Michigan Finance Authority

Detroit, Michigan; General Obligation;

Miscellaneous Tax
Primary Credit Analyst:
Jane H Ridley, Chicago (1) 312-233-7012; jane.ridley@standardandpoors.com
Secondary Contact:
John Sauter, Chicago (1) 312-233-7027; john.sauter@standardandpoors.com

Table Of Contents
Rationale
Outlook
Very Weak Economy
Very Weak Management
Weak Budgetary Performance
Very Weak Budgetary Flexibility
Adequate Liquidity
Very Weak Debt And Contingent Liability Profile
Strong Institutional Framework
Related Criteria And Research

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Michigan Finance Authority

Detroit, Michigan; General Obligation;
Miscellaneous Tax
Credit Profile
US$134.725 mil local govt loan prog rev bnds (Fincl Recovery Income Tax Rev & Rfdg Local Proj Bnds) ser 2014F-1
Long Term Rating

A/Stable

New

US$110.275 mil local govt loan prog rev bnds, (Fincl Recovery Income Tax Rev & Rfdg Local Proj Bnds) ser 2014F-2
Long Term Rating

A/Stable

New

B/Stable

New

US$0.0 mil ICR

Long Term Rating

Rationale
Standard & Poor's Ratings Services has assigned its 'A' rating, with a stable outlook, to Michigan Finance Authority's
Local Government Loan Program revenue bonds, series 2014F, issued on behalf of Detroit, based on a first-lien pledge
of the city's income tax. The bonds are also secured by a limited-tax general obligation (GO) pledge. At the same time,
Standard & Poor's assigned its 'B' issuer credit rating (ICR), with a stable outlook, to Detroit. The bonds are rated based
on the income tax pledge.
In our opinion, credit factors supporting the 'A' rating on the income tax bonds include:
Projected coverage of 6.5x or higher based on projected revenues to be deposited in the pledged income tax
account, based on 2014 actual collections with no growth.
Monthly coverage of MADS of not less than 2.85x in the past three years.
The creation of a statutory lien and trust under the indenture, with income tax revenues paid to the trustee for
principal and interest;
Approximately 90% of the collections made electronically to Comerica Bank as the income tax depository bank,
with the balance going to a deposit account at JPMorgan Chase Bank (also an income tax depository bank) with
daily transfers to Comerica. All collections at both banks are transferred daily to a trustee-held account at Comerica.
Per the authorizing statute, the revenues held by the trustee are exempt from being levied upon, taken, sequestered,
or applied to any other debts of the city other than the bonds to which they are pledged.
Adequate bond provisions, including debt service reserve (DSR) fund funded at the standard three-prong test;
additional bonds test of 2x historical maximum annual debt service (MADS) on the income tax pledge; and a rate
covenant of 2x on the income tax pledge, although Detroit is currently levying the maximum rate.
Offsetting factors of the income tax pledge include our view of the following:
A dedicated transfer of the income tax to support the police operating budget, which is superior to the pledge on the
bonds, and makes up about 8% of total tax collections.
Concentrated nature of the tax base, with more than 90% of income tax collections coming from approximately 40
employers.

