CHICAGO — Moody’s Investors Service hit Detroit with a two-notch downgrade Tuesday afternoon, while hours earlier an Ingham County circuit court judge issued a decision that could delay negotiations between Michigan and its biggest city over a proposed consent agreement.

Detroit was already Moody’s lowest-rated American city, and the downgrade pushes it deeper into junk-bond territory.

The ratings agency warned that ongoing uncertainty over the city’s future is increasing bondholders’ risks.

The downgrade is yet another financial headache for the struggling city, as it triggers a termination event under the terms of interest-rate swaps that hedge roughly $800 million of certificates of participation issued in 2005 and 2006.

That could force the city to pay up to $350 million over the next seven years.

Detroit officials said they were in discussions with the swap counterparties to avoid having to make the payments.

Moody’s downgraded to B2 from Ba3 $553.1 million of general obligation unlimited-tax bonds and cut to B3 from B1 the rating on $486.4 million of outstanding GO limited-tax bonds.

The agency also cuts its rating to B2 from Ba3 on $1.5 billion of certificates of participation. The downgrade of the COPs below Ba3 triggers a termination event for the swaps, which hedge $800 million of the $1.5 billion of debt.

Detroit remains on review for downgrade even at the lower rating, Moody’s said.

“Although efforts to stabilize the city’s finances and improve liquidity are ongoing and could be resolved over the very near term, protracted discussions continue and this uncertainty increases bondholder risks,” Moody’s analyst Genevieve Nolan wrote in the downgrade report.

“The state continues its in-depth review of the city’s finances, which could result in bringing the city one step closer to bankruptcy filing.”

The threat of having to make termination payments on the swaps would “further complicate the city’s ability to manage its cashflow over the medium to longer term,” Nolan said.

Detroit chief operating officer Chris Brown said the downgrade was not unexpected.

“In December, we narrowly averted a downgrade,” Brown said in a statement. “Since then, we’ve been concerned about the continued possibility and we’ve worked to avoid it.”

Brown said the city is negotiating with its swap counterparties to “avert any negative financial impact.” The termination event could force the city to pay $50 million a year over the next seven years to pay off the swaps. The agreement was part of a 2009 re-negotiation of the swap terms with counterparties UBS and Siebert Brandford Shank & Co.

Standard & Poor’s and Fitch Ratings also maintain below-investment-grade ratings on Detroit’s debt.

The downgrade comes as city and state officials enter into what is expected to be a final week of negotiations over final terms of a consent decree. If negotiations fail, the state could appoint an emergency manager to take over the city.

Gov. Rick Snyder has said repeatedly that he would like to see a final agreement in place by March 26, which is the day that a state review team examining the city’s books is required to make a final recommendation.

But Tuesday morning, Ingham Circuit Court Judge William Collette ordered that the state not enter into a consent agreement with the city before March 29, which is when he will hear a contempt hearing for members of the state review team.

Collette earlier ruled that the review team violated the state’s open meetings act by meeting in private. The contempt hearing was set after the review team formed a subcommittee that was going to meet in private. State Treasurer Andy Dillon, who is one of the 10 people on the team, later disbanded the committee.

The state asked the judge to delay the contempt hearing, and Collette agreed, but only on the condition that Michigan not enter into any formal consent agreements with the city before March 29 hearing date.

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.