Detroit’s proposed 74 cent recovery rate on general-obligation debt, almost five times more than its last offer, has sent yields to the lowest in 10 months and signals a broader rally in local government securities.
The extra return that investors demanded on nine-year city bonds backed by an unlimited tax pledge dropped 0.75 percentage point last week to the narrowest since June. That compares with a 0.03 percentage point decline for benchmark muni yields.
Emergency Manager Kevyn Orr had proposed giving investors in debt with unlimited tax backing from the bankrupt city the same 15 cents on the dollar he offered those holding limited bonds. The deal announced last week compares with an average of 65 percent on defaulted bonds from 1970 to 2012, according to Moody’s Investors Service data. The outcome should renew the view of general obligations as sacrosanct, said John Dillon at Morgan Stanley Wealth Management.
“If the recovery is 74 percent in what has been one of the worst municipal bankruptcies, that should give some people in the market more comfort,” said Dillon, a managing director in Purchase, New York.
Detroit’s treatment of bondholders in negotiations amid the biggest U.S. municipal bankruptcy has called into question the safety of any security backed by a government’s pledge to pay what it owes, a tenet of the $3.7 trillion municipal market. Investors have watched the Chapter 9 proceedings for clues about how the debt would fare when a city can’t meet its obligations.
Orr said last week the unlimited-tax general-obligation debt was secured because it has a claim on a portion of property-tax revenue. He previously included them among bondholders with lesser claims on revenue.
The city settled on $388 million of debt backed by insurance units of Assured Guaranty Ltd. (AGO), MBIA Inc. (MBI) and Ambac Financial Group Inc. (AMBC) The agreement calls for general obligations to be exchanged for new securities issued by the Michigan Finance Authority that are secured by the unlimited-tax general obligation pledge of Detroit and a fourth lien on distributable state aid payments.
Though the insurance meant that investors were likely to receive full value regardless of the recovery rate, it boosts confidence in buying bonds from other Michigan cities, including those that could also seek bankruptcy protection, according to a report this week from Municipal Market Advisors.
The treatment of unlimited general obligations “resolves - - positively -- much of the market’s worry about precedents that could have been set,” according to Concord, Massachusetts-based MMA.
Moody’s concurred in a report this week that called the proposed settlement a credit positive for holders of the bonds, which it rates Caa3, the third-lowest grade. The rank signals that investors should recoup 65 percent to 80 percent.
The Detroit general obligations affected by the settlement have outpaced a broad rally in municipal debt.
Unlimited-tax general-obligation bonds maturing in April 2023 traded April 10 at an average yield of 7.05 percent, or 4.7 percentage points more than benchmark munis, data compiled by Bloomberg show. It’s the narrowest spread since June 6. The debt is backed by Ambac Assurance Corp.
Similar bonds backed by National Public Finance Guarantee Corp. due in April 2019 exchanged hands yesterday at a yield 3.96 percentage points higher than AAA munis, the least since June 27.
“The muni market has probably breathed a giant sigh of relief that they’ve deemed general obligations to be secured by particular revenue,” said Hugh McGuirk, Baltimore-based head of municipal investments at T. Rowe Price Group Inc., which oversees about $20 billion of local debt.
In an interview at Bloomberg’s New York headquarters last week, Orr said the agreement was based on an argument that the city couldn’t collect property taxes that voters had designated for debt service if it didn’t pay bondholders with the revenue.
“It’s not so much that their percentage has changed from 15 to 74, it’s that they’ve agreed to give us the equivalent of 26 percent of what they’re owed from a dedicated revenue stream,” Orr said about bondholders. “We’re paying them a portion, but the city also benefits.”
Retired municipal workers would see more money if U.S. Bankruptcy Judge Steven Rhodes approves the deal. It will “insure that the most vulnerable retirees remain above the federal poverty line,” mediators appointed by Rhodes said in a statement.
Detroit yesterday reached an agreement on pensions and health benefits with a group representing retired police officers and firefighters. They would see no cuts in their monthly pensions, while cost-of-living increases would be reduced.
The settlement is an improvement from a plan submitted to the court in February and revised last month. That stated the pensions would be cut about 6 percent if the police officers and firefighters vote for the plan, 14 percent if they don’t.
The deal can go through only if the city wins approval of an $816 million proposal to bolster the city’s pension systems. To get that money, the city must have the support of current and retired city workers who haven’t yet settled.
The settlements show how creditor expectations have changed since Detroit initially filed bankruptcy in July, said Duane McAllister at BMO Asset Management Corp.
“I wonder if Kevyn Orr wasn’t just playing chess the whole time,” said McAllister, who helps oversee $4 billion of munis at BMO in Milwaukee. Compared with earlier proposals for investors, “74 percent seems like a great settlement.”
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