S&P upgrades Detroit’s GO debt to investment grade

Bonds

S&P Global Ratings on Wednesday upgraded its long-term rating on Detroit’s unlimited-tax general obligation debt to investment grade, raising it to BBB from BB-plus. The outlook is stable.

The rating agency said the change reflected a stronger financial position and its “increased confidence in the city’s ability to sustain balance within the construct of its latest pension funding framework.”

S&P’s follows an upgrade by Moody’s Ratings in March to Baa2 on Detroit’s issuer and general obligation unlimited tax bond ratings, also lifting the city to investment grade from junk.

The Detroit skyline as seen from across the Detroit River. Detroit on Wednesday won a two-notch upgrade of its GO debt, which is now investment grade, from S&P Global Ratings.

Bloomberg News

And it comes just over a decade after Detroit defaulted on its bond debt and filed for bankruptcy. The city exited the Chapter 9 process in December 2014 and returned to market the following August with junk ratings.

S&P also raised its long-term ratings to A-minus from BBB on the city’s financial recovery income tax revenue and refunding local project bonds, series 2014F-1, and Public Lighting Authority local project bonds, series 2014B. 

“We view the stand-alone quality of both revenue pledges as higher than Detroit’s GO rating, but the priority-lien ratings are constrained to no higher than two notches above the GO rating,” S&P said in a statement. “Therefore, the two-notch upgrade on the GO rating results in the same action on these income- and UUT [utility user tax]-secured obligations. The two-notch rating distinction for both pledges reflects our view that the pledged revenue and the flow of funds… are sufficiently removed from the city’s control so as to substantially, but not completely, mitigate operating risk.” 

In a statement, Detroit Mayor Mike Duggan praised the city’s financial leadership over the past decade, including that of current CFO Jay Rising.

“The double-notch upgrade from both rating agencies stems from the hard choices, discipline and sound financial management they’ve made over the years,” Duggan said. “No one in 2014 would have predicted Detroit returning to investment grade with both rating agencies in less than a decade.”

In its rating report, S&P noted Detroit’s flexibility from operating reserves, the Retiree Protection Fund and stimulus funds and its “commitment to maintaining balanced operations.” The rating agency also nodded to Detroit’s “achievable” pensions strategy, strong pipeline of economic development and the “disciplined planning and budget oversight” of the city’s management team. 

“The city has shown continuous operational and financial improvements that have allowed it to make significant strides to solidify its financial and economic position to a point that supports a BBB rating,” S&P said.

As for the municipal income tax and utility user tax bonds, S&P said that “both ratings are limited from going higher by our view of Detroit’s creditworthiness… a higher rating would only be possible if our view of the UUT pledge improved in addition to a higher rating on Detroit’s GO.”

The A-minus ratings “reflect the application of our priority-lien tax revenue debt criteria, which factors in both the strength and stability of the pledged revenue, as well as our view of Detroit’s general creditworthiness, as reflected in its BBB GO rating,” S&P Associate Director John Sauter and Director Randy Layman said by email.

On the city’s near-term horizon, S&P flagged uncertainties such as slowing wage growth, budgetary implications should pension trends fail to track assumptions and the pace of the city’s planned spend-down of reserves. 

And its list of credit challenges includes risks around the city’s ability to maintain balanced operating results; plans to draw down general fund reserves in the short term; an economically sensitive revenue mix; sustained losses from remote working nonresidents; the significant exposure of the local economy to economic downturns; and employment concentration in cyclical industries. 

Those plans to draw down reserves involve capital projects and blight and beautification projects, Sauter and Layman said. It’s also reallocating its unassigned fund balance toward those projects, they added.

On the plus side, the rating agency pointed to a shift in Detroit’s pension funding policy this year. The city moved to a level principal amortization instead of a level dollar, leading to higher pension contributions, funded with increased draws on the Retiree Protection Fund rather than the operating budget. 

S&P said a positive rating action could hinge on its view of budget conditions “in the context of the future reserve cushion.”

Sauter and Layman noted certain pressures looking ahead: “We view the pension contributions, wage pressures amid tight labor market conditions and potential increasing required support for non-general fund operations to be key expenditure pressures that could challenge long-term balance,” they said. “We also feel that, despite management’s financial strengths, most expenditures are for essential services which can result in resistance to cuts.”

Still, they acknowledged that the city has met all the requirements of its post-bankruptcy Plan of Adjustment, and has often “exceeded expectations.” And they praised the “concerted management action and institutional support” that enabled Detroit to accelerate its own financial recovery, including through improved public safety responsiveness and economic development initiatives.

“This historic accomplishment belongs not only to the city’s leaders – the mayor, his staff and City Council – but to all the residents, businesses, philanthropic partners and other organizations who kept their faith and investment in Detroit,” CFO Rising said in a statement. “Most importantly, these upgrades are a validation that residents can be assured that their city is fiscally stable and able to preserve and maintain city services.”

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