Fitch Ratings has affirmed the following Detroit, Michigan bond ratings:
–Approximately $411 million unlimited tax general obligation
(ULTGO) bonds at ‘CCC’;
–Approximately $202.8 million limited tax general obligation
(LTGO) bonds at ‘CC’;
–Approximately $1.5 billion pension obligation certificates of participation (COPs) series 2005-A, 2006-A, and 2006-B issued through the Detroit Retirement Systems Funding Trust, Michigan at ‘CC’.
ULTGO bonds are supported by the city’s unlimited property tax pledge. LTGO bonds are a first budget obligation. Pension COPs are unconditional contractual obligations of the city, not subject to appropriation. If the city fails to make a COP debt service payment, the contract administrator may file a lawsuit against the city to enforce the obligation, and a court can compel the city to raise the payment through the levy of taxes without limit as to rate or amount pursuant to Michigan law.
KEY RATING DRIVERS
PERSISTENT LIQUIDITY CHALLENGES: Cash flow forecasts project the city will be in a negative cash position by the third week of December, absent corrective action. A cash infusion that
was expected no longer seems likely, raising the likelihood that the city will face a brief cash crisis before property tax receipts restore liquidity in January.
FINANCIAL AND POLITICAL INSTABILITY: Progress toward achieving financial reform goals is contingent upon cooperation among the various branches of city government and between the city
and state. The instability of the city’s financial position is reflected in the fragility of these relationships and the difficulty in achieving the identified milestones.
SEVERE ECONOMIC WEAKNESS: The economic base continues to be stressed and signs of recovery are slow to emerge. Unemployment remains exceptionally high relative to the state and nation and resident wealth levels are low.
CONSENT DECREE SURVIVES OVERTURNING OF EMERGENCY MANAGER LAW: While the consent decree under which the city operates is not based upon PA4, the overturned statute did form the basis for a number of provisions in the financial stability agreement (FSA) including the suspension of collective bargaining requirements.
SIGNIFICANT OPERATING DEFICITS CONTINUE: Officials estimate a $100 – $110 million operating deficit for FY12, although the general fund balance is expected to decline only $30 – $40 million due to the deficit financing undertaken by the state on behalf of the city. Projections show the deficit will grow by another $60 million in FY13.
SIGNIFICANT LABOR SAVINGS UNDERPIN BUDGET GOALS: Concessions assumed in the FY13 budget were not implemented. Instead, the amended budget relies upon changes to the city’s labor agreements, called city employment term (CET) agreements, which are projected to yield a similar amount ($60 million) of savings in FY13, and an annualized $102 million in FY14.
WHAT COULD TRIGGER A RATING ACTION
SEVERE LIQUIDITY CRISIS: Absent a default the ratings could be adjusted if a potential liquidity crisis results in an inability of the city to make payments on basic governmental obligations such as payroll.
FURTHER OBSTACLES TO FSA: Fitch believes a number of possible political hurdles could further hinder what appeared to be the shared goals of the mayor, city council, and governor to avoid a deepening of the fiscal crisis.
ECONOMIC IMPROVEMENT LEADING TO FINANCIAL STABILITY: Fitch believes that regional economic improvement is evident and may benefit the city’s financial operations over the long term.
THIN LIQUIDITY PROJECTED
Adequate cash flow has been a recurring concern for the city. City officials planned to receive a $10 million disbursement of state escrowed bond proceeds on November 20th and a $20 million disbursement on December 20th to forestall illiquidity in mid- to late-December. Several milestones are required for the state to release the funds. The city council and city attorney recently opposed the approval of a contract for legal services, which was one of the required milestones.
The failure of the city to meet the agreed-upon milestones raises the risk that the escrowed funds will not be released in time to avoid a cash crisis. City officials plan to make offsetting cuts, including unpaid furlough days, to conserve cash and avoid illiquidity. The receipt of property taxes in January should restore minimum levels of liquidity until the next low cash-flow point in April. Since the near-depletion of liquidity has been a recurring problem Fitch believes this may continue.
FSA MUST BE SUCCESSFUL TO BE CONSIDERED A CREDIT-POSITIVE
Fitch believes that the FSA has the potential to improve long- term financial stability for the city. The FSA establishes a nine-member financial advisory board (FAB) and sound budgeting guidelines including use of three-year budget, more realistic revenue estimates, mid-year budget adjustments as needed, and approval by the FAB. However, some sections of the FSA, including the relaxation of collective bargaining laws and the ability to impose an emergency manager if the city does not comply with the agreement, are premised on the existence of PA4, which was recently overturned by the voters.
