Debt Has City on Ropes
The first time most Gardena residents heard that their city was on the brink of financial collapse was last month, after the City Council announced that it had hired a law firm that specialized in municipal bankruptcy.
But municipal leaders have known for years that they had a $26-million debt coming due with virtually no money available to repay it.
They tried various plans to deal with the debt, but made little progress toward paying it off.
In 1995, the city refinanced a loan -- a move that backfired badly. The refinancing helped create a multimillion-dollar deficit. Wall Street bond-rating agencies saw it as an indication that Gardena might default on the loan, and a couple of years later downgraded the city’s credit to junk status.
Since then, Gardena has cut costs and closed the deficit. But it has not significantly paid down the debt, which was caused by two failed city ventures.
City leaders don’t like to use the word bankruptcy, knowing that such talk could result in another major downgrade from Wall Street. But they are blunt in their assessment.
“We’re never going to be able to pay $26 million,” Councilman Oscar Medrano said. “My great-grandchildren will not be able to pay that debt. My great-great-grandchildren will not be able to pay that debt unless they win $26 million in the Lotto.”
Officials now hold out hope that the banks might forgive their two loans to Gardena.
Japanese banks “wrote off bad loans as losses all the time during the 1990s,” Councilman Steven Bradford said.
But financial experts are dubious.
“Anything is possible,” said Sajan George, managing director of the New York turnaround firm of Alvarez & Marsal. “However, I never like to use mercy as my main restructuring strategy. It infers either a lack of competence or lack of optimism.”
Gardena was supposed to pay off the debt by Dec. 15. But recently, the two banks agreed to a five-month extension. Even then, the city said it still couldn’t repay the loans without a generous restructuring by the banks.
“I fully intend to fix this problem. It’s fixable,” City Manager Mitchell Lansdell said. “But there’s pieces of the pie I can’t control.”
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Gardena is a working-class city of 60,000 located between the suburbs of the South Bay and the industrial towns of southeast Los Angeles County. It was formed a century ago by Japanese produce farmers; now much of the farmland has given way to development.
The germ of the city’s crushing debt was sown in the late 1980s when Gardena leaders thought they could generate income by creating an insurance company that would attract other municipalities as policyholders.
The city borrowed $14.9 million to start Municipal Mutual Insurance Co. But the venture ultimately failed, largely because few cities would buy insurance from it.
The company never made a dime for Gardena, and instead had left it with a debt of $20 million by the mid-1990s.
A later loan, for $6 million, was used in a failed city venture involving a program for first-time homebuyers -- boosting the debt to $26 million.
The city insurance company was scheduled to repay part of the debt in 1995, but didn’t have the money. In fact, Lansdell said, Gardena’s finances were worsening rapidly, though then-leaders of the city told the public things were fine.
To cover the payment, the city refinanced the loan.
But this was viewed by rating agencies as a sign of Gardena’s financial uncertainty, and its bond rating dropped. This made it difficult if not impossible for the city to borrow to repay the debt.
The refinancing also came with larger debt payments that forced the city to dip into its general fund. That resulted in deficits that had reached $5 million by 1998.
City officials went to work trying to close the deficit. They cut spending and forced some workers to accept early retirement. Dozens of service fees were raised for the first time since the 1970s. Voters passed a business license tax and a hotel room tax.
By August 2003, the city was operating with a $2.3-million surplus. The improvement prompted Standard & Poor’s to raise Gardena’s credit rating from junk to low investment grade.
Officials felt triumphant at their turnaround.
But there was one problem: The $26-million debt remained, and the bill was due in just 16 months.
Initially, city officials thought they could use their improved bond rating to borrow money to repay the debt. But they found little interest from banks, because Gardena’s current rating was still just above junk status.
“They have two card clubs that make 15% of their general fund revenue, and those tend to be volatile revenue sources,” said Gabriel Petek, a credit analysis with Standard & Poor’s. “They’re much more reliant on narrow sources of revenue, and one of them happens to be an industry that is at risk if the gaming pacts between the Indians and the state change, opening up more competition.”
In November, the city tried to pass a measure to create a redevelopment agency, which could have provided revenue to pay back the debt. But voters turned it down.
Then things got worse. Aware that the city appeared unlikely to be able to make the $26-million payment by Dec. 15, Standard & Poor’s put Gardena on its watch list, a move that made potential investors aware that the city had significant financial problems.
Gardena officials have stressed that bankruptcy was only a final option, but acknowledged that they couldn’t rule it out.
Standard & Poor’s officials said they have received assurances that the city was trying to avert bankruptcy. If bankruptcy became an option, the rating agency probably would move Gardena’s credit from investment grade back to junk status.
“We fully expect they will not consider this option,” Petek said. “To be considered ‘investment grade’ is incongruous with that word.”
However, turnaround specialist George said that “the best way to avoid bankruptcy is to be absolutely prepared to go into it. It tells everyone you are serious and forces everyone to the negotiating table.”
George said the city probably would have to consider such options as layoffs, raising taxes or selling surplus property not only to repay its debt and remain solvent, but also to improve its credit rating.
“They’re not going to be able to manufacture $26 million overnight unless they try to pass a bond offering to pay the debt,” he said.
Lansdell, the city manager, said his hope was to negotiate with the banks to restructure the debt in such a way that Gardena could make payments while continuing to run the city effectively.
The loans list several city properties -- including the police station, parks and a gym -- as collateral. But officials say they doubt that the banks would or legally could attempt to seize these assets.
Mayor Terrence Terauchi, for one, remains hopeful.
“We’re dealing with one creditor who has been flexible in the past,” he said. “Maybe they’ll give us a five-year extension.”
