SAN FRANCISCO — San Jose officials said Monday’s downgrade of its lease revenue bonds by Moody’s Investors Service will cost the city more than $350,000 a year.

San Jose will have to pay more now that two of the three rating agencies have downgraded its general fund lease-revenue bond ratings, which are tied to the fees the city pays for letters of credit.

“Last year we were downgraded by Fitch [Ratings] so this will trigger an increase in our letter-of-credit fees,” said Julia Cooper, San Jose’s acting finance director.

Cooper said the fees would increase to about $350,000 a year for $237 million of outstanding general fund lease-revenue bonds. The letter-of-credit fees are based on the lowest of two of the three rating agencies.

San Jose, California’s third-most populous city, expects a $10 million general fund surplus for the fiscal year starting July 1 after 10 consecutive years of deficits. However, officials project a more than $20 million deficit for the following fiscal year.

Late Monday, Moody’s released a report downgrading San Jose’s general obligation bond rating to Aa1 from Aaa. The rating agency also cut various lease revenue bonds to Aa3 from Aa2. The action involves more than $1 billion of debt.

“The rating reflects the multi-year erosion of the city’s general fund reserves,” Moody’s analyst Michael Wertz said in the report. “This decline is indicative of the difficulty the city has faced to manage costs versus weakened revenues resulting from the economic downturn and a very slow and tenuous recovery.”

Moody’s now has a stable outlook on the city’s rating.

Analysts said the two-notch difference between the lease and general obligation ratings reflect the risk of abatement, the related lack of earthquake insurance coverage, and the narrower security for leases compared to San Jose’s unlimited property-tax pledge for GO debt.

“We agree with the strengths that Moody’s points out in their credit report,” Cooper said. “That we are benefiting from the recovery and growth of the Silicon Valley economy and that we really have made significant progress reducing our costs and increasing revenues.”

According to Moody’s, the challenges facing the city include several consecutive years of deficits and increasing retiree benefits costs.

San Jose Mayor Chuck Reed has proposed a controversial ballot measure to help reduce the city’s pension costs. Last year Reed said the city’s annual retirement costs quadrupled to $250 million in 2001 from $63 million in 2000.

Last year, Fitch downgraded the city’s general obligation bonds to AA-plus from AAA and its lease revenue bonds to AA from AA-plus. Standard & Poor’s still rates San Jose AAA and its general fund lease revenue bonds AA-plus.

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