Detroit at 90 Cents on Dollar Worth 100 Cents Today: Muni Credit

Photographer: Jeff Kowalsky/Bloomberg

Detroit’s emergency financial manager Kevyn Orr has said bond payments are crimping spending on public safety and transportation, and will be among the first of $9.4 billion of long-term liabilities to be addressed. Close

Detroit’s emergency financial manager Kevyn Orr has said bond payments are crimping... Read More

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Photographer: Jeff Kowalsky/Bloomberg

Detroit’s emergency financial manager Kevyn Orr has said bond payments are crimping spending on public safety and transportation, and will be among the first of $9.4 billion of long-term liabilities to be addressed.

Detroit’s emergency financial manager may decide within six weeks if he can avert bankruptcy. Bond investors are buying the Michigan city’s insured debt at a discount in a bet they’ll get paid regardless of the outcome.

Kevyn Orr, appointed by Republican Governor Rick Snyder in March, said on May 13 he will determine within 60 days whether he needs to file the biggest U.S. municipal bankruptcy. Orr, 55, has said bond payments are crimping spending on public safety and transportation, and will be among the first of $9.4 billion of long-term liabilities to be addressed.

Michael Camarella at OppenheimerFunds Inc. and John Loffredo at MacKay Municipal Managers say they’ll get paid in full, no matter what Orr does. They hold general-obligation bonds backed by both Detroit’s full taxing power and insurers such as Ambac Assurance Corp. and National Public Finance Guarantee Corp. Some of the Ambac-backed bonds trade at 90 cents on the dollar, meaning full repayment would generate a profit.

“As a bondholder I’m indifferent whether they file bankruptcy or not,” said Camarella, who helps oversee $38 billion in munis for OppenheimerFunds in New York. “I’m going to get a timely payment under both scenarios. I expect all insurers to make payments so bondholders don’t miss a beat.”

‘Real Option’

A Chapter 9 filing or default is “a real option,” Moody’s Investors Service said this month after Orr released a report on Detroit’s finances. If debt payments are reduced, the brunt of the liability will fall on insurers, which back about 80 percent of the $2.5 billion of Detroit general-obligation and pension bonds, according to Lisa Washburn, a managing director at Concord, Massachusetts-based Municipal Market Advisors.

Bond insurers, which had top credit grades before the financial crisis, help localities reduce borrowing costs by promising to make up any debt-service shortfalls. Just 3 percent of new securities sold last quarter had the protection, which once covered more than half the $3.7 trillion municipal market, data compiled by Bloomberg show.

Even though Orr has called the hometown of General Motors Co. “insolvent on a cash-flow basis,” some debt trades at a premium, reflecting the credit of the insurer. Some bonds backed by Assured (AGO) Guaranty Corp. traded last week at 104 cents on the dollar. Assured is the highest-rated of the city’s guarantors, with an AA- rating from Standard & Poor’s, fourth-best.

Vanguard’s Holdings

Vanguard Group Inc., which oversees about $136 billion of munis, owns Detroit general obligations backed by Assured, according to David Hoffman, a company spokesman. Chris Alwine, Vanguard’s head of muni funds in Valley Forge, Pennsylvania, said he’s “comfortable” owning the securities.

Hamilton, Bermuda-based Assured is “committed to honoring its unconditional and irrevocable guaranty to holders of its insured obligations,” a company spokeswoman, Ashweeta Durani, said in a statement. The insurer covers about $320 million in general-obligation or general-fund Detroit securities, she said.

“Should the city of Detroit fail to make a required debt service payment for any reason, including a bankruptcy filing, National’s insured bondholders are guaranteed their scheduled interest and principal payments on time and in full,” Adam Bergonzi, National’s chief risk officer, said in a March 5 statement. The rating of the unit of Armonk, New York-based MBIA Inc. (MBI) was raised by S&P this month to A, sixth-highest.

Debt Backers

Michael Fitzgerald, a spokesman for Ambac, declined to comment, as did Michael Corbally, a spokesman for Syncora Guarantee Inc. The companies, neither of which is rated by S&P, back some Detroit debt.

“There’s still a chance we can avoid bankruptcy, but we have to be realistic,” Bill Nowling, a spokesman for Orr, said in a phone interview.

Moody’s said in a report this month that municipalities that do seek protection or default are heading toward the average recovery rate of 50 percent seen in corporate cases.

In Jefferson County, Alabama, which filed the biggest U.S. municipal bankruptcy in November 2011, a 60 percent recovery was offered on general-obligation and sewer bonds in 2009, according to Moody’s. Stockton, California, which last year became the nation’s biggest city to seek court protection, initially offered 17 percent on its pension-obligation securities, the rating company said.

Repayment View

“If you think they’re going to try to walk away from 100 percent of their debt, you need to be careful” which insurer backs the bonds, said Matt Fabian, a managing director at MMA. “If you think a 25 percent haircut is more likely,” all insurers will be able to fully repay investors, he said.

That’s the bet OppenheimerFunds and MacKay are making. OppenheimerFunds’ $84 million Michigan Municipal Fund (ORMCX) has $4 million in Detroit general obligations, said Camarella. The company, which bought some insured debt at a discount this year, also has $26 million in its national high-yield fund, he said.

MacKay has less than 1 percent of its high-yield fund dedicated to insured Detroit general obligations, some of which it bought at levels from 80 cents to 90 cents on the dollar, said Loffredo, whose company manages $7.7 billion in local debt.

The securities it holds are unlimited-tax debt, meaning they’re backed by the city’s full taxing power. Detroit is less likely to reduce payments on those bonds, Loffredo said. The city also offers limited-tax general-obligation bonds, which are secured by a levy that is capped by rate or amount.

2009 Turn

Detroit’s unlimited-tax bonds have a Caa1 rating from Moody’s, seven steps below investment grade. They have had junk grades since January 2009. The limited debt is one level lower, at Caa2. Both have negative outlooks.

“There are much easier parameters to do a restructuring of the limited bonds,” because the issuer faces restrictions in raising taxes for the debt, Loffredo said.

The state may prevent a debt-service reduction on the unlimited-tax bonds to avoid setting a precedent that would penalize issuers across Michigan, Loffredo said. Treasurer Andy Dillon, who said he’s been told Detroit would be the largest U.S. municipal bankruptcy, said in February that Chapter 9 proceedings would prove unpredictable.

The prospect of state support, along with insurers’ pledges, ensures gains on bonds bought at a discount, Loffredo said.

Elsewhere in the municipal market, yields on benchmark 30-year munis, at 3.25 percent, are the highest since April 3, Bloomberg data show. Similar-maturity Treasuries this week touched 3.37 percent, the highest since April 2012.

The ratio of the two interest rates, a gauge of relative value, is about 99 percent, the highest in almost three weeks. The higher the figure, the cheaper local bonds are compared with federal securities. The ratio has averaged 103 percent since 2001.

To contact the reporter on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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