CHICAGO -- Fitch Ratings Tuesday knocked Detroit’s Downtown Development Authority into junk-ratings territory.

The action comes with the authority expected to take a central role in financing a $650 million sports and entertainment complex.

Fitch downgraded $63.5 million of outstanding tax increment debt to BB-plus from BBB-minus, and another $4 million of junior-lien bonds to BB from BB-plus. All the bonds were issued in 1998.

The downgrade reflects thin and declining debt service coverage levels that could force the authority to dip into its reserves this year, Fitch said.

The authority’s captured value is expected to decline nearly 6% in fiscal 2014. It also remains uncertain whether the city of Detroit itself, which is in the midst of the largest municipal bankruptcy in American history, will make its future tax increment remittances, the ratings firm said.

The development authority’s boundaries encompass the core of Detroit’s downtown, where the authority captures incremental tax revenue growth from some of the city’s largest taxpayers, including General Motors and the stadiums for the Detroit Tigers and Detroit Lions.

It also includes the site of a controversial proposed $650 million hockey arena and adjoining 45-block entertainment district that would be financed in part with a $450 million private activity bond deal.

Despite the DDA’s strained balance sheet, the additional debt is expected to come from a different pledge and remain separate from outstanding debt, Fitch analyst Amy Laskey said.

“Our understanding is [the $450 million new debt] is not going to be on a parity lien with the 1998 bonds,” Laskey said in a telephone interview. “The additional debt would not use the revenues pledged to the bonds that we rate.”
The DDA’s existing debt is secured by a pledge of tax increment revenues captured in the area except for those revenues captured for school district purposes.

The new debt for the hockey arena would be secured by the school district capture, according to Fitch. The new bonds would also have a junior lien on tax increment revenues. No debt service is anticipated until 2019, according to Fitch.

The DDA’s existing debt is also secured by cash-funded debt service reserve. The authority may have to use a small amount of those reserve funds for payments on the $4 million junior-lien debt, analysts said.

Fitch believes the DDA is insulated from Detroit’s bankruptcy, noting that emergency manager Kevyn Orr’s June 14 proposal for creditors treats DDA bonds as special revenue debt under Chapter 9 of the bankruptcy code.

“Fitch takes some comfort from this, as tax increment revenues are specifically cited as special revenues in the code,” analysts said in the report. “The city remitted the most recent tax payment in June, however, Fitch believes there is a remote possibility that the city will delay future tax increment remittances, which could be cause for negative ratings action.”

Debt service coverage from pledged revenue fell to “very thin” levels of 1.17 times for senior lien maximum annual debt service and 1.06 times for combined senior and junior debt in fiscal 2013, Fitch said.

Part of the problem was a $2 million loss from a tax appeal settlement with GM, but Fitch said it expects captured value to fall another 5.8% in 2014. On the plus side, the development authority has healthy cash balances and is fully reserved against a $33.6 million loan it made to the city that Orr is treating as unsecured. Fitch said the decision to reserve against the loan adequately protects the DDA from a city default.

Analysts also said they believe the district’s captured value will stabilize after fiscal 2014.

The proposed $650 million sports and entertainment district, being pushed by Gov. Rick Snyder as a way to boost downtown Detroit revenues, would feature a new 18,000-seat arena for the Red Wings hockey team as its anchor. The stadium carries a $450 million price tag. The entertainment district is estimated to cost $200 million.

The city would partner with Olympia Development of Michigan, a real estate company owned by the Illitch family, which owns the Red Wings, baseball’s Detroit Tigers, and the Little Caesars pizza chain. The new district would connect a section of the city’s downtown with its midtown.

The project is estimated to include $365.5 million of private dollars and $284.5 million of public funds.

The bonds would be backed by a pledge of the downtown development authority to set aside for debt service at least $12.8 million but not more than $15 million a year. The DDA pledged to contribute up to $62 million over 30 years in revenues in addition to those pledged for the bonds to support the additional projects.

Olympia Development would make an annual payment of $11.5 million. Wayne County also may make a contribution.

The city, the Economic Development Corporation of the City of Detroit, and Olympia would transfer land to the downtown authority for the project.

The DDA would own the arena and enter into a 35-year concession agreement with Olympia to manage and operate the complex.

Olympia would be responsible for any cost overruns.

If Wayne County contributes, the authority may transfer its ownership to the Detroit/Wayne County Stadium Authority or another entity, according to documents filed with the strategic fund.

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