The credit ratings of Stockton, California, were slashed on Wednesday by two Wall Street credit agencies because the city plans to file for bankruptcy soon.
Standard & Poor's downgraded Stockton to default from selective default on Wednesday, citing expectations that the city will not pay "substantially" all of its obligations as they come due.
Moody's Investors Service cut Stockton's pension obligation debt to Caa3 from B3 and its lease revenue debt to Caa3 from Caa1.
"The city is running out of cash and faces limited time and options to fix its structural imbalance," Moody's said in a statement.
Bankruptcies have been rare in the $3.7 trillion municipal bond market in recent decades. But experts now expect at least a slight increase because counties, cities, towns, schools and other bond issuers have yet to fully recover from the recession, while costs for everything from pensions to healthcare keep climbing.
Stockton's elected officials approved a 2013 budget on Tuesday night, which includes savings from a proposed bankruptcy filing.
The downgrade by Moody's to Caa3 puts the ratings on some of Stockton's debt in the "substantial risk" category, just one notch above the "may be in default, extremely speculative" grouping.
A bankruptcy filing would shield the city from its creditors. The process could last several years, Moody's said.
Stockton was ill-prepared to withstand the real estate collapse. City officials say Stockton's finances have been mismanaged over two decades, with too much borrowing in good times and generous pay and unsustainable benefits granted to city employees and retirees.
BONDHOLDERS TO SUFFER LOSSES
Both credit agencies predicted that at least some of the investors in debt issued by Stockton and some of its borrowing arms likely will have to take losses.
Moody's said its Caa3 rating implies that investors' losses will top 20 percent. "The negative outlook reflects the high likelihood that losses could exceed our estimates," it warned.
In a bankruptcy, Stockton's pension obligation bonds and lease bonds would be considered unsecured.
S&P cut to C from CC the ratings on the city's pension obligation bonds, lease revenue bonds and certificates of participation - some of which were issued by the Stockton Public Financing Authority and the Stockton Redevelopment Agency. The outlook on these ratings is negative.
"We see a strong likelihood of a default on the city's 2007A and 2007B pension obligation bonds in September because these obligations lack the protection of a dedicated debt service reserve," the credit agency said.
S&P said it gave the lease revenue bonds and Certificates of Participation negative outlooks because it could lower their ratings in the next year "as debt service reserves, sureties, and restricted funds ... are exhausted and/or otherwise not paid to bondholders."
Bondholders in some lease revenue bonds might face a little less risk. "For the series 2004 lease revenue bonds, 2006A lease revenue bonds, 2007A and 2007B lease revenue bonds, and 2009A lease revenue bonds, we understand debt service reserves or surety policies will be sufficient to cover debt service in the fall," S&P said.
It added: "For its series 2003A and 2003B Certificates of Participation and series 2004 revenue bonds ... the city plans to continue to meet contractual requirements for timely payments because of the availability of restricted resources."
Some of the other bondholders also have brighter prospects.
Moody's said it confirmed ratings on the city's water and sewer enterprise debt at Ba3, sewer enterprise debt at Ba1, and two of the community facilities districts' special tax bonds at Baa2.
All of that debt was assigned a "developing outlook" because of how long a bankruptcy could last. Moody's said it made these determinations because "losses are unlikely, although how the bonds continue to perform in a potential bankruptcy remains uncertain."
© 2013 Thomson/Reuters. All rights reserved.