August 14, 2012 / 10:21 PM / 5 years ago

Municipal bankruptcy a risk, even where it's disallowed-Fitch

Aug 14 (Reuters) - Barely half of U.S. states allow their local governments to file for bankruptcy, but Fitch Ratings will continue to factor in the probability of a Chapter 9 filing for all tax-supported local debt it rates, the agency said on Tuesday.

Fitch added a new section on the legal and structural framework of debt in its criteria for rating U.S. local government bonds supported by taxes, highlighting growing concerns for municipal bankruptcies and explaining its views of the ties between local and state governments.

Only 24 out of 50 states currently allow local governments to file for bankruptcy, "but Fitch believes that in an extreme case..the state would make the legal provisions necessary to file," it said.

"Therefore, Fitch makes no distinction in rating bonds that might be at risk of payment interruptions due to a filing between entities in states that allow for local government bankruptcies and those that do not," it said.

It added that some states have other mechanisms to help local governments get their finances in order, but the agency does not assume "that such mechanisms will be invoked and that, once invoked, they will be effective."

For decades, bankruptcies in the $3.7 trillion municipal bond market were rare. There have been nine Chapter 9 municipal bankruptcy filings so far this year, compared with 13 in all of 2011.. California is home to three.

As its landmark bankruptcy filing wends its way through the federal court system, Jefferson County is seeking help from Alabama's state legislature, which has the sole authority to restore a local jobs tax that was declared unconstitutional in March 2011 and was a driver of the country's Chapter 9 filing on Nov. 9.

In its new section, Fitch explained that it also "does not cap a local government's rating at the state's rating," because cities and counties "have varying degrees of autonomy to generate revenue and control spending, and in some cases, have few or no state-imposed restrictions."

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