MuniLand

A bankruptcy scorecard for Detroit

Settlements in the Detroit bankruptcy case are arriving quickly. I thought that it might be useful to have a scorecard to tally the pieces. I took the chart above from the Detroit’s June 13, 2013 Proposal to Creditors (page 98). It lists the unsecured creditor claims. So far, Detroit has settled four unsecured liabilities valued at $4.107 billion for $1.213 billion, or 30 percent.

Here are four announced settlements with numerous caveats.

UTGO settlement: Detroit originally argued that the unlimited tax general obligation bonds (UTGO) were unsecured. This interpretation flew in the face of established muniland legal precedents and was watched closely by market participants. In its settlement with the bond insurers who wrapped these bonds, the city reversed its stand and agreed to acknowledge that the debt was secured by a specific lien on property tax revenues. Bond insurers will be paid 74 cents on the dollar and bondholders will be made whole by the insurers. The property tax lien will continue to be collected by the city and 26 cents on the dollar will go to a fund to help the lowest income retirees. It will cost the city $287 million to resolve $369 million in liability with the bond insurers.

Pension unfunded liabilities: Detroit originally estimated that its two pension systems were underfunded by $3.4 billion. Morningstar and others argued that the city had over-inflated the pension liability. They were right. Retirees will not face big cuts. The city has reached agreements with pension leaders. Detroit expects contributions from the state, private foundations and the Detroit Institute of Art to further fund the pension systems in exchange for preservation of the city’s art collection. The Detroit News has the pension settlement details:

Detroit reached tentative deals with two pension funds late Tuesday that would lead to modest reductions in monthly pension checks, free up cash to revitalize city services and speed the end of the biggest municipal bankruptcy in U.S. history.

The city’s general employees would take a 4.5 percent cut to pensions and lose an annual 2.25 percent cost-of-living adjustment under the proposed deal, multiple sources told The Detroit News.

Detroit’s wildly accelerating bankruptcy process

The technocratic governor of Michigan, Rick Snyder, and the emergency manager he appointed to restructure Detroit, Kevyn Orr, spoke at an event sponsored by the Manhattan Institute for Policy Research this week. Their relentless positivity contrasted with the creditor mess they had left behind in Detroit.

Orr insisted, as he has in other media appearances, that Detroit creditors must rapidly concede to proposed settlement terms so that the largest bankruptcy case in American history can be concluded. Bloomberg reported:

Detroit Emergency Manager Kevyn Orr said time is running out for creditors to reach an agreement with the city on a plan to resolve the biggest U.S. municipal bankruptcy by reducing $18 billion in debt.

Did Michigan kill Detroit?

After studying Detroit’s wrecked finances for several years, it was never clear if the city has been collecting the taxes it was entitled to within the law. Now a new report from the Michigan Municipal League suggests that the state gobbled up a portion of Detroit’s share of the state sales tax, adding severe stress to an already weak budget.

I wrote last year:

Detroit has no local sales tax, according to the Michigan state website. Michigan has no city, local, or county sales tax. The state sales tax rate is 6 percent.

The state collects a sales tax of 6 percent and sends it back to the city. For 2012, the state passed $172 million in sales taxes to Detroit, or 11.4 percent of general and governmental funds of $1.5 billion (page 47).

How much will Detroit bondholders suffer?

 

Detroit’s proposed treatment of general obligation bondholders has turned muniland upside down. Here is what Fitch Ratings says:

Fitch Ratings believes the recent Detroit plan of adjustment filed with the Bankruptcy Court on Friday, Feb. 21, 2013, if confirmed, would set a troubling precedent in the municipal market. The plan not only classifies unlimited tax general obligation (ULTGO) bonds as ‘unsecured,’ but further degrades ULTGO value by giving other similarly classed ‘unsecured’ creditors preferential treatment, including unfunded pension and retiree health care liabilities.

