Detroit Lighting Debt Illuminates Bankruptcy Stigma: Muni CreditBrian Chappatta and Chris Christoff
A debt sale by an agency responsible for illuminating the streets of bankrupt Detroit will put a spotlight on bondholders and their willingness to lend after investors took an unprecedented cut on city general obligations.
On its face, the $186 million deal has no mention of Detroit: The Michigan Finance Authority will sell the bonds today for the Public Lighting Authority, an agency the state established. The debt has an A- grade from Standard & Poor’s, four steps above junk, and the utility taxes that repay the debt flow to the agency’s trustee before the city. Detroit, which hasn’t had a rating that high in 15 years, can’t lower the levy over the life of the securities.
Yet even with those protections, bond investors say there’s no sure thing when it comes to Detroit. Last year, the city defaulted on general obligations before agreeing in April to pay 74 cents on the dollar on some debt. It may also push water and sewer bondholders into a distressed-debt exchange. Dan Solender at Lord Abbett & Co. said if he were to buy the bonds, it would be for a high-yield fund.
“There should be extra yield,” said Solender, director of municipal bonds at the Jersey City, New Jersey-based company, which oversees $15.5 billion of state and local debt.
“You have to take into account how they treated the water bonds, the sewer bonds and the general-obligation bonds,” he said. “It’s hard to know what to trust and what not to trust.”
Detroit’s record bankruptcy last year rattled the $3.7 trillion municipal market. It challenged the tenet that cities and states would do everything possible to repay debt backed by their full faith and credit, including raising taxes. The city argued that decades of decline left it too poor to cover the billions it owed and still provide public safety.
Lighting bonds maturing in 10 years were being offered today at a preliminary yield of 3.46 percent, according to three people with knowledge of the sale who requested anonymity because pricing wasn’t final. That’s the same rate as benchmark BBB muni revenue bonds, according to data compiled by Bloomberg.
The lighting authority’s goal of replacing broken street lamps is part of a plan to brighten neighborhoods where darkness breeds crime and fear. Detroit’s population has dropped 60 percent since the 1950s. About 40 percent of the Motor City’s 88,000 street lights have been ruined, many by scavengers who stole wiring.
Michigan’s legislature authorized the lighting authority in 2012 as a separate entity from Detroit, though the mayor and city council appoint its five-member board. It replaced the city-run lighting department. About 9,000 brighter lamps have been installed since February, with 55,000 to go.
Offering documents make clear that the revenue backing the bonds is dedicated by state law and can’t be diverted, said Odis Jones, the authority’s chief executive officer. The debt is paid from funds generated by a tax on utility users. The money is deposited with a trustee before being distributed to investors. Any excess goes to the city.
“There’s a tremendous amount of safeguards built in place, and this is a safe bond to buy,” Jones said in an interview. “A smart investor is not going to get hung up in rumors and innuendo.”
The agency sold $60 million of bonds in December to begin the project. The debt is held by Citibank N.A., according to offering documents for today’s deal. Those bonds will be paid off with a portion of today’s sale, for which Citigroup Global Markets Inc. is lead underwriter.
Scott Helfman, a spokesman for the New York-based bank, declined to comment.
Officials are “making a lot” of the mechanism to intercept the tax revenue, said Shawn O’Leary, a senior research analyst in Chicago at Nuveen Asset Management, which oversees $90 billion in munis. “Which is fine, but as a water and sewer holder, I note that we have a trustee that’s holding our revenues for us as well, and they’re planning to try to impair our coupons.
‘‘So when they come to you as an investor and say ‘we’ve structured this so you’re safe,’ we look at that with a very jaundiced eye,” he said.
Nuveen won’t participate in the lighting deal. The company is negotiating on Detroit water and sewer debt and is restricted in buying and selling city bonds, O’Leary said.
The new debt is most similar to Detroit general obligations backed by distributable state aid, said Jane Ridley, an analyst at S&P in Chicago. The first-, second- and third-lien state aid bonds carry ratings of AA, AA- and A+, respectively.
Those securities change hands at higher yields than ratings indicate they should.
Detroit state aid bonds maturing in November 2035 and carrying a AA grade from S&P traded last week at a 5.28 percent yield, Bloomberg data show.
By comparison, benchmark revenue bonds with a similar rating and maturity yield 3.6 percent, and BBB debt yields 4.4 percent.
Even with the legal structure, “this is still Detroit,” Ridley said. “There are other concerns that are built into the rating as well,” such as those inherent in dealing with bonds associated with a bankrupt city.
The offering stands to benefit from demand for debt with higher yields as muni interest rates remain close to one-year lows. Individuals have added money to high-yield muni mutual funds for 24 straight weeks, the longest stretch since 2012, Lipper US Fund Flows data show.
Bond documents list risks including that revenue from the taxes backing the debt has “declined materially in the past and may continue to decline in the future.”
Fitch Ratings cited the dwindling cash stream in grading the deal BBB+, three steps above junk. Offsetting that is the separation of the money from the city’s reach, said analyst Arlene Bohner. Fitch consulted with outside counsel for an independent legal opinion, she said.
“We’ve gotten very comfortable with the idea that these revenues are insulated from the city, and in the case of a current bankruptcy and a future bankruptcy, these revenues would not be considered property of the city,” she said.
Though the lighting initiative has elicited gratitude from residents, its financing will hinge on investors’ comfort with the new bonds. The debt matures as late as July 2044, offering documents show.
“They’ll find buyers, but I don’t think it will price like an A rated security, nor should it,” Nuveen’s O’Leary said.