Warning about a “heightened potential” for a default this summer and greater risk that Central Falls, R.I., cannot stabilize a pension plan without filing for Chapter 9 bankruptcy, Moody’s Investors Service on Friday downgraded the city’s general obligation rating one level to Caa1 from B3, affecting about $20.8 million of outstanding debt.

“The rating action today was driven by two factors,” said Conor McEachern, an analyst with the U.S. public finance group at Moody’s.

Caa1 is a notch of highly speculative grade. The outlook remained negative. “The negative outlook on the Caa1 rating reflects the uncertainty regarding bondholder recovery in the event of a default, and/or a Chapter 9 filing,” the report said.

Moody’s warned that a pension plan for public safety employees — one of three pension plans run by the city — is expected to run out of assets by October without additional funding or worker concessions.

The announcement came as the House Finance Committee was set to release its budget for next year. It was to include controversial elements from Gov. Lincoln Chafee’s spending plan, which encouraged municipalities to keep up with pension and retiree health care obligations.

Groups such as the Rhode Island League of Cities and Towns worried about an excessive burden for municipalities, should lawmakers cut $19 million in incentive funds Chafee had earmarked under his plan, called the Municipal Accountability, Sustainability, and Transparency, or MAST, fund.

McEachern said the current state budget was “not a driver” in Friday’s rating action.

“We’re continuing our discussions with the city. We talk to them regularly, and if something develops, we’ll update the market,” McEachern added,

Rhode Island is also considering legislation that would require municipalities to guarantee lenders first rights to their property tax and general fund revenues to payment on all GO debt. But, Moody’s said in the report, “it is unclear how this new law, should it pass, would hold up in a bankruptcy proceeding.”

Central Falls has yet to develop a balanced operating budget for fiscal 2012.

Moody’s also affirmed the Ba1 Rhode Island Health and Education Building Corp.’s 2007B pool financing, of which Central Falls is a minor participant. It revised the outlook on those bonds to negative.

Central Falls, with a population of just under 20,000, is Rhode Island’s poorest city. Its unemployment rate in April was 14.6%. The city has been under receivership since May 2010. The receiver is retired Supreme Court Justice Robert Flanders. The state funds Central Falls’ school system.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.