Budget uncertainty in Paterson, N.J. is a credit negative, according to Moody’s Investors Service.

Budget woes in Paterson, N.J. that led to a one-day government shutdown on March 1 are a credit negative for New Jersey's third largest city, according to Moody's Investors Service.

Paterson Mayor Jose Torres ordered non-essential government services shuttered on March 1 after the city council rejected a proposed budget for the fiscal year ending June 30, 2016. Paterson, which Moody's rates Baa1 with a negative outlook, has been operating on a series of monthly interim budgets in part because of not finding out until February how much state transitional aid it would receive. The city, which has low reserve levels with a fund balance just under $3 million, lifted the government services suspension on March 2 after another interim budget was agreed to.

"Although the shutdown lasted only one day, the council's failure to pass a budget in a timely fashion and avoid a government shutdown is evidence of political deadlock and dysfunction," which is credit negative for the city and its bondholders, said Moody's analyst Douglas W. Goldmacher in a report Friday. "Paterson is in a state of profound fiscal distress."

Goldmacher noted that Paterson depends heavily on the state's transitional aid, of which it received $25 million in 2015 or 9.6% of its budget. The uncertainty about how much transitional aid the city would receive for fiscal 2016 led to Paterson not being able to produce a balanced budget until late February. Mayor Torres' proposed budget calls for a 6.1% tax levy increase with the same amount in transitional aid ($25 million), but city council members who voted down the spending plan demanded a lower tax increase with additional cuts to offset revenue losses. The proposed cuts are unrealistic, according to Torres, since much of the money in the budget proposal has already been spent on the interim budgets, Goldmacher said.

"The city's reserves are narrow, liquidity is poor, and its equalized value, which is the estimated value of all taxable real and personal property, is shrinking," said Goldmacher. "In order to wean the city off transitional aid and reestablish a sound fiscal basis, a considerable amount of work is required, none of which is possible without extensive forward planning."

While certain essential services such as police, fire, sanitation, and debt service are exempt, the city "cannot fully function" until a budget is passed, according to Goldmacher. A prolonged government shutdown would lead to "operational distress" and compound the city's weak housing market and high foreclosure rate, Goldmacher said.

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