DIRECTION OF STAKEHOLDER RELATIONSHIPS CAN SHARPLY ALTER OUTCOMES
Fitch believes that cooperation among the various stakeholders toward common goals is a necessary prerequisite for any sort of improvement to credit quality. An element of contentiousness remains, despite the impressive level of cooperation that was required to realize substantial recent achievements. These include the implementation the FSA, execution of the recent deficit financings, and achievement of the CET agreements.
The recent inability of the various branches of government to work together to reach the agreed upon milestones in a timely fashion highlights how quickly this environment can change, and how severely such changes can threaten the city’s tenuous operating environment. Given this volatility Fitch is concerned that additional actions by these or other stakeholders, including unions or taxpayers, could deepen the city’s fiscal crisis.
FINANCIAL POSITION CONTINUES TO WEAKEN
The city projects fiscal 2012 ended with an operating deficit of $100-110 million (9 – 10% of spending), as compared to a $30 million surplus projected at the beginning of the year. The fund balance is expected to decline by a lower $30 – 40 million due to the BAN proceeds but represents a dramatic shortfall in expectations. The projected deficit is also about twice the size of the fiscal 2011 operating deficit, indicating a significant weakening of what had seemed like a slight improvement in operating results. The forecasted deficit continues a trend of significant budget variances and increases the accumulated deficit from already high levels. It also leaves the general fund unrestricted deficit at about 20% of spending.
FISCAL 2013 EXPECTED TO ADD TO ACCUMULATED DEFICIT
Projections show the general fund accumulated deficit will grow by at least $60 million in FY13, reaching a very high, approximately negative $250 million. The gap is expected despite progress is controlling labor costs, which account for a majority of operating spending.
Total salaries for the first third of the fiscal year were down 14%, or $22 million from fiscal 2012 actual levels, representing an annualized savings of over $60 million. While the associated headcount reduction is central to the FY13 budget, Fitch is also concerned that the cuts will leave insufficient personnel to provide basic services, particularly in public safety where cuts equal 5% and 7% of uniformed police and fire employees, respectively, despite continued concerns about crime and safety.
The FY13 original budget included significant labor concessions which were not ultimately enacted. Rather, the amended budget relies upon the CET agreements, which include a 10% wage cut, work rule changes and an amended health plan, among other provisions. Many of the CET changes have been implemented; some are expected to be implemented with the next 2.5 months, while others are on hold indefinitely. The CET changes are projected to yield $60 million in savings for the remainder of FY13, and an annualized $102 million for FY14.
Fitch remains concerned that potential legal challenges to the CET agreements could threaten achievement of the identified savings and further widen the gap between recurring revenues and expenditures.
SEVERE ECONOMIC STRESS
The Detroit area economy remains pressured after severe weakening during the recent recession. Despite the loss of thousands of automotive jobs, the economy remains heavily dependent on the auto industry. The city’s resource base remains under considerable stress, as evidenced by the very high unemployment rate, poor wealth indices and declining tax base.
The seasonally unadjusted August 2012 unemployment rate of 19.6% showed little improvement over the 20.8% recorded a year prior, despite contraction of the labor force. It remains more than double the state and national rates of 9.2% and 8.2%, respectively.
Similarly, resident wealth indices are depressed at 59.9% of the state, limiting the revenue raising capacity of the income tax. The individual poverty rate is extremely high at 34.5% and market value per capita is below median at $31,000. Full market value has dropped 24% over the past four years, and
Fitch expects further declines before stabilization occurs.
A developer’s recent investment in rehabilitation of office and residential space has spurred higher occupancy in the downtown area and some high profile employers, including Quicken Loans and Blue Cross/Blue Shield, have moved employees into the city. These developments, while positive, have not compensated for the out-migration underscored by the 25% population loss between the 2000 and 2010 censuses. Prospects for long-term economic improvement remain closely tied to the auto industry and are highly dependent upon continued macroeconomic growth.
In addition to the sources of information identified in Fitch’s Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope,University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, National Association of Realtors, Underwriter, Bond Counsel.
Applicable Criteria and Related Research:
–‘Tax-Supported Rating Criteria’ (Aug. 14, 2012);
–‘U.S. Local Government Tax-Supported Rating Criteria’ (Aug.14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. Local Government Tax-Supported Rating Criteria