Detroit's credit strength is tied to healthy reserves

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Detroit’s deliverance from state oversight is positive but the city’s ability to sustain strong reserves will be a key credit factor going forward, according to S&P Global Ratings.

The rating agency said in a report Wednesday that Detroit’s reinvestment in its tax base will drive economic recovery, but healthy reserves are crucial to addressing looming increases in debt and pension expenditures.

“In our view, continued maintenance of very strong reserves will be a significant credit factor for the city, S&P said.

In December, S&P Global Ratings upgraded the city’s issuer credit rating to B-plus, deep in speculative-grade territory. The outlook is stable.

On Monday the Detroit Financial Review Commission unanimously voted to waive active oversight of the city. The city now has the power to enter into contracts and enact city budgets without seeking state approval.

The FRC's decision to scale back oversight was triggered by three consecutive years of balanced budgets along with three years of projected balanced operations.

Much of Detroit's improved budgetary performance was made possible by shedding some fixed costs during bankruptcy, including debt service and retiree costs for pensions and other post-employment benefits.

S&P said that the increase in these fixed costs could pressure operations for the city going forward.

The city has done a number of things to plan ahead for those challenges.

It has put aside money in a Retiree Protection Fund to meet an increase in pension payments of nearly $100 million more than initial post-bankruptcy estimates beginning in fiscal 2024.

The city has also worked on a strategy to deal with a scheduled escalation of debt service payments.

On April 13 Detroit redeemed $52.3 million of principal and $2 million of accrued interest remaining on its general obligation limited tax Series 2014C financial recovery bonds. By using fund balance to pay off this debt, the city freed up about $10 million in annual spending.

“From now on, the city's challenge will be to manage these rising costs in relation to economic growth, and the costs the city incurs to support growth,” S&P said.

Aside from using accumulated fund balance, the city's remaining capital budget is almost entirely funded through annual operating revenues. The city projects ending the current fiscal year with an operating surplus of $36 million, marking the city’s fourth straight budget surplus since exiting bankruptcy.

The $2 billion balanced budget maintains more than a 5% reserve that is projected at $62.3 million. The city’s general fund — budgeted at $1 billion — continues to do well because of strong income tax revenues.

Under the terms of the waiver, the FRC will continue to meet monthly to review city reports, and it will vote annually for the next ten years on the oversight waiver. Should Detroit revert to deficit spending, fail to meet outlined pension contributions, or show signs of fiscal distress, the FRC would have the authority to rescind its waiver.

“We view the addition of the RPF funding plan to the waiver determination as a positive development, as even though the RPF funding is still not legally required, failure to adhere to the plan could trigger a return to full oversight,” S&P said.

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