Detroit looks ahead, five years after Chapter 9 exit

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Five years after exiting its landmark Chapter 9 bankruptcy case, the city of Detroit is on track to post a fifth balanced budget and grow its rainy day fund, evidence that it continues to tread a fiscally responsible path.

As the city looks ahead to the next five years, it needs to be ready for an economic contraction, the city's CFO, Dave Massaron, said in an interview. The goal, he said, is to position Detroit to keep spending within its revenues while maintaining services at a level that allows the city to continue to grow.

“At the end of the day, when people focus on the bankruptcy and the five years out, a lot of people will focus on just the balance sheet, but what we have to remember is that over 200,000 people left the city between 2010 and 2013,” Massaron said. “They left because the city had a service insolvency.”

A recent report by Moody’s Investors Service listed Detroit as of one of two of the weakest big cities in the U.S. when it comes to preparedness for a recession. Chicago was the other.

Moody’s rates Detroit's general obligation bonds Ba3, three notches below investment grade. 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. They assign stable outlooks.

“The debt burden is still above average even after the deleveraging in bankruptcy,” Moody’s analyst David Levett said. “That is something that weighs on the credit profile given that there are still capital needs on the tax base.”

Massaron said that the Moody’s report shouldn’t come as a surprise.

“The city went bankrupt five years ago; coming out of bankruptcy the plan of adjustment is a 10-year plan,” he said. “So there is a 10-year journey to get back into a position where the city has the same level in strength in its credit as other cities.”

To that end the city continues to build up its rainy day fund. Mayor Mike Duggan’s administration intends to propose a budget that makes an additional deposit into the fund in fiscal 2020. The city has doubled the size of its rainy day fund to better prepare for any economic downturn — the fund is now about 10% of the general fund, up from 5%.

The city had a general fund balance of $611.2 million at the end of fiscal 2018; it reported a $73 million total fund deficit at the end of fiscal 2013. Fiscal 2019 fund balance expected to be larger, pending completion of the audit.

Moody's in its report recognized Detroit's progress in the last five years. The rating agency said the city has taken steps to prepare for a potential downturn: establishing an irrevocable trust to smooth spikes in pension contributions, developing a capital improvement plan that identifies a variety of sources to finance capital investments, and continuing to increase its already strong reserves.

The steps "are all positive" for the city's credit profile, according to Moody’s. "If these trends continue, Detroit’s overall preparedness for a future recession will be more in line with major city peers," Moody’s analysts wrote.

“The sobering part of the report is that it reminds us of all the work that is left to do,” Massaron said.

Starting about 2026, the city's expenditures will exceed revenues, according to the city’s fiscal 2020 long-term forecast report. Massaron said that the key to avoiding that problem is economic growth and development.

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.

It's a different story in other parts of the city.

Massaron said that city has built a baseline budget to provide those services and remains on pace to achieve its $1.7 billion spending goal for city services by the 10th anniversary of its bankruptcy exit. The city’s investments have helped improved tax collection to over 89% in fiscal 2019 from 69% in fiscal 2014.

“That is what we have to continue to work for,” Massaron said. “At the end all of these service improvements we have made need to last through the highs and lows in order to make the city long-term financially stable.”

This focus is also the way the city is going to be able achieve a second goal: getting its bond ratings back to investment grade, according to Massaron.

“The way we think we will do it is if we continue to make investments in city services, infrastructure and in the residents that live here,” he said. “We are going to continue to make targeted investments in an efficient way so we can build our tax base and get back there.”

Blight reduction, he said, is a necessary precursor to increasing taxable values in outlying neighborhoods.

“The city has definitely made strides in terms of services so I think capital is the next piece after addressing service needs,” Levett said.

The Duggan administration failed to gain city council approval last month to put a $250 million blight bond on the March ballot, but Massaron said the city plans to continue to work on a bond proposal.

“It is incumbent upon the administration to design and develop a proposal that meets the concerns of council and we haven’t done that yet,” Massaron said. “The fact that we have market access, and we proved that last December, is a good way for us to fund capital going forward and way for us to fund other blight-related activities.”

The bonds would have been sold on the city’s own credit and would be repaid with an existing 9-mill property tax over about 30 years. Massaron has said the city's improved credit profile allows it to borrow.

Another challenge comes in 2023, when Detroit must start making full yearly contributions toward two city retirees' pension funds. Rating agencies and municipal analysts have said this scheduled spike in pension payments is the most material credit pressure facing the city.

The 2014 plan of adjustment Detroit used to exit bankruptcy froze the city's legacy pension plans and provided an initial funding infusion from the so-called "grand bargain" funded with help from the state and private entities. The city received a funding holiday, but payments resume in 2024.

"The city has fairly significant fixed costs with pension payments and that is something they will have to absorb in their budget," Levett said. "It’s something they have done a lot of planning around so they have a strategy."

The city is putting aside money in a Retiree Protection Fund to meet the increase in pension payments of nearly $100 million more than initial post-bankruptcy estimates beginning in fiscal 2024. That fund is on track to grow to over $335 million by 2024 and will provide a buffer to increased contributions beginning then.

“We know there will be a greater need in the future for payments because we did not meet the actuarial measuring plan of adjustment rate of return [of 6.75%],” Massaron said.

Massaron said the retirement systems have not yet established funding policies for the annual required contributions that resume in fiscal 2024.

“Depending on amortization period selected the obligation of the general fund may increase in 2024 and if that happens the city will have to set aside more funding so that it’s in position to meet that obligation,” he said.

Along with accelerating the timeline for the city’s blight removal program, the blight bond would have also freed up the general funds dedicated to blight abatement for the retiree fund.

The city accessed the bond market on its own credit at the end of last year with a $135 million junk-rated deal. The new money unlimited tax general obligation bonds are part of $225 million in tax-exempt borrowing the city council authorized. Massaron said the city is evaluating progress on capital projects the bonds fund to determine when remaining bonds from the authorization will be issued.

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