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Limited geographic reach of the income tax as it is collected only within Detroit.
No limitations on the city's ability to reduce the income tax rate besides a 2x rate covenant.
Track record evidencing extreme prior credit stress, given the city's bankruptcy filing in 2013.
Income taxes are collected by Comerica Bank and JPMorgan, and per Michigan Act 17, as part of the trust are
considered the property of bondholders immediately upon being owed. A Deposit Account Control Agreement
governs the flow of revenues from the point of payment directly to the trustee, UMB Bank, for the payment of debt
service. All collectionsregardless of the collection pointare transferred daily to the trustee account. On a monthly
basis, after sufficient collections have been received for debt service and any DSR replenishment, the remainder goes
to the city for general operations.
The bonds are secured by the city's income tax, which is levied at 2.4% of taxable income for residents working in
Detroit, 1.2% for non-residents, and 2.0% for businesses. Per the indenture, the city has granted a security interest in
the pledged revenues, on behalf of bondholders, on a first-priority lien basis, of all rights, title, and interest in the
pledged income taxes. The pledge of income tax revenues is net of its pledge to police operations; 0.2% of the 2% tax
on residents (0.1% of the 1% for non-residents), is transferred monthly from the income tax account to the city for
supporting police operations. The total annual amount is about $20 million. Although the pledge is superior to the
pledge on the bonds, the transfer to police operations will come after money is set aside for debt service.
In our view, coverage of MADS (2020) is good at 6.50x of 2014 actual collections. Set-asides of one-sixth interest and
one-12th principal are made monthly, and the lowest coverage of pro forma MADS in the past three years is 3.27x.
Collection rates on income taxes have ranged from 97% to 99% for the past seven years.
There is a historical additional bonds test that calls for 2x coverage of MADS, which we consider good. There is also a
2x rate covenant but the city is currently levying at the maximum tax rate. The debt service reserve fund will be
funded at the standard three-prong test, but given an uneven debt service schedule it is likely to be 10% of par, which
is about $12 million less than MADS.
The city's 10 largest employers are dominated by government and health care, but with only 40 employers making up
more than 90% of income tax collections, we feel there is some credit risk associated with concentration. Although
income tax revenues in Detroit have been falling in the past 10 years--from total collections of $322 million in 2004 to
$274.6 million in 2014, an overall decline of 15%--from 2010 to 2014 collections increased annually. This includes a
reduction to the individuals income tax of 0.1% (0.05% for non-residents), but an increase to businesses income tax of
1%. The city currently has no plans to adjust the tax rate further.
During the 2015 legislative session, Michigan passed Act 17, which places a first-priority lien on the city's income tax
revenues as soon as they become due, as part of the trust pledged to the bonds. Pursuant to the legislation, the pledge
constitutes a statutory lien and is paramount and superior to all other liens and interests of any kind, for the sole
purpose of paying the principal of and interest on bonds. The lien and trust is created for the benefit of bondholders,
and the tax revenues held by the trustee are for the sole benefit of bondholders. They cannot be levied upon, taken,
sequestered, or applied toward paying the debts or liabilities of the city other than for payment of debt service on the
bonds.

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Michigan Finance Authority Detroit, Michigan; General Obligation; Miscellaneous Tax

The 'B' ICR on Detroit is based on the following credit factors:

Very weak economy, with significant population decline, but access to a broad and diverse metropolitan statistical
area (MSA);
Very weak management given the city's bond defaults, although the city maintains "standard" financial policies and
practices under our Financial Management Assessment (FMA) methodology;
Weak budgetary performance, with operating results that we expect could deteriorate in the near term relative to
fiscal 2014, which closed with operating surpluses in the general fund and at the total governmental fund level;
Very weak budgetary flexibility, with an available fund balance that we expect will improve in the near term from its
fiscal 2014 level of negative 15% of operating expenditures, as well as limited capacity to reduce expenditures and
limited capacity to raise revenues;
Adequate liquidity, with total government available cash of 39.4% of total governmental fund expenditures and 2.0x
governmental debt service, but with access to external liquidity that we consider uncertain;
Very weak debt and contingent liability profile, with debt service carrying charges of 19.8% of expenditures and net
direct debt that is 126.9% of total governmental fund revenue in fiscal 2014, as well as high overall net debt at
greater than 10% of market value and a large pension and other postemployment benefit (OPEB) liability; and
Strong institutional framework score.
Detroit filed for bankruptcy in July 2013 and exited in December 2104, just 18 months later. During the bankruptcy
process, the city shed a considerable amount of its long-term obligations, resulting in annual operating cost reductions
averaging $300 million per year. The reductions come from lower pension costs and the loss of most OPEB benefits
for retirees. There were also significant cost reductions generated from lower debt service following the bond defaults,
as the replacement debt service is much lower. Not paying debt service on the defaulted pension obligation certificates
and associated swaps alone will save the city approximately $75 million per year.
Among the other changes post-bankruptcy is the creation of a Financial Review Commission (FRC) that will oversee
Detroit's financial operations for at least 10 years. The oversight provided by the FRC includes approvals of a four-year
financial plan, budgets, the issuance of debt and contracts; the FRC also governs the selection of the city's chief
financial officer.
Although such sizable annual operating cost reductions can make a significant impact on the city's ability to operate in
structural balance, we feel Detroit will continue to be challenged to deliver the services residents need and address the
backlog of capital and other needs a large city has. In our view, doing both of these simultaneously is critical to
spurring the economic improvements the city will need to make in order to be a viable entity long term. Detroit's
ability to maintain balance while transitioning away from a consultant-run government will also be a critical step in
demonstrating it can survive economically and financially.

