CHICAGO -- For the third time this year, Moody’s Investors Service has downgraded Detroit, warning Wednesday that a razor-thin cash cushion, political instability, and the recent repeal of the state’s emergency management law are pushing the beleaguered city closer to bankruptcy or default.

The downgrade lowers Detroit deeper into junk-bond territory.

The ratings agency cut its rating on the city in March and June. In October, it warned it was keeping Detroit on review for downgrade through at least November to await the result of a ballot proposal on the state’s emergency management law. Voters overturned the controversial law in a Nov. 6 ballot referendum.

Detroit operates under a financial stability agreement with the state that has ties to the emergency management law, Public Act 4.

“We believe that the city’s precarious cash position, along with uncertainty surrounding state oversight, including the potential for new legislation, challenges to implementing the financial stability agreement and ongoing political instability, all point to an increase in the potential for a bankruptcy filing by the city,” Moody’s analyst Genevieve Nolan said in the downgrade report, released late Wednesday.

The city ended fiscal 2012 in June 30 with a cash position of $1.9 million, according to preliminary figures. City officials have recently warned that without an infusion of bond proceeds from the state it could run out of money by the end of the year.

Moody’s lowered the city’s general obligation unlimited-tax debt and certificates of participation to Caa1 from B3 and its general obligation limited-tax bonds to Caa2 from Caa1. The water and sewer senior-lien revenue bonds and second-lien bonds fell to Baa3 and Ba1, respectively.

The outlook on all the debt remains negative even at the lower rating.

“The ratings for the city’s GO, COPs, and GOLT debt reflect the possibility that in a bankruptcy filing these bonds would likely be treated as unsecured and subject to a default because of the automatic stay under the bankruptcy code,” Moody’s said.

Holders of the city’s water and sewer debt are less likely to suffer a loss in the event of a bankruptcy, Nolan said.

Detroit’s chief challenges are weak liquidity, weakened state oversight, challenges to implementing the consent agreement, and a potential termination payment due for interest-rate swap agreements on the COPs, according to the ratings agency.

Positives include a dedicated executive team working closely with the state and bond proceeds meant for the city that are currently being kept in escrow after a recent bond deal led by the Michigan Finance Authority.

Ongoing political instability, mostly between the city council and Mayor Dave Bing’s administration and various city departments, is blocking progress, Moody’s said. 

“Favorably, the mayor’s office and the governor’s office continue to communicate regularly,” Moody’s said. “Both have demonstrated a strong commitment to the city, and the continuation of this commitment, along with the working relationship between the governments, will continue to be a subject of ongoing credit reviews,” the agency said. “To the extent that actions of City Council or other city leaders undermine the cooperative relationship, the city’s ability to regain financial stability could be delayed.”

Detroit has $511 million of unlimited-tax GO bonds, $453 million of limited-tax GO bonds, and nearly $1.5 billion of COPs. Detroit also has $1.9 billion of senior-lien water bonds, $1.9 billion of senior-lien sewer bonds, and $1 billion of second-lien sewer paper and $642 million of second-lien water paper. 

Standard & Poor’s maintains a B rating on the city’s GO debt. Fitch Ratings assigns a B rating to the unlimited-tax GO bonds and B-minus rating to its limited-tax GO debt. It rates the COPs B.

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