SAN FRANCISCO (Reuters) - Cities in California face ongoing financial challenges from rising employee compensation and restrictions on their ability to raise revenue, which will maintain pressure on their credit ratings, Fitch Ratings said in a statement on Wednesday.

"Even as the broader economy shows signs of stabilization, California cities face state-specific uncertainties based on their diverse economic profiles, and revenue raising environment," Karen Ribble, senior Director in Fitch's Public Finance group, said in the statement.

"California cities facing the most fiscal stress are those with limited options to address budget imbalance, reinforcing the divide between the strong and the weak," Ribble added.

Fitch downgraded nine California cities last year and three this year, representing 30 percent of its portfolio of cities in the state. Concerns about municipal bankruptcies were stoked this year by Chapter 9 bankruptcy filings by the cities of Stockton and San Bernardino.

"While the costs of bankruptcy - both financial and reputational - remain high, some cities may see bankruptcy as worthwhile depending on how the outcome of current cases affects incentives," Fitch said in its statement.

"Stockton and San Bernardino are concerning because in both cases management suggested bondholders accept delayed, and perhaps reduced, payments rather than significant reductions in labor costs, though San Bernardino does provide for full debt service in its current budget," Fitch said.

Moody's Investors Service last month noted the potential for other financially distressed cities in the most populous U.S. state to seek Chapter 9 bankruptcy protection from their creditors in the wake of San Bernardino's bankruptcy filing.

"San Bernardino's bankruptcy is not a sign of systemic risks in the municipal market, but the filing does signal the level of distress and potential for an increase in bankruptcy filings, particularly among California cities," Moody's said in a report.

Fitch rates 40 of 482 cities in California with an average unlimited tax general obligation rating (ULTGO) of 'AA,' which the rating agency said is consistent with its ULTGO rating for municipalities nationwide.

(Reporting By Jim Christie; Editing by Chizu Nomiyama and Alden Bentley)