May 13 (Bloomberg) -- Detroit may run out of cash next month and must cut long-term debt and retiree obligations, according to emergency financial manager Kevyn Orr’s preliminary plan to save Michigan’s largest city from bankruptcy.
Orr’s report says the cost of $9.4 billion in bond, pension and other long-term liabilities is sapping the ability to provide public safety and transportation. He listed cutting debt principal, retiree benefits and jobs among his options.
“No one should underestimate the severity of the financial crisis,” Orr said yesterday in a statement. He called his report “a sobering wake-up call about the dire financial straits the city of Detroit faces.”
The report, required under a state law that gives Orr broad authority over city government, offers guidelines for cost cuts while giving few details. The document delineates Detroit’s financial situation, noting it is “insolvent on a cash basis.” Its accumulated deficit will top $380 million by June 30, and by then it will run out of cash unless it defers pension payments and other obligations, according to the plan.
The Motor City is caught in a downward spiral of revenue from a shrinking tax base -- it has lost two-thirds of its postwar peak population -- while unemployment at 18 percent is twice the state level, according to Orr’s report. Managing an area larger than Boston, San Francisco and Manhattan combined has become increasingly difficult.
“Without a significant restructuring of its debt, the city will be unable to break the cycle of damaging cutbacks in essential municipal services and investments,” according to Orr’s report. He also cited the need for concessions from unions, and revamping the police and fire departments to protect residents beset by crime and arson-inviting blight.
Detroit’s long-term obligations are at least $15.7 billion, including unfunded pension and retirement benefits. The general fund this fiscal year, with revenue of about $1.1 billion, will pay about $461 million for debt and health costs, according to the report.
All the city’s revenue couldn’t pay off its debt in 20 years, said Bill Nowling, a spokesman for Orr.
“If we don’t change and restructure, we are going to run out of cash,” he said yesterday by telephone. “That shouldn’t come as a shock to anybody.”
“This is exactly the situation the city is in, and our creditors need to know that,” Nowling said. “Some do. A lot don’t.”
Orr’s plan lays out alternatives for dealing with long-term debts, including reducing interest rates, stretching out payment schedules and outright forgiveness of principal or refinancing. The city’s credit rating is below investment grade.
Any reduction of Detroit’s general-obligation bond payments “would have significant implications for the city’s ability to borrow in the future,” Lisa Washburn, managing director at Concord, Massachusetts-based Municipal Market Advisors, wrote in a report today. Doing so might taint Michigan as a whole by increasing borrowing costs for other localities, Washburn said.
The $3.7 trillion municipal market is already penalizing city securities after Orr’s report. A tax-exempt Detroit general-obligation bond maturing in April 2015 traded today at an average yield of 8.52 percent. That’s the most investors have demanded to hold the debt since before March 5, according to data compiled by Bloomberg. On May 10, it traded at a 7.27 percent yield.
It will be difficult to reach consensus among debt holders, said Doug Bernstein, a bankruptcy lawyer with Bloomfield Hills, Michigan-based Plunkett Cooney PC. Curbing pension benefits will be crucial to gaining an agreement from bondholders to cut debt costs without resorting to bankruptcy-court protection, he said.
“That’s an optimistic view, that you can do it by consensus,” Bernstein said. “Maybe when they read the numbers, they’ll agree. But given the number of different credit classes and collective-bargaining units, I don’t see them conceding voluntarily.”
Orr’s report is probably a prelude to the city’s seeking Chapter 9 bankruptcy protection, said Manny Grillo, the New York-based head of restructuring practices for Goodwin Procter LLP. He said there are too many creditors, including 48 employee unions, to reach a consensus without court intervention.
“No one is ever going to be the first to cut a deal,” Grillo said.
State Treasurer Andy Dillon has saidthe city would be the biggest U.S. municipality to declare bankruptcy. Michigan, led by Republican Governor Rick Snyder, may step in with financial help “to fill in the gaps” only after deals have been struck to lower debt costs, Grillo said.
Orr’s report doesn’t mention the prospect of state assistance. Michigan borrowed $137 million last year to aid the city. It has given Detroit about $80 million, holding the rest in escrow, according to Nowling.
The report is a “source of truth” as negotiations begin to cut costs and overhaul government, Nowling said.
Mayor Dave Bing, in an e-mailed statement, said he would conduct a full review of Orr’s report today.
“The assessment by Mr. Orr of the city’s financial condition is consistent with my administration’s findings,” Bing said.
Snyder named Orr, a lawyer in Washington who specializes in restructurings, to solve Detroit’s fiscal crisis and he assumed control March 25. Orr must hold a public hearing within 30 days of releasing his plan, which also sketches out ways to deal with nonfunctional street lights, removal of vacant buildings and improving bus service.
Orr wants to continue an effort to turn over the aging streetlight system to a public lighting authority by 2020. The plan calls for eliminating almost half of 88,000 streetlights, concentrating replacements in more populous areas. The plan also says Detroit should exit the business of supplying electricity to businesses and municipal operations.
Orr’s report notes that workers have already absorbed pay and benefit cuts. However, those reductions weren’t spread uniformly over all the unions, and the plan indicates more equitable concessions will be sought.
Orr can impose new contract terms if he can’t wrest cuts and givebacks from union leaders, according to the law.
Hiring a new police chief and restructuring the department will happen soon, Nowling said. Given cuts in the city workforce over the past few years, additional employees may be needed in the short term to implement more efficient practices, including the replacement of outdated computers, according to Orr’s plan.
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