Detroit cites latest balanced budget as a mark of continued fiscal progress

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Detroit’s approval of a fourth consecutive balanced budget since exiting bankruptcy in late 2014 — and its first since leaving direct state oversight — offers evidence the city is staying on a course toward fiscal recovery.

How soon the city's gains translate into a restoration of investment-grade ratings remains far from clear.

The City Council early last week approved a 2020 fiscal year budget and has socked away $45 million in surplus revenue to fund post-bankruptcy pension obligations coming due in five years.

Moody’s Investors Service called the $2.1 billion spending plan for the fiscal year that begins July 1 a "credit positive" for Michigan's largest city more than four years after it emerged from what was then the largest municipal bankruptcy in U.S. history.

The rating agency rates the city’s general obligation bonds Ba3, three notches below investment grade, and last upgraded the city nearly a year ago. S&P Global Ratings in February upgraded the city’s general obligation ratings to BB-minus — also three notches away from investment grade — from B-plus.

"The credit-positive budget reflects sound financial practices, including conservative revenue assumptions and long-range projections, a significant capital investment and continues to set aside funds for a scheduled pension cost spike in fiscal 2024," Moody's analysts wrote in a note published Thursday.

Fitch Ratings and Kroll Bond Rating Agency do not rate Detroit, but Kroll rates the city’s development authority bonds BBB-minus, the lowest investment grade, with a stable outlook. The bonds are secured by two property tax increment revenue streams from a district that encompasses much of Detroit’s most valuable real estate including the city’s downtown central business district.

Karen Daly, a senior managing director at Kroll, said she follows the economic conditions and underpinning of the city because of the impact it could have on the development authority’s bonds. She said that the budgets presented since exiting bankruptcy and the financial improvement made under Mayor Mike Duggan’s administration show how much headway the city has covered in a short time.

“It is clear that the city has turned a corner,” Daly said.

The city was given back control of its finances last April. The release of active state oversight came after the city met the requirements of posting three consecutive balanced budgets, though the state's Financial Review Commission, which is responsible for oversight of the city and the Detroit Public Schools Community District, will meet every year for the next decade to determine whether the city should continue having local control. After 10 consecutive years of annual waivers, the commission dissolves.

“This is the first budget that was done without active FRC oversight, and in that first budget it’s gratifying that Moody’s within a couple of days recognized that the budget continued the financial turnaround of the city,” said Dave Massaron, the city’s interim CFO.

The goal, Massaron said, is to get Detroit back to investment grade. “At this point it’s a little too early to tell when that might be,” he said.

Massaron said that the city has nearly doubled the size of its rainy day fund, and plans to make deposits into the fund so that it is able to weather an economic contraction.

“Right now we are fairly confident in the strength of our revenues, but we will continue to monitor them and we are fairly confident that the state and the investment it made in the Grand Bargain [deal to end the city's bankruptcy] will continue to fund revenue sharing at the levels it was projected to at the time of the Grand Bargain,” Massaron said.

Daniel Berger, a senior market analyst with TM3/MMD and Refinitiv, said that since the city issued $135 million of unlimited tax general obligation bonds in December — its first standalone deal since its 2013 bankruptcy — there has not been a trade for more than $1 million on Detroit GOs. The city has issued other deals post-bankruptcy supported by a state aid intercept.

A recession is definitely not going to be the city's friend, said Tom Kozlik, an independent municipal analyst. “The city needs to concentrate on building up its tax base,” Kozlik said. “That is a surer road to stability. I know that is much easier to write than to execute.”

The fiscal 2020 budget uses reasonable revenue assumptions, which is crucial because Detroit's primary revenue streams are sensitive to economic trends. The city’s top revenue sources are income taxes, wagering taxes from casinos and state-shared revenue.

Kozlik said that short-term the iterative fiscal gains that the city can make are steps in the right direction.

“The key, from a credit or rating perspective, is if they can hold up in the medium to long term," Kozlik said. “Or, are those gains sustainable? Sustainable gains will let the city to earn upgrades and hopefully keep the higher ratings.”

James Spiotto, a municipal bankruptcy expert and managing director of Chapman Strategic Advisors, said how Detroit tackles the challenge of economic development beyond the city’s downtown and midtown areas and into its neighborhoods is central to a full recovery. One of the key benefits of growth is that an increased tax base translates into economic gains to support recovery efforts.

The city has budgeted to use more than $100 million of assigned fund balance for capital projects and blight remediation in fiscal 2020.

“Detroit has to stay the course and constantly be improving on everything that they have done,” Spiotto said. “They have done the initial part coming out into recovery, but now that they are in recovery mode they need to increase the efforts. Businesses don’t move into areas where education and employee population isn’t well-educated for what they need. You need to encourage that by demonstrating it and it is going to take effort and dedication.”

That sort of change normally comes 10 to 15 years post-bankruptcy, Spiotto said.

An influx of affluent residents and large-scale developments has transformed Detroit's downtown. The core downtown, which accounts for just 6% of the city’s population, has added almost 1,000 residents since 2010 and the greater downtown area has added about 9,000 residents, according to Moody’s. Also contributing to income tax growth is improved administration and enforcement of collections.

That downtown growth has not spread throughout the city, Moody's said in a November report. It estimates Detroit has lost about 35,000 residents since 2010.

Spiotto believes that the city’s bankruptcy puts it in a unique position after shedding some $7 billion in debt.

“Removing urban blight becomes easier when you are in recovery mode after you have gone all the way down," he said. “They now have land that can be developed into new businesses and it can link those new businesses, whether it is manufacturing or high tech, to its community colleges and high schools."

“They have areas that can be easily turned into areas of economic development because of the blight that is to be removed. They have real potential, but that potential has to be realized and you have to stay the course and you have to keep on going at a greater and greater pace to accomplish what you want," Spiotto added.

Frank Shafroth, director of the Center for State and Local Leadership at George Mason University, said the city’s economy is diversifying and the state government better recognizes the city’s ongoing recovery is essential to Michigan.

“When a city has been down as far as Detroit, it has great incentives to ensure that does not happen again; and I think we are going to see more families moving back into a city relatively unique with regard to its reliance on income taxes,” Shafroth said.

Spiotto believes that when the next downturn arrives, liquidity is going to become a real issue for Detroit and other cities like it.

“The reason why liquidity is a problem for a recovering municipality is because people, if they don’t have the money, can’t move there and they can’t pay their taxes so you have to be careful that you have the right programs up and that you are continuing your upswing," Spiotto said.

The future belongs to cities that invest in business development, particularly high-tech and the "sharing economy," he said.

“Those municipalities that do that, they are going to wind up staying in investment grade and those that don’t will drop,” Spiotto said. “Spreads might very well widen especially if liquidity becomes tight.”

Detroit's fortunes are also tied to its public schools. Detroit Public Schools Community District Superintendent Nikolai Vitti said last week the district is close to shedding financial oversight after nearly two decades of state control and supervision.

The district has been under the oversight of the commission since 2016, when Michigan lawmakers approved a $617 million plan to create the new district to educate students and leave the old district — Detroit Public Schools — as a legal structure that exists only to pay off debt.

Vitti said the new district is already eligible to issue municipal securities or debt obligations, complies with state laws regarding local government budgeting, and makes all payments to the state’s school employee retirement system — three conditions it must meet to regain local control. The district is also required to approve balanced budgets three years in a row. It has already had two consecutive years of balanced budgets and is on track for a third.

“The audit in November will confirm if the district adhered to the budget and remained balanced,” Vitti said.

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Budgets Speculative grade bonds Detroit bankruptcy City of Detroit, Michigan