CHICAGO — Fitch Ratings Friday downgraded $4.6 billion of Detroit water and sewer revenue bonds, citing weak financial performance and future challenges, including looming capital needs and risks associated with derivatives.
The downgrades mark the latest in a series of negative credit actions to affect the fiscally struggling city, which carries a junk bond general obligation rating.
Fitch lowered its rating to A from AA-minus for $1.4 billion of outstanding senior-lien sewer bonds and $1.5 billion of senior-lien water bonds. The agency also downgraded to A-minus from A-plus $1 billion of second-lien sewer bonds and $660 million of second-lien water bonds.
All bonds are payable from the systems’ net revenues.
The downgrades reflect a “deteriorating financial performance in recent years and the expectation that financial results will remain challenged” as a result of the systems’ weak operating environment, Fitch analyst Doug Scott wrote in a report released Friday afternoon.
The systems’ strengths include a large metropolitan service area that spans a wide swath of suburbs and relatively moderate debt profiles despite risks tied to an extensive swap program.
The systems also appear to be “sufficiently” insulated from some of the city’s political and economic pressures, as city officials cannot tap water and sewer funds for other purposes, Scott said.
The water system serves 45% of Michigan’s population and the sewer system serves about 30% of the state’s population.
The systems have implemented rate increases nearly annually to address financial and capital needs. But those increases will likely not be enough to offset the weak regional economy and other looming pressures, Fitch warned.
The systems have significant exposure to swaps with poor levels of liquidity to honor payments in the event that the swaps are terminated at current values.
The systems are also highly leveraged, with more capital work needed.
The city proposed extensive capital plans for the systems that have since been scaled back in recent years as certain projects have been delayed or removed. But Fitch noted that looming capital needs could still pressure the systems in the future.
“Funding is expected to be predominantly derived from debt sources, which likely will lead to increased pressure on the system’s debt profile,” Scott wrote about the sewer system’s capital improvement plan.
Moody’s Investors Service downgraded the city’s water and sewer debt last December, cutting the rating to A1 from Aa3 on the senior-lien bond and to A2 from A1 on second-lien bonds.
