Huge payout to investors would leave city near bankruptcy, analyst says

BY ZACHARY GORCHOW • FREE PRESS STAFF WRITER • January 7, 2009

The City of Detroit’s finances slid into crisis Tuesday after one of the country’s leading credit rating agencies downgraded the city’s rating to junk-bond status, a move one financial analyst said could eventually push the city into bankruptcy

One official expected the move to lead to a substantial increase in the interest the city pays on its debt, which could affect how the city delivers services. The downgrade also enables investors with which the city engaged in so-called credit swap agreements to request a payout from the city totaling $400 million.

Either scenario would rob the city of money from its general fund at a time when it faces a $300-million deficit and by most accounts already is failing to deliver adequate services to residents.

City officials say they are assembling a plan to avoid having to come up with $400 million and instead offer guarantees to the investors, such as collateral.

“We are resolved to ensure that Detroit is financially stable,” Mayor Ken Cockrel Jr. said at a news conference at Cobo Center.

Credit swaps are agreements between the city and investors. In exchange for a lower interest rate on bonds, the city agrees to maintain an investment-grade rating.

City’s options

Joseph Harris, the city’s chief financial officer, said officials are putting together a plan so that holders of the credit swaps will be convinced not to demand their money. He declined to offer details, but said it would involve putting up city assets as collateral or other measures.

“We won’t be able to come up with $400 million,” Harris said. “We don’t expect anyone to ask us for $400 million. What we expect them to ask us for is some guarantees or some assurances.”

Irvin Corley Jr., the City Council’s fiscal analyst, said a $400-million payout could push the city into bankruptcy.

“I would think they would understand that the city is not in a position to come up with $400 million,” he said.

Corley said the downgrade could result in the city’s interest rates rising between 50% and 75%, meaning a 5% rate could rise to 7.5%-8.75%.

Junk-bond status is not unheard of for major U.S. cities. New Orleans, Miami and Pittsburgh all spent time in junk-bond status in the last 10 years. So has the Detroit Public Schools.

Late audits a problem

In a statement, Standard & Poor’s explained it lowered the city’s ratings from BBB and BBB- to BB for two kinds of debt because the city had failed to meet promises to eliminate its deficit and turn in its annual audit on time, because of the local economy and because of perceived instability in the city with multiple mayoral elections this year.

There was no word on whether Moody’s or Fitch Ratings, the other major credit rating agencies, would follow suit.

Detroit has failed to submit its audit on time for years, and is more than a year late in finishing its 2006-07 fiscal year audit, which has caused the state to withhold $42 million in revenue sharing aid and require prior approval to issue any bonds.

Terry Stanton, spokesman for the Michigan Department of Treasury, said the state is not considering an emergency financial manager as a result of the city’s lowered bond status.

“Obviously the downgrade is unfortunate, though not necessarily a surprise,” he said.

The state is in contact with city officials and “will assist in any way we can,” Stanton said. No other Michigan city is in junk-bond status, Stanton said.

Just a year ago, then-Mayor Kwame Kilpatrick had boasted of S&P boosting the city’s outlook from negative to stable. But Cockrel, who became mayor Sept. 19 after Kilpatrick resigned, said S&P officials feel deceived.

Cockrel is expected to unveil his deficit-elimination plan this month and also must present a fiscal year 2009-10 budget to the council in April.

“We’ve got to put together a budget whereby our revenues either equal or exceed our expenditures,” Harris said.

Councilwoman Sheila Cockrel, chairwoman of the council’s Budget, Finance and Audit Committee, called the downgrade “as serious as you can get.”

She said the situation should prompt everyone in the city — elected leaders, business, labor and residents — to make the sacrifices necessary to finally balance Detroit’s budget.

“We as a City Council, as a community and as a group of city leaders are going to have to address the fundamental restructuring of city government,” she said.

Besides the potentially severe financial cost to the city, the downgrade also is a major image blow to the city.

“Ultimately the only way to deal with the problem is to fix it,” Mayor Cockrel said.

Contact ZACHARY GORCHOW at zgorchow@freepress.com or 313-222-6678. Staff writer Naomi R. Patton contributed to this report.

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Survey: Detroit second-worst place to live

BY LATESHIA DOWELL • FREE PRESS STAFF WRITER • January 7, 2009

Detroit is the second-worst city in the United States to live and work in, according to a survey listed on Yahoo Real Estate.

The survey commented that Detroit has an image problem — citing the dwindling population, poverty, auto industry woes and, of course, the text message scandal.

This survey was completed by 2,500 employees and entrepreneurs across the country.

• SURVEY: See the complete results

The respondents were asked about 40 large cities. The questions asked were “Imagine you were offered your dream job that required you to relocate. Which region in the following list would you be most likely to choose? … and which city region … would you be least likely to choose?”

Out of the 2,500 workers surveyed, 14% said they would not like to move to Detroit.

The survey takers were asked to choose the top three attributes for each city. The top two negative attributes of the city, according to the survey, were health and safety (55%) and image (49%).

The best and worst cities were then ranked based on the total number of first-, second-, and third-choice votes as a percentage of total votes.

Americans have a love/hate relationship with New York as it topped both lists as being the best and worst city to live and work in. San Diego and San Francisco came in second and third place on the best list, and Los Angeles took third place on the worst.

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Leonard N. Fleming and Christine Macdonald / The Detroit News

DETROIT — The city, already grappling with a $300 million budget shortfall and future layoffs, is now bracing for a $400 million payment that must be made to bond investors because Detroit’s credit rating was downgraded, the Detroit News has learned.

The decision by Standard & Poors to lower the city’s rating to junk bond status Tuesday has triggered what city officials have described as a ‘termination event” that requires the city to pay millions.

“It’s as serious as you can get,” said Councilwoman Sheila Cockrel. “It is not doomsday, but it is a very, very serious situation and requires everybody to step up and understand that there’s no political solution to this.”

Irvin Corley Jr., the city’s fiscal analyst, said the downgrade was bad news for the already struggling city and will mean further cuts. Harris has already said the city’s deficit could reach $300 million.

“Oh wow,” Corley said when told of the downgrade. “It just exacerbates our budget challenges.”

Corley said he is hoping the city can put together a payment plan so that it doesn’t have to come up with the full amount at once.

“Given the magnitude, I am assuming the city wouldn’t have to come up with the full amount,” Corley said. “Obviously that would crash the city.”

Mayor Kenneth Cockrel Jr. was unavailable for comment.

Cockrel is currently putting together a deficit elimination plan, which likely will include layoffs and sale of city assets.

This financial calamity happened because the city entered into a swap agreement that sought to secure the city’s interest rates as if the bonds had always been issued at a fixed rate, city officials said.

“No one is going to expect us to come up with $400 million tomorrow,” said Joe Harris, the city’s budget director, in an interview Tuesday. “It has to be handled. They have to be reasonable when this termination event happens.

The tough year that financial markets had in the past few years caused interest rates to drop and the trigger amount — which once stood at $90 million if the city fell into junk bond status — to increase.

You can reach Leonard N. Fleming at (313) 222-2072 or lfleming@detnews.com.