Bankruptcy Rumor Mill

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SAN FRANCISCO — Municipal bankruptcy rumors have swept California since the city of Vallejo sought Chapter 9 protection from creditors last year.

Newspaper writers, bloggers and even public officials have taken turns speculating about whether Stockton, San Diego, Rio Vista, Isleton, Half Moon Bay, Pacific Grove or the state of California will be the next government to declare bankruptcy.

The rumors range from justified to nonsensical to self-inflicted.

Among the justified, the small cities of Rio Vista and Isleton have seriously considered following Vallejo into bankruptcy over the past year. Among the nonsensical, California isn’t even eligible for bankruptcy protection under federal laws. Among the self-inflicted, elected or appointed officials in Stockton, San Diego and Pacific Grove have uttered the word bankruptcy, though none of the cities has seriously considered the option. While some Half Moon Bay residents have suggested bankruptcy, city officials say it's not an option.

“We’re not declaring bankruptcy,” said Kathleen VonAchen, Stockton’s finance officer.

That doesn’t mean the city is rolling in cash, and it doesn’t mean the rumor was meritless. Stockton faces a $28 million budget gap next year in a roughly $190 million general fund. The city expects revenue to fall to about $172 million in fiscal 2009-2010. That’s led to increasingly dire warnings about the deficits from politicians pushing workers for new contracts that bring expenses back in line with revenue.

In Stockton, City Councilman Dale Fritchen, chair of the Budget and Finance Committee, asked staff to give his committee a presentation on municipal bankruptcy, saying constituents had asked if it was an option for the city of 290,000.

“I think it would be prudent and wise for the budget committee to have someone come and report about what the effects of bankruptcy would be, the pros and the cons,” he said at a committee meeting in February.

He didn’t have to wait long to find out about the cons. The next day, investors insisted on higher-than-previously-negotiated rates for a planned private placement of infrastructure bonds.

VonAchen said officials pulled the deal when investors demanded rates in excess of the 7% cap in the city’s bond documents. She has also seen rates on $40 million of Stockton’s variable-rate demand obligations surge, though she’s been unable to figure out how much of the rate increase is because of problems with the bonds’ insurer and liquidity bank.

While she refused to criticize her elected bosses, VonAchen said she has been frustrated to see the remark reported and distorted endlessly. It’s shown up in newspapers, including the New York Times and the San Jose Mercury News, both of which reported that the city is considering bankruptcy.

She said a simple question from a single council member doesn’t mean the city is actively or seriously considering bankruptcy.

“That’s not happening,” said VonAchen. “Solvency is the only option we’re discussing.”

Moody’s Investors Service analyst Eric Hoffmann said he doesn’t expect any of California’s rated credits — including all of the bigger cities mentioned here — to declare bankruptcy within the foreseeable future. Moody’s in March put Stockton’s A2 issuer credit rating on watch for possible downgrade, citing the city’s budget woes.

“Politicians like to throw around the B-word when they’re trying to position the city for negotiations, but there’s nothing I’ve seen that says any of the credits we have ratings on are at risk of bankruptcy,” Hoffmann said.

But he also doesn’t think investors have much time or patience for sorting through which bankruptcy rumors are founded and unfounded.

“Any name that becomes a story that’s going to raise people’s eyebrows in a portfolio review committee, in your credit committee, you might choose simply to sell that debt rather than have to go through the trouble of explaining what it is,” he said.

Pacific Grove, which is nestled between Monterey and Pebble Beach just north of Big Sur, is another victim of self-inflicted bankruptcy rumors. Its Budget and Finance Advisory Committee, which includes three members of the general public and two City Council members, queried the city attorney about bankruptcy in response to losses in the California Public Employees’ Retirement System.

