Michigan relinquishes Detroit oversight, allowing city to forge its fiscal path

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The end to Michigan's direct oversight of Detroit's finances is a milestone in the city's recovery from bankruptcy, giving it autonomy to manage fiscal fortunes that remain pressured by debt, pension, and economic development challenges.

With the city having met the requirement of posting three balanced budgets, the state's Detroit Financial Review Commission unanimously voted Monday 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 first.

“This is a day we hoped would come but nobody knew it could come this quickly,” Detroit Chief Financial Officer John Hill said Monday.

State officials praised the city for fiscal gains that came quicker than many anticipated after its Chapter 9 exit in December 2014. The city shed $7 billion of its $18 billion in debts during the 18-month bankruptcy.

“The progress the last few years has been amazing. I am confident the city is on a continued path of balanced budgets, improved services, and paying down long term debts," said State Treasurer Nick Khouri, a member of the review commission.

But the praise is tempered by looming fiscal strains led by a spike in pension and debt payments beginning in 2024 that will require discipline to manage and the need to expand economic development throughout the city. The city's ratings remain deep in junk territory and while the commission won't have a say over city finances, it does remain passive but intact.

Hill said that Detroit must continue to present monthly information to the commission so that it may continue to monitor the city’s fiscal health and ensure that the city continues to meet the conditions for waiver.

“The path of monitoring, assuming that we don’t go back to active oversight, is a ten-year period,” said FRC Executive Director Kevin Kubacki. Pension and debt service are two areas the FRC will monitor in its passive mode.

Those fixed costs pose the “main risks to the city’s long-term fiscal stability,” Moody's Investors Service said in a report issued after the vote. Moody's assigns Detroit its B1 issuer rating, with a positive outlook.

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

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

When the city exited bankruptcy at the end of 2014, actuarial estimates in the city's Plan of Adjustment projected a payment of $111 million in 2024. In November 2015, the system's actuary raised the figure to $194.4 million.

The city has also worked on a strategy to deal with a scheduled escalation of debt service payments tied to $1.28 billion of borrowing the city closed on in December 2014 to fund creditor settlements and raise funds for revitalization efforts, paving the way for its exit from Chapter 9.

General obligation debt service costs were scheduled to rise to $161 million in fiscal 2021 from $132 million in fiscal 2017.

“Clearly increasing our revenue was important to getting to the point where we could meet those payments but also reducing those costs if we can,” Hill said.

Detroit’s income-tax collections rose 8% in 2017, while rising home prices this year lifted the assessed value of property for the first time in at least 17 years.

The cost reduction came April 13 when 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. The redemption reduces the city’s annual debt service by $10 million beginning in 2019 and reduces growth in debt service to 15% from 23% between fiscal 2017 and 2021.

Moody's analyst David Levett described the bond redemption as a mild credit positive. “The redemption is yet another step toward strengthening the city's financial operations,” Levett said.

“There is still more to be done and this is something we will be working on over next several years, to make sure we can meet those hurdles in 2025 and beyond,” Hill said. “Should we be able to substantially change our debt structure, which is what we are working on now, it will make it that much easier for the city to remain in balance for at least a decade.”

Bond market access on its own, without state enhancement, remains elusive but is on the city's list of goals. Ongoing fiscal strides will help with ratings and eventually get the city to a place where it can access the market on a standalone basis, Hill said.

“We believe that there will come a time when the city will want to issue its own general obligations in order for it to be able to fund its capital,” Hill said. “Right now we are funding capital to a large extent that would be funded by debt with surpluses. A normal city would use its GOs.”

The commission's waiver marks a meaningful step on the city’s road to recovery, said Tom Schuette, partner and co-head of the Investment Research & Strategy department at Gurtin Municipal Bond Management.

“I also think there are a lot of municipal investors that will need to see a longer track record and stronger evidence of an economic and demographic recovery before buying the city’s debt,” Schuette said. “I would say a necessary step on the path, but still a long road to go.”

Lisa Washburn, an analyst at Municipal Market Analytics, said Detroit has yet to test its resilience against an economic downturn. “There is little room to really weather a downturn at this point,” Washburn said. “They have limited reserves.”

Washburn is also concerned that the city’s recovery hinges on following the current plan in place. “To the extent that there is a leadership change that could be a risk,” she said.

Then there is the fact that the city’s regeneration has really been focused on a small area of the city’s downtown and midtown areas. There are signs that it's beginning to broaden to other neighborhoods but Washburn’s says that the city’s outer neighborhoods suffer from very high poverty rates and haven’t received the same level of attention. “Elevating those areas will be critical to the overall health of Detroit,” Washburn said.

According to Frank Shafroth, director of the Center for State and Local Leadership at George Mason University, the city is fiscally unique because more than 20% of its revenue comes from a municipal income tax versus 17% from property taxes. The city levies the highest city income tax in the state at a rate of 2.4% on residents and 1.2% on nonresidents.

“That means the Motor City cannot fiscally rest: as in Chicago, city leaders need to continue to work with the state and the city’s School Board to improve the city’s public schools in order to attract families to move back into the city," Shafroth wrote on his blog. He said the city is doing so in the face of a Republican-controlled Congress and administration that aren't interested in supporting cities. "So Detroit is not competing on a level playing field," he wrote.

Detroit was the last Michigan city still under a form of state oversight. It's been under some form of federal or state oversight since 1977, beginning with federal court-ordered oversight of the Detroit Water and Sewerage Department.

“For the first time in four decades, Detroit’s elected leadership will be in complete control of government functions,” said Mayor Mike Duggan in a statement. “Thanks to the outstanding team we’ve assembled here at the city, the leadership of our partners on Detroit City Council and our hard working city employees, Detroit is once again finally a city of full self-governance.”

The city has since posted three consecutive years of balanced budgets and operating surpluses. It expects to end 2018 with a $36 million operating surplus and says it has created a 10-year budget forecast to "ensure continued stability."

The city’s bond ratings, though still deep in junk territory, were upgraded last year. In December, S&P Global Ratings upgraded the city’s issuer credit rating to B-plus. The outlook is stable. Moody’s upgraded Detroit one notch from B2 in October.

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