Hannah Dreier and Gosia Wozniacka, The Associated Press
Created: 08/17/2012 03:29:40 PM PDT

SACRAMENTO – One of the nation’s top credit rating agencies said Friday that it expects more municipal bankruptcies and defaults in California, the nation’s largest issuer of municipal bonds.

Moody’s Investors Service said in a report that the growing fiscal distress in many California cities was putting bondholders at risk.

The service announced that it will undertake a wide-ranging review of municipal finances in the nation’s most populous state because of what it sees as a growing threat of insolvency.

The report has both investors and government leaders worried.

Three California cities – Stockton, San Bernardino and Mammoth Lakes – have filed for bankruptcy so far this year. They are not likely to be the last, Moody’s said.

Moody’s reports that some cities are turning bankruptcy as a new strategy to take on budget deficits and avoid obligations to bondholders, an emerging dynamic that could have ripple effects throughout the investment community.

The municipal bond market has long been characterized by low default rates and relatively stable finances, Moody’s said, but that outlook is beginning to change as bankruptcy becomes a tool for cash-strapped cities.

As a result, the agency will reassess the financial position of all cities in California, which issues about 20 percent of the municipal bond volume nationwide, “to reflect the new fiscal realities and the governmental practices.”

The agency also will examine the outlook for municipal bonds in other troubled states, according to Robert Kurtter, managing director of public finance at Moody’s.

Moody’s would not say which states it will review, though Kurtter mentioned Michigan and Nevada as possibilities. Friday’s report noted that cities across the country are in financial distress but said that a greater share of bankruptcies are expected in California.

In California, officials rushed to downplay the report.

“Moody’s has an obligation to review changing circumstances, but we would just suggest that their assessment of the framework and ground activities is perhaps exaggerated,” said Chris McKenzie, executive director of the League of California Cities.

The state treasurer’s office also cautioned against overacting to three bankruptcies among California’s 482 cities.

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