California bankruptcies will likely rise, Moody's Investors Service said on Friday, saying that it is considering credit-rating downgrades as financial stress on cities and other localities rise, encouraging lawmakers to use bankruptcy as a tool to win bondholder concessions.
Three cities have sought bankruptcy protection since June, including Stockton, which became the largest U.S. city ever to file. The housing bust and California laws that limit tax hikes and encourage negotiations could raise that number, Moody's Investor Services said.
"Bondholders could become embroiled in the solution to local government fiscal stress," Moody's said in a new report. Stockton and San Bernardino both have indicated they want to cut pension bond payments as part of their turnaround strategies.
"We are considering ... potential across-the-board adjustments of debt ratings for California cities to reflect the new fiscal realities and the governmental practices in addressing them," Moody's said.
Counties, school districts and special districts could be downgraded, it said, adding that bankruptcy risks are still low but increasing.
Many counties, cities and towns around the nation are struggling with the rapidly rising costs of pensions and health benefits for public workers. Their financial problems are heightened by the still-fragile economic recovery, which is restraining revenue growth.
The remedies California's municipalities can employ are more limited than those of some other states, citing restrictions on property tax hikes and cities' considerable independence from the state government, Moody's said.
Moody's also cited a law enacted in 2011 that allows municipalities in California to file for bankruptcy after a 60-day period of mediation talks with creditors. The directive to negotiate "appears to condone, if not normalize, less than full and timely payments to bondholders," it said.
Some of the most vulnerable California localities are located inland, "within the Empire and Central Valley, where cheap financing and speculative residential and commercial development during the boom years resulted in high foreclosure rates and depressed prices," Moody's said. These factors reduce property tax revenue.
The credit agency underscored how the handful of bankruptcy filings around the nation is altering the traditional understanding of the municipal market's default risks.
"This inability and unwillingness to honor obligations to bondholders is relatively new in modern day U.S. public finance and still remains rare," the credit agency said.
Moody's rates about a fifth of California's 482 cities. Its lowest city ratings are Baa2 for Marysville unsecured debt and Montebello secured. Unsecured debt of the cities of Fresno, Azusa and Santa Ana are rated Baa1, one rank up from Baa2.
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