February 11, 2019
Good Morning! In this morning’s eBlog, we report on the Motor City’s ongoing fiscal recovery from the nation’s largest chapter 9 municipal bankruptcy, as it has succeeded in stabilizing its fiscal situation—even as it is not wholly yet out of the fiscal woods.
Taking the Fiscal Checkered Flag. The Motor City, which exited from state oversight at the end of last April, after Michigan’s Financial Review Commission, set up in 2014 to serve as a fiscal monitor of Detroit, voted unanimously to end its oversight of a city that officials said has been under some form of outside supervision since 1975—a vote which came after Detroit ran three years of budget surpluses—and marked the phenomenal fiscal achievement of eliminating some $7 billion of accumulated debt. No one had anticipated such a swift exit that demonstrated such a reversal of the city’s long economic, fiscal, and population decline that pushed it into a record-setting chapter 9 municipal bankruptcy—or, as Mayor Mike Duggan noted: no one expected Detroit to move out-of-state supervision within three budget years, the soonest time available. The city’s recovery was, indeed, phenomenal according to Mayor Mike Duggan. The scale of the recovery was illustrated by S&P Global Ratings’ upgrade last Thursday to BB-minus from B-plus in recognition of its stabilizing fiscal picture—an upgrade to stable, which still leaves the city three notches away from investment grade. While the upgrade was not small, it marked still another step of recognition of the city’s fiscal turnaround—and the biggest step since, last April, Detroit emerged from ns bonds. The outlook is stable. S&P analyst John Sauter wrote: “The one-notch upgrade to Detroit’s GO rating reflects our view of the city’s stabilizing financial position, whereby we feel it is well situated to absorb increasing pension commitments and scheduled increases in debt service in the coming years, as well as possible revenue setbacks, while still sustaining year-to-year budget balance and very strong reserves.”
The upgrade, while small, is the latest signal of the turnaround afoot for Michigan’s largest city, whose fortunes were once tethered to the automobile industry. Last April, the Commission, created in 2014 to act as a fiscal monitor/overseer of the Motor City, had voted unanimously to end its oversight of a city that officials said has been under some form of outside supervision since 1975—with the vote coming after Detroit achieved three years of budget surpluses—an exit which Mayor Mike Duggan noted was an achievement no one had anticipated: “I don’t think anybody expected us to work together so well: This has been a great collaborative effort.” In a city more dependent on income than property taxes, the city’s income-tax collections rose 8 percent in 2017, while assessed property values rose for the first time in seventeen years. Indeed, Michigan State Treasurer Nick Khouri, in the wake of the vote, noted: “There’s much to do, but much has been accomplished over the last three and a half years: The progress has been nothing but amazing.” Nevertheless, Detroit Chief Financial Officer John Hill, in an interview prior to the Commission vote, noted the Commission will still continue its fiscal reviews, because it will be required to formally waive its oversight annually for the next decade. He also noted that the city may not resume its issuance of general obligation bonds for another two to three years.
Sandy Baruah, President and CEO of the Detroit Regional Chamber, a business group, reported that investment has increased, because the private sector is “voting with their feet” and checkbooks, noting: “When I moved here in 2010, downtown was pretty much dead all the time…Now it’s pretty much vibrant all the time. It’s a pretty significant change.”
While parts of Detroit are thriving, others are still economically depressed and crime-ridden, according to Luther Keith, the Executive Director of Arise Detroit, a neighborhood community group, who noted there are still a “significant number” of residents who feel the progress has not come to their block, because the improvements are not as widespread as they should be—or, as he put it: “We have not recovered…We have not completed the comeback. We are coming back. There are signs of that, but we still have huge, huge issues that we are confronting, but we are moving the needle in the right direction.’’
