Question

The 2010 CAFR for the City of Detroit indicates that in the fall of 2009, Moody’s Investors Service downgraded the general obligation debt rating from Ba2 to Ba3. Information from the MD&A of the 2010 CAFR provides valuable information concerning the bond rating received by Detroit. The following is excerpted from the MD&A.

Financial Highlights
The primary government’s total net assets decreased by $635.0 million and its assets exceeded liabilities at June 30, 2010, by $265.1 million. The primary government’s unrestricted deficit was $1.6 billion at June 30, 2010, an increase of $692.4 million from the $920.2 million deficit at June 30, 2009. The implementation of GASB Statement No. 53, Accounting and Financial Reporting for Derivative Instruments (GASB Statement No. 53) (see the following paragraph for details), accounted for $408.5 million of the decrease in net assets and increase in deficit.
Declining tax revenues, State revenue sharing, charges for service revenues, and an increase in postemployment benefits also contributed to the decrease in net assets. While total expenses were $171.1 million less than in 2009, the decrease was not sufficient as total revenues were $316.9 million less than expenses for the year ended June 30, 2010. The postemployment benefits other than pensions resulted in an additional $164.4 million in expenses and related liability for the year ended June 30, 2010. This adversely impacted the net assets and cumulative surplus/deficit of the governmental and business-type activities of the City.
The City transferred control, via a long-term lease, of the Cobo Hall Convention Facility (Cobo Center) to the Detroit Regional Convention Facility Authority (the Authority) in September 2009 eliminating the City’s funding of the Cobo Hall operations. The financial impact of the transfer is recorded as a $50.0 million special item and increase in governmental activities net assets in the financial statements. The transfer of $86.5 million of long-term obligations and $36.5 million of other assets such as liquor and hotel tax escrow funds increased net assets by $50.0 million.
At June 30, 2010, the City’s governmental activities had a net assets deficit (liabilities exceeded assets) of $467.9 million, an increase of $285.5 million from the deficit at June 30, 2009. The governmental activities cumulative unrestricted deficit increased by $322.1 million to $1.3 billion at June 30, 2010. As discussed above, the implementation of GASB Statement No. 53, accounted for $167.4 million of the governmental activities increases in the net assets deficit and cumulative unrestricted deficit. In addition, the weak economy in 2009-10 and resulting high unemployment and depressed property values greatly contributed to the reduction of revenues and increase in the deficit. The $99.5 million decline in governmental agencies revenues were mainly charges for services ($67.3 million decrease), income tax ($24.3 million decrease) and State revenue sharing ($29.2 million decrease). Also, adversely impacting the governmental activities deficit was the impact of postemployment benefits other than pensions which increased expenses and liabilities by $124.3 million. Furthermore, the Capital Projects Funds had a $9.2 million deficit and the Construction Code Fund needed a $9.0 million contribution from the General Fund to avoid a deficit for the year ended June 30, 2010. Bond and note proceeds received in the prior year funded the Capital Projects Funds’ capital outlays and development expenses for the year ended June 30, 2010.
City deficit reduction efforts resulted in the following positive financial results for the General Fund when compared to the year ended June 30, 2009: (1) $36.0 million decrease in salaries and wages costs from lay-offs and furlough days; (2) $24.2 million decrease in contractual costs mainly due to the completion of the payroll system and treasury cash management projects; (3) $10.3 million increase in casino revenues mainly due to receipt of $9.6 million from the Greektown Casino in settlement of taxes due; (4) $10.6 million decrease in pension costs mainly due to the reduction in payroll costs through layoffs; (5) $8.3 million reduction of natural gas power production expenses for the Mistersky power plant; and (6) $8.8 million reduction of net costs for the Civic Center because of the Cobo Hall transfer to the new Authority.
At June 30, 2010, the General Fund had a total fund deficit of $91.1 million, a decrease of $175.6 million from the prior year. The main reason for the decrease was the issuance of $249.8 million of fiscal stabilization bonds in March 2010. Without the fiscal stabilization bonds the City deficit would have grown by $74.2 million. Adversely impacting the City’s deficit reduction efforts were the: (1) $24.3 million decline in income tax revenues due in part to the bankruptcies of General Motors and Chrysler, two of the City’s largest employers; (2) $18.0 million expense and liability to the State of Michigan for overcapture of school property taxes during the tax years 2001–2008 for the Central Industrial Park Project TIFA; (3) $13.6 million increase in chargebacks due Wayne County for uncollectible delinquent property taxes, which reduced property tax revenues; and (4) $13.3 million decline in sales and charges for services mainly due to the $11.5 million reduction of personal services revenues, primarily central staff services.

Required
a. Determine the quality of Detroit’s general obligation debt based on the rating assigned by Moody’s
b. Under the Credit Analyst Models section of this chapter, the factors used by rating agencies in assigning bond ratings are discussed. What are some of the factors listed in the Financial Highlights excerpt that would contribute to Moody’s ratings change, increasing the risk of Detroit’s debt?



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  • CreatedJanuary 11, 2014
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