Michigan Pays 40% More as Detroit Debt Hits Spread: Muni CreditBrian Chappatta
The yield penalty on Michigan’s debt has climbed 40 percent in less than two weeks as defaults by Detroit and two school districts lead investors to question the state’s commitment to protect bondholders.
Buyers demand about 0.49 percentage point of extra yield to own general obligations of Michigan instead of benchmark securities, data compiled by Bloomberg show. That’s up from 0.35 percentage point on June 13, the day before Detroit emergency financial manager Kevyn Orr released his plan to avert a record municipal bankruptcy. The proposal included halting payments on $2 billion of munis.
The month before, school districts in Buena Vista and Pontiac defaulted. They were the first such issuers in the state to do so, according to research firm Municipal Market Advisors. The events call into question Michigan’s willingness to preserve the safety of securities backed by a municipality’s full faith and credit, said Shawn O’Leary, a senior research analyst in Chicago at Nuveen Asset Management, which oversees $95 billion of local-government debt.
“There’s a tremendous amount of selling -- people are very anxious about Michigan cities,” said Matt Fabian, a managing director at Concord, Massachusetts-based MMA. “Those districts defaulting are absolutely a sign of the state’s eroding concern about bondholders.”
In Michigan, where no locality has filed for Chapter 9 bankruptcy, about 10 percent of its 9.9 million residents live in communities under fiscal oversight, said O’Leary. Orr, a former bankruptcy lawyer, is trying to turn around a city that has lost a quarter of its population since 2000.
He proposed a deal June 14 that included skipping a $39.7 million payment on pension-obligation debt as the city grapples with $17 billion in liabilities. Uninsured Detroit debt maturing in April 2016 traded this week at 33 cents on the dollar, down from 90 cents earlier in June.
“Michigan historically has been a state that will work to support the credit quality of its underlying municipalities,” O’Leary said. “If the state has any interest at all in preserving the market access of those communities, it needs to say that it supports the legality and strength of the general-obligation pledge.”
Karen Cain, treasurer of Pontiac School District, about 30 miles (48 kilometers) northwest of Detroit, wasn’t available to comment, said Valdria Rowe, executive administrative assistant. A message left with Brittanny Anderson, secretary to the superintendent of the Buena Vista district, wasn’t returned. The community is about 100 miles northwest of Detroit.
Terry Stanton, a spokesman for Michigan Treasurer Andy Dillon, said the state had “no involvement in either issue.” The deals weren’t part of a state program that provides credit enhancement to debt approved by Dillon for capital projects.
The Republican-controlled legislature last week passed two bills allowing the state to dissolve Buena Vista and the Inkster district near Detroit. The bills await Republican Governor Rick Snyder’s signature.
About 55 Michigan school districts project budget deficits this year, said Matt Butler, an analyst at Moody’s Investors Service. The New York-based company doesn’t grade Buena Vista’s district, and has Pontiac’s at Caa1, seven steps below investment grade. Michigan has an Aa2 rank, third highest.
Jurisdictions facing budget shortfalls must submit a deficit-elimination plan to the state, said Martin Ackley, a spokesman for Mike Flanagan, state superintendent. If a system fails to, the state withholds funding, he said.
Pontiac and Buena Vista schools both missed May 1 debt-service payments because Michigan halted aid in the prior two months, Butler said.
The state’s not intervening to protect bondholders was a surprise, he said.
“Our understanding has been with these tools that the state has, it would not allow a district to default,” Butler said in a telephone interview. “It does raise new questions going forward for any other districts that fall into a position like this.”
Tax-exempt Pontiac school bonds maturing in May 2015 traded this week at an average yield of 9.14 percent, or about 93 cents on the dollar. That’s about 7.5 percentage points more than benchmark munis. The debt is insured by Syncora Guarantee Inc.
“Syncora Capital Assurance Inc. received and duly paid a claim in full” related to the Pontiac district, Michael Corbally, a spokesman for Syncora, said in an e-mail.
The Pontiac system has $14 million of debt, while the Buena Vista district has about $2.5 million, Bloomberg data show. Buena Vista’s district enrolls 435 students, compared with about 5,200 in Pontiac’s.
The state may not have intervened because the debt was insured and authorities were focused on Detroit, said Tom Metzold, co-director of munis at Eaton Vance Management in Boston.
“I’ve got to believe that Detroit has taken up 100 percent of the state’s time,” said Metzold, who helps oversee about $30 billion in munis. “These are the very same insurers that are in Detroit. In effect, it’s being taken care of regardless as part of the whole Detroit situation.”
Insurers back about 80 percent of Detroit general-obligation and pension bonds, according to Lisa Washburn, a managing director at MMA. Syncora said in a June 17 statement that it would pay claims on the certificates of participation on which the city failed to make payments.
School districts in Michigan are also allowed to have emergency managers appointed by the state. An emergency has been in place for Detroit Public Schools since March 2009, according to the treasurer’s website.
Highland Park School District and Muskegon Heights School District also have state-appointed overseers, according to the website. Pontiac’s system is under review for an emergency manager.
Investors will watch for signs that Snyder approves of Orr’s plan for bondholders, Nuveen’s O’Leary said. A sign of endorsement from the governor could further punish localities statewide by weakening the perception of their full faith and credit backing, he said.
“If the governor signs off on the plan as currently proposed, the state is tacitly supporting the view that the G.O. pledge isn’t worth its credit,” O’Leary said. “In that case, you suddenly call into question the creditworthiness of every G.O. offered in the state of Michigan.”
In the $3.7 trillion municipal market, Illinois is set to sell $1.3 billion of general obligations today, the week’s biggest offer, as investors are poised for their worst monthly losses since 2008.
Institutional investors are joining individuals in exiting the market as yields surged to the highest since 2011.
Bondholders such as mutual funds were offering about $2 billion of munis for sale as of June 24, the most since Bloomberg data began in 1996.
Ten-year AAA munis yield 2.96 percent, the highest since April 2011. The interest rate compares with 2.61 percent for similar-maturity Treasuries.
The ratio of the yields, a gauge of relative value, is about 113 percent, the highest since August. The greater the figure, the cheaper munis are compared with federal securities.