Earlier this year, the city of Stockton, California, defaulted on its debt and filed for bankruptcy. For analysts at ratings agency Moody’s, it marked a growing trend in local governments. Cities, which have historically been nearly flawless on their obligations, are opting to default on their debt because of financial troubles.
This story was originally published by 24/7 Wall St.
In a report issued Wednesday, Moody’s rated the debt of 30 cities, towns, villages, counties, and school districts as “speculative grade,” up from 25 last year. A speculative-grade rating for a local government means, at best, its debt is risky and, at worst, it could end in default. 24/7 Wall St. looked at 13 of the riskiest local governments that may be on the verge of bankruptcy.
In an interview with 24/7 Wall St., Moody’s Managing Director and Chief Credit Officer of U.S. Public Finances explained that the number of cities, counties and towns that default on some or all of their debt is growing. She attributes this to “a significant amount of credit pressure, sluggish economic recovery, and cities not being able to grow out of their problems this time around.” She added that many cities see defaulting as the only way to avoid total economic disaster.
Perhaps the best example of this is Stockton. Even in bankruptcy, the city opted not to pay off its debt. The city was one of the most seriously affected by the housing crash. Stockton bonds are currently rated Caa3 by Moody’s, tied with Jefferson County, Alabama for the worst rating issued to a local government.
Different circumstances brought each government to this point. However, a few underlying causes are shared. In some cases, governments severely mismanaged their debt: they borrowed based on unrealistic projections of expenses. In other cases, the economic downturn hit particularly hard, weakening revenue. For some local governments, it was a combination of factors.
A weak economy with a fragile or shrinking tax base is one of the worst problems a local government trying to balance its budget can face. In Detroit, the population has fallen by roughly half in the past 50 years, including a 25% drop in the past decade alone. Unemployment is well into the double digits, and per capita income has been steadily declining. All these factors make it extremely difficult to continue raising revenue to service its debt.
Detroit’s 2011 general fund revenue was $ 1.23 billion while its outstanding debt was more than $ 2.5 billion. For some speculative-grade-rated governments, debt exceeds annual revenue by three, four, or even five times.
Poor management and the failure to accurately project revenues plague many of these governments. Le Center, Minnesota, has chronically overestimated revenues from real estate developments. Menasha, Wisconsin issued government issued bonds for a new steam power plant it had been building to attract manufacturers to the region. The project was cancelled, and the city’s general obligation debt was more than seven times its 2011 revenue.
Many of the local governments rated as speculative grade have been rated poorly for years. “Once you’re downgraded to speculative, it’s possible to reverse course,” said Medioli, “but it doesn’t happen that often.”
Moody’s also expects more local governments will be downgraded in the future. In its report, the ratings agency explained, “The credit pressures will continue to exert themselves on virtually the entire local government sector. For municipalities unable to adjust to the new environment, downgrades into speculative grade are unavoidable realities.”
Based on Moody’s report on U.S. speculative-grade local governments for 2011, 24/7 Wall St. reviewed the 13 towns, cities, villages, and counties with a credit rating of Ba2 or worse. Moody’s also provided reports on why these cities had been rated as speculative grade, as well as general fund debt and revenue for 2011. This level of credit rating implies a substantial risk of default.
These are the thirteen American cities going broke.
13. Wenatchee, Wash.
> Credit Rating: Ba2
> 2011 general fund revenues: $ 22.4 million
> 2011 general fund debt: $ 13.2 million
> Median income: $ 44,156
In December 2011, the Greater Wenatchee Public Facilities District defaulted on $ 42 million of debt associated with the Town Toyota Center, a multi-purpose arena. In order to help pay off that debt, the city imposed a 0.2% regional sales tax in July 2012. Bonds also went on sale in September to further alleviate the debt. Despite these plans, Moody’s noted in its May downgrade that any long-term plan to pay off the city’s debt “would further stress city finances … operational flexibility and ability to invest in infrastructure.” Moody’s also pointed out the city faces financial risk associated with litigation following the arena’s default.
