Why a Detroit-style bankruptcy is unlikely in Canada

While Canadian cities have a number of funding hurdles to overcome on the horizon, the possibility of a Detroit-style bankruptcy of a Canadian municipality is unlikely.

While Canadian cities have a number of funding hurdles to overcome on the horizon, the possibility of a Detroit-style bankruptcy of a Canadian municipality is unlikely.

That's the conclusion of a report by CIBC economic Warren Lovely, released Thursday, that looked at a number of metrics to gauge the overall health of Canadian municipalities.

Detroit gained notoriety last month when the city entered Chapter 9 bankruptcy proceedings, the end of a decades-old struggle as the former centre of America's car industry slowly receded into a financial morass, and collapsed under the weight of billions of dollars of legacy debt.

"If Detroit isn't a harbinger of wide-scale U.S. municipal defaults — and it doesn't appear to be — it's even less the proverbial canary in the coal mine for Canadian municipalities," Lovely said.

He outlines a variety of reasons for that in the report. For starters, the rules are different here. Canadian municipalities are subject to much more financial and regulatory oversight than U.S. towns and cities.

"True, capital spending pressures exist, and in some select cases, related debt accumulation could ultimately threaten credit ratings," he said. "But there's no equivalent to Detroit lurking in the shadows of Canada."

Of the more than 50 municipal-based entities in Canada that one of the major ratings agencies cover, not a single one is rated below A grade — and almost 90 per cent of them are at least AA- or better.

Notwithstanding some isolated incidents, "the average credit rating of Canada's large municipal issuers is actually stronger today than it was before the global financial crisis," Lovely said.

The main advantage that virtually every Canadian municipality has over Detroit is an expanding population. In the 1950s, at the start of the postwar boom, Detroit had 1.8 million people, making it America's fifth-largest city. Today, about 700,000 call Detroit home and it barely cracks the Top 20.

Detroit lost almost 30 per cent of its population in the last decade alone, a time during which most Canadian municipalities saw their populations expand by between 10 and 40 per cent. Of the 35 largest municipalities in Canada, only two — Thunder Bay, Ont., and Saguenay, Que., — were in negative territory, with each contracting by less than one per cent over more than a decade.

Cities generally depend on property taxes for about 40 per cent of their revenue, so a shrinking tax base often causes a vicious cycle of declining services and declining revenues.

The simple fact of having an increasing population — even though that brings with it higher expenses — should be enough to help Canadian cities avoid bankruptcy, Lovely says.

Another weight that dragged Detroit down is exorbitant pension costs, something Canadian municipalities aren't nearly as vulnerable to. In Canada's largest province, Ontario, municipal workers' pensions aren't a concern for cities. They're jointly managed by OMERS. In recent years, the fund has made changes to both contributions and benefits with a view to see the OMERS plan be fully funded in the next 10 to 15 years.

But even if the plan runs into problems, it won't be cities on the hook for a bailout. Contrast that with Detroit, which owes $3.5 billion in unfunded pension liabilities. (That's about a quarter of the City of Toronto's entire annual budget.)

Infrastructure costs rising

Which isn't to say that it's clear sailing for Canadian municipalities. "If there's a worry for Canadian municipalities, it's long-term infrastructure needs," Lovely warns.

Much of Eastern Canada is struggling to keep its aging infrastructure up to date, and in Western Canada, "many cities are rushing to put in place the roads sewers and other vital capital required to support a burgeoning population and rapidly growing industrial base," Lovely writes. Public transit needs are "particularly pressing" in the largest urban centres, he says. 

While there are pockets of concern, most cities in Canada still have very low debt levels, compared to the U.S. and elsewhere. Local government net debt is at about two per cent across Canada, a tiny fraction of what's seen at the federal or provincial level. "Across the border from Detroit," Lovely notes, "Windsor's tax-supported debt burden is actually falling.

"With populations growing, economies reasonably diversified, financial management practices sound and provincial oversight strong, investors in Canada's municipal government sector needn't fear a Detroit-style crisis."