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(Reuters) - Standard & Poor's downgraded Stockton, California to default from selective default on Wednesday, citing expectations that the city will not pay "substantially" all of its obligations as they come due.
Stockton's elected officials approved a 2013 budget on Tuesday night based on the city filing for bankruptcy as soon as Wednesday. A bedroom community of 300,000 some 85 miles east of San Francisco and a casualty of the real estate bust, Stockton is set to become the most populous U.S. city to file for bankruptcy. It has $700 million of outstanding debt.
"The rating action also reflects the city's decision to file for bankruptcy protection," the report by S&P said.
The Wall Street credit agency cut to C from CC the ratings on the city's pension obligation bonds, lease revenue bonds and certificates of participation - some of which were issued by the Stockton Public Financing Authority and the Stockton Redevelopment Agency. The outlook on these ratings is negative.
The negative outlook for the pension obligation bonds was due to S&P's expectation that the city will not make all the required payments.
"We see a strong likelihood of a default on the city's 2007A and 2007B pension obligation bonds in September because these obligations lack the protection of a dedicated debt service reserve," the credit agency said.
S&P said it gave the lease revenue bonds and Certificates of Participation negative outlooks because it could lower their ratings in the next year "as debt service reserves, sureties, and restricted funds...are exhausted and/or otherwise not paid to bondholders."
Bondholders in some lease revenue bonds might face a little less risk. "For the series 2004 lease revenue bonds, 2006A lease revenue bonds, 2007A and 2007B lease revenue bonds, and 2009A lease revenue bonds, we understand debt service reserves or surety policies will be sufficient to cover debt service in the fall," S&P said.
It added: "For its series 2003A and 2003B Certificates of Participation and series 2004 revenue bonds...the city plans to continue to meet contractual requirements for timely payments because of the availability of restricted resources".
Stockton was ill-prepared to withstand the real estate collapse. City officials say Stockton's finances have been mismanaged over two decades, with too much borrowing in good times and generous pay and unsustainable benefits granted to city employees and retirees.
Filing for bankruptcy will protect Stockton from its creditors. S&P also estimated that the bankruptcy court would hear the city's petition in September 2012.
Reporting by Joan Gralla; Editing by Leslie Gevirtz