5 years out of bankruptcy, can Detroit avoid another one?

JC Reindl | Detroit Free Press

Tuesday marks the five-year anniversary of Detroit's exit from the largest city bankruptcy in the nation's history.

Now billions lighter in debt and running $100 million-plus annual surpluses, Detroit is in phenomenally better financial shape than when it entered the bankruptcy, which lasted 17 months.

But the process did not eliminate all future obstacles, and whether the city can keep its budget act together — and avoid a do-over bankruptcy — is a question that may find an answer over the next five to seven years.

The first big challenge comes in mid-2023, when Detroit's "pension holiday" ends and it must start making full yearly contributions — about $163 million a year and every year — toward two city retirees' pension funds. The city was given a vacation from pension payments as part of its post-bankruptcy restructuring plan.

The next obstacle arrives in about 2026, when expenditures in Detroit's annual budget are projected to begin exceeding revenues.

And yet another hits in the mid-2030s with the expiration of the so-called "Grand Bargain" money that saved city pensioners during the bankruptcy from deeper benefits cuts.

"We still have a lot of challenges ahead," said Gerald Rosen, a retired federal judge who was the mediator in Detroit's bankruptcy case. "But I don’t think anyone could have predicted on July 18 of 2013 that in six years, we'd be where we are. The city has rebounded; it’s fiscal health is terrific now compared to where it was."

When Detroit filed for bankruptcy in that summer of 2013, it was beyond broke and face down in $18 billion of debt, unable to pay for many basic city services and at risk of seeing an artwork firesale at the Detroit Institute of Arts to pay off creditors.

More: Even 5 years later, retirees feel the effects of Detroit's bankruptcy

More: How Detroit went broke: The answers may surprise you — and don't blame Coleman Young

It was the culmination of many bad things, including a giant exodus of residents, plummeting tax revenues, a billion-dollar borrowing binge and a failure by leaders to cut expenses when they needed to.

The bankruptcy eradicated $7 billion in debt, eliminated billions more in future payments and health-care obligations for retired city workers and saved DIA artwork from a forced sale.

When Detroit exited bankruptcy on Dec. 10, 2014, the future wasn't supposed to be one of endless austerity. Detroit was given a restructuring path, called the Plan of Adjustment, that envisioned the city spending $1.7 billion over 10 years to finance new investments and improvements to services.

Yet Detroit didn't emerge with an entirely clean slate. The city still had debt and future obligations on its books and the problem of a predominately poor and still-shrinking population within a 139-square-mile city once home to 1.2 million in 1980. The latest population estimate is 673,100 as of last year.

To prepare for the coming spike in required pension payments, Detroit City Council and Mayor Mike Duggan created a Retiree Protection Fund to squirrel away some of the budget surplus money to later ease the shock of the big pension payments that start in the 2024 budget year, which actually begins July 1 of 2023.

The protection fund wasn't in the original restructuring plan, but became necessary when it emerged that pension consultants during the bankruptcy had used outdated mortality tables which lowballed the city's estimated pension payments.

The Retiree Protection Fund is expected to have $335 million in it by the time the "pension cliff" arrives next decade.

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Bigger rainy day fund

In another move, Detroit recently doubled the size of its rainy day fund to better prepare for any economic downturn. The rainy day fund is now about 10% of the general fund, up from 5%.

Financial experts had warned that two of Detroit's three largest annual revenue sources — income taxes and gaming taxes from the three casinos — are at risk if and when the next recession happens.

“There wasn’t a single dissenting voice on (city) council, because they all understand the importance of that," Detroit Chief Financial Officer David Massaron said about the rainy day fund increase. “I think we’ll be able to manage any economic headwind and the pension cliff in 2024."

Council President Brenda Jones, who is also a member of the Detroit Financial Review Commission, declined through a representative an interview for this story.

The city's other big revenue source, its roughly $200-million-per-year take of state revenue-sharing funds, is projected to drop by a modest degree as a likely result of Detroit having a smaller population in the 2020 U.S. Census than in 2010.

"The mayor's office has been mobilizing to make sure everyone is counted, but the effect could still be negative for Detroit," financial analysts at S&P Global Ratings said in a report this year.

Mayor Duggan cited the Retiree Protection Fund when asked last week whether the city would be ready to make its large pension payments.

"That’s a big reason why we’ve had so many credit upgrades," he told the Free Press. "So I feel very good about where we are.”

Still 'junk' rated

Wall Street credit rating agencies have praised Detroit since the bankruptcy for its stabilized finances, revitalized downtown and success in attracting new high-profile development projects such as the Flex-N-Gate automotive supplier plant, Ford's train station redevelopment and this year's announcement of a large Fiat Chrysler plant expansion.

The city's income tax receipts have grown more than $70 million since leaving bankruptcy.

But despite giving Detroit some credit upgrades, the rating agencies still deem the city's debt as somewhat risky and below investment grade, what is commonly known as "junk."

Financial analysts note how most of the eye-catching growth has happened in and around downtown — not throughout the city — and how Detroit city schools, now known as the Detroit Public Schools Community District, are still struggling and "could also become a major drag on revitalization beyond downtown."

