CHICAGO - Standard & Poor's raised Detroit's water and sewer revenue bonds three levels up from junk bond territory ahead of the city's $1.8 billion sale of mostly refunding bonds, offering a more positive assessment than Fitch Ratings or Moody's Investors Service.
Standard & Poor's assigned a BBB-plus to both the senior lien and second lien tranches of the sale and outstanding bonds in the $5.2 billion debt portfolio of the Detroit Water and Sewerage Department. The portfolio was previously rated CCC by the rating agency.
"The 'BBB-plus' rating reflects our opinion of the underlying creditworthiness of the sewer disposal and water supply systems," said Standard & Poor's analyst Scott Garrigan. "Even though the rating on bonds secured by the pledged assets of each system could diverge, at this time we believe the creditworthiness of each system is the same, regardless of lien position." A stable outlook was assigned.
Fitch Ratings said it expects to boost the senior lien pieces of Detroit's $1.8 billion deal out of junk territory while leaving the second lien below investment grade. Moody's Investors Service has assigned a Ba2 to the senior lien and a Ba3 to the second lien, both below investment grade.
The sale slated for Tuesday will provide the funding needed for the city to purchase $1.5 billion of bonds tendered at the city's request, refund currently callable bonds, and raise $190 million of new money. The Michigan Finance Authority is serving as issuer and Citi is the senior manager.
Standard & Poor's veered somewhat from the others in its assessment over whether the tender represented a distressed debt exchange since some bondholders agreed to accept less than par. Fitch and Moody's said they don't consider the tender and refinancing under the category of a distressed debt exchange.
Standard & Poor's s lowered to CC from CCC the impaired tendered bonds, purchased below par, and said it intends to lower them to D when the transaction closes and then will remove the rating.
"Generally, we consider an exchange offer to be distressed if we believe that the bondholders receive less than originally promised, and if the bondholders are accepting the offer because of the risk that the issuer will not fulfill its obligations," Garrigan said. The action will have little practical effect on any of the bonds as the rating will eventually be removed as the bonds are retired.
Fitch assigned its lowest investment grade rating of BBB-minus to the $152 million senior lien new money sewage disposal system senior lien bonds and the $684 million of senior lien sewer refunding bonds. The $100 million of second lien sewage refunding bonds received a BB-plus, one level below investment grade.
The same low investment grade rating of BBB-minus was applied to $774 million of senior lien water system supply refunding bonds and the same BB-plus was assigned to the $81 million second lien refunding series. A stable outlook was assigned.
The respective BB-plus and BB ratings assigned to the remaining outstanding $1.1 billion of senior lien water bonds and $1.6 billion of senior sewer bonds, $565 million of second lien water bonds and $788 million of second revenue bonds were placed on positive watch.
Fitch said it expected to raise the ratings on the outstanding bonds to the same level as the bonds being sold this week when final ratings are issued following completion of the transaction and execution of agreements that involve bondholders and insurers dropping their objection to the city's plan of adjustment.
Fitch's rating action "reflects the city's tender offer to DWSD bondholders, which is anticipated to yield certain economic benefits for the systems and simultaneously resolve contentious legal issues relating to the city's attempted impairment of certain DWSD bond."
The refinancing transaction is expected to achieve debt service savings of at least $240 million and removes a key class of creditors who objected to the city's plan to deal with its $18 billion.
The tender was devised as an alternative to the city's current bankruptcy plan for the revenue bonds, which calls for the impairment of nearly 50% of the debt by either stripping out call protection or replacing the current coupon with a lower interest rate.
If the tendered bonds are purchased, the city intends to amend its plan of debt adjustment to treat all the debt as unimpaired, with the untendered bonds continuing to get the scheduled principal and interest payments.
Moody's raised its ratings on the senior lien and second lien by two levels, assigning a Ba2 rating to the senior lien water enterprise refunding bonds and a Ba3 to the second lien refunding bonds. The rating applies to the upcoming sale and existing bonds not being refinanced in the deal.
The action upgrades existing debt by two levels, from B1 and B2, respectively. The new rating remains two and three levels, respectively, in junk territory. The rating agency assigned a "developing" outlook to all the bonds. Moody's assigned the same ratings to the city's sewage disposal system revenue bonds.
Standard & Poor's said its rating is supported by the bonds' legal framework, provisions under the city's plan of adjustment that would consider all DWSD-related bond claims as unimpaired, and an order entered by the bankruptcy court that precludes the city from amending the plan to impair DWSD-related bond claims.
The rating reflects the city's economic distress but more diverse revenue stream from a broader service area, adequate financial performance, high leverage, and upward pressure on rates to fund capital needs.
The bonds are secured by a lien on net revenues of each respective water and sewer system that include user fees, investments and earnings.
Fitch said the expected ratings on the 2014 bonds and change in watch also reflect its belief that the department will achieve steadily improving financial margins going forward.
The systems' funds and accounts are separate from the city with excess revenue invested by the bond trustee at the direct of the water and sewer department. The city has sought to stress the separation, but the investment community looks skeptically on those assertions as most believed the city would not drag the $5.2 billion of revenue debt into its Chapter 9 case given its sturdy revenue pledge.
"This transaction diminishes the risk of an economic loss to water debt bondholders in the near term, though the system's rating is constrained by its ongoing linkage to Detroit as it remains a department of the city," Moody's wrote.
Fitch said the systems' are hurt by weak financial results and a high debt load. The systems' 2015-2019 capital improvement program for water was recently raised by 34% to $674 million and by 9% to $553 for sewer.
The water system benefits from an expansive service area that covers 43% of the state's population and more than 70% of operating revenues coming from wealthier suburban customers. The sewage system covers 30% of state residents with more than 50% of revenue coming from suburban customers.
Moody's attached a developing outlook to the credit to reflect uncertainty over the proposed creation of a new regional authority system to oversee water supply operation. Negotiations are ongoing but creation of the authority would be viewed as a credit positive as it would further separate the city from the enterprise system operations, Moody's said.
The bankruptcy court approved Detroit's tender purchase and refinancing Monday. The deal removes one of the few remaining hurdles to the city's exit from Chapter 9.
