Fitch Rates $954MM Detroit Retirement Funding Trust 'BBB'; Rating Watch Negative.

CHICAGO -- Fitch Ratings has assigned a 'BBB' rating to the Detroit Retirement Systems Funding Trust, Michigan, $153,500,000 taxable certificates of participation (COPs), series 2006 (fixed-rate) and $800,000,000 taxable COPs, series 2006 (floating-rate). The rating remains on Rating Watch Negative, reflecting Fitch's planned monitoring of the city's financial results in fiscal 2006 and 2007. The certificates represent undivided proportionate interests in the rights to receive payments under separate service agreements between the City of Detroit and the Detroit General Retirement System Service Corp. and the Detroit Police and Fire Retirement System Service Corp. The transaction will restructure a portion of the $1.4 billion of outstanding pension certificates to accommodate the more manageable amortization of unfunded accrued actuarial liabilities (UAAL) of the city's pension systems.

The COPs are expected to price on or about June 5 through a syndicate led by UBS Investment Bank and Siebert Brandford Shank & Co., which are serving as co-senior managing underwriters. Robert W. Baird & Co. and Scott Balice Strategies, LLC are serving as financial advisors. These issues will reschedule floating-rate certificates and a portion of fixed-rate certificates to match the 30-year amortization of the police, fire and general retirement systems UAAL.

The 'BBB' rating is based on the City of Detroit, unconditional contractual obligation to make its service payments, which are not subject to appropriation. The city is bound to make its contractual payments to the service corporations for the full term of the contracts. Under the trust agreement, the service corporations will assign their right to receive service payments to the funding trust for the benefit of certificate holders. Failure to make COP service payments when due allows the contract administrator to file a lawsuit against the city to enforce payment of the contractual obligation. A court may require the city to raise the payment through a tax levy without limitation as to rate or amount. Voter approval would not be necessary to levy such supplemental taxes. This transaction does not affect normal annual pension payments, just the scheduled payments which financed the unfunded accrued liabilities. Proceeds are deposited with the pensions systems and managed the same as other assets.

The transaction is designed to reduce the annual funding cost of the unfunded liability; minimize financial risk; and incorporate new amortization schedules of the unfunded liability.

The Michigan Constitution and the Home Rule City Act enable the city to establish the pension systems and provide for their funding. The obligation to fund normal and unfunded accrued pension liabilities is further clarified through Shelby Township Police and Fire Retirement Board v. Shelby Township and the Public Employees System Investment Act. The Detroit City Council in February 2005 adopted ordinances that provided for the alternative pension liability funding.

The city has two retirement systems: the General Retirement System (GRS) and the Police and Fire Retirement System (PFRS). Each has a strong history of pension funding and rapid amortization of the unfunded liabilities. As recently as 2002, the GRS was 91.6% funded and the PFRS, 103.2%. The estimated funding for 2004 was 73% for the GRS and 79.7% for the PFRS, both primarily due to diminished asset value. The estimated unfunded liability for fiscal 2004 (June 30 year-end) was $1.7 billion, from $1.3 billion in fiscal 2003. The sharp increase in the UAAL was due primarily to the recognition of investment losses. Through the pension certificates, the funding improved to 96.3% in fiscal 2005 in the GRS and 99% for the PFRS; the unfunded liability in fiscal 2005 for both systems totals $147.6 million. Although at the time of the 2005 pension certificates the city had not completed its negotiations with both retirement systems' boards to extend the pension amortization period, it structured the deal with floating-rate notes, anticipating the restructuring of the certificates. State law and GASB require pension liability funding of no more than 30 years.

GRS Service Corporation and PFRS Service Corporation are nonprofit corporations formed by the city to receive COP service payments. The service corporations irrevocably assign to a funding trust (formed under the trust agreement) all rights to receive, collect and enforce all COP service payments. Since the service corporations are not expected to have an active role, the funding trust and service corporations will enter a contract administration agreement with the U.S. Bank N.A., the contract administrator. Interest rate swaps will change effectively the variable-rate certificates to a fixed obligation. The funding trust issues the certificates to the certificate holders and the city makes debt service payments through the contract administrator and funding trust to the certificate holders. Proceeds of the certificates flow through the service corporations to the two pension systems.

Through an interest rate swap, the LIBOR-indexed floating-rate certificates (FRCs) will be swapped into fixed payments. After a short lock-out period, the FRCs are callable at par on interest payment dates. Unlike other variable-rate transactions, which have various term structures that may change and require liquidity support, the FRCs have interest rates that fluctuate with the three-month LIBOR rate on U.S. dollar deposits plus a margin. The actual rate is set by the contract administrator each quarter according to LIBOR rates available through Moneyline Telerate, Inc. A liquidity provider is not necessary for the transaction since there is no remarketing or liquidity risk. Since the rate is tied to LIBOR, there is no basis risk. The counterparty is not selected yet, but is expected to meet high-quality standards and must post collateral.

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