SAN FRANCISCO – The Stockton, Calif., City Council voted Tuesday night to default on some bonds payments and begin negotiations with creditors in an effort to avoid filing for Chapter 9 bankruptcy.

City council members voted 6-1 to approve a rescue plan to try to avoid filing for Chapter 9 bankruptcy amid a “best case” $20 million budget gap.

“It has been no secret to the world, and especially to the citizens of Stockton, that we have been dealing with a fiscal crisis for three years and instead of getting better, it has gotten worse,” said Stockton Mayor Ann Johnston. “We are still trying to avoid the ultimate bankruptcy.”

The plan includes delaying debt service payments until the end of June on bonds backed by the city’s general fund in an effort to save around $2 million. In addition, the city would launch negotiations with stakeholders as outlined by state law to try to reduce debts.

The resolution adopted by the city also included other belt-tightening measures, such as suspending employee sick and vacation day payouts.

The council’s action causes a technical default on $327 million of lease revenue and pension obligation bonds issued by the city, its redevelopment agency and its public financing authority. Investors would still be initially paid either through bond reserves, previous payments to bond trustees, or bond insurance, according to a city staff report.

All of the bonds except about $35 million are insured by National Public Finance Guarantee Corp., Assured Guaranty and Ambac, according the city’s most recent comprehensive audited financial report filed for the fiscal year ending June 30, 2010.

The negotiations would also test for the first time a new process passed into law last year, AB 506. The law requires a majority of a municipality’s elected body to either vote during a public hearing to declare a fiscal emergency or take part in a 60-day evaluation process by an independent third party before declaring bankruptcy.

If the city is able to restructure debts during the negotiations, it said it could produce $20 million in savings for the next fiscal year. If not, it may be forced into bankruptcy.

Stockton would join an exclusive California club if it files for bankruptcy. Vallejo filed for bankruptcy in 2008, Desert Hot Springs in 2001 and the largest ever in the state, Orange County filed in 1994.

The city has hired Orrick, Herrington & Sutcliffe, which represented Vallejo during its bankruptcy, to advise the city.

The news of Stockton’s woes Friday led to “super-downgrades” to junk status of California’s 13th-largest city by Moody’s Investors Service and Standard & Poor’s. Moody’s cut Stockton’s rating to Ba2 from Baa1. S&P dropped the city’s issuer rating to BB from A-minus. Both agencies kept the credit on watch for another downgrade.

Moody’s also downgraded the city’s water enterprise bond rating to A3 from Aa3 out of concern that if the city council admits it cannot pay its debt, it could also trigger default on the bonds. It said it may trigger the bank backing the bonds with a letter of credit to buy the bonds and demand reimbursement.

There were more than $702 million in bonds issued by Stockton, including the city government, the redevelopment agency, as well as water, sewer and parking enterprises outstanding as of June 30, 2010, according to the CAFR.

Located in the Central Valley, the housing bust crushed the city of 290,000 residents during the recession. The city’s assessed property values dropped 19% in fiscal 2010 and then 5% in fiscal 2011.

Stockton has declared a fiscal emergency the last two years.

As of the end of the year, Stockton’s unemployment rate stood at 15.9%, one of the highest in the nation, according to the U.S. Department of Labor.

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