Fitch Ratings is negative on localities and expects an increase in their defaults and bankruptcies.

“Although the large majority of municipal ratings are expected to be maintained over the near to medium term, downgrades will likely outpace upgrades by a wide margin,” Fitch analyst Dan Champeau and three others wrote in a report.

This year through July, 12% of local government tax-supported Fitch rating actions were downgrades and just 2% of its actions were upgrades.

Local governments receive 29% of their revenue from property taxes, second only to 33% from state government transfers. “Fitch’s mortgage-backed securities group’s most recent home price sustainability projection indicates that prices nationwide will decline another 8% before reaching a bottom in late 2013,” the analysts wrote. Meanwhile, the assessment process lags the decline in real estate values and Fitch does not expect to see “much, if any” improvement in assessed values in the near future.

The Northeast outside of New York City faces the steepest further declines in real estate values, managing director Rich Raphael said Thursday. The top six states in the United States for percent of local revenue gained through property taxes are also in the Northeast, according to the Fitch report.

There were few major state cuts in local aid in fiscal 2013, unlike in previous years, the analysts wrote in a report, “U.S. Local Government Downgrades to Persist.”

Contributing to the analysts’ negative outlook on municipalities is what they say is a possible erosion of municipalities’ willingness to pay their debts. The analysts are concerned by “heightened discussions regarding municipal bankruptcy and default and the recent actions of a few California cities.”

“The cities of Stockton and San Bernardino, Calif. are seeking to solve their problems in part by defaulting on their obligations to bondholders and the financial guarantors backing the debt,” the analysts wrote. These cases “represent not only a very troubling departure from municipal governments’ demonstrated willingness to avoid default on long-term bonded debt but also a specific targeting of bondholders.”

However, for the most part issuers retain a strong willingness to repay their debts, the analysts wrote.

Inflexible labor terms have hindered localities’ ability to deal with declining revenues, the analyst wrote. Employee compensation typically makes up two-thirds of local government budgets. In the constrained revenue environment that localities find themselves in, “achieving labor compensation savings is essential in order to avoid severe service reductions.”

Localities ability to achieve labor costs savings vary. “In states that do not have so-called right to work laws, particularly in the Northeast and Midwest and on the West Coast, leverage over labor can be more limited,” the analysts wrote.

States with effective means for handling municipal financial problems can help prevent local defaults, the authors wrote. “State intervention programs vary from very strong (e.g. North Carolina and Michigan) to very weak or non-existent (e.g. California and Alabama).”

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