As with Stockton, there’s truth in the idea that the city faces daunting financial challenges. Some local officials are concerned that CalPERS smoothes contributions too much, building up unfunded liabilities that could bankrupt the city if they continue to grow. Pacific Grove’s pension payments jumped from $100,000 in fiscal 2002 to $2.6 million in 2007, due to market losses after the dot-com bubble burst. That’s forced service reductions, and the city’s pension contributions are sure to climb again after 2008 losses are factored into its annual required contributions.

But the pension losses are not going to force the city into bankruptcy anytime soon, said Jim Becklenberg, director of Pacific Grove’s Office of Management and Budget. Recent CalPERS losses will be smoothed over 15 years. Before the current downturn, the city’s pension obligations were about 85% funded, according to its 2007 comprehensive annual financial report. The city expects its annual required pension contribution to rise 1% next year and then to rise much more steeply in 2012.

“We’re far away from bankruptcy as a serious option,” Becklenberg said. “Neither the City Council, nor staff, is considering bankruptcy as an option right now.”

He said the city of 15,400 has a balanced budget for the current budget year and has plans for balancing the budget in the upcoming budget year.

San Diego, which is now rebounding from a pension-related financial scandal, may have found the best way to put bankruptcy worries to rest. When then-city attorney Michael Aguirre, after losing a reelection bid, proposed that the state’s second-biggest city hire bankruptcy lawyers to explore a Chapter 9 filing last November, the mayor called the move “grandstanding” and the City Council quickly voted to reject his proposal.

While none of the state’s large, rated cities seems poised for bankruptcy, a handful of small California cities has seriously discussed following Vallejo into bankruptcy this year. Rio Vista, population 7,500, and Isleton, population 830, have been hard-hit by the collapsing housing market in the Central Valley. The towns are located in the Sacramento River Delta northwest of Stockton.

With limited resources and plunging home values, both towns discussed bankruptcy last year, but they’ve fought hard to avoid it. Rio Vista cut a third of its workforce to reduce a $900,000 deficit in its $6.6 million general fund. City manager Hector De La Rosa earlier this year told the San Francisco Chronicle that he thought the city would be able to hold off bankruptcy for this fiscal year. He didn’t return calls seeking comment for this article.

Isleton’s problems had as much to do with bad accounting as economic collapse. City manager Bruce Pope, who was hired in 2007, says previous managers ignored the restrictions on grants and basic fund accounting, allowing the city to continue with operating deficits when it should have been making cuts. The result was a nearly $1 million operational debt that now has to be paid back.

“The city was torn about what to do about it,” said Pope. He said officials considered bankruptcy, but it instead chose to cut services deeply and are seeking to issue certificates of participation to pay back the operational debt.

“We have made considerable cutbacks in our operational costs,” reducing spending by $800,000 over two years to about $925,000, said Pope. “At this point in time, we do not foresee going into bankruptcy.”

Pope has also turned over responsibility for Isleton’s accounting services to Sacramento County. The city hopes to sell $900,000 of COPs this month after it finishes up financial audits. Nollenberger Capital Partners Inc. of San Francisco is the underwriter.

Half Moon Bay, a city of 12,300 on the coast 30 miles south of San Francisco, is also frequently mentioned as a possible bankrtupcty case in the local media, but City Manager Michael Dolder said there's no way. The bankruptcy speculation started after the city lost a lawsuit and agreed to pay a developer $18 million, a reduction from the initial $41 million judgement. The city is seeking state aid to pay off the debt. Local lawmakers are pushing a bill that would allow the city to borrow $10 million from the California Infrastructure and Economic Development Bank to help pay off the settlement.

If it doesn't get the loan, the city will issue judgement obligation bonds to finance the debt, Dolder said. While the city has enough reserves to pay almost half of the settlement, it has judicial approval to sell judgement obligation bonds equal to the entire $18 million. In the meantime, it’s made deep cuts to its $11.6 million general fund budget to free up capacity to service any new debt, Dolder said.

"The City Council has never put forward a desire to declare bankruptcy," he said. Dolder said he hasn't and wouldn't reccommend bankruptcy because the city has the financial wherewithall to pay its bills.

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