12. Le Center, Minn.
> Credit Rating: Ba2
> 2011 general fund revenue: $ 1.1 million
> 2011 general fund debt: $ 8.3 million
> Median income: $ 41,481
On Feb. 1, Moody’s downgraded Le Center, Minnesota, from A1 to Ba2, with a negative long-term outlook. This small town, located in the south central part of the state, had to borrow to pay debt due in February 2012 , and received an extension on loan payments due December 2011. Besides the payment deferral, Moody’s cites the city’s very small tax base and “weak management practices” to explain the low rating. City management used unrealistic budgeting. In particular, it overestimated the amount of cash it would bring in from a new real estate project. The ratings agency projects that if these trends continue, the city will remain dependent on costly short-term loans to pay its debts.
Read: 10 Cities With The Fastest Growing Home Prices
11. Strafford County, N.H.
> Credit Rating: Ba2
> 2011 general fund revenue: $ 52.8 million
> 2011 general fund debt: $ 19.9 million
> Median income: $ 57,809
Strafford County’s financial state improved in fiscal 2011, when it eliminated a general fund deficit of $ 7.2 million from fiscal 2010 and ran a small surplus. Still, because of its tight budget, the county has had to regularly borrow money to cover short-term cash needs. Moody’s described Strafford’s ability to reduce its future borrowingas a “key factor” in determining its poor rating. According to Moody’s, Strafford County has no plans to issue any more long-term debt, and will shed an estimated 83.8% of its existing debt within 10 years. Moody’s altered its outlook from last year for the county from “negative” to “stable.”
10. Menasha, Wis.
> Credit Rating: Ba2
> 2011 general fund revenue: $ 16.2 million
> 2011 general fund debt: $ 43.4 million
> Median income: $ 45,897
In 2007, the city of Menasha defaulted on bonds it had issued to fund a steam plant. The utility operation closed down several years later. The fallout from this venture has left the city permanently in the red. As of 2011, it brought in just over $ 16 million in general fund revenue, but had $ 43.4 million in outstanding general fund debt. In 2010, nearly 20% of the city’s budget was devoted to paying off debt, which was the second-largest expense on the balance sheet in 2010. The city recently repossessed the abandoned steam plant, and is currently deciding whether to repurpose it or demolish it for scrap.
9. Harrison, N.J.
> Credit Rating: Ba2
> 2011 general fund revenue: $ 36.8 million
> 2011 general fund debt: $ 113.8 million
> Median income: $ 51,193
In 2006, Harrison guaranteed $ 39.4 million in bonds to buy land for the Red Bull Arena, the stadium used by the New York Red Bulls. The deal has not been profitable for Harrison. Condominium developments, expected to help pay off the stadium, were not finished as of last June. Additionally, for several years the Red Bulls refused to pay property taxes. In July, the franchise paid the town $ 5.6 million in overdue taxes after a judge ruled the arena was taxable. In late 2011 the state of New Jersey created a $ 1 million reserve fund to help pay off the city’s debt. Since last October, the town’s credit rating has improved from Ba3 with a negative outlook to Ba2 with a positive outlook.
8. Salem, N.J.
> Credit Rating: Ba3
> 2011 general fund revenue: $ 8.0 million
> 2011 general fund debt: $ 36.0 million
> Median income: $ 25,682
In 2007, Salem guaranteed bonds to finance the construction of the Finlaw State Office Building. The project was a disaster. There were construction delays and the state leased the building for just 20 years, while the town will have debt repayments for 30 years. Lease revenue was not high enough to cover both maintenance fees and debt payments. As of May, the city had already spent all but $ 772,000 of the $ 1.8 million set aside in reserves to cover shortfalls in revenue from the project. If this fund is exhausted, the city, and possibly the taxpayers, will be on the hook for any debt payments that lease revenue does not cover. Moody’s describes the deal as “a liability which is disproportionate to the city’s size and ability to pay.”
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