Detroit’s 10 cents-on-the-dollar meme
Detroit’s emergency manager, Kevyn Orr, held his big creditor meeting today and presented his Proposal For Creditors Powerpoint (PDF) for how he would like to treat the city’s liabilities. The mainstream media is running with the story that Orr’s proposal will give creditors 10 cents on the dollar, but the proposal is far from having those terms.
The Proposal calls for the following treatment of various classes of debt:
For secured debts:
For the $5.5 billion of secured water and sewer revenue bonds, Orr proposes to issue new bonds with the current full principal amount (with accrued interest) at a lower interest rate (i.e. no haircuts or reduction in principal). (page 101)
For the $411 million of Secured General Obligation Debt (unlimited property tax pledge) Orr says, “Treatment: Subject to negotiation with holders”. So no stated haircut there. (page 104)
For other secured debts, Orr says, “Treatment: Subject to negotiation with holders.” So no stated haircut there. (page 105-106)
For unsecured debts:
Unsecured General Obligation Bonds/Notes (approx $650 million) will be exchanged for a pro rata (relative to all unsecured claims) principal amount of new notes (unknown haircuts). (page 107)
The place where there is potential for haircuts is the unsecured $1.5 billion of pension obligation Certificates of Participation (COPs) series 2005-A, 2006-A and 2006-B issued through the Detroit Retirement Systems Funding Trust. Orr says it will be a general obligation of the city to pay interest on the notes. The City shall have no obligation to pay the principal amount of the notes. (page 107)
Fitch said in a statement how those bonds would be treated after default:
Pension COPs are unconditional contractual obligations of the city, not subject to appropriation. If the city fails to make a COP debt service payment, the contract administrator may file a lawsuit against the city to enforce the obligation, and a court can compel the city to raise the payment through the levy of taxes without limit as to rate or amount pursuant to Michigan law.
There will be a legal battle over repayment of pension bonds that bond insurers, who insured that debt, will undoubtedly wage. Orr must rush into bankruptcy court fast to escape litigation that would force repayment for those bonds.
The biggest piece of puffery in Orr’s plan is the sudden ballooning of unfunded pension fund liabilities. Orr says (page 109):
As set forth above, preliminary analysis indicates that the underfunding in the General Retirement System and the Police and Fire Retirement System is approximately $3.5 billion. At this level of underfunding, the City would have to contribute approximately $200 million to $350 million annually to fully fund currently accrued, vested benefits. Such contributions will not be made under the plan.
The Detroit News reported that current actuarial studies are being completed for the city’s two retirement systems, but they are reasonably well-funded according to national standards (emphasis mine):
A preliminary actuary report on the other city pension fund, the Police and Fire Retirement System, pegged its funding level at 96.1 percent for the fiscal year ending June 30, 2012. Fund officials on Thursday said a final assessment confirmed the findings. The general system had contended its funding level was 83 percent. On Thursday, the general retirement system issued a statement saying the draft copy of its actuarial valuation puts the funding level at 77 percent.
Orr is going to have to show math that demonstrates the pension funds are so massively underfunded that retiree pensions must be so dramatically haircut. Detroit’s actuary firm is Gabriel, Roeder, Smith & Company, a nationally respected firm. Undoubtedly labor representatives will be poring over their latest report when it is issued.
This is merely an opening gambit by Orr, who will have to demonstrate to a bankruptcy judge that he has held general negotiations with creditors in “good faith.” His proposal seems to be in good faith for bondholders, but less so for the city’s retirees. Ziegler’s Adam Buchanan commented that Orr’s plan seemed to be a leveraged buyout on the backs of bondholders. It feels to me that Orr’s plan is an LBO on the public employees backs.