S&P downgrades Detroit bonds to junk status

CHICAGO (Reuters) - Detroit, a city already struggling due to the depressed auto industry, was hit with another blow on Tuesday when Standard & Poor's Ratings Services downgraded the city's general obligation ratings to junk status, citing ongoing financial deterioration.

The ratings on about $2.4 billion of unlimited and limited tax debt were cut to "BB" from "BBB" and "BBB-minus," respectively, S&P said.

The "BB" rating is two notches into junk territory and will make it considerably more expensive for the city to issue debt as investors demand a premium to compensate for higher risk.

The downgrade also triggered a possible $400 million payment tied to a swap entered into by former Mayor Kwame Kilpatrick's administration, although the city was hopeful it could negotiate and avoid making a payment, said Daniel Cherrin, spokesman for Mayor Kenneth Cockrel.

S&P noted Detroit's fiscal 2009 budget was expected to have an operational deficit, continuing a string of deficits in most years since 2003, and that "economic challenges in the city have translated directly to the financial bottom line."

The rating "reflects a downward trend in some revenue sources that has made balancing operations difficult and the continued difficulty in assessing the city's financial position, given its chronically late audits and its historical tendency to end the fiscal year with results that compare unfavorably with initial projections," said S&P analyst Jane Hudson Ridley.

Other factors include Detroit's reliance on the durable manufacturing sector, and in particular the auto industry. U.S. automakers are struggling with slumping sales, massive legacy costs and dwindling cash reserves, forcing them last month to plead with Congress for a government bailout.

Cherrin said the mayor planned to soon release a plan to tackle the city's $300 million accumulated deficit, but was disappointed that S&P chose to downgrade the city at this time.

"We're working diligently creating a plan to deal with our budget situation," Cherrin said.

Cockrel, the former Detroit City Council president, took over as mayor in September after Kilpatrick pleaded guilty to obstruction of justice charges and resigned his position.

Moody's Investors Service dropped the city's unlimited GO bond rating to "Baa3" from "Baa2" in May, citing nagging budget deficits, late financial audits and a struggling economy. It downgraded Detroit's limited-tax GO debt into the junk category.

A handful of U.S. cities are rated junk by Standard & Poor's. They include New Orleans, East Chicago, Indiana and Scranton, Pennsylvania, all of which are rated "BB" with a stable outlook.

Littlefield, Texas, is rated "BB" but with a negative outlook, meaning the rating could be lowered again within two years.

(Reporting by Karen Pierog; Additional reporting by Ciara Linnane; editing by Richard Chang)