Detroit’s 20% Offer Jeopardizes Insurers’ Recovery: Muni CreditDarrell Preston and Steven Church
Detroit’s bid to stick investors with losses as part of an effort to avert a historic bankruptcy is jeopardizing municipal bond insurers’ recovery prospects.
Insurers, including Assured Guaranty Ltd. and FGIC Corp., are on the hook for at least 95 percent of the $2 billion of unsecured Detroit debt that wasn’t issued for city utilities, data compiled by Bloomberg show. Kevyn Orr, the city’s emergency financial manager, proposes paying investors less than 20 cents on the dollar on those bonds as the auto-industry capital bleeds cash.
Even as last month’s surge in muni yields to a 26-month high makes it more economical for localities to pay for the bond backing, Orr’s plan may damp confidence in the insurers, said Matt Fabian at Municipal Market Advisors. By serving as a model for other municipalities facing financial distress, the approach makes insured bonds a target for cost savings, he said.
“The city is relying on insurers to pay bondholders that it chooses not to pay,” said Fabian, a managing director at the Concord, Massachusetts-based research firm. “It does appear that the insurance companies are sitting ducks.”
Insurers are attempting to win back market share that shriveled when they lost their top credit ratings during the recession that ended in 2009. About 3 percent of U.S. muni issuance had their backing in the first half, the least since at least 2006 and compared with 44 percent in the same period of 2007, data compiled by Bloomberg show.
The protection was traditionally a draw for individual investors, who own about 70 percent of the $3.7 trillion municipal market. Insurance from Assured saved municipalities as much as 0.25 percentage point on bonds marketed from July 2010 through June 2011, according to research by Alan Schankel at Janney Montgomery Scott in Philadelphia.
Build America Mutual Assurance Co. last year became the first new muni insurer since 2007, joining the dominant company, Assured. National Public Finance Guarantee Corp., a unit of MBIA Inc., had its rating raised three levels in May after its parent settled with the last of 18 banks that challenged a 2009 restructuring. Shares of Armonk, New York-based MBIA have risen 77 percent this year, compared with about 18 percent for the Standard & Poor’s 500 index.
Last month, Hamilton, Bermuda-based Assured said it was committed to honoring obligations to holders of debt it insures. Kevin Brown, spokesman for National, declined to comment. The company said last month it will insure principal and interest payments to investors in Detroit debt.
FGIC didn’t respond to a request for comment placed to its offices in New York. Ambac Assurance Corp. said in a statement July 8 it would honor Detroit bond commitments under its policies. Michael Fitzgerald, spokesman for New York-based Ambac, declined to comment further.
Orr’s plan “is harmful to Detroit and the interests of taxpayers in Michigan” because it may imperil access to the municipal market, the company said.
The episode gives insurers a chance to highlight their importance if they can ensure timely principal and interest payments, said Richard Ciccarone, chief research officer at Oak Brook, Illinois-based McDonnell Investment Management, which oversees $8 billion of munis.
“It’s an opportunity for the bond insurance companies to prove their worth and validate their mission,” Ciccarone said.
Yields on 10-year benchmark munis touched 2.96 percent last month, the highest since 2011. Before yields rebounded from generational lows set at year-end, the reduced borrowing costs were giving issuers little incentive to buy insurance.
“A rising rate environment makes bond insurance more valuable,” said Schankel, Janney’s head of fixed-income research.
In Orr’s plan, the companies are in the same category as unions for city workers, who face reductions to pensions and retiree health care. The Washington restructuring lawyer has threatened to take the city into Chapter 9 bankruptcy if creditors don’t accept his June 14 plan. Orr proposed that unsecured creditors with $11.5 billion in claims receive notes worth about $2 billion.
The plan doesn’t single out insured debt and treats all unsecured creditors the same, said Bill Nowling, Orr’s spokesman.
The approach to restructuring Detroit’s more than $17 billion of debt and long-term obligations is the best way to get the city back on its feet, he said. The city has no more legal capacity to raise taxes, he said. It would be a record U.S. municipal bankruptcy.
“The investors who bought the insured bonds no doubt understood the risks that the city faced,” Nowling said. “And the insurers that wrote the policies understood the risks.”
The insurers remain operational and their guarantees in place, according to a report last month from Morningstar Inc. For holders of insured debt, the assumption is that interest and principal will be protected, the report said.
That conclusion is reasonable, said Jonathan Carmel, a money manager at Carmel Asset Management LLC in New York.
“You’re not talking about a massive amount of exposure compared to the capital of these insurers,” said Carmel. He cited the example of Assured, which he said faces a potential of $360 million of obligations for its $12 billion of claims-paying resources.
Since 2008, two California cities and Jefferson County, Alabama, have filed for bankruptcy with the intention of imposing principal cuts on insured bonds. Last month, bond insurers in the bankruptcy of Jefferson County struck a deal to shift some losses onto their customers, who had coverage on more than $2.87 billion in sewer warrants.
Under that proposed settlement, warrant holders have a choice of either collecting 65 cents on the dollar and filing claims against the insurers, or collecting 80 cents on the dollar and waiving the insurance.
“Related to the 35 cents due to investors that select the 65 cents option, Assured Guaranty will make future policy payments without the need for a claim being filed by an individual warrant holder,” Robert Tucker, a managing director at the company, said in an e-mail.
“There is not a whole heck of a lot that bond insurers have had to worry about until the last few years,” said Clayton Gillette, a law professor at New York University who has written about municipal bankruptcies.
Insurers have more to fear from bankruptcy than unions because a judge will probably side with workers trying to keep the city operating, said Mark Schwartz, a former bond lawyer who tried unsuccessfully to help the city of Harrisburg, Pennsylvania, restructure debt using Chapter 9.
“In court, you are going to try to fund essential city services,” he said. That doesn’t include “paying some bond insurer who miscalculated,” he said.