Insolvency Looms in Detroit Suburb as Studio Fails: Muni CreditChris Christoff and Brian Chappatta
Investors chasing the biggest rally in high-yield municipal debt since 2008 are drawing the line at the bonds of Allen Park, Michigan, whose ill-fated plan to build a movie studio has left it facing possible bankruptcy.
The Detroit suburb of 28,000 sold $31 million of bonds about three years ago for the venture, the brainchild of California film executive Jimmy Lifton. Instead of his Unity Studios, the city is stuck with partially leased buildings that aren’t meeting costs, and $2.6 million in annual bond payments from a $16 million general budget.
Next month, a new law gives Allen Park’s emergency manager more power to stave off insolvency. Still, in the $3.7 trillion muni market, investors are standing clear even as yields close to 47-year lows lure buyers to riskier, higher-yielding debt. Allen Park bonds have trailed gains in benchmark local debt, pushing the extra yield for some securities to about seven percentage points from 6.5 percentage points in June.
“There has to be a legitimate turnaround plan for some of these communities before it warrants a high-yield investor like me getting involved,” said Tim Pynchon, who helps manage $3 billion of high-yield munis at Pioneer Investment Management Inc. in Boston.
Allen Park, near Detroit’s southwest border, joins a roster of municipalities burned by assuming debt to finance commercial or sports-related projects with promises of economic salvation. Last year, Vadnais Heights, Minnesota, had its credit rating dropped 12 levels after it borrowed for a $25 million sports complex that wound up costing one-third of its annual budget.
In Allen Park, the deficit when including costs such as pensions and health care has ballooned to nearly $4 million and the city’s future as “a going concern” is in doubt, according to a Dec. 29 audit report. Its credit was cut five levels below investment grade by Standard & Poor’s in March.
Lifton didn’t immediately return a call to his studio in Burbank, California. He signed an agreement with Allen Park in 2010 that left him with no liability. Under the accord, he’s not allowed to talk about the deal.
Joyce Parker, appointed emergency manager in October, unveiled plans last week to fix the city’s finances. They include selling assets such as vacant property; cutting pay and requiring employees to assume a bigger share of health-insurance costs; hiring a private contractor for trash pickup; and refinancing bonds sold for the failed studio, Parker said in a statement.
Bankruptcy “is always an option if the other plans are not feasible,” Parker, 60, president of Ann Arbor, Michigan-based The Municipal Group LLC, said in an interview. She would need state approval for that.
Rather than run out of cash this month, the city has delayed payments to some vendors, she said.
No Michigan city has declared bankruptcy, and state laws aimed at averting defaults are helping turn around municipalities such as Flint and Pontiac.
Parker’s toolkit will expand at the end of March. That’s when a law signed in December by Governor Rick Snyder, a 54-year-old Republican, takes effect and gives emergency managers more authority, including renewed power to cancel union contracts. Voters in November repealed a similar law that critics labeled as undemocratic, anti-union and too protective of bondholders at the expense of government services.
The emergency manager law makes the state more attractive to investors, said Hector Negroni, New York-based chief investment officer of Fundamental Credit Opportunities, which invests in the municipal market.
“I’m interested in investing in places where I understand that there’s a framework by which responsible actions can be taken to address credit stress,” Negroni said in an interview.
Falling property values and $3 million in annual employee retirement costs added to the fiscal strain, said Parker. Yet finances went over a cliff when officials sold the bonds to buy property for a $146 million movie studio and 3,000 new jobs promised by Lifton, a Detroit native and president of Oracle Post, a Burbank, California, video post-production company. The 104-acre site once housed an automotive supplier.
The studio didn’t materialize, though the movie company, Unity Studios, operated a film school at the property for a few months until it shut in 2010. Portions of the site are leased, though not enough to cover the city’s cost of maintenance.
As the stress mounted, investors marked down prices on debt financing the venture. They have been left out of a rally in tax-free munis rated BBB, or two levels above junk, for which the extra yield on 10-year maturities is close to the smallest since 2008, data compiled by Bloomberg show.
Taxable general-obligation bonds sold for the project in 2009 with a 7.33 percent yield and due in 2039 have traded this month with yields averaging about 10.8 percent, data compiled by Bloomberg show.
For Michael Brooks, who helps oversee $31 billion at AllianceBernstein LP in New York, including a Michigan state fund, Allen Park’s debt has no appeal, no matter what the yield.
“We’re staying away from weak local issuers,” Brooks said.
In trading last week, benchmark 10-year muni yields rose to 1.88 percent, the highest since August, Bloomberg Valuation data show.