In addition, Detroit did a citywide parcel-by-parcel reappraisal several years ago that resulted in some lower property tax assessments.

"Detroit is left with a combustible brew: a reliance on volatile revenue sources and growing fixed costs," Moody's Investors Service said in report last year. "Detroit's combined debt and pension burden compared to the property tax base is extremely high compared with other major cities."

Even so, Detroit hit a milestone last December when it sold about $135 million in general obligation bonds for capital improvements, at a surprisingly low 4.8% interest rate for a junk-rated city not long out of bankruptcy.

The bond sale was not only the city's first since bankruptcy, but also its first bond sale in more than 20 years that didn't require "credit enhancements," such as buying bond insurance, to reassure investors and get a better rate, according to Massaron. The city even upped the size of the sale by over $20 million in response to strong investor demand.

"We were a number of times oversubscribed, which means we had more investors than we had debt to sell," Massaron said, "which shows that people believe in the continued resurgence and financial stability of the city.”

'Ticket to Chapter 18'

One of its biggest achievements was the Grand Bargain, an unprecedented deal that pooled about $820 million over 20 years in philanthropic foundation money and state funds to shore up city retirees' pension funds and safeguard the DIA collection.

Steven Rhodes, the federal judge who presided over the bankruptcy, memorably warned representatives for the city's retirees to not dismiss the Grand Bargain, even though the deal called for cuts to pensions and health care benefits.

Detroit's bankruptcy was officially classified as a Chapter 9 municipal bankruptcy.

"Now is not the time for defiant swagger or for dismissive pound-the-table, take-it-or-leave-it proposals that are nothing but a one-way ticket to Chapter 18," he said. "This is bankruptcy jargon for a second Chapter 9."

In the end, the city's two older pension plans were frozen and retirees saw their benefits cut. Still, the cuts were smaller than they likely would have been without the Grand Bargain. Two new pension plans were created for current and future workers. About 32,000 active or retired workers were impacted.

The police and firefighter pensioners didn't face upfront cuts to their pension checks, but saw their 2.25% annual cost-of-living increases reduced to about 1%. They also took cuts related to health care.

The city's general retirees took a 4.5% base cut in pensions and the elimination of annual cost-of-living increases.

To implement the Grand Bargain funding, a new nonprofit affiliate of the Community Foundation for Southeast Michigan was set up called the Foundation for Detroit's Future.

"The idea in the Grand Bargain was there were going to be financial controls and oversight to make sure the city did not fall into the same bad habits that got them there," said Doug Bernstein, a bankruptcy attorney at Plunkett Cooney in Bloomfield Hills who is counsel for the new foundation.

State financial oversight

Upon exiting bankruptcy, the city was placed under oversight of a nine-member Detroit Financial Review Commission, chaired by the state treasurer, that initially oversaw all city budgets, borrowing and large city-issued contracts.

After the city delivered three consecutive years of balanced budgets, the commission released Detroit in April 2018 from direct oversight. The commission continues to monitor Detroit's financial situation and can come back if the budget falls out of balance.

On the budget front, starting about 2026, the city's expenditures are forecast to begin exceeding revenues. Avoiding that problem will require "more economic growth and development," according to the forecast.

Detroit did a debt restructuring last year to prevent a $25-million debt spike in the mid-2020s. That maneuver ultimately saved some money, but pushed forward some higher debt payments into the following decade.

"It is incumbent upon the mayor and city council to work together through upcoming budgets to ensure we continue on a fiscally sustainable path," Massaron, the city's CFO, said in an email about the forecasted budget imbalance.

Bargain expires

Yet another big challenge arrives in 2034-2035 budget year, when the Grand Bargain expires. The city's pension payments from its general fund will then jump to about $181 million per year.

Massaron said Detroit remains on pace to achieve its $1.7 billion spending goal for city services by the 10-year anniversary of exiting bankruptcy. Some of the investments so far include:

Hundreds of new police and fire vehicles

Renovating 148 parks

Purchasing 168 new buses, adding more 24-hour routes

Expanded snow plowing

Resumed street sweeping

Continued blight elimination

An estimated 40% of Detroit's streetlights weren't working at the time of the bankruptcy. In 2016, Detroit became the largest U.S. city to have all light-emitting diode (LED) streetlights. That three-year, $185-million project was financed through a public authority separate from city government and was set in motion by former Mayor Dave Bing.

An A+ so far

Massaron said he doesn't consider the city in any danger of a second bankruptcy.

“Right now, I would say the answer is no," he said. "And I would say the answer is no in large part because we have alignment among policymakers around making fiscally responsible decisions."

Rosen, the former bankruptcy mediator, said he gives city officials "an A+" for their management of Detroit since leaving bankruptcy.

"I think the measure of the success is the rebound the city is experiencing now," he said.

Contact JC Reindl at 313-222-6631 or jcreindl@freepress.com. Follow him on Twitter @jcreindl. Read more on business and sign up for our business newsletter.