Source: Reuters

Stockton, California was poised on Tuesday to take a major step toward becoming the largest U.S. city ever to file for bankruptcy after talks with its creditors on Monday at midnight.

Negotiations aimed at averting bankruptcy may press on informally, the city’s spokeswoman said, adding that city officials would next discuss any moves toward bankruptcy at the city council meeting on Tuesday evening.

The council’s main order of business will be taking up and voting on a proposed budget to guide Stockton during bankruptcy, an option city officials have been considering since February.

City Manager Bob Deis, who the council has authorized to file for Chapter 9 bankruptcy, last week unveiled the budget proposal, also known as a pendency plan.

The plan assumed Stockton, a city of 292,000 people about 85 miles (about 135 km) east of San Francisco, would fail to win concessions from its 18 creditors to close its $26 million shortfall for the fiscal year beginning on July 1.

To help close the budget gap, Stockton’s plan would suspend $10.2 million in debt payments, a move likely to trigger rating agencies to further downgrade the city, and reduce spending on employee compensation and retiree benefits by $11.2 million.

About $7 million in savings would come from cutting retiree health care benefits for one year and then phasing them out. Stockton officials have said the benefits are a crushing expense due to their fast rise and projected liability of $417 million.

Stockton’s confidential mediation with its creditors – required by a state law approved after the bankruptcy of Vallejo, California in 2008 – was part of an effort launched in February by city officials to restructure the city’s finances in time for the beginning of its next fiscal year.

The plan, however, left open the possibility of a bankruptcy filing in light of Stockton’s severe financial troubles.

Mark McLaughlin, a member of the board of the city police officers’ union, said he is resigned to a bankruptcy filing but expects his group will try to seek common ground with city before it should take that drastic step.

“It’s unfortunate we’re here but we need to keep working with the city,” McLaughlin said.

Stockton’s finances collapsed along with its housing market, forcing city officials to slash $90 million in spending in recent years and a quarter of positions across agencies.

Despite the cuts, Stockton has not been able to avoid recurring deficits. Its revenue is weak and its financial troubles have been compounded, according to city officials, by generous pay and benefits for city workers and retirees and too much debt taken on by the city when it enjoyed a home-building boom in the early part of the last decade that transformed it into a distant bedroom community for the San Francisco Bay area.

Many of the houses built and bought in that boom have been abandoned, repossessed and sold at deep discount as Stockton has been at the top or near the top of lists of housing markets suffering a glut of foreclosures in recent years.

Under its restructuring plan, Stockton has already defaulted on about $2 million in debt, allowing the trustee for one of its bond insurers to seize a building once slated to be its future city hall and three parking garages.

The intentional default and of bankruptcy prompted Moody’s Investors Service and Standard & Poor’s Ratings Services to drop their credit ratings on Stockton, which has more than $700 million in debt across its various agencies.

Moody’s has its issuer rating for Stockton at a junk level Ba2 from Baa1 while S&P has its issuer rating on the city from BB to SD, one notch above its D default rating.

A bankruptcy filing by Stockton is a “high-probability event,” Gregory Lipitz, a vice president and senior analyst at Moody’s, said on Monday. (Reporting By Jim Christie)