SAN FRANCISCO — Finance officials in Vallejo, Calif., which filed for Chapter 9 bankruptcy protection last month, told the City Council last week that they are close to an agreement with Union Bank of California to restructure outstanding variable-rate debt.

"We think we are going to be able to conclude that successfully in the very near future," finance director Robert Stout told the council in an update on the confidential negotiations. He declined through a spokeswoman to discuss the details of a deal, but he outlined the city's position to the council in broad terms.

The city is asking Union Bank the letter of credit provider on about $49.4 million of general-fund backed certificates of participation to buy the debt from current holders and hold the COPs while the city works its way through bankruptcy. The bank is also the trustee on $26 million of the debt. Wells Fargo & Co. is trustee on the balance.

Stout told the council that the interest rates on the variable-rate demand obligations have jumped to 6% from about 3% since the bankruptcy filing. Vallejo wants the bank to offer it a lower rate on the COPs, which are in weekly mode.

Holders have thus far tendered $1.2 million of the COPs to Union Bank, said deputy finance director Susan Mayer in an interview. The penalty rate on the COPs tendered to Union Bank is set by a formula and rises to equal the prime rate plus three percentage points.

Mayer would not describe the city's proposal to Union Bank or the bank's counteroffer.

"We are in ongoing discussions with the city of Vallejo and cannot comment further," said Joanne Curran, a spokeswoman for Union Bank of California.

The bank has some incentive reach to a deal with the city. It already faces the full credit risk associated with the COPs and faces significant uncertainty about the outcome of the legal proceedings. If the city chooses not to pay its debt service at any point, holders could ask the bank for their money. In the meantime, Union Bank is not collecting most of the increased interest payments the city is paying.

Stout told the City Council that city administrators wanted to avoid missing payments on the debt "at all costs." Vallejo hopes to eventually return to the capital markets.

Vallejo sits on San Pablo Bay in rolling hills about 30 miles northeast of San Francisco, and officials hope to redevelop its waterfront. Private developers including a LennarCorp. unit that declared bankruptcy last week are in the midst of redeveloping the city's giant Mare Island Naval Shipyard, which closed in 1996.

The City Council declared bankruptcy hoping to cut labor costs that are written into contracts with public employee unions. Officials said the labor agreements made by previous administrations or in binding arbitration rulings were unsupportable.

Before the filing, city bankruptcy lawyer Marc Levinson of Orrick, Herrington & SutcliffeLLP, said Vallejo's goal was to do as little damage as possible to bondholders and to its long-term access to capital. City manager Joseph Tanner last week proposed a budget for fiscal 2008-2009 that would renege on pay increases owed to public employees but continue to meet the city's debt service payments.

Mayer said the city has not missed any debt service payments since declaring bankruptcy in May.

Under the proposed budget, general fund debt service costs jumped to $2.2 million from $1.8 million projected for this year before rates on the city's variable-rate debt surged.

Vallejo's Union Bank of California-backed COPs represent the bulk of its unsecured general fund debt. All told, the city has $53.3 million of general fund-backed debt that was issued in five COP deals between 1999 and 2003. In addition to the $49.4 million of variable-rate COPs backed by Union Bank, Vallejo has $4.1 million of fixed-rate COPs insured by MBIA InsuranceCorp.

The balance of the city's $126 million of long-term municipal bond debt about $72.6 million is owed by enterprise funds, such as its water department and marina. That debt is secured by dedicated revenue streams that the city says it cannot and will not interrupt.

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