Reactions to Detroit’s plan of adjustment

Detroit’s plan of adjustment was filed on Friday by Emergency Manager Kevyn Orr (Plan of Adjustment Disclosure Statement):

Losers:

Retirees
Unsecured bondholders
Swaps counterparties
Bond insurers

Winners:

Detroit Institute of Art (DIA)
Various foundations contributing to save the DIA
Secured bondholders
Residents of Detroit
The state of Michigan

Here is a 140-character summary:

‘There is no lien, there is no property interest, these creditors are like all others’

A showdown between bond insurers and city attorneys in Detroit’s bankruptcy highlights the level of protection that secured bondholders have in Chapter 9 bankruptcy. Detroit attorneys argued that federal bankruptcy law trumps Michigan state law and that “secured” bonds could be impaired. From Chad Livengood of the Detroit News:

[Bond insurers] Ambac Assurance Corp., Assured Guaranty Municipal Corp. and National Public Finance Guarantee Corp. want [federal bankruptcy judge Stephen] Rhodes to order the city to segregate special property taxes Detroit voters approved for economic development, cultural and recreation projects and public safety facilities and resume paying bondholders the full amount owed.

‘These monies were raised solely for repaying the bonds and no other purpose,’ Guy Neal, attorney for National Public Finance Guarantee, said in court Wednesday.

Detroit’s hasty plan of adjustment

Having watched six municipal bankruptcies happen before Detroit filed for Chapter 9 protection, it was never clear why Michigan Governor Rick Snyder and Detroit Emergency Manager Keyvn Orr thought that they could conclude court proceedings in only fourteen months. Previous bankruptcies were much smaller and less complex, and each took several years to conclude.

Detroit’s bankruptcy leaders have set an aggressive schedule to resolve difficult elements of the case. Reuters reported:

Detroit will file a plan to adjust its debt with the Bankruptcy Court next week, an attorney representing the city told the judge overseeing the case on Monday.

The shadows of muniland

There is a shadowy part of muniland. It is populated by liabilities that are absent from balance sheets and municipal debt that was contracted by circumventing the law.

Muniland’s biggest unknown liabilities are unfunded pensions and retiree health care benefits that until recently were not required to be on issuers’ balance sheets. The information related to these often enormous future expenses had previously only been reported in footnotes. Muniland’s accounting overseer said in 2012:

GASB Chairman Robert H. Attmore. ‘Among other improvements, net pension liabilities will be reported on the balance sheet, providing citizens and other users of these financial reports with a clearer picture of the size and nature of the financial obligations to current and former employees for past services rendered.’

Is it time to replace Detroit’s emergency manager?

In a stunning decision, bankruptcy judge Steven Rhodes refused to approve a $165 million settlement proposed by Detroit emergency manager Kevyn Orr to pay off Bank of America/Merrill Lynch and UBS for dubious interest rate swaps. Orr’s swap proposal has been contentious since Detroit formally filed for bankruptcy on July 18th, 2013. The Detroit News reported:

U.S. Bankruptcy Judge Steven Rhodes on Thursday denied a deal that would have allowed Detroit to pay two banks $165 million to terminate a troubled pension debt deal blamed for pushing the city into bankruptcy.

The market reaction to Detroit’s bankruptcy ruling

Fitch Ratings managing director Amy Laskey talked to Fox Business about how Detroit is a unique story in muniland. Fitch published a research note on the bankruptcy ruling and concluded that Detroit’s ruling would not lead to a “spate” of local bankruptcies in Michigan:

Although the judge ruled that pensions could be adjusted, Fitch does not believe the ruling grants Detroit’s emergency manager unlimited freedom to adjust these obligations. The city must submit a plan of adjustment to the bankruptcy court, which must be deemed ‘fair and equitable’ by the presiding judge. The emergency manager expects to submit the plan to the court by year-end. Fitch does not believe that the judge’s decision on pensions will lead to a spate of additional bankruptcy filings in Michigan.

The New York Times, on the other hand, suggested that the Detroit’s ruling could impact other cities:

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