We’ve been very disciplined,” said Detroit’s finance director, John Naglick.

CHICAGO – Long-term pressures continue to weigh on Detroit's recovery, a year after the city emerged from bankruptcy with a healthier balance sheet.

The city marked the one-year anniversary on Dec. 10 of its exit from the largest-ever municipal bankruptcy.

The city has hit fiscal targets laid out in its Chapter 9 Plan of Adjustment, and will soon complete a long-planned shift of its water and sewer debt to a new regional authority.

Detroit's ability to respond to profound economic challenges and attract residents and businesses was helped, but not solved, by the city's elimination of $7 billion of debt through bankruptcy, market participants say.

The city, led by Emergency Manager Kevyn Orr with the support of Michigan Gov. Rick Snyder, filed for bankruptcy in July 2013.

Market perception of Detroit remains tainted by its poor treatment of bondholders, pension burdens loom large, and its school district is struggling with solvency.

"Detroit is on the road to recovery but it would be shortsighted to say it has recovered. Recovery for a distressed municipality like Detroit is better determined five or ten years later and judged by the extent of addressing the systemic problems that lead to the financial distress," said restructuring specialist James Spiotto, of Chapman Strategic Advisors LLC.

Some on the buyside echo that sentiment.

"We believe one year of positive budget results should be placed in perspective against a credit that is still deeply wounded from decades of economic and demographic decline," said Tom Schuette, co-head of credit research at Gurtin Fixed Income.

Schuette said the city must make more progress in sustaining economic growth and repairing failing infrastructure without over-leveraging its tax base, while greatly improving city services without erasing modest fiscal progress.

Moody's Investors Service marked the anniversary with a commentary highlighting both accomplishments and strains. The rating agency in July lifted the city's issuer rating- still deep in junk territory -- to B2 with a positive outlook from B3 with a stable outlook.

"Over the past 12 months, the city's economic and fiscal profiles have improved as indicated by growing employment and updated revenue estimates topping initial projections, both a credit positive," said the report from analyst Matt Butler.

The city's September 2015 unemployment rate of 11.5% remains high but is lower than the 16.3% a year ago. Monthly average employment is up more than 1% in the current year and could benefit from commercial investments planned by General Motors Co. at its Detroit-Hamtramck assembly plant.

The most detailed look at the city's post-bankruptcy finances came in late November from the Detroit Review Commission. The nine-member group was established under the so-called "Grand Bargain" legislation that drove the bankruptcy exit plan and is charged with ensuring that Detroit stays on course by reviewing borrowing, some contracts, and long-term fiscal plans.

Detroit ended fiscal 2015 June 30 with operating revenues up 1% over budgeted projections. For the current fiscal year, revenue is tracking about 3% over budget, according to the city. Based on first-quarter fiscal 2016, the city projects a $35 million budget surplus.

"We are very pleased that revenues are coming in slightly ahead. We've been very disciplined," said the city's finance director, John Naglick.

Naglick also points to progress in removing blight, attracting economic investment, and improving service delivery as the city works to improve its overall economic outlook and retain and attract residents and business.

The city has stepped up the demolition of abandoned buildings and is handing off vacant lots for development. Big construction projects also are underway including a new hockey arena and entertainment district and a residential building near downtown.

The establishment of the Great Lakes Water Authority, expected to launch in January, also marks an achievement for the city.

The plan of adjustment set in motion the establishment of GLWA after years of stalled efforts. Under the 40-year lease agreements, GLWA will assume responsibility for regional water and sewer infrastructure while the city will maintain responsibility for local water and sewer infrastructure.

Holders of the city's $5 billion of water and sewer debt recently gave their consent to the shift and key legal documents and contracts have been finalized paving the way for the authority to launch in January.

The lease calls for the GLWA to make an annual $50 million contribution to finance capital improvements and debt service and fund assistance programs. "It truly is a win-win as the city gets the lease payments to improve infrastructure," Naglick said.

The city is also hoping that the state's impending takeover of processing for individual income tax returns will generate more revenue through increased compliance.

The city in February will hold its second formal consensus revenue estimating conference of the fiscal year and in March will present its four-year fiscal plan to the commission. The city anticipates completing its comprehensive annual financial report also in March.

PRESSURES

Pension obligations and remaining debt pose challenges to the city's balance sheet recovery.

