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Fitch: More municipal downgrades than upgrades in 2014

Tuesday, 3 Dec 2013 | 4:40 PM ET
Detroit bankruptcy ruling ahead
CNBC's Scott Cohn reports U.S. Bankruptcy Judge Steven Rhodes is saying Federal bankruptcy law allows for the alteration of contracts, which includes pensions. The judge is not necessarily allowing for deep pension cuts. Jessalynn Moro, Fitch head of U.S. local governments, provides insight.

While bankruptcies like the one gripping Detroit should remain rare, downgrades of municipal bonds will outpace upgrades in 2014, according to Fitch Ratings' outlook for next year.

Jessalynn Moro, the head of U.S. local governments at Fitch, told CNBC on Tuesday that needed reforms to municipal pensions, which have strangled city budgets with ballooning health-care costs and other obligated debts, won't go into effect soon enough to relieve cash-strapped cities.

Cities with downgraded bond ratings should still make up the minority of the municipal bond market, according to Fitch's outlook.

(Read more: Detroit eligible for bankruptcy protection: Judge)

A dilapidated building in Detroit.
Justin Solomon | CNBC
A dilapidated building in Detroit.

"Our outlook on the sector for 2014 is negative," Moro said on "Squawk on the Street." "And one of the key things driving that is the fact that while pension reforms have taken place, they really take quite a few years to effect change on municipal budgets."

Fitch, which last month handed Chicago a steep ratings downgrade, will look toward Tuesday's court ruling that declared Detroit eligible for bankruptcy protections as a bellwether for how courts view general debt obligation versus pension requirements and other liabilities.

(Read more: Illinois sets $350 million bond sale after pension reform vote)

"Municipal bankruptcies are really going to be isolated incidents," Moro said. "They're so few and far between. So the fact that we've had a few over the last couple years is interesting. Each one is very unique and is going to give us more information as they continue to play out."

Moro said if pension reform remains out of reach in Chicago, the rating agency may downgrade the city even further. Chicago's retirement funds held $19.4 billion in unfunded liability in 2012, up from $11.9 billion in 2009, according to Standard & Poor's.

"We downgraded the city last month, and while the city has taken some pretty important steps in righting its fiscal ship, we still have a negative outlook on the rating," Moro said. "And if there is no pension reform, that rating is likely to go down again."

(Read more: US municipal bond sales fall in November as refundings shrink)

Fitch analysts forecast that areas that have seen a strong rebound in the housing market may see better growth, but that labor unions seem to harbor more of an unwillingness to negotiate further concessions, especially in areas that have already seen sharp spending cuts.

—By CNBC's Jeff Morganteen. Follow him on Twitter at @jmorganteen and get the latest stories from "Squawk on the Street." Reuters contributed to this report.

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