U.S. municipality downgrades are expected to continue to outpace upgrades as acute fiscal stress and an increased threat of default and bankruptcy persists, according to a new Fitch Ratings report.

Despite this trend, most local government ratings are expected to be maintained over the near to medium term.

Seven local U.S. governments have filed for Chapter 9 bankruptcy protection over the last year, including three recent cases in California, out of an estimated 52,000 U.S. municipalities and school districts.

'The consideration of municipal bankruptcy as a viable option for relief in itself calls into question an issuer's commitment to repaying debts,' said Dan Champeau, group head of U.S. public finance and global infrastructure. 'Chapter 9 filings on a broader scale would represent a marked departure from municipal governments' long demonstrated willingness to avoid default and bankruptcy.'

Fitch believes cases of severe local government credit stress are not limited to California although California cities do have certain challenges including Proposition 13 and a hard hit real estate market.

Inflexible labor contracts with onerous provisions or external arbiters that severely impede fiscal adjustments remain a key local government credit concern. Additionally, local government revenues have not been rebounding as overall property tax revenue, linked on a lagged basis to real estate values, continue to drag in many locations.

Effective state fiscal intervention mechanisms such as control boards to address distressed local governments can help stabilize finances and limit downside credit deterioration. State intervention programs for local governments vary from very strong, such as North Carolina and Michigan, to very weak or non-existent, such as California and Alabama.

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