Extraordinary state oversight imposed on Newburgh, N.Y., prompted Moody's Investors Service on Friday to take the fiscally challenged city off watchlist for possible downgrade.

The agency put the city on negative watch April 15 after downgrading it to Ba1 from Baa3, citing its "severely strained" finances, "extremely limited internal liquidity," and heavy reliance on cash-flow borrowing. The rating affects $33.7 million of outstanding long-term debt.

The Newburgh Fiscal Recovery Act, signed into law on July 15, gives New York's comptroller oversight of the city's budgeting and borrowing and permits the sale of up to $15 million of deficit bonds or notes to liquidate accumulated deficits.

The city plans to sell $12 million of deficit notes and roll over $5.2 million of Bans on Tuesday. Jefferies & Co. is underwriter on the deal. Capital Markets Advisors LLC is financial adviser and Hawkins Delafield & Wood LLP is bond counsel. Newburgh expects to retire the deficit notes with proceeds of a bond sale in August 2011.

The comptroller's powers over the city will last as long as deficit bonds or notes are outstanding. The act limits maturities to 15 years. The law also directs the city to send its property tax revenue directly to the comptroller, who will deposit the revenue, along with state aid, into a debt-service reserve fund that will cover annual debt service on bonds or notes before officials can use the funds for operations.

"The removal from watchlist reflects stabilization in the past four months, primarily related to the state of New York's establishing oversight of city finances and creation of a special debt-service reserve fund which will operate as a lock-box for payment of debt service," Moody's said.

The city manager must submit budget proposals for the upcoming fiscal year to the comptroller at least 30 days before the scheduled City Council vote to adopt it. The statute says the comptroller can make recommendations and requires the council to review them and "make adjustments to the proposed budget consistent with any recommendations made by the state comptroller."

The city of Newburgh, located on the Hudson River about 65 miles north of New York City, has an estimated population of 31,000. It is adjacent to the town of Newburgh, which has a similarly sized population. Median household income in the city was estimated at $37,107 in 2008, compared a national median of $52,175 according to U.S. Census data.

City Comptroller Christine Mitchell, who was appointed by the acting city manager in February, said Newburgh's troubles arose from "poor management, underestimating expenditures and overestimating revenues, and not having a strong handle on capital projects." The city had fallen behind on completing audited financial statements, compoundint the problem.

"They were moving forward with budgets where they really didn't have their numbers finalized from previous years," Mitchell said. "They appropriated $5.5 million of fund balance in the general fund to balance 2010 and that fund balance actually did not exist."

The City Council sought to have the state impose a control board but the governor's and comptroller's offices came up with an alternative. The city has now completed its 2008 and 2009 audited financial statements, made appointments to senior posts, and is reviewing its budget to make consolidations.

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