NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the ratings for the following Wayne County, Michigan bonds:
--$186.3 million limited tax general obligation (LTGO) bonds issued by Wayne County to 'B' from 'BB-';
--$51.3 million building authority (stadium) refunding bonds, series 2012 (Wayne County LTGO) issued by Detroit/Wayne County Stadium Authority to 'B' from 'BB-';
--$203.5 million building authority bonds issued by Wayne County Building Authority to 'B' from 'BB-';
--Wayne County unlimited tax general obligation (ULTGO) (implied) to 'B' from 'BB'.
The ratings are on Negative Watch.
LTGO bonds issued by the county carry the county's general obligation ad valorem tax pledge, subject to applicable charter, statutory and constitutional limitations.
Stadium authority and building authority bonds are secured by lease payments from the county to the respective authority. The obligation to make the rental payments is not subject to appropriation, setoff or abatement for any cause, and carries the county's LTGO pledge.
KEY RATING DRIVERS
FURTHER FINANCIAL DETERIORATION PROJECTED: The downgrade stems from updated county projections showing the structural deficit to be wider and liquidity narrower than previously thought. Fitch believes state intervention is likely.
STATE INTERVENTION OPTIONS VARY: The Negative Watch reflects the uncertainty regarding potential state intervention. Options available to the county under the Local Financial Stability and Choice Act (Act 436) represent a range of possible outcomes for bondholders.
LACK OF BUDGETARY FLEXIBILITY: Recessionary property tax declines have left the county with little to no revenue raising flexibility; efforts to cut expenditures are hampered by the governance structure and have been insufficient to restore balance.
STRESSED ECONOMY SLOW TO RECOVER: The weak local area economy is reflected in elevated unemployment rates, population loss and below-average income levels.
JAIL DEBT COULD BE PARTICULARLY VULNERABLE: Stadium authority and building authority debt service is not subject to abatement or appropriation. Debt service comprises a relatively small share of governmental spending, but Fitch believes the jail debt could be vulnerable given the failure to complete the project.
LIQUIDITY DETERIORATION: Inability to maintain adequate liquidity, either internally or by external borrowing, would lead to a cash flow crisis and trigger a further downgrade. County projections show pooled cash depletion in June 2016 assuming continued $75 million annual TAN borrowings; inability to access the market for cash flow borrowing could cause depletion to occur earlier.
DEMONSTRATED IMPROVEMENT: The rating could stabilize at the 'B' level if the county successfully implements a realistic plan that puts it on a path toward structural balance, with or without Act 436.
FINANCIAL DETERIORATION, NARROW LIQUIDITY PROJECTED
The county relies upon a pooled cash model, supplemented by external cash flow borrowing to meet its day-to-day needs. The new county executive commissioned an analysis from Ernst & Young which includes updated financial and cash flow projections. In public statements discussing the report, the county executive was quoted as saying that bankruptcy is a possibility, albeit not a likely one at this point.
The report includes cash flows projecting that pooled cash will be completely depleted by June 2016, even assuming continued TAN borrowing of $75 million each spring. Fitch remains concerned about the county's ability to access the market for cash flow borrowing, particularly given recent dire announcements, ratings downgrades, and the presumed need for increasing amounts of cash flow borrowing.
LARGE GENERAL FUND DEFICIT POSITION
The county's efforts to reduce its sizeable fund deficit positions are hindered by persistent economic pressure and a limited revenue environment. The general fund recorded a $10.3 million net operating deficit (after transfers) in fiscal 2013. The large $159.5 million unrestricted general fund deficit (representing a very high -26.8% of general fund spending) in fiscal 2013 is primarily the cumulative result of steep revenue declines and budgetary overspending primarily for mandated services.
The delinquent tax revolving fund (DTRF) transferred $82 million of cash to the general fund for deficit reduction in fiscal 2014, as was called for in the county's previous DEP. An additional $68 million was reported to have been transferred, including $24 million for deficit reduction; however, Fitch has learned that only $10 million of this additional transfer was actually made. A slightly lower $78 million is slated to be transferred in fiscal 2015.
Preliminary, unaudited fiscal 2014 results suggest the accumulated unreserved general fund deficit fell to $85.8 million in fiscal 2014. Assuming larger than typical transfers from the DTRF in fiscal 2015, the accumulated deficit is projected to fall further, to $8 million in fiscal 2015, before reversing course to a $38 million deficit in fiscal 2016. The projections show the accumulated deficit continuing to grow, reaching $200 million by the end of the projection period, in 2019.
STATE INTERVENTION INCREASINGLY LIKELY
The county plans to present a new DEP in the near term, but previous plans have failed to produce enduring, structural progress. The county has long met the conditions for Act 436 involvement, but neither the county nor the state has initiated such action. Fitch believes the lack of available revenue-raising and expenditure-cutting flexibility, combined with the county's recent dire projections, make the prospect of state intervention under Act 436 increasingly likely. On the one hand this could mean strengthened financial discipline, but on the other, could open a path to bankruptcy.
OPTIONS PRESENT VARYING RISKS
Should the state declare that a financial emergency exists under Act 436, the county would be faced with four options: consent agreement, emergency manager, neutral evaluation (mediation), or bankruptcy. Each of these options may be chosen once and each presents a different risk profile to investors. The least favorable to bondholders would be the bankruptcy option, which requires the written approval of the governor and a majority vote of the county commission. Fitch believes it is unlikely the county would be permitted to declare bankruptcy without first exploring another of the options.
The emergency manager (EM) option would place the county into receivership. The powers and functions of the elected and appointed county officials would be assumed by an EM, who would have broad powers including approval/rejection of contracts, including collective bargaining agreements. Outcomes under the EM option may be favorable or unfavorable for bondholders, depending upon the EM's approach. Some Michigan EMs have prioritized repayment of bonded debt, but in the Detroit case, the EM chose to have the city file for bankruptcy and default on its general government debt.
Neutral evaluation would involve a mediated approach reliant upon cooperation of various stakeholders. Fitch believes this option would be neutral for bondholders, but likely not be successful in producing the changes necessary for restoration of structural balance. The county has successfully reached agreements in the past, including one for 10% reduction in employee wages, and one to rein in court costs; while the cost savings involved were arguably substantive, they were not sufficient to eliminate the structural imbalance. Given this history, Fitch believes it is unlikely that mediated agreements could achieve savings on a scale necessary to reverse the county's fiscal decline.
The risk to bondholders under the consent agreement option is similar to the risk presented by the EM option. Under Act 436, the county and state can enter into a tailored consent agreement which could provide the county with some or all of the powers granted to an emergency manager, including rejecting contracts, but with the exception of abrogating collective bargaining agreements. Since all of the county's collective bargaining agreements are expired, the county may not feel that particular power is essential to their recovery plan.
Choosing the consent agreement option could present both opportunities and risks. A carefully crafted consent agreement that includes the granting by the state to the county of broad powers under Act 436 could assist the county in material and permanent alteration of its cost structure, but would have little impact on revenues. It is also possible that, with a consent agreement in place, the state could choose to borrow on behalf of the county. Previous financially distressed municipalities in Michigan have benefitted from the state undertaking cash flow borrowing on their behalf, with proceeds disbursed upon achievement of milestones contained within the agreement. Conversely, in the case of Detroit, lack of achievement of the agreed-upon milestones resulted in the state withholding the borrowed cash, which precipitated the liquidity crisis and receivership.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from CreditScope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, National Association of Realtors, Underwriter, Bond Counsel, and Financial Advisor.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. Local Government Tax-Supported Rating Criteria