Moody's Investors Service downgraded various debt supported by Stockton, Calif.'s general fund to Caa3 after the city announced it would skip payments as it enters bankruptcy.

Moody's believes that the magnitude of the budget gap and heavy reliance on debt service reductions as part of the budget solutions is an indication of the likelihood of a high level of losses that the city's pension obligation and lease bonds would experience in bankruptcy, the rating agency said in a report Wednesday.

Under the bankruptcy code, these bonds would be treated as unsecured debt and would likely be subject to restructuring and losses in order to facilitate a recovery, the agency said.

The City Council voted 6-to-1 Tuesday night to file for bankruptcy after officials said negotiations with the city's creditors failed.

City manager Bob Deis said negotiations with Stockton's 18 creditors under a mediation process set up under California law failed by Monday's deadline to provide enough cuts to close an estimated gap $26 million for the next fiscal year.

The agency downgraded the city's pension obligation bonds to Caa3 from B3 and its lease revenue debt to Caa3 from Caa1.

"We have also withdrawn the city's issuer rating for business reasons," Moody's said in the report.

Moody's also said it will keep the city's water enterprise debt Ba3, its sewer enterprise debt Ba1 and two of its community facilities district special tax bonds Baa2. The agency said the outlook on these bonds is developing.

"The confirmation of the ratings of the city's water and sewer enterprise debt and community facilities districts’ special tax bonds reflects our view that losses are unlikely," Moody's said.

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