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The decision by Stockton, California to file for bankruptcy under Chapter 9 of the Federal Bankruptcy Code is not expected to affect most of the city’s bondholders.
The city plans to stop paying on the seven bond issues that depend on general fund revenues. These issues total more than $300 million. However, six of the outstanding general-fund supported issues have bond insurance, so investors can expect to receive principal and interest on a timely basis as the bankruptcy process unfolds.
The bond insurers with exposure to these issues include Assured Guaranty, Ambac and National Public Finance Guarantee Corp., which is responsible for MBIA insured debt. Only the Series 2009A Lease Revenue bonds issued through the Stockton Public Financing Authority lack bond insurance and will be subject to the payment moratorium.
City will continue to pay “enterprise” and other bonds
Stockton intends to continue to pay “enterprise” bonds backed by water and sewer revenues, as well as debt secured by special assessments and special taxes. Such “land-secured” debt is backed by levies on property, directly benefiting from infrastructure improvements made with bond proceeds.
Under Chapter 9, both types of securities are considered “special revenue debt,” whose pledges and liens remain in place despite the bankruptcy filing. Neither type of debt is paid from general funds of the city but relies on the taxes and revenues dedicated to each bond issue.
Stockton, a city of 300,000, found itself unable to pay its bills after the recent recession left it with too much debt, high labor costs and a reduced revenue base. Despite staffing cuts of over 25%, the city’s cost structure remained unsustainable. Stockton’s entrance into Chapter 9 was preceded by a 90-day mediation process with creditors as specified under California’s newly enacted AB 506 law. AB 506 seeks to provide an opportunity for communities in financial distress to reach a solution short of bankruptcy.
Unfortunately, in the case of Stockton, an agreement was not reached with creditors. The city’s $26 million budget gap could not be overcome.
Under Chapter 9, the city will be expected to produce a plan of financial reorganization that treats all interested parties, including bondholders, fairly. A Chapter 9 process can take at least a year or more to resolve.
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