Moody’s Investors Service Tuesday downgraded $69.4 million of Harrisburg Authority water bonds to Ba1 from A1. The outlook is negative.

Also on Tuesday, Mayor Linda Thompson allowed Harrisburg’s 2011 budget to become law without her signature.

The downgrade to junk status for the water bonds is due to Harrisburg severe financial problems. Pennsylvania’s capital city is operating under the state’s distressed municipalities program, called Act 47. It stopped paying debt service in June 2009 on $282 million of incinerator debt that it guarantees. It narrowly covered general obligation debt-service and payroll costs at the end of 2010.

The authority owns the water system and implements rate increases. The city operates and manages the system and has access to its funds.

Outsides professionals selected by the state are now working on a fiscal recovery plan for Harrisburg. That recovery plan could include using water system funds to help the city meet its operating costs.

Cravath, Swaine and Moore LLP is set to offer by the end of March its recommendations to the City Council on a possible bankruptcy filing.

“This relationship exposes the water system to the city’s financial distress, which could result in a disruption in financial operations should the city file for bankruptcy under Chapter 9,” a Moody’s report said. “In addition, with the authority’s consent the water system’s liquidity may be drawn into the financial plan developed by the Act 47 coordinator, which is expected to be formulated over the next few months.”

Moody’s placed the credit on review for possible downgrade on Oct. 4.

Thompson Tuesday opted to let the city’s 2011 budget become law absent her signature. The mayor has said that City Council’s amended budget does not include nearly $4 million of mandated and contractual obligations. In addition, the 2011 spending plan does not budget for $14.9 million of principal and interest payments due this year on the incinerator bonds.

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