The city of Stockton, California, is expected to become the largest U.S. city to file for bankruptcy, but we do not believe this is the beginning of a nationwide trend.

Following 90 days of required mediation, the city’s negotiations with unions and creditors failed. As such, the Stockton city council voted on June 26th in favor of filing for Chapter 9 bankruptcy protection, which is likely to occur prior to the end of its fiscal year on June 30th. As part of the city council’s vote, the city will default on the remainder of its lease debt that it had not opted to default on earlier this year. Stockton has no outstanding general obligation (GO) debt. The filing was not a surprise to most market participants and remains an outlier due to a confluence of events that are somewhat unique to Stockton. As we’ve written before, we do not believe situations like Stockton are pervasive in the municipal market. However, we would not be surprised to see municipal credit downgrades continue to outpace upgrades in California and across the country over the next year.

The Stockton filing and our expectation of continued credit downgrades highlight the importance of independent credit research in seeking to avoid investment pitfalls and unearthing attractive investment opportunities.

Related reading: Stockton, CA — Omen or Outlier?

A closer look at municipal bonds

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There are risks associated with fixed income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is more pronounced for longer-term securities.