Atlantic City faces a severe liquidity problem coupled with a huge structural deficit, Lenny Jones, Managing Director at Moody’s Investors Service, tells The Bond Buyer. On Monday, Moody’s cut the city’s credit rating to Caa3 and Jones says bondholders now face an increased likelihood of taking significant losses. He also looks ahead at several possible financial and political scenarios the city could face.

SPEAKER: Moody's took this action now because Atlantic city's credit has deteriorated. Atlantic city has a big liquidity problem. They have a huge structural deficit. Their liquidity problem is so severe that they're going to run out of money within weeks, if not days. That includes them not having made payments to the school district. It's the major reason we downgraded them right now.

Also, there's a rescue package that is on the table with Atlantic city that if it passed would really help the city have a plan to get out of these current problems. That rescue package right now is stalled. With this combination of actions, we consider that the credit of Atlantic city has continued to deteriorate and therefore, we downgraded them.

I guess the first thing is what does significant mean in a municipal context with the rarity of municipal defaults. Even a recovery by bond-holders of 65, 75, 85%, we would consider significant. We think that the likelihood of a significant loss by bond-holders is increased. As of now, we've seen three separate indications that the likelihood is increased. First, when Atlantic city instituted the financial manager, fiscal manager, part of his edict was to figure out what kind of cuts might need to happen to the bond-holders in order to survive.

Second, he came out with a report after he had been in Atlantic city for a while. His report did not recommend any kind of a cut for bond-holders, but it listed as one of the possible options. Thirdly, recently, the governor has said that bond-holders should be prepared to share in the pain to save Atlantic city. With these increasing indications, yes, we do think there's a possibility of significant loss for bond-holders.

There are several scenarios. The politics and finances are linked. I don't think they can be separated. The first scenario would be that both the pilot bill and the takeover bill pass. It would really allow Atlantic city to get out of its structural deficit. It would provide liquidity for them to survive in the short-term. It would be good for the financial numbers in Atlantic city. Right now, that's in a stalemate. Another scenario would be one of the bills passes. More likely, be the pilot bill than the takeover bill although the governor's made it clear that if he doesn't get both bills, he's not playing. That's a scenario that's not very likely.

Third scenario is that neither of the bills pass. In that scenario, Atlantic city defaults. There's no way for it to survive on its own. It'll either default into bankruptcy or outside of a bankruptcy. That may be called the distressed exchange or something like that. The payments that are promised on the date will not be paid. Therefore, we will consider it a default. I guess there's a fourth scenario which is that the state provides some sort of aid outside of the current legislation. That seems very unlikely. The governor has said that this is the way out or nothing.