Detroit received its second dose of positive rating news this month with an upgrade from S&P Global Ratings that moved its general obligation rating further up the speculative grade ladder and restored some revenue-backed bonds to investment grade.
S&P Monday raised the rating on $361 million of unlimited tax GO debt issued in 2018, 2020, and 2021 to BB from BB-minus. Moody’s Investors Service
"The upgrade reflects Detroit's growing revenues and improved budget position, sustained reserves, and overall increasing flexibility with substantial federal funds and a bolstered retiree protection fund," S&P analyst John Sauter said. “Detroit remains, in our view, on a trajectory to meet increasing pension costs in the near and long term within a balanced budget framework, and if it does so, we could raise the rating.”
The rating agency also lifted some Detroit debt into investment-grade territory. S&P raised to BBB-minus from BB-plus $157 million of 2014 income tax bonds issued through the Michigan Finance Authority’s local government loan program and $162 million of utility tax-backed Public Lighting Utility debt sold through the local government loan program. Moody’s does not rate the debt.
The upgrades affirm “the efforts taken to improve the city’s general obligation credit” and return “an important segment of our portfolio to investment grade,” Jay Rising, Detroit’s chief financial officer, said in a statement.
Both rating agencies signaled that the city’s credit remains on the upswing.
“We are going to be to an investment grade rating within a few years which I have to tell you in bankruptcy nobody believed that would ever be possible,” Mayor Mike Duggan said during his State of the City address Wednesday when only the Moody’s upgrade had been made public.
The S&P action marks the sixth upgrade from a rating agency in the last seven years, by Duggan's count. The city emerged from bankruptcy in December 2014.
S&P knocked the city’s GOs down to junk in January 2009 as its financial position deteriorated on its way to a Chapter 9 filing in 2013. The income tax and Detroit Public Lighting Authority debt landed in junk in February 2019 when S&P revised its priority lien criteria.
The city could draw another upgrade in the next one to two years if its sustains budgetary balance amid rising pension contributions, doesn’t rely on reserves and avoids deferring expenses or depleting quicker than expected the special Retiree Protection Fund set up to supplement contributions.
The city has a total of $2 billion of debt including $1.5 billion of GOs with enhanced or revenue pledge ratings. The number includes $649 million of GOs issued through the Michigan Finance Authority and linked to the state’s rating because it is supported by the city’s share of distributable state aid.
The positive outlook is notable in that the city remains challenged by income tax revenue losses as 30% of non-residents with city-based jobs continue the COVID-19 pandemic-sparked trend of working remotely and because legacy pension contributions suspended for 10 years in the bankruptcy exit plan resume in 2024.
Newly implemented collections on internet gambling has helped offset the hit to income taxes, according to a
S&P also views population trends and high poverty levels as risks because they limit revenue-raising abilities and increase service needs, but sees some successes in the city’s efforts to build its residential tax base in increasing property values, improved public safety metrics, and reduced poverty rates.
“We feel the city has fiscal discipline and flexibility that can keep it on track should it experience economic slowdowns or higher-than-forecasted pension increases,” Sauter said.
Lingering questions over the trajectory of pension payments and COVID-driven economic challenges loom large the city’s ability to reach investment grade and make further headway with the buy side, said Howard Cure, director of municipal bond research at Evercore Wealth Management LLC.
The city finance team and Duggan have “done a good job” of making progress on fiscal management as required under post-bankruptcy oversight policies, tackling blight and other quality of life issues and expanding the job base.
“The question mark” is the impact of COVID on the economic base, Cure said. What does it mean for tax base and job creation and whether people will permanently work from home at the same time that federal relief is being exhausted and big pension payments loom.
“You always want to invest in junk that has the potential to get to investment grade. I have trouble handicapping that based on all those questions on the recovery,” Cure said.
The city gets high marks in the governance criteria due to its strong fiscal controls and formal long-term forecasting, S&P said. The city must abide by rules imposed in its bankruptcy plan of adjustment that require balanced budgets and four-year budgeting all of which is reviewed by the Detroit Financial Review Commission.
A balanced fiscal 2023 budget would put the city on a path to win a fifth consecutive waiver from direct oversight by the commission later this spring, but any slips backward can trigger a return.
Economic headwinds that could interfere with fiscal and economic progress and the soon-to-resume pension payments pose the toughest challenges.
“We still consider there to be a pending funding gap that constitutes a structural imbalance, as if the city were annually paying full costs as other cities do, it would likely have a budget gap,” S&P said. “However, as the funding policy is set and payment schedules established if we feel the budget is likely to accommodate increasing costs in unison with a gradual use of the RPF, we may consider removing our structural imbalance consideration.”
S&P’s criteria limits ratings to BBB-plus when it believes there’s a structural gap.
When contributions resume in fiscal 2024, the city owes an estimated $131 million based on the police and fire fund's recent policy change to pay down legacy obligations over a 20-year period instead of 30 years, while the general employee fund remains at 30 years.
Duggan said last week he
If the city prevails in its efforts to amortize both legacy funds over 30 years, the contribution drops to $117 million. If the other fund moves to a 20-year term, the payment rises to $141 million. The Retiree Protection Fund is on track to hold $460 million when payments to resume to cushion the blow on the general fund.
The city’s closed, legacy general retirement fund has net pension liabilities of $1.1 billion for a 59.2% funded ratio and the legacy police and fire system has a $1.2 billion net liabilities for a funded ratio of 66.8%. The post-bankruptcy hybrid pension plans range from a 91% to 117% funded ratio.
Duggan last week unveiled a proposed budget for the fiscal year beginning July 1 that funnels $31 million from a $130 million fund balance that would bring the reserve to $138 million and another $30 million would go to boost a scheduled $60 million contribution to the special Retiree Protection Fund.
Duggan said reserve deposits planned over the next three years — $15 million in 2024 and $5 million in 2025 — would bring the account to 12% of budget. The goal is to eventually reach 15% in hopes that will help lift the city from junk rating territory, Duggan said.
If the deposits are approved, it would bring the Retiree Protection Fund balance to $460 million, providing a cushion to help meet annual contributions that are expected to range from $130 million to $200 million in the coming decades.
