California Cities May Face Rating Cuts as Default Risk Rises

Cities in California, where three have declared bankruptcy in the past seven weeks, may get credit-rating downgrades from Moody’s Investors Service.

The situation is worsened by the state’s boom-bust real-estate economy and “hands-off” policy on the finances of local governments, Moody’s said today in a report.

“The risk of default on municipal bonds in California is rising,” Managing Director Robert Kurtter, lead author of the report, said in a statement. “Across-the-board rating revisions are possible.”

Governor Jerry Brown last year balanced the state budget partly by killing redevelopment programs that helped finance decaying city neighborhoods. Localities also face rising pension costs, growing unemployment and drops in property- and sales-tax revenue. Stockton, San Bernardino and Mammoth Lakes all filed for bankruptcy protection.

California cities at particular risk include those in the Inland Empire, east of Los Angeles, and Central Valley localities, which run through the middle of the state, according to the report.

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Moody’s has an average general-obligation rating of Aa2, its third-highest grade, for the 93 California cities that it rates, according to the report. Its average rating for lease-backed bonds issued by California cities is one level below at Aa3.

Those average ratings “may not be consistent with the rising but still small risk of bankruptcy among cities,” according to the report.

Even with the recent filings, investors are demanding less extra yield to hold municipal bonds sold in the state.

The additional yield on 10-year debt sold by California and its localities relative to 10-year benchmark tax-exempts has shrunk to 0.76 percentage point as of Aug. 16, below the five-year average of 0.99 percentage point, data compiled by Bloomberg show. That’s the narrowest yield spread since December 2008. The difference was as wide as 1.71 percentage point on July 1, 2009.

To contact the reporters on this story: Michelle Kaske in New York at mkaske@bloomberg.net; Will Daley in New York at wdaley2@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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