Last updated: August 17, 2012 11:45 pm

Moody’s warns on California city defaults

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Moody’s has unveiled a sweeping review of its ratings of California cities, warning of rising default risk on debt issued in the state, while rival Standard & Poor’s has downgraded one of the state’s largest cities.

Moody’s move comes after three California cities – Stockton, Mammoth Lakes and San Bernardino – filed for bankruptcy this summer, raising concerns about the outlook for the $4tn municipal bond market.

Local governments across the US have been under pressure since the 2007 recession undercut revenues, but California has been particularly hard hit because it was at the epicentre of the housing boom and subsequent bust. Moody’s also said that the state had a “hands-off” policy with regard to the fiscal problems of local governments.

“As a consequence of the adverse economic and fiscal governance environment, the risk of default on municipal bonds in California is rising,” said Robert Kurtter, managing director at Moody’s, on Friday.

Focusing on Fresno, the state’s fifth-largest city by population, S&P on Friday cut its long-term debt rating by three notches to triple B from A, citing fund imbalances. S&P said the outlook for the city’s credit rating is negative.

“The negative outlook reflects our view of current budgetary constraints that may limit the city’s ability to cure projected multiyear general fund deficits absent strong revenue growth, which we consider unlikely given current indications that the city will continue to experience a slow economic recovery,” the agency said.

Moody’s rating revisions on California cities are possible over the next month or two, Mr Kurtter said, adding that further negative rating actions are also possible for the cities experiencing more acute economic and budgetary distress.

Tom Dresslar, a spokesman for Bill Lockyer, the California state treasurer, said: “Moody’s and others should think twice before jumping to the conclusion there’s a significant new risk of cities rushing into bankruptcy to stiff bondholders. California has 482 cities. Three have declared bankruptcy this year. That’s troubling for sure, but hardly evidence of a looming stampede into bankruptcy court and default.”

Mr Lockyer said the treasurer’s office was exploring a system that would identify cities in fiscal distress and help them avoid default or Chapter 9, the part of the federal bankruptcy code applicable to municipalities.

Moody’s has an average general obligation rating of Aa2, the agency’s third-highest grade, for the 93 California cities that it rates. Those average ratings “may not be consistent with the rising but still small risk of bankruptcy among cities,” Moody’s said. The rating agency predicted that bankruptcy and defaults are likely to be higher among unrated entities, which are generally smaller and weaker.

Still, Moody’s said it expects the vast majority of rated municipalities that are under distress in California and across the US will not resort to bankruptcy. Instead, the cities are expected to implement measures such as spending cuts, service reductions, tax increases, and reserve drawdowns in order to raise funds.

Moody’s downgraded nearly 300 US municipal issuers in the second quarter, the most for any quarter in more than a decade.

Overall municipal bond yields are near historic lows. The debt has remained popular with investors, largely wealthy individuals, because of their tax breaks. With those breaks, the debt of states, local governments and other municipal bodies is considered attractive versus Treasuries in the current low-yield environment.

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