine months after it filed for relief and following a three-day trial over challenges by bond market creditors.
Levinson said the city has already started working on negotiations with creditors with the help of a federal bankruptcy judge who was appointed to mediate between the sides in the case. City manager Bob Deis said after the trial the city hopes to exit bankruptcy in three to five months, and Levinson agreed, saying they hope to have a plan ready this summer.
And with the high legal costs, even Levinson said the process needs to move quickly because of Stockton’s dire fiscal problems. “I feel my city is in the cross hairs,” he said. “We are just trying to get through, and get the city stable.”
The city has already spent between $4 million and $5 million just battling to enter bankruptcy, Deis said. The city also had to pay the full cost of three months of state-directed mediation prior to the filing of its petition, a cost bond firms didn’t share as they should have, U.S. Bankruptcy Judge Christopher Klein said from the bench last week. The city elected not to pursue cost-sharing from others after the bond creditors refused, Levinson said. (Vallejo spent $12 million on its bankruptcy case.)
The firms include insurers Assured Guaranty Ltd. and National Public Finance Guarantee Corp., holders Franklin Advisors and trustee Wells Fargo. They are fighting city proposals that look to them more like decapitations than haircuts.
In the pre-bankruptcy mediation, Stockton proposed a major hit to bond interest and principal, including permanently ceasing payments from the general fund toward $124 million in Assured Guaranty-wrapped pension obligation bonds.
The city has already missed payments on four series of bonds totaling $231 million, all of which are insured, according to Moody’s Investors Service.
According to the city’s recently released 2011 Comprehensive Annual Financial Report, Stockton had $353 million of “general bond debt” outstanding.
Now the next phase of the process will be for the city to try to negotiate with its different types of determined classes of creditors, such as secured or unsecured, and then develop and propose a so-called plan of adjustment for Klein to approve.
Klein will decide on the rights of the creditors. Including the bond creditors, the city negotiated with 18 sets of creditors during its mediation. Those include its employee unions as well other stakeholders Dexia Credit Local, Union Bank and the U.S. Department of Housing and Urban Development.
In the Vallejo case, the city was still hammering out the details of its pact with its largest bondholder even after the judge green-lighted its plan of adjustment.
“There seems to be a misunderstanding; the negotiations really just start now,” ex-Vallejo finance chief Robert Stout said in an interview. “They are not over, they are literally just getting started. The bondholders are trying to hold the process back. “
Vallejo, a working-class San Francisco Bay Area city of about 120,000, filed for bankruptcy in May 2008 and exited in November 2011.
Perhaps the biggest question hanging over Stockton’s reorganization is whether it will challenge the California Public Employees’ Retirement System, the largest pension fund in the country, which is listed in court documents as its largest creditor.
The sum of the city’s top 20 unsecured creditors is around $500 million, with CalPERS owed an estimated $147 million, according to court filings. Estimates of its actuarial liabilities to CalPERS have been pegged at nearly $1 billion.
Bond creditors argued during the trial that the city needs to tackle the CalPERS liability to have any chance at solvency following bankruptcy. During his ruling last week, Judge Klein said in reference to the questions surrounding CalPERS role in Stockton’s financial problems that a plan of adjustment needs to be free of discrimination among creditors.
Levinson said during the trial that seeking concessions from CalPERS is a move that the city could only conceivably take in bankruptcy, if at all.
In the Vallejo case, which pitted the city mostly against its unions rather than its bondholders, the judge ruled the city could impair collective bargaining agreements, an argument CalPERS fought in court.
The pension fund argued unsuccessfully that state law in that area trumped the federal bankruptcy code. That ruling could possibly show up in this case. Levinson also represented Vallejo.
If the city tries unsuccessfully to get creditors to agree to what it thinks are fair settlements, it could seek a so-called cram-down plan that would still need to be approved by the judge.
Other fights could also weigh against a speedy exit from bankruptcy.
As seen during the long Stockton City Council meeting Tuesday night that saw members shoot down a public safety tax out of concerns it might jeopardize it bankruptcy process, local politics or other unseen factors could also lengthen the stay.
As in Vallejo, Levinson said Stockton would likely go to the City Council to seek approval for a long-term financial plan that would be tied to its plan of adjustment that would be presented in court.
“The more fighting you have, like in Vallejo, the more delay,” said James Spiotto, an expert in Chapter 9 bankruptcy and a partner at Chapman & Cutler in Chicago. “The best plans are when people come together.” He added that it’s very important the city come up with a plan that is feasible and treats creditors fairly.
“These cases are typically measured more in years than in months,” Spiotto said.
If they want to read tea leaves, bondholders may take solace in the deal the city has already reached with insurer Ambac, its smallest bond firm creditor. The deal addresses $22 million in debt payments, according to the city.
As part of that settlement, the firm said Stockton is also pledging $12 million in additional payments to Ambac, which could result in zero present-value losses to the insurer.
“The proposed settlement between Ambac and Stockton leaves unanswered the question of how much Stockton’s other creditors should expect as recovery,” Moody’s said in a report Wednesday. “If the court determines that the Ambac settlement is fair, it may raise the possibility that the city’s other creditors will demand — and obtain — similar treatment.”
Vallejo is one of few precedents for what could possibly happen in the Stockton debt reorganization. But the city has much more bond debt than Vallejo had, and its bondholders are being asked to take a bigger hit.
In the Vallejo case, union members and retirees made up the majority of the unsecured creditors and were paid roughly 5 cents to 20 cents on the dollar of their initial claims, largely for retirement health care. Their CalPERS pensions were not affected. Stockton has already cut retiree health care payments.
Union Bank, the largest bondholder with $45 million of certificates of participation, conceded a 40% present value hit in interest payments. National, a creditor in Stockton’s case, insured a small share of Vallejo’s debt and had its interest payments delayed a year and cut by more than a percentage point.
In the best-known California municipal bankruptcy case, Orange County filed for Chapter 9 in 1994 amid a liquidity crisis caused by its losing bets on derivatives. The county was able to pass a tax that helped it recover and make good on its debts. It spent 18 months in bankruptcy.
There are other recent examples of bankruptcy around the country, but it’s hard to make comparisons since circumstances are so varied amid the few examples, and state laws also vary and have a major impact on how Chapter 9 bankruptcy are handled.
“Rhode Island made the political decision that bond obligations must be protected in order that a default in one struggling city not affect the bond ratings of other struggling cities within the state,” said Ted Orson, bankruptcy attorney for Central Fall and a partner at Providence firm Orson and Brusini Ltd. “California has not made that same decision.”
Neither Vallejo or Stockton made any effort to reduce their obligations on bonds backed by enterprise revenue streams, such as water system revenue debt.
And neither Vallejo, Stockton or California’s other well-known bankrupt city, San Bernardino, have outstanding general obligation bonds. Local GO bonds in California must be approved by voters, who approve a tax levy dedicated to repaying the bonds. Holders of Sierra Kings Health Care District GOs were not affected in that 2009 Chapter 9 bankruptcy case.