CHICAGO — Moody's Investors Service Monday knocked down its rating on $4.6 billion of Detroit water and sewer debt by three notches, a move the agency said reflects the risk that the city will default or file for bankruptcy.
The possible forced termination of interest-rate swaps hedging some of Detroit's debt as well as a piece of the sewer debt poses another problem, analysts said.
The debt remains on watch for further downgrades.
The move comes less than a week after Detroit and the state of Michigan signed a historic consent decree to avoid an emergency takeover and to try to stabilize the cash-strapped city's fiscal position.
"While the agreement tempers the immediate threat of a Detroit bankruptcy, the city's finances have continued to deteriorate," Moody's analyst Ted Damutz said in an email to The Bond Buyer.
"This heightened risk, added with the fact that bankruptcy is not yet off the table, has raised the risk to water and sewer bondholders and are thus reflected in our new rating."
Moody's cuts its rating to Baa1 from A1 on the senior-lien water and sewer debt and downgraded to Baa2 from A2 its rating on the second-lien water and sewer bonds.
The ratings remain on review for another downgrade pending Moody's review of the consent agreement, among other factors.
The water and sewer systems are owned by Detroit but are operated as separate enterprise funds. Most of their customers are from outside the city.
But the assets could still suffer fallout from the city's fiscal problems, Moody's said.
"We cannot rule out the possibility of the systems getting caught up in a city bankruptcy," Genevieve Nolan wrote in the downgrade report.
Three weeks ago, Moody's hit Detroit with a two-notch downgrade on its general obligation bonds, pushing the city's GO debt rating to B2, and keeping the credit on review for potential downgrade.
That downgrade triggered a termination event under the terms of interest-rate swaps that hedge some $800 million of certificates of participation issued in 2005 and 2006.
The termination event poses another risk to the water and sewer bonds.
"Both systems could possibly be liable for some portion of the city's liability," Nolan said.
Interest-rate swaps also hedge a chunk of the sewer system bonds, and those swaps had termination events triggered last December when Gov. Rick Snyder appointed a state team to review the city's finances.
Moody's said the city hopes to head to market within the next 60 days to generate proceeds to voluntarily terminate some or all of the sewer-bond swaps.
As of March 27, the negative valuation of the swaps totaled $278 million.
Moody's put Detroit's water and sewer debt on review for possible downgrade last December, a week before the city entered the market with nearly $500 million of water and sewer bonds. The city used $210 million of the proceeds to shed what had become costly interest-rate swaps.
Standard & Poor's maintains A-plus and A-minus ratings on the senior-lien and subordinate-lien water and sewer bonds. Fitch Ratings has an A and A-minus rating on the debt.
