Costliest Detroit Debt Shows Junk Appeal Undimmed: Muni CreditDarrell Preston and Chris Christoff
Detroit’s emergency manager says “everything’s on the table” to avoid bankruptcy, including bond payments. That hasn’t deterred investors from pushing the city’s relative borrowing costs to the lowest since January.
Investors demanded as little as 7.2 percentage points of extra yield above top-rated municipal borrowings this week for Detroit general obligations due in April 2016, data compiled by Bloomberg show. That was the smallest spread since Jan. 25 for the tax-exempt securities, which have been graded junk for four years.
High-yield munis have beaten the $3.7 trillion local-debt market for five straight quarters. A month after Michigan Governor Rick Snyder named Kevyn Orr to handle Detroit’s finances, the debt gains shows that even with the risk, buyers are still seeking higher yields, said Michael Schroeder, president of Wasmer Schroeder & Co. in Naples, Florida. The state emergency-manager law dictates that investors must agree to changes in the amount and timing of repayment, he said.
“The city’s general-obligation bonds have speculative-grade credit ratings, but the risk-reward comparison is pretty interesting,” said John Miller, co-head of fixed income in Chicago at Nuveen Asset Management. The firm oversees about $95 billion of munis, including some Detroit bonds.
In the hometown of General Motors Co., the world’s second-biggest automaker, officials struggle to provide public safety and street lights for a population that has shrunk about 26 percent since 2000, to 707,000. The city has a B general-obligation rank from Standard & Poor’s, five steps below investment grade.
The municipality faces a $380 million spending gap by June as it strains to limit cuts to basic services such as police and fire protection, Mayor Dave Bing said this month. If Orr, a lawyer who specializes in restructuring, can negotiate reduced interest rates on long-term debt, that would free up money for services and shrink the deficit, Bing said.
Improving public safety and reducing the deficit are Orr’s priorities, his spokesman, Bill Nowling, told reporters last month.
The emergency-manager law “provides a variety of mechanisms to address the city’s financial emergency,” Nowling said via e-mail today. “The emergency manager intends to consider all of the provisions” the law offers, he said.
Detroit has about $8.6 billion of long-term bonds. That includes $963.4 million of general obligations, $1.5 billion to fund pension liabilities and $6.1 billion of non-general-obligation bonds, such as water and sewer utility debt, according to a February report on the city’s finances. Counting other pension and retiree health-care obligations, the burden approaches $15 billion.
The emergency-manager law, designed to put an outside official in charge of financial restructuring and avoiding bankruptcy, says scheduled debt service should be paid “in full” under any plan. That may conflict with Orr’s stated intent to reduce some debt through negotiation.
His plan could mean all investors in Detroit securities, even water and sewer bondholders who considered themselves insulated from the financial pressure, will be asked to take reductions or delays in repayment, according to Orr. The water and sewer debt is backed by utility revenue rather than the city’s credit.
In a March 14 press conference with Snyder, he said he’d negotiate in good faith with creditors, unions, pension funds and other interested parties.
“Everything’s on the table” when it comes to bond obligations, Orr said in a March 27 phone interview. “We’ll have to look at what bondholders and insurers want.”
To reduce or delay payments, Orr would have to overcome the challenge of getting all bondholders to agree, said Nuveen’s Miller. Just the general-obligation bonds probably involve thousands of investors, he said.
“You either need 100 percent agreement, a tender offer or a bankruptcy to negotiate a haircut,” said Miller. “It’s a stretch to expect you’re going to get to 100 percent agreement.”
The threat of Chapter 9, in which bondholders would lose control, bankruptcy costs would eat into available revenue and city services could become a higher priority, may be an incentive for bondholders to work with the manager.
Under Chapter 9 of U.S. bankruptcy law, which allows municipalities to restructure, cities have an advantage because they need enough money to provide adequate services, according to Orr.
“Don’t make me go to bankruptcy court,” he warned during the March press briefing.
The emergency-manager act “limits his ability to unilaterally impose haircuts,” said Schroeder, whose firm manages $4.6 billion and holds some Detroit debt. Yet there are limits to “what you can expect from a city with limited resources. At the end of the day someone is going to have to give in and compromise.”
It’s unlikely bondholders would take permanent reductions in how much they would be repaid, in part because the state created the emergency-manager law to protect access to the market for other Michigan localities, said Matt Fabian, managing director with Concord, Massachusetts-based Municipal Market Advisors. He expects to see deferrals of full payment.
“Any attempt to force a cram-down would be bad for all debt in Michigan,” said Fabian. “It would be viewed as a failure of the state.”