NEW YORK (Reuters) - Moody's Investors Service on Wednesday cut to Caa3 various general fund-supported debts of the City of Stockton, California, citing the city's announcement that it likely will file for bankruptcy after talks with its creditors failed.
"The city is running out of cash and faces limited time and options to fix its structural imbalance," the Wall Street credit agency said in a statement.
The downgrade puts Stockton's ratings in the "substantial risk" category, just one notch above the "may be in default, extremely speculative" grouping.
"We have downgraded the city's pension obligation debt to Caa3 from B3 and its lease revenue debt to Caa3 from Caa1. The outlook on these bonds is negative" the rating agency added.
Moody's said that its rating decision "reflects the city's June 26 adoption of a budget that would suspend payments on some of its lease and pension obligation bonds backed by its general fund in fiscal 2013 in order to close an approximately $26 million budget gap."
Stockton's elected officials approved a 2013 budget on Tuesday night based on the city filing for bankruptcy as soon as Wednesday. A bedroom community of 300,000 located some 85 miles east of San Francisco and a casualty of the real estate bust, Stockton is set to become the most populous U.S. city to file for bankruptcy. It has $700 million of outstanding debt.
Stockton officials say the city's finances have been mismanaged for over two decades and a bankruptcy filing would shield it from its creditors. The process could last several years, Moody's said.
The Wall Street credit agency said the Caa3 ratings assume investor losses will top 20 percent. "The negative outlook reflects the high likelihood that losses could exceed our estimates," Moody's warned.
Stockton is proposing to balance its new budget partly by suspending $12 million of debt service. "Moody's believes that the magnitude of the budget gap and heavy reliance on debt service reductions as part of the budget solutions is an indication of the likelihood of a high level of losses that the city's pension obligation and lease bonds would experience in bankruptcy," the agency said.
In a bankruptcy, that debt would be considered unsecured.
In contrast, 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."
Reporting By Tiziana Barghini and Joan Gralla; Editing by Eric Walsh