Steps for Municipal Fiscal Recovery. A key physical and fiscal challenge going forward will be the focus on blight revitalization in neighborhoods abandoned as families left the city for its suburbs—challenged by fear of crime and a dysfunctional public school system. When I was in the city on the morning it filed for the nation’s largest ever chapter 9 municipal bankruptcy, I was warned that trying to walk from my downtown hotel to the Governor’s Detroit offices—a distance of less than a mile—would be too dangerous. It was a walk past abandoned homes and empty buildings, with the abandoned homes a lure for looters. Although the crime rate has decreased, Detroit still ranks as one of the most dangerous cities in the country; notwithstanding the city’s recovery, in a city uniquely dependent on municipal income taxes, more than one-third of the city’s resident (approximately 34.5%) were still below the federal poverty level in 2017—a level, however, which marked a slight decline from the previous year; the child poverty level, however, remained at the exceptional level of 48%–a level with stark implications for the city’s public school system—and for attempting to be a magnet for young suburban families thinking about moving into the city, nearly a 20% decrease. While only a slight change from 35.7% in 2016, the rate is down from about 41% five years ago. Gabe Diederich of Wells Fargo Asset Management, noted: “The city is continuing on a step ladder toward improvement; that is a very good thing for their citizens, and, I think, investors…but the economic conditions in Detroit, while improved, still don’t convey material strength: While the core has gotten better, you still are surrounded by a ring of pretty distressed areas.” But the Dean of chapter 9 municipal bankruptcy, Jim Spiotto, notes Detroit needs to continue its focus and energy on fiscal responsibility: “You’ve got to stay the course: You’ve got to keep fiscal responsibility as a key issue.”
Detroit Mayor Mike Duggan noted: “We believe an improved credit rating is a strong reflection that our strategies to improve the quality of life in Detroit are working: Detroit can provide effective public services to its residents only if city government operates in smart, financially sound ways, and that has been our mission from day one.”
Nevertheless, Mr. Sauter warned that the Motor City still faces substantial short and long-term fiscal challenges credit pressures, noting that stabilization of the population and tax base is key to future budgetary performance and long-term viability, wiring: “In our view, the city has positioned the budget to be able to absorb increasing pension and debt service costs in the near term, while relying on conservative revenue estimates and still remain balanced.” Detroit’s new Chief Financial Officer David Massaron, whom the Mayor appointed in December, as Detroit’s acting CFO, said the city will continue to work to increase its reserves to make strategic investments so that the economic growth that the city has experienced over the last four years continues, noting: “Given our strong liquidity and positive budget results, it’s important we consider increasing our budget reserve, while also continuing to invest in infrastructure and economic development to help grow our local economy,” he said.
In its fiscal report, S&P noted that the Motor City’s strong financial reserves and recent return to the bond markets for capital investment have earned it a credit rating boost, adding that Detroit is positioned to absorb increasing pension commitments and debt service payments as well as possible revenue setbacks while sustaining a balanced budget and funding reserves. His report also cited Detroit’s return last December to the municipal market for its capital borrowing as a “significant stabilizing factor” in its financial trajectory, noting: “Detroit is demonstrating ability to meet its budget demands, while also providing a strong reserve cushion against unexpected events or stagnating revenues…The city is experiencing good economic growth (though mostly centered in the downtown area) and population declines are moderating. At the same time, it continues to post budget surpluses, grow reserves, and meet objectives as defined in its Plan of Adjustment and subsequent planning documents.”
For his part, governing recovery architect Mayor Mike Duggan said the improved rating is a reflection of Detroit’s strategies to improve quality of life in the city, noting: “Detroit can provide effective public services to its residents only if city government operates in smart, financially sound ways, and that has been our mission from day one.”
Part of that “smartness” is reflected by the increasing property tax revenues and plans to accrue some $335 million by 2024 to address looming public pension obligations due to its two pension funds as part of the city’s chapter 9 plan of debt adjustment.
Nevertheless, S&P notes this will not necessarily be a Yellow Brick Road, but rather a road still encumbered by “substantial credit pressures,” noting the city: “operates within a very limited revenue-raising framework that is intricately tied to economic activity. Therefore, continued stabilization of the population and tax base will be key to future budgetary performance and long-term viability: To support this stabilization, the city must continue investing in public infrastructure and economic development initiatives, while also managing increasing annual pension and debt service burdens.” Over the longer term, S&P adds that Detroit’s “very large unfunded pension obligation will continue to grow, and there remains risk that projected funding requirements, starting in FY’2024, could be larger than anticipated.”
Acting CFO Massaron noted: “Given our strong liquidity and positive budget results, it’s important we consider increasing our budget reserve, while also continuing to invest in infrastructure and economic development to help grow our local economy: It’s essential that we take actions like these today in order to help support our long-term financial and economic outlook. I look forward to working with the City Council to consider these efforts.”