Moody’s: 2010 Could See a Few More Localities Default Than Usual

WASHINGTON — Local government defaults and bankruptcies could be higher this year than the historical norm, but are expected to remain rare, Moody’s ­Investors Service said in a report released yesterday.

The fiscal pressures on local governments, fueled by the national recession, mean Moody’s will keep its negative outlook on the state and local government sectors in 2010, the rating agency said yesterday in two other separately published sector outlook reports.

Government bankruptcy filings, however, will likely remain low — within the historical trend — because of the “significant restrictions” municipalities have that discourage them from filing for bankruptcy, Moody’s analysts said. “The frequency of default by local governments could increase modestly, although any increase would be expected to remain very small relative to the rated universe,” said Gail Sussman, managing director at Moody’s and one of the co-authors of the 15-page report.

Moody’s is expected before the end of the quarter to update the market on the status of its migration to a so-called global rating scale, which would presumably lead to upgrades for many credits.

However, the report does not mention any change to its scale. Currently munis are rated on a separate, more rigorous scale than corporate debt even though they have a lower chance of default.

Moody’s listed two reasons why local governments rarely file for bankruptcy protection. First, municipalities, unlike corporations, are not eligible for Chapter 11 bankruptcy.

In addition, many states limit which municipalities can file for Chapter 9 bankruptcy and the conditions under which they can file. Twenty-six states prohibit bankruptcy filings, Moody’s said. Further, states cannot file for bankruptcy, according to the report.

Moody’s said also that if a municipality does enter Chapter 9 bankruptcy, there is little a court can do to it.

The court cannot take over the municipality’s operations, require change in governance or management, or appoint an overseer to run the government’s affairs. The court cannot override state law and it cannot require the municipality to sell assets.

Bankruptcy judges “play a different role in Chapter 11 cases where they have the ability to serve as an arbiter,” said Anne Van Praagh, one of the co-authors of the report.

The provisions of what a bankruptcy court can do in a Chapter 9 case are “more limited,” Sussman said.

Two local governments rated by Moody’s filed for bankruptcy protection or defaulted on their general obligation bonds last year, the report said. California’s Sierra Kings Health Care District, a taxing authority that issued GOs, filed for bankruptcy and Menasha, Wis., defaulted on debt-service payments, the rating agency said.

Menasha’s troubles stemmed from an enterprise investment project — a utility plant that was converted to steam operations but became too costly to operate due to construction cost overruns and regulatory fines and was shuttered last year.

The city defaulted on notes issued for the plant that carried an appropriation pledge. It is retiring some GO notes issued for the plant with proceeds from a state loan.  The case serves as an example of a local government that has financial ­exposure to a “riskier” project, like a ­hospital or nursing home, the analysts said.

Strained by the recession, a local project’s financial troubles “can spillover” to issuer government and require financial contributions from a general fund, the analysts wrote. Enterprises that can no longer fund themselves “create a drain” on the issuer’s financial situation, Sussman said. Harrisburg, Pa., is in a similar situation with an incinerator project, the analysts said.

In 2009, Moody’s lowered ratings on five states: California, Illinois, ­Nevada, Ohio, and Arizona. Fifteen states currently have a negative outlook from Moody’s, and two states, Louisiana and West ­Virginia, have positive outlooks.

Yvette Shields contributed to this story.

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