February 21, 2013 / 3:20 PM / in 5 years

UPDATE 2-Moody's outlook for US local governments remains negative

WASHINGTON, Feb 21 (Reuters) - Moody’s Investors Service is keeping its outlook negative for U.S. local governments in 2013, as cities and counties must continue to contend with tight revenues, high demand for spending, and an “uneven economic recovery,” the rating agency said on Thursday.

Those local governments with “elevated reliance on federal employment or funding that is subject to federal budget cuts” have an increased risk of rating downgrades as the U.S. Congress wrestles over the federal debt and deficit.

Automatic spending reductions across most federal programs are set to take effect in a little more than a week, in a process called sequestration, and the military is warning it will have to furlough thousands of civilian employees.

Moody’s said local governments in Maryland and Virginia, along with the nation’s capital city of Washington, D.C., are particularly at risk. But it noted that those places “with significant labor force concentration in the healthcare sector,” could also face threats to their credit quality from reductions in federal Medicare spending.

“Stagnant or reduced state aid is a significant drag on local government credit quality,” Moody’s added. “State tax receipts are slowly rebounding, but other state spending priorities, such as Medicaid, are competing with resources available for local governments.”

Property taxes provide the bulk of local governments’ revenues, and cities and counties are still feeling aftershocks of the housing market downturn more than five years ago.

“Despite signs that home prices are increasing, municipal property tax revenues remain under pressure. Many local governments will not immediately realize material revenue growth because property tax receipts typically lag tax base assessments by several years,” the agency said.

The 2007-09 recession forced many local governments to stretch their resources to cover rising demand for services, and most cities are struggling to manage. In the latest case showing the impact of these financial constraints, Michigan is considering taking over the shaky finances of the city of Detroit.

At the same time, the financial crisis ravaged the investments of many public pension funds. Moody’s noted that those losses “have yet to be fully recouped.” It noted that swelling pension liabilities are putting pressure on many Illinois local governments, especially as the state attempts to address its pension, the worst-funded in the nation.

Cities unable to make up for pension shortfalls have been pushed close to or into bankruptcy.

“Local government bankruptcy filings, defaults, and other severe credit events are increasing but are still rare, especially among rated entities,” Moody’s said.

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