OREANDA-NEWS. S&P Global Ratings has assigned its 'AA' rating to Michigan Finance Authority's local government loan program first-lien revenue bonds series 2016C-1, assigned its 'A+' rating to the series 2016C-2 third-lien bonds, and its 'A-' rating to the series 2016C-3 and 2016C-4 fourth-lien bonds. The bonds are issued on behalf of Detroit, Mich. At the same time, S&P Global Ratings affirmed its 'AA-' rating on the second-lien bonds and its 'B' rating on Detroit's unlimited tax general obligation (GO) debt rating. The outlook on all bonds remains stable.

A pledge of all distributable state aid payable (DSA) to Detroit secures the bonds, and all bonds also carry the city's GO pledge. First - and third-lien bonds are a limited tax (LT) GO; the second - and fourth-lien bonds are an unlimited tax obligation. Because the second - and fourth-lien bonds are unlimited tax GO (UT GO) bonds, the city will levy a property tax millage for 100% of the debt service. Given the double-barrel pledge, we rate the bonds to the stronger of the two pledges, which is the DSA revenue stream.

DSA consists of a portion of the 6% retail sales tax revenues collected across Michigan. The pledged revenues are divided into constitutional and statutory components. Constitutional state aid is distributed based on population; statutory aid is distributed based on a formula the state determines. S&P Global Ratings views the constitutional share of state aid as the more stable of the two components given the state's ability to make adjustments (including reductions) to the statutory portion.

"The ratings on the distributable state aid bonds reflect our view of the continued strong DSA revenue stream based on the broad statewide collection area for revenues," said S&P Global Ratings credit analyst Jane Ridley. "The affirmation of our 'B' rating on the city's GO debt reflects our view that the city continues to make progress to improve its financial and operating position post-bankruptcy," she added.

Key credit factors include:A statutory lien on DSA, consisting of state sales tax revenues Detroit receives from the state;The state treasurer's requirement to send all state aid due to the city directly to the trustee, in an amount sufficient for set-aside payments, before releasing any state aid to Detroit;Strong coverage of the closed first-lien debt of 2.9x constitutional revenues and 10.3x all-in;Good coverage of second-lien debt of 1.9x constitutional revenues and 6.8x all-in, coupled with an additional bonds test (ABT) of 150% of constitutional and 200% of constitutional and statutory revenue;Adequate coverage of third-lien debt of 1.4x constitutional revenues and 5.0x all-in, and an ABT of 115% of constitutional and 200% of constitutional and statutory revenue;An agreement with the state treasurer that no delay of set-aside payments will occur, even if state aid is withheld or delayed; andThe treasurer's ability to advance any appropriated state aid to the trustee for payment of debt service, if needed. Offsetting factors include Maximum annual debt service (MADS) coverage from the constitutional portion of distributable state aid of 0.68x following the addition of $35 million in new fourth-lien debt, although all-in coverage from both statutory and constitutional rises to 2.4x ; andThe pledged revenue stream's sensitivity to both city and state economic conditions, given the constitutional distribution of state aid is based on Detroit's population, and the total amount of state aid available for distribution is based on statewide sales tax collections. The state uses the U. S. Census as its basis for population, so Detroit's population will not be reassessed until the 2020 census. The bonds' structure has several enhancements that we believe significantly offset the credit weaknesses arising from Detroit's financial condition. These include the statutory lien and trustee involvement for both the DSA revenues and the UT GO debt millage; the state treasurer's requirement to make set-aside and debt service payments regardless of delays in statutory state aid due to the city; and the ability to advance any state aid due to Detroit for payment of debt service. DSA must be annually appropriated by the state in its budget, but constitutional aid is not discretionary. Although this does leave the revenue stream vulnerable to late budget adoption, Michigan has no history of such. In addition, we feel late budget adoption risk is mitigated by the timing of debt service payments, which come in the middle of the state's fiscal year on April 1.

The stable outlook on the DSA bonds reflects our expectation that over the two-year time horizon of the outlook, state aid distributions to Detroit will not drop significantly, and that coverage for all bonds, including the fourth-lien series, from total state aid revenues will remain adequate. If delays in the statutory portion of state aid occur, we expect that the legal mechanisms will ensure timely payment of debt service.

The stable outlook on the GO debt reflects our opinion that the city has stabilized its operations post-bankruptcy, but is still challenged to demonstrate and maintain structural balance. Maintenance of the GO rating is predicated on continued oversight from the Financial Review Commission (FRC).

With the city having room to issue additional debt under the second and third liens and low all-in coverage on all series, we view dilution of coverage on the DSA bonds as a possibility and, as such, do not expect to raise the rating over the outlook's two-year horizon.

If Detroit demonstrated improvement in financial performance and execution, we view an upgrade of the GO bonds over the one-year horizon of the outlook as possible, but given the challenges still facing the city, think that likelihood is less than one-in-three.

Over the outlook's two-year horizon, we could lower the ratings on the bonds if DSA coverage drops significantly, or if additional debt further dilutes coverage.

We could also lower the GO rating during the one-year outlook horizon if there is deterioration in any of our key credit characteristics: economy, finances, management, and debt, including pensions.