"The city's debt service, even after the debt relief provided in the plan of adjustment, remains substantial," the commission report said. The city is required to provide quarterly debt service reports to the FRC certifying its ability to meet its obligations through the fiscal year. The last tranche of current city debt matures in fiscal year 2044, and the current annual debt service requirements through fiscal year 2025 average $147.4 million.

While Detroit's bond debt is known, its pension costs are cloudier.

After 2023, the city will draw from its general fund to cover pension obligations. When it exited bankruptcy a year ago, actuarial estimates in the city's Plan of Adjustment projected a payment of $111 million in 2024. In November, the system's actuary raised the figure to $194.4 million. The fiscal commission report says the big leap was due to changes in mortality tables and a differing effective date of the exit plan and pension plan amendments.

"It is important to understand that many changes in the projections will occur over the next few years and these changes may be positive or negative," the commission report said.

Naglick said the city intends to engage a consultant next year to look at funding options.

"In the absence of substantial economic expansion and revenue growth, the requirement to resume funding pensions from general operations risks posing serious financial challenges for Detroit," Moody's warned.

Oversight also remains central to keeping the city on track as city finances have little room to veer, Spiotto said.

"Detroit will benefit from continued monitoring and recovery assistance to help it help itself and provide moral support in doing the right things. While all hope the road to recovery will be smooth, there may be some bumps," Spiotto said.

MARKET ACCESS

"The city doesn't have any borrowing plans over the next several years," Naglick said.

That's probably a good thing, market participants said, given lingering resentments that will force steep premiums from the city for years to come. In bankruptcy, Detroit became the largest city to default on unlimited tax general obligation bonds. Detroit eventually settled with ULTGO insurers for a 74% recovery rate.

"This is not a credit that we would consider at this point and we suspect that many in the market will continue to view Detroit as a speculative grade name and choose to sit on the sidelines," Schuette said. "However, there will be those willing to see sufficient progress in the year since bankruptcy to chase the higher yield that any Detroit deal would inevitably offer."

The resentment has spilled on to other distressed credits.

"Market perception is only hardening that Detroit's bankruptcy was an overtly political restructuring that favored art patrons, local businesses, and employees over bondholders," said Matt Fabian, partner at Municipal Market Analytics. "There is little trust that any new Chapter 9s would be any better, so any whiff of bankruptcy talk—as in Chicago, Atlantic City, and Puerto Rico—is enough to capsize that city's bond prices."

Detroit paid a steep yield penalty on its first post-bankruptcy bond sale in August despite a statutory lien provision that landed the deal an investment-grade rating. The $245 million of local government loan program revenue bonds were sold through the Michigan Finance Authority with most of the proceeds going to repay its bankruptcy exit loan from Barclays.

The deal was rated A by Standard & Poor's, which still rates Detroit itself deep in speculative-grade territory. The tax-exempt series was priced with yields that landed 194 basis points over the Municipal Market Data's top-rated benchmark and 133 basis points over an A-level credit. The $110.28 million taxable series was priced about 300 basis points above the comparable Treasury security.

LESSONS

Detroit's bankruptcy contributed to the burgeoning debate over the potential cracks in general obligation pledges and the use of statutory liens for GO bonds to strengthen bondholders' positions in a municipal workout.

Legislation offering GO bondholders a statutory lien is pending in Michigan.

Similar legislation was been approved in California, New Jersey, and Rhode Island.

Supporters of the Michigan legislation say that without it the state's local governments will continue to pay a market penalty for Detroit's move, and that a statutory lien would mean savings for taxpayers.

The legislation would bolster recoveries after a default and could better investors' regard for local government credits, but it won't help stave off the risk of default, Fitch Ratings said in a report on the Michigan proposal.

Municipal experts continue to stress that bankruptcy is no panacea.

Spiotto said no city, county, town or village has filed for Chapter 9 bankruptcy since Detroit other than the small city of Hillview, Kentucky, which filed in August.

"This demonstrates that Detroit has been a lesson to other municipalities that Chapter 9 should be the last resort when all other alternatives have failed and rarely used," Spiotto stresses. "This is due to the fact that Chapter 9 is time consuming, expensive, uncertain, has a stigma and consequences that are not helpful and generally does not produce the results that were desired."

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