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Thirteen American Cities Going Broke

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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.

Read: Thirteen American Cities Going Broke

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, Anne Van Praagh, 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 Van Praagh, “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.”

7. Riverdale, Ill.
> Credit Rating: B2
> 2011 general fund revenue: $12.9 million
> 2011 general fund debt: $7.0 million
> Median income: $42,690

Riverdale, a community of under 14,000 people about 20 minutes south of downtown Chicago, had its credit rating downgraded in October due to a growing deficit in its general operating fund. The village is expected to report a deficit of $1.5 million for fiscal 2012, bringing the total general fund balance to -$1.95 million, or 15.8% of projected revenue. Riverdale is also underfunding its four pension plans.  Moody’s said Riverdale’s coffers are hurting due to “declining full valuation, taxpayer concentration, elevated unemployment and a net population loss.” According to the U.S. Census, the village population fell 10% from 2000 to 2010, while per capita income was only 61% of the U.S. average income.

Read: States with the Highest (and Lowest) Taxes

6. Woonsocket, R.I.
> Credit Rating: B2
> 2011 general fund revenue: $80.6 million
> 2011 general fund debt: $203.2 million
>Median income: $38,625

In June 2012, Woonsocket faced a severe cash flow crisis, but managed to avoid disaster after Rhode Island’s budget oversight commission increased state aid. As of 2011, Woonsocket’s general fund had debt equivalent to 2.5 times its revenue that year. Moody’s report on the city’s speculative-grade rating cited the city’s continuing difficulties making spending cuts because of poor management and imprecise accounting.

5. Central Falls, R.I.
> Credit Rating: B2
> 2011 general fund revenue: $17.9 million
> 2011 general fund debt: $21.0 million
> Median income: $34,389

Central Falls, a city of around 20,000 people located outside of Providence, filed for Chapter 9 bankruptcy in Aug. 2011. At the time, the city faced $80 million in unfunded pensions liabilities and retiree health benefits, or about than four-and-a-half times its annual general fund revenues of $17.9 million. During its time in bankruptcy, the Rhode Island legislature funded $2.6 million to help prevent severe cuts during bankruptcy. A judge approved of the city’s plan to emerge from bankruptcy in September 2012. As part of its plan to emerge from bankruptcy, the city will increase property taxes by 4% annually for the next five years. It will also cut pensions of workers who retired at a young age by up to 55% and will have a reduced workforce indefinitely.

4. Detroit, Mich.
> Credit Rating: B3
> 2011 general fund revenue: $1,229.2 million
> 2011 general fund debt: $2,508.3 million
> Median income: $28,357

Since last October, Detroit’s credit rating has fallen significantly — from Ba3 to B3. According to Moody’s,  the city “suffers from high unemployment, high poverty, low income, concentrated exposure to a dominant industry, and a depressed housing market.” In April, Michigan reached an agreement with Detroit that prevented the appointment of an emergency manager, who would manage the city’s finances and would have authority to remove the mayor and city council. Although Michigan raised $129 million in funds for Detroit in August, the city has only received $50 million — the rest is dependent on its ability to make financial reforms. On Oct.15, Moody’s noted that Detroit remains under review for a further downgrade, highlighting uncertainty surrounding possible amendments to the city’s fiscal 2013 budget.

3. Pontiac, Mich.
> Credit Rating: Caa1
> 2011 general fund revenue: $36.2 million
> 2011 general fund debt: $86.7 million
> Median income: $30,753

Pontiac is the only city on this list to have a speculative rating predating the recession — since March 2006. Pontiac’s financial troubles, mostly the result of its reliance on the declining automotive industry, have been evident for years. As of June 2012, the city’s unemployment rate was a whopping 22.2%, or about 2.5 times the national rate. The city’s tax revenue continued to dwindle as its population diminished — the population of 59,515 as of the 2010 U.S. Census was 10.3% lower than in 2000. During 2012 alone, the city outsourced its police force to Oakland County and its fire department to Waterford township. Despite these moves, Moody’s projects that the city will close out fiscal 2012 with a deficit of $8.4 million due to retiree healthcare obligations and debt service expenditures. And if Pontiac doesn’t make reforms in regards to health care and debt service expenses, the deficit could rise to $14 million by the end of fiscal 2013.

Also Read: America’s Richest Cities

2. Jefferson County, Ala.
> Credit Rating: Caa3
> 2011 general fund revenue: $311.1 million
> 2011 general fund debt: $1,141.3 million
> Median income: $45,244

In November 2011, Jefferson County, Alabama, filed for the largest municipal bankruptcy in U.S. history in terms of amount owed after county leaders and investors couldn’t reach agreements to refinance $3.1 billion in sewer bonds. The bonds have been in default since 2008. The county has continued to pay school and special tax bonds while in bankruptcy, although its sewer bonds remained in default. Moody’s placed a negative outlook for the bonds because “losses to bondholders once bankruptcy proceedings conclude could exceed the levels implied by the current ratings.”

1. Stockton, Calif.
> Credit Rating: Caa3
> 2011 general fund revenue: $180.3 million
> 2011 general fund debt: $248.5 million
> Median income: $47,946

Stockton, with a population of nearly 292,000 people in 2010, became the most populous city to file for bankruptcy in June after the city was unable to close a $26 million deficit. According to Moody’s, the Caa3 rating given to Stockton’s debt assumes that bondholder losses will be greater than 20%. A weak economy has hit Stockton particularly hard. The unemployment rate was 15.4% in April, cutting the revenues coming into city coffers. Stockton’s current year budget, which began in July, called for suspending $10.2 million in debt payments and $11.2 million in employee compensation and retirement benefits.

By Michael B. Sauter, Alexander E.M. Hess, Samuel Weigley

Also Read: America’s Poorest Cities

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