Assumed rate of return on pension benefits below national average, could tempt city toward risky investments
DETROIT (Reuters) — Detroit’s plan to recover from bankruptcy includes several blueprints for a new future. The only problem is the city, the largest ever to file for bankruptcy, is still a long way from financially healthy and its restructuring plans leave little room for error.
Detroit is far short of the $1.7 billion it needs over the next 10 years to remove abandoned buildings, replace outdated technology and increase public safety to stem the exodus from the city. The city will be hard pressed to get its daily operations onto a stronger footing and has few clear ways to raise all the needed revenue, critics say.
“What Detroit needed to start with was a reinvestment program,” said James Spiotto, managing director of Chapman Strategic Advisors, a municipal finance consultancy. “If you don’t solve the systemic problem and fix it for real, all you’re going to do is repeat it going forward.”
Detroit’s 1,034-page plan for fixing the city’s finances will be the subject of a weeks-long bankruptcy court proceeding, beginning on Tuesday.
Detroit filed the largest-ever municipal bankruptcy in July 2013, with $18 billion of debt. Critics, including a court-appointed bankruptcy expert, are raising questions about whether Detroit has reduced its debts aggressively enough, and even city officials acknowledge Detroit faces significant challenges, with little room for error.
Federal bankruptcy Judge Steven Rhodes ultimately will rule on whether the financial restructuring proposed by Kevyn Orr, Detroit’s state-appointed emergency manager, is realistic.
City officials are beginning to see glimmers of hope in the form of business investment, a downtown housing boomlet, and major investment from Quicken Loans founder Dan Gilbert, who has snapped up dozens of downtown buildings.
Short of cash
The $1.7 billion over the next decade is meant to address some of the city’s most vexing challenges. The biggest chunk, $558.7 million, would go to public safety, while an upgrade of the city’s decrepit information systems would eat up the second-largest piece, $479.9 million.
But it is not clear how the city will get the money. So far, the biggest chunk for Detroit's restructuring initiative is coming from $300 million in federal grants. JPMorgan Chase & Co announced a $100 million, five-year commitment in May to help spur bankrupt Detroit's economic recovery that includes $25 million to address blight.
There is no cash in a bank account to fund the initiatives, court-appointed expert Martha Kopacz wrote in her report that gave Detroit’s plan a tepid endorsement for feasibility.
The state of Michigan has committed $195 million toward the $661 million “Grand Bargain” designed to protect the Detroit Institute of Arts collection, but all of that money is earmarked to ease city retiree pension cuts, and will not be directed toward the $1.7 billion of restructuring initiatives.
Even if funds are found, the city in some cases has downplayed the size of its problems. For example, the $420 million allocated for blight removal is less than half the $850 million called for by the city-backed Blight Removal Task Force.
On one key area of reform, pensions, the city has frozen accrual of pension benefits and restructured them going forward. But Kopacz has noted that the assumed rate of return on its pension investments — 6.75 per cent — is below the national average for public pension funds and could tempt the city toward volatile and risky investments.
Even when Detroit has arranged funding to meet its needs, it has not met its original objectives. Exit financing announced last week, $275 million in new borrowings from Barclays Capital, came in $25 million lower than city officials had forecast.
Figure in the fact that most of the proceeds will go toward paying off an existing loan and fund certain creditor settlements, and Detroit will have little free cash from the loan to cover operating costs as the city exits bankruptcy.
Confidence in the plan is weak in part because figures put forward by Orr often do not match Detroit’s own budget figures.
“The feasibility reports don’t even make a real attempt to make them convincing,” said William Brandt, a Chicago-based turnaround expert whom Rhodes interviewed for the expert’s job.
Brandt called the plan “a treatise in equivocation.”
Judge could reject plan
John Hill, Detroit’s chief financial officer, acknowledged the city is dealing with significant uncertainties.
Judge Rhodes could reject the plan.
Detroit could lose in its controversial effort to invalidate over $1.4 billion of certificates of participation (COPs) the city sold in 2005 and 2006 to pay its pension liability.
The restructuring initiatives are budgeted to bring in $483 million in new revenue and save the city $358 million over the next decade. To make it happen, though, Detroit will need access to debt financing to fund the upfront costs of investment, Hill said.
Mayor Mike Duggan, who will be responsible for Detroit’s fiscal health after emergency manager Orr’s term expires later this month, is moving ahead regardless of the uncertainties.
Inside the Coleman A. Young Civic Center, Hill and other city officials are scrambling to rebuild Detroit’s balance sheet, restock city departments with new personnel and redesign Detroit’s information infrastructure.
“Moving out on all these things at the same time makes it difficult,” Hill said.
Hill is putting controls in place to help the city stay within budget: Placing representatives from the CFO’s office into city departments to help control costs, for example. A new grants management office will scout for federal and foundation cash. By streamlining hiring procedures, the city aims for a significant reduction from the six months it currently takes to hire an employee.
In the area of information infrastructure, Detroit’s historic under-investment is proving an unanticipated benefit. “There’s not a system worth saving,” Hill said. “I look at it as an opportunity.”
After years of troubling headlines, conditions are beginning to improve say entrepreneurs like Zak Pashak, who founded Detroit Bikes, which is hand building bicycles on Detroit’s west side.
“On the ground, bankruptcy is not as dramatic as it might seem from a distance,” said Pashak, who pointed to improvements in city services and the local business climate. “It’s nice to see the situation addressed. It’s not dire. It’s actually really positive.”