Detroit at 91 Cents on Dollar Not Distressed Enough

Detroit bonds trading at 91 cents on the dollar are still too costly for municipal investors after the city’s emergency manager said the U.S. auto industry’s capital may run out of cash and consider cutting debt payments.

Kevyn Orr, appointed by Republican Governor Rick Snyder in March, said in a May 12 report that the cost of $9.4 billion in bond, pension and other long-term liabilities is sapping the city’s ability to provide public safety and transportation. In a preliminary plan to avert bankruptcy, Orr, 55, listed reducing debt principal, retiree benefits and jobs among his options.

Tax-exempt Detroit general obligations maturing in April 2016 traded today at an average price of 90.5 cents on the dollar, 9.5 percent below their 2008 issue price, data compiled by Bloomberg show. The discount is too small for buyers waiting to see whether the city becomes the biggest U.S. municipal issuer to seek bankruptcy protection.

“Should Detroit fall into deeper stress or file for Chapter 9, it would become a compelling investment opportunity at a price,” said Hector Negroni, who invests in the municipal market, including distressed securities, as New York-based chief investment officer of Fundamental Credit Opportunities.

“Detroit can’t solve the problems by just reducing expenses and reducing services -- creditors at some point are likely going to have to be part of the solution,” he said.

Stockton Precedent

Detroit would join Stockton and San Bernardino, both in California, and Jefferson County, Alabama, in trying to stick bondholders with a loss. Stockton is one of five municipal issuers rated by Moody’s Investors Service that defaulted in 2012. In comparison, 15 U.S. companies graded by Moody’s defaulted through the first four months of 2013.

In the hometown of General Motors Co., the world’s second-biggest automaker, officials are struggling to provide public safety and street lights for a population that has shrunk about 26 percent since 2000.

The city of 707,000, Michigan’s biggest, has a Caa2 general-obligation rank from Moody’s. That’s eight steps below investment grade and a signal that “there may be present elements of danger with respect to principal or interest,” according to the ratings company.

‘Insolvent’ City

Orr’s report to Michigan’s treasurer, required under a state law giving the manager broad authority over city government, offered guidelines for cost cuts. In a statement yesterday, Mayor Dave Bing said Orr’s assessment “is consistent with the findings of my administration.”

The financial manager’s document said Detroit is “insolvent on a cash flow basis.” The city’s 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 report.

“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,” the report said. Orr also cited the need for concessions from unions, and revamping the police and fire departments to protect residents beset by crime and 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.

Water Protection

While the cash crunch depressed some Detroit general obligations to as little as 71 cents on the dollar last week, bonds backed by revenue from its municipal water system are trading at a premium.

Dan Solender at Lord Abbett & Co. and John Miller at Nuveen Asset Management said the legal protection and extra yield relative to other U.S. water systems make the bonds more attractive than those backed by the city’s full faith and credit. Both investors hold the Detroit water-revenue debt.

Tax-exempt Detroit water revenue bonds maturing in July 2041 traded May 8 at an average price of about 108 cents on the dollar, the highest since February. Moody’s rates the securities Baa3, its lowest investment grade and eight steps higher than the city’s general obligations.

The water-revenue bonds and municipal securities from across Michigan may still be penalized if Detroit reduces general-obligation payments, Lisa Washburn, managing director at Concord, Massachusetts-based Municipal Market Advisors, wrote in a report this week.

Statewide Impact

Such a move would affect other distressed Michigan cities the most, she said. Pontiac and Flint are among the five localities besides Detroit under state-appointed emergency managers. Any increased yield penalty statewide could offset savings from reducing bond payments, Washburn said.

Orr’s report offers alternatives for dealing with long-term debt, including reducing interest rates, stretching out payment schedules, forgiveness of principal or refinancing.

The report is probably a prelude to seeking Chapter 9 bankruptcy protection, said Manny Grillo, New York-based head of restructuring practices for Goodwin Procter LLP. There are too many creditors, including 48 employee unions, to reach a consensus without court intervention, he said.

State Treasurer Andy Dillon has said he’s been told the city would become the biggest U.S. municipality to file for Chapter 9 bankruptcy protection. Orr is a Washington bankruptcy lawyer who worked on the reorganization of Chrysler Group LLC.

Table Talk

“If he can’t compel creditors to come to the table, a filing might be the next shoe to drop,” said Negroni. “If you’re an investor, a lot more has to be told before you can take a constructive view on the credit.”

In the $3.7 trillion municipal market this week, Michigan issuers led by Wayne State University plan to sell a combined $174 million. The sales are part of a wave about $6.5 billion of local-debt issuance.

At 1.79 percent, yields on benchmark 10-year munis compare with 1.9 percent for similar-maturity Treasuries. The ratio of the two interest rates, a gauge of relative value, is about 94 percent, the lowest since March 11. The lower the figure, the more expensive local bonds are compared with federal securities. The ratio has averaged 92 percent since 2001.

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