Only in municipal bonds.

Matt Dalton is willing to buy the debt of a bankrupt borrower — and he can’t find any for sale at a suitable price.

The chief executive officer of Belle Haven Investments is on the lookout for bonds issued by Vallejo, the distressed California city trying to renegotiate its union contracts while operating under Chapter 9 bankruptcy protection.

Dalton seldom sees Vallejo’s debt come on the market, and when it does it doesn’t carry the deep discount he would expect from an issuer that has already declared bankruptcy.

Dalton believes Vallejo will ultimately pay every penny of principal and interest on its debt. Even if those payments come late, he thinks the city will compensate bondholders with additional interest.

It may take a few extra years, Dalton said, but the bonds are money-good.

Nevertheless, the bonds are not for the risk-averse, he said. While he thinks Vallejo will ultimately repay its debts, the uncertainty of when is a real risk that warrants a discount. Dalton is yet to see that discount when Vallejo’s debt trades.

Vallejo has about $51.6 million of debt, little of which trades with any frequency. A lot of the city’s debt is held by Union Bank, which provided a letter of credit on much of the city’s variable-rate debt.

A $3.3 million Vallejo Public Financing Authority bond maturing in 2029 traded in early September at a yield of 7.6%. A $130,000 bond from the same issuer maturing in 2012 traded later that month at a yield of 5.9%.

This for bonds whose interest payments were frozen temporarily last year.

“There haven’t been many trades because it’s not a big deal; they don’t have a lot of debt outstanding,” Dalton said. “We love to take advantage of situations like this. I haven’t been able to get them at the prices I want.”

He declined to say what discount he thought was appropriate, but said it should be “substantial.”

Dalton’s White Plains, N.Y.-based firm manages about $350 million for clients.

Vallejo, population 121,000, made national headlines in May 2008 when the Solano County city 30 miles northeast of San Francisco filed for Chapter 9 bankruptcy protection. The city was — and still is — suffering from a highly purified strain of financial crisis.

Plummeting real estate values have eviscerated the city’s property tax collections. The property tax receipts forecast in Vallejo’s fiscal 2010 budget represent a 19% decline from fiscal 2009 and a 27% plunge from fiscal 2008. This while property taxes nationwide have yet to decline, according to the Census Bureau.

The city anticipates a 12% decline in revenue during the current fiscal year, to $67.7 million. Revenue in fiscal 2008 was $83.6 million.

Meanwhile, the city is locked into hefty costs for police and fire protection, which eat up 70% of the budget. The spiraling costs are mainly because of union contracts that mandate salary increases based on a formula. Labor costs increased 11% during fiscal 2006, 2007, and 2008. Revenue increased only 3%.

In its bankruptcy petition, Vallejo listed some of the costs of employing police and firefighters in fiscal 2009 should the contracts be honored. The average police officer would cost the city $191,060 annually, and the average firefighter would cost $193,174. A police captain would cost $347,726.

With tax collections trailing spending increases, the city burned through most of its $9.9 million reserve in 2006, 2007, and 2008, leaving it with less than $1 million. It had little room to cut costs other than labor, which constitute 76% of the city’s budget. Vallejo has pruned its work force to 340 employees from 494.

Much of the bankruptcy proceedings concern whether Vallejo can renege on the contracts with its unions, which run through the middle of this year.

U.S. Bankruptcy Judge Michael McManus in March ruled that Vallejo could scrap its union contracts and negotiate new ones.

Dalton thinks that decision is a potential game-shifter. It is possible more municipalities will try to cut labor costs by seeking bankruptcy protection, he said.

“It opened the door for public entities all over the nation to file similar motions to gain relief from their contractual obligations,” he wrote in his monthly newsletter.

A 25-year veteran of municipal bonds, Dalton began his career at Shearson Lehman Brothers. He joined Rodman and Renshaw in 1994 and two years later joined Belle Haven Investments.

He has been CEO since 2002.

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