Detroit: D is for DISASTER

Those in Washington and elsewhere have little interest in drawing attention to the municipal disaster that is the City of Detroit, Michigan.

While nobody likes dealing with disasters, there is no other single appropriate word to describe this once proud burgeoning metropolis. As recently reported by The Wall Street Journal,

The city of Detroit's manifold problems are coming to a head. Emergency manager Kevyn Orr warned the city's 150 or so creditors and unions on Friday that Chapter 9 bankruptcy is in the offing if they don't accept the steep cuts he's presented.

I will allow others to opine on the multitude of reasons that has brought Detroit to its current state but lets not deny that corruption and fiscal malfeasance have played a very real role in decimating this city.

Let's dive into this disaster so we can gain a greater appreciation for life within this city. To do so, let's navigate and review the City of Detroit: Proposal for Creditors released last Friday. What do we learn?

> Declining Population: The City's population has declined 63% since its postwar peak, including a 26% decline since 2000

> High Unemployment: Despite some recent improvement, the City's unemployment rate has nearly tripled since 2000 to a rate of 18.6% at end of 2012.

> RESIDENTS AND BUSINESSES ARE LEAVING DETROIT TO ESCAPE HIGH TAXES AND INSURANCE COSTS.

> THE CITY IS INSOLVENT: Absent ongoing cash intervention (primarily in the form of payment deferrals and cost cutting), the City would have run out of cash before the end of FY 2013.

> In 2012, the City had the highest rate of violent crime of any U.S. city having a population over 200,000 (based on the FBI's Uniform Crime Reports database). The City's violent crime rate is five times the national average.

> Residents and business owners have been forced to take their safety into their own hands; some relatively well-off sections of the City have created private security forces.

> As of April 2013, approximately 40% of the City's street lights were not functioning.

> In regard to the Detroit Police Department, employee accountability is limited. Individual employee performance metrics do not exist for either positive or negative police activity. Morale is extremely low. Disciplinary processes are slow and cumbersome, preventing leadership from effectively managing the department.

> There are approximately (i) 78,000 abandoned and blighted structures in the City, nearly half of which are considered “dangerous” and (ii) 66,000 blighted and vacant lots within the City limits.

> The City estimates that, as of the close of its 2013 fiscal year (i.e., June 30, 2013), the City will have liabilities reflected on its balance sheet of approximately $9.05 billion.

> Off-Balance Sheet Liabilities: unfunded liabilities increased from $4.8 billion to $5.7 billion from June 30, 2007 through June 30, 2011 (the most recent actuarial data available).

> During fiscal year 2012, more than 38% of the City's actual revenue was consumed servicing legacy liabilities. Going forward, legacy liabilities are expected to consume increasing portions of City revenues.

> UNSUSTAINABLE RETIREE BENEFITS: Liabilities are large and unfunded consist of the Health and Life Insurance Benefit Plan and the Supplemental Death Benefit Plan; 99.6% of the City's OPEB liabilities are unfunded.

> PENSION CONTRIBUTIONS; The City has consistently deferred year-end pension contributions by using a payment plan financing arrangement paying 8% interest.

> IN THE ABSENCE OF A COMPREHENSIVE FINANCIAL RESTRUCTURING, BUDGET DEFICITS WILL CONTINUE FOR THE FORESEEABLE FUTURE: The City Has Limited Options for Further Revenue Generation and, in the absence of a Comprehensive Financial Restructuring, Cost-Saving Measures.
– Legacy obligations continue to increase;
– Limited or no access to capital markets;
– Diminishing, if any, returns from further tax increases; and
– Minimal potential for further payroll related reductions.

> The City's already high tax rates are widely believed to have contributed to its population loss and economic decline. For a number of reasons, higher tax rates could have a negative effect on revenue.

> The City is currently levying taxes at or near the statutory maximums.

> The City believes that lowering selected tax rates – primarily income and property tax rates – to levels that are at least competitive with surrounding jurisdictions is critical to reversing the City's crippling population and job losses.

CONCLUSIONS BASED UPON PROJECTIONS
> The City acknowledges that it must exert reasonable efforts to maximize recoveries for all creditors.

> As demonstrated by the 10-year projections, however, the City's expected revenues will fall significantly short of the levels required to fund the City's operations and fully satisfy its liabilities.

> Given the City's (i) substantial debt levels (ii) significant labor related liabilities and (iii) continuing operating expenses, shared sacrifice will be required from all stakeholders to achieve the City's dual (and complementary) goals of maximizing returns for its stakeholder constituencies while simultaneously establishing the framework for a healthy and growing Detroit moving forward.

Detroit today . . . where tomorrow?

Navigate accordingly.

Larry Doyle

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I have no business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.