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Ruling on Stockton bankruptcy eligibility likely Monday

By Jim Christie

SACRAMENTO, California (Reuters) - A verbal ruling on whether Stockton, California, is eligible for bankruptcy protection will likely come next Monday, a federal judge said on the third and final day of a trial that the U.S. municipal debt market is closely watching.

U.S. Bankruptcy Judge Christopher Klein said he would need more time than anticipated to make a ruling over whether Stockton should be allowed to press on with its bankruptcy case, which could result in bondholders and bond insurers of the city swallowing losses while leaving pensions of city workers and retirees intact.

"I'm pretty confident I will not be in a position to make my findings by Friday," Klein told attorneys for Stockton and its so-called capital markets creditors at the third hearing of the trial that started on Monday.

Stockton aims to aggressively impair its bond debt if found eligible for bankruptcy court protection, a strategy other cash-strapped municipalities could follow, breaking a tradition in the $3.7 trillion municipal bond market, which provides financing for various public capital projects, from school construction to sidewalk repairs.

Since at least the 1930s, bondholders in major municipal bankruptcies have consistently repaid their entire principal. If Stockton establishes it is eligible for bankruptcy protection, other financially troubled municipalities could follow its example and try to adjust debts through bankruptcy.

A city of nearly 300,000 in California's Central Valley, Stockton filed for bankruptcy last year, becoming the biggest U.S. city to declare bankruptcy.

Bond insurers Assured Guaranty Corp, Assured Guaranty Municipal Corp and National Public Finance Guarantee Corp have been joined by Wells Fargo Bank, the Franklin California High Yield Municipal Fund and Franklin High Yield Tax-Free Income Fund in contesting Stockton's bid for bankruptcy eligibility.

The insurers have more than $300 million of exposure to the city's debt and have said that Stockton's decision to keep making payments to its largest creditor, the California Public Employees' Retirement System, showed lack of good faith during the initial stages of the city's bankruptcy plan.

The $254 billion pension fund manages pension accounts for Stockton's current and retired employees.

A lawyer for the capital markets creditors during the trial's closing arguments said Stockton officials gave the creditors a "take-it-or-leave-it" offer instead of negotiating in good faith, adding that the city's decision to exempt Calpers from impairment was "tainted" because city officials involved in the decision had a conflict of interest due to having retirement accounts with the pension fund.

"The process was hopelessly flawed," attorney Matthew Walsh told Klein.

Norman Hile, a lawyer for Stockton, characterized the capital markets creditors as resisting negotiations, adding that most of the city's creditors have already agreed to concessions.

Hile added that Calpers should be viewed as a trustee for Stockton's employees and retirees rather than as a creditor, adding that the city has met the requirements in federal law for eligibility for bankruptcy court protection.

Guy Neal, another lawyer for the capital markets creditors, said Stockton's financial future is bleak unless it tackles its pension obligations and brings the state pension fund into negotiations.

"The evidence demonstrates that Stockton cannot afford these liabilities," Neal said.

If Klein finds Stockton eligible for protection from creditors under Chapter 9 of the U.S. bankruptcy code, the city could begin drafting a so-called plan of adjustment for its debts.

The process could take some time and creditors can object. Any plan of adjustment would eventually require a court finding it is fair and equitable to all creditors.

Stockton's capital markets creditors will also be able to appeal a finding of eligibility to U.S. District Court or a bankruptcy appellate panel.

If Klein finds Stockton is not eligible for bankruptcy protection, the city could operate under its current spending plan while negotiating concessions with creditors, who could at the same time press their claims against the city in state or federal court.

(Editing by Paul Simao, Tiziana Barghini, Bob Burgdorfer and Philip Barbara)

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