Moody's: Detroit is among weakest of big US cities to weather recession

Christine Ferretti | The Detroit News

Detroit — The city is among the weakest of the country's 25 largest in its preparedness to weather a financial downturn, a report from Moody's Investor Service found.

The rating agency released its findings Tuesday on the five-year anniversary of Detroit's exit from municipal bankruptcy.

The 14-page report examines how ready the country's largest cities are to handle a recession similar to the one that struck a decade ago, without an adverse impact on credit. It ranked Detroit and Chicago at the bottom of the list.

Six other cities — Boston, Charlotte, Denver, San Antonio, San Francisco and Seattle — are in a stronger position to maintain good credit standing in a downturn and the remaining 17 cities are positioned moderately, according to the report.

Nicole Serrano, a vice president and senior analyst for Moody's, said on the positive, Detroit is as an "outlier" for its funding reserves. At more than 60% of revenue, it's strong. But the report, she said, also details "credit challenges that lie ahead for the city."

Among those, pension contributions, fixed costs, revenue volatility and capital needs.

"However, Detroit has taken steps to prepare for a potential downturn: establishing an irrevocable trust to smooth spikes in pension contributions, developing a capital improvement plan that identifies a variety of sources to finance capital investments, and continuing to increase its already strong reserves," the report notes.

The steps "are all positive" for the city's credit profile, it reads. Detroit, at Ba3, is rated below investment grade.

"If these trends continue, Detroit’s overall preparedness for a future recession will be more in line with major city peers," it reads.

David Massaron, Detroit's chief financial officer, said the report reflects the city's efforts to stay on a positive financial track and prepare for future obligations.

"But it's also a sobering report. It reflects that the city is still one of the weakest in its standards," he said. "It's a sobering report because it basically recognizes what we have done over the last five years to be in a position to withstand the next time there's an economic contraction."

The rating agency's assessment was based on fiscal volatility, reserves, financial flexibility and pension risk.

The city established the Retiree Protection Fund, an irrevocable trust to help offset its future contributions to the city's two pension funds that will come due beginning in 2024.

Through bankruptcy, Detroit was relieved through 2023 from most of those costs through a funding package coined the "grand bargain," which pulled in funding from a number of foundations and shielded the Detroit Institute of Arts collection from creditors.

The city's bankruptcy Plan of Adjustment assumed the city would be paying about $111 million into the General Retirement System and Police and Fire Retirement System from its general fund beginning in 2024. Today, that figure is projected to be $162 million per year, Massaron said.

The protection fund will put together $335 million in the coming years to help meet the required contributions, he said.

"It's already significantly off what the Plan of Adjustments projected which is, in large part, why the City Council and mayor created this fund to help meet that obligation," he said. "Over the next several years, we may have to put more money in than we're currently planning. It's something we monitor every year."

In April 2018, Detroit was released from the state oversight that went into place as a condition of its bankruptcy. Until that time, a nine-member financial review board had the final say on its budgets, collective bargaining agreements and certain contracts.

Last year, Massaron noted, the city adopted its first budget without that active state oversight. At that time, Detroit's City Council also voted in favor of doubling the city's budget reserve fund from 5% to 10%. Nearly $107 million has been set aside for the 2020 fiscal year, city documents note.

Massaron said it's reasonable to assume that a downturn could happen. As of now, he said, Detroit is projecting continued growth but it "needs to be ready."

One challenge on the horizon, he said, is that the city's economic forecast shows operating costs will begin to exceed revenues by $11 million in the 2026 fiscal year. It's a number that Massaron said is "manageable."

David Levett, a senior analyst and vice president for Moody's, said the city has done a lot to build up funding reserves and is aware of its challenges.

"I would say the fact they are thinking that far ahead is positive," Levett said of the projected shortfall. "The biggest issue for the city is finding ways to finance the capital needs that are still outstanding."

The city's nearly 17-month Chapter 9 journey helped it shed $7 billion in debt and restructure millions more. It also carved out $1.7 billion for service improvements over a decade.

Since then, Detroit has posted five consecutive balanced budgets and operating surpluses. It had a general fund balance of about $611 million at the close of the 2018 fiscal year, compared with a $73 million deficit at the end of the 2013 fiscal year, data compiled by the CFO's office notes.

The city's recurring income tax revenue is up 26% over five years. For the 2019 fiscal year, it was $321 million, according to the latest unaudited figures. In 2014, it collected $253 million.

Massaron on Tuesday also reiterated Detroit's operational improvements in recent years, including EMS and police response times, 150 neighborhood park renovations and 2,000 weekly trips added to the Detroit Department of Transportation bus schedule.

He doesn't expect the city could be destined for another financial crisis, crediting Detroit Mayor Mike Duggan and Detroit's council for "making fiscally sound decisions on how to spend the money."

The most important thing for the city, he said, is to continue to adhere to the policies it adopted for budgeting responsibility.

"If we stick to that, I think we can manage the other risks as we move forward," he said. "But the Moody's report brings home an important message: we're still in the weakest category. There's still a lot of work to do, and the budget still is very tight."

cferretti@detroitnews.com