Outlook
The stable outlook on the series 2014F bonds reflects our expectation of continued high debt service coverage and a
stable revenue base. Should coverage improve dramatically, we could raise the rating, although that is not likely under
the two-year outlook horizon. Should coverage fall due to additional debt or softening of income tax revenues, we
could lower the rating. The outlook on the ICR is stable, reflecting the city's current ability to meet all fixed cost

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payments. Given the history of default, we aren't likely to raise the rating during the outlook horizon. We could lower
the rating during the outlook period if Detroit demonstrates a structural imbalance sizable enough to pressure its ability
to make fixed cost payments or operate effectively.

Very Weak Economy

We consider Detroit's economy very weak. The city, with an estimated population of 678,376, is located in Wayne
County in the Detroit-Warren-Dearborn, Mich. MSA, which we consider to be broad and diverse. The city has a
projected per capita effective buying income of 53.5% of the national level and a low per capita market value of
$22,387 in 2016, which, in our view, indicates a limited tax base supporting the debt and is a negative credit factor.
Overall, the city's market value fell by 2.8% over the past year to $15.2 billion in 2016. Weakening Detroit's economy is
its demographic profile, which includes significant population decline of negative 7%.
Detroit's efforts to renew and revitalize itself continue, and the city reports there have been notable changes and
improvements including shorter emergency responder times and a variety of business development projects. In 2014,
the Wayne County unemployment rate was 10.0%, eliminating the negative adjustment for high unemployment. A key
part of the Detroit's plans include economic growth, and there are numerous economic projects and initiatives under
way. However, it is still too soon to determine if the city's efforts at stabilizing and expanding the economy will be
successful, and market value trends indicate it has not yet started to turn the corner.

Very Weak Management

Given the city's default on nearly all its bonded debt in the past two years, the ICR is capped at 'B', resulting in a
management score of very weak. However, the city does have "standard" financial policies and practices under our
Financial Management Assessment methodology, indicating the finance department maintains adequate policies in
some but not all key areas.
Historical pressures related to political gridlock and an inability to execute reforms also play a role in our assessment
of the city's overall management pressures. As Detroit winds down its relationships with the consultants who
supported it during bankruptcy, city staff will have to step in to make challenging operating decisions. The city has a
new professional management team in place with a stated focus on staying structurally balanced. However, given the
magnitude of the legacy problems facing the city, there are likely to be difficult choices ahead for Detroit. The ability,
or inability, of the mayor, city council, and staff to work together to solve the problems constructively will be key to the
direction of our management score over time.
A key part of Detroit's ongoing oversight post-bankruptcy was the creation of a FRC. The FRC has formal meetings
once a month as well as two subcommittees (Finance and Procurement) that also meet monthly with the city. While
the FRC provides an additional level of oversight for the city's financial operations, some of the policies Detroit had in
place before the bankruptcy have not been recreated yet.
Detroit performs a formal historical trend analysis--encompassing both revenues and expenditures--that is updated

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annually, and regularly monitors conditions via a revenue estimating conference. Budget-to-actual results are
presented to FRC monthly, but not to city council. The city has four-year financial projections that are reviewed and
approved annually by the FRC. Detroit has a multiyear capital plan that goes through 2023 with some funding sources
identified, but not all. The city does not have its own investment policy, but follows the state's policy; reports on
holdings are made annually via the audit. Detroit does not currently have a formal debt management policy or a formal
fund balance policy.

