Fitch Upgrades Wayne County, MI's IDR to 'BB+'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has upgraded the ratings on the following Wayne County, MI obligations to 'BB+' from 'B':
--Issuer Default Rating (IDR);
--$81.7 million limited tax general obligation (LTGO) bonds issued by Wayne County;
--$47.5 million building authority (stadium) refunding bonds, series 2012 (Wayne County LTGO) issued by Detroit/Wayne County Stadium Authority;
--$195.5 million building authority bonds issued by Wayne County Building Authority.
The Rating Outlook is Stable.
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 backed 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
Upgrade Factors: The upgrade to 'BB+' from 'B' reflects the significant progress that the county has made toward structural balance by fundamentally realigning its expenditure and long-term liability profiles with its likely revenue trajectory. The previous rating of 'B' with a Stable Outlook incorporated the county's financial distress as well as recovery plan execution risk. The county's achievement of most of the recovery plan elements has ameliorated financial distress, materially alters future prospects for budgetary balance and significantly improves credit quality.
Economic Resource Base
The Detroit area economy remains pressured despite some improvement after severe weakening during the recent recession. Economic indices for county residents are below average overall, as the effect of impoverished city residents outweighs that of the relatively wealthier suburban residents.
Revenue Framework: 'bb' factor assessment
Fitch expects revenues to grow marginally in the near term, as property values recover; however, the county's revenue framework remains vulnerable to future economic downturns. The county's independent legal ability to raise revenues is limited by state law and the county remains unable to adjust tax rates for assessed value (AV) declines.
Expenditure Framework: 'a' factor assessment
The county operates under an Act 436 consent agreement with the state, which affords the county tools that it is using to improve its expenditure flexibility, particularly labor costs. Implementation of the recovery plan has realized significant savings from wages, benefits, outsourcing and layoffs.
Long-Term Liability Burden: 'aa' factor assessment
Long-term liabilities, including unfunded pension and overall debt, are moderate when measured against the resource base. Recent changes to pensions and other post-employment benefits (OPEB) have materially improved the county's credit profile.
Operating Performance: 'bb' factor assessment
The county has made marked progress towards structural balance and recently eliminated the accumulated general fund deficit. However, the existing cushion is still not sufficient to compensate for the vulnerability of the revenue stream to recessionary declines, given the county's limited capacity to take offsetting budgetary action.
Sufficient Reserve Cushion: Restoration of a reserve safety margin that provides an adequate cushion against future volatility of the revenue stream could cause an upgrade.
Reversal of Progress: Recent progress achieved during the consent agreement period has been instrumental to credit quality improvement. Any reversal of such progress could put downward pressure on the rating.
Taxable value dropped sharply during the recession with more moderate declines recorded throughout the recovery. The local economy has been slow to recover but development activity has picked up in Detroit's central business district as well as certain other portions of the county outside the city.
The employment outlook is brightening after a long period of weakness. Total employment and the labor force both contracted severely over the last decade. More recently, the April 2016 unemployment rate of 5.3% was far below the 16.2% recorded in 2009, although still higher than the state rate of 4.3%.
The county remains dependent on property taxes for more than half of general fund revenues and is highly susceptible to losing revenue during times of declining property values.
Fitch expects underlying economic trends to produce stagnant revenues absent additional revenue raising measures. As an urban center with Detroit's distressed tax base at its core, the county remains vulnerable to a state-imposed framework that has the effect of accelerating revenue declines in a downturn while limiting upside potential in a recovery. Property tax collections have declined an aggregate $186 million or 42% since 2007, only recently showing signs of stabilization.
Legal ability to raise revenues is constrained. The county may not adjust the mill rate to compensate for tax base declines. Growth in the property tax levy may not exceed CPI plus new construction and growth in assessed valuation is limited to the lesser of 5% or the rate of inflation, according to Michigan state law. In addition, Wayne County voters imposed a further limitation: the necessity for a supermajority of the county committee and 60% of voters to approve tax increases.
The county has operated under a consent agreement with the state under Act 436 for the past year and has used the powers granted under that agreement to fundamentally change its expenditure profile in a way that makes attainment of structural balance a realistic goal. Previously, the county's expenditure framework suffered from a lack of independent control, leading to chronic structural imbalance.
Fitch expects that the changes that management has effected while under the consent agreement will lower the trajectory of spending growth, even after the county exits Act 436 supervision.
Historically, the county's efforts to rein in expenditures were not enough to offset the catastrophic loss of property tax revenues during the recession. Fitch believes that expenditure flexibility has been greatly improved by management's success in using consent agreement powers to realign core spending, including wages, benefits and post-retirement costs.
Recovery plan implementation has largely closed the structural budget deficit and eliminated the accumulated general fund deficit. Key plan achievements include department eliminations/consolidations, significant negotiated health care savings, and the switch to a stipend model for OPEB/retiree health care. Changes to OPEB alone resulted in a $34 million (63% of prior OPEB payments) cost reduction annually. Modifications to the county's defined benefit pension plan, including changes in retirement age, vesting requirements and the limitation of average final compensation to base wages should reduce the required contribution by $11.7 million or 17% in the first year. The county is eligible to be released from the consent agreement when the county executive certifies and the state treasurer concurs that financial stability has been restored, the county has repaid amounts owed to the state, and audited financial statements show the county is not required to submit a financial plan under existing state law. The county anticipates release within one year from now.
Long-Term Liability Burden
Long-term liability burden is moderate, with the unfunded pension liability and overall debt at 12.6% of personal income. Post-retirement benefit liabilities previously were a pressure point on the county's credit profile, but recent changes under the consent agreement make these obligations more manageable. The changes affected both pension and OPEB liabilities as well as their future cost trajectories.
The county's main pension plan has a weak asset to liability ratio (47%) despite the changes, but a comparatively short amortization schedule (24 years) and planned supplemental payments should materially improve the net position.
The county has very little direct debt, although substantial overlapping borrowing drives debt burden to an above-average 8.1% of market value. Future new money borrowing plans are uncertain, as plans for the jail construction are not yet settled. The county halted the jail project, for which it borrowed $200 million in 2010, when cost projections rose from $300 million to $390 million. Management is evaluating its options for the site and further borrowing for project completion is a possibility.
Unrestricted general fund balance returned to a positive position in fiscal 2015, for the first time since recessionary revenue losses severely depleted reserves, largely due to large transfers from the delinquent tax revolving fund. While greatly improved, the current level of reserves (almost 10% of spending, including unrestricted general and delinquent tax revolving fund balances) still represents what Fitch views as an insufficient cushion to absorb potential revenue shortfalls in another recession, given the exceptional vulnerability of the county's revenue stream to economic downturns and the limited inherent budget flexibility to compensate for any revenue losses.
The county's revenue stream has been slow to recover from recessionary declines, making restoration of adequate cushion a challenge. Actions taken during the past year, under the consent agreement, are the first to successfully improve the county's structural balance and long-term liability profile and thus improve its ability to withstand a future economic downturn. Fitch expects that the changes effected under the consent agreement will generate more positive structural results beginning in fiscal 2016.