Weak Budgetary Performance

Detroit's budgetary performance is weak, in our opinion. The city had operating surpluses of 14.2% in the general fund
and 19.1% across all governmental funds in fiscal 2014. Our assessment takes into account our expectation that
budgetary results could deteriorate from 2014 results in the near term. Weakening our view of Detroit's budgetary
performance is the city's deferral of significant expenditures, which we think inflates the budgetary result ratios.
Detroit's bankruptcy filing occurred at the start of its fiscal 2014 reporting year. As a result, the expenditures made in
fiscal 2014 are not an accurate representation of the city's regular operations. The weak score for performance reflects
positive operations for 2014, but also encompasses our view of the impact that the city's backlog of capital projects
and other needs are likely to have on operations.
Revenues and expenditures for fiscal 2015 were higher than 2014, and also higher than projected 2016. However, the
city has a number of one-time items included in its 2015 results. Based on adjustments to remove what we consider to
be non-recurring items, we believe that results will swing to a deficit position.

Very Weak Budgetary Flexibility

Detroit's budgetary flexibility is very weak, in our view, with an available fund balance that we expect will improve in
the near term from its fiscal 2014 level of negative 15%, or negative $145.9 million. Negatively affecting budgetary
flexibility, in our view, is limited capacity to reduce expenditures and limited capacity to raise revenues.
The city projects that fiscal 2015 will end with a positive unreserved balance that could be as high as $75 million, or
5.5% of expenditures. This is due to a bankruptcy-related Governmental Accounting Standards Board Statement 58
adjustment of $190 million and a positive operating variance of approximately $30 million on a budgetary basis. Given
the accounting adjustment--regardless of operating results--we project there will be a positive balance in the general
fund at year-end 2015. This would move the flexibility score up under our criteria were it not for the city's limited
capacity to cut spending or raise revenues.

Adequate Liquidity
In our opinion, Detroit's liquidity is adequate, with total government available cash of 39.4% of total governmental
fund expenditures and 2.0x governmental debt service in 2014. In our view, Detroit's liquidity levels are adequate, but
access to the capital markets is uncertain. Although there has been some demonstrated bondholder interest, given the

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potential need for additional security pledges for any GO-backed issuance--as well as the possible need to pay a
premium to sell debt--access to the capital markets is considered weaker than for most other issuers.

Very Weak Debt And Contingent Liability Profile

In our view, Detroit's debt and contingent liability profile is very weak. Total governmental fund debt service is 19.8%
of total governmental fund expenditures, and net direct debt is 126.9% of total governmental fund revenue. Negatively
affecting our view of the city's debt profile is its high overall net debt of 23.1% of market value. Detroit no longer has
any swaps or variable-rate debt outstanding.
After shedding its postemployment benefits during bankruptcy and adjusting some of its pension costs, Detroit has
significantly reduced its annual retiree-related costs. The city estimates the elimination of the annual OPEB cost saves
it approximately $125 million per year, and the estimated pension cost for the next 10 years will drop to about $40
million from between $80 million and $100 million annually.
In our opinion, Detroit's large pension liability remains a credit weakness. Detroit's combined pension and OPEB
contributions totaled 10.0% of total governmental fund expenditures in 2014. The city made 23% of its annual required
pension contribution (ARC) in 2014. The pension funded ratio is for the General Retirement Systems is 69.9%. The city
will continue to pay the ARC and has a goal of 75% funding by 2023.

Strong Institutional Framework

The institutional framework score for Michigan municipalities with a population greater than 600,000 is strong.

Related Criteria And Research

Related Criteria
USPF Criteria: Local Government GO Ratings Methodology And Assumptions, Sept. 12, 2013
USPF Criteria: Special Tax Bonds, June 13, 2007
USPF Criteria: Methodology: Rating Approach To Obligations With Multiple Revenue Streams, Nov. 29, 2011

Related Research
Institutional Framework Overview: Michigan Local Governments

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