Detroit Chooses Bankruptcy
July 19, 2013 12:04 PM
Detroit filed for Chapter 9 bankruptcy on Thursday, the largest municipal bankruptcy filing ever. The restructuring of the city's more than $18 billion of debt, already contentious, may take years and is likely to be painful for all stakeholders. Emergency manager Kevyn Orr, a corporate bankruptcy attorney brought in by Gov. Rick Snyder to run the city in March, has stunned the muni market by putting forth a plan that characterized the city's general obligation bonds as unsecured debt. GOs typically are regarded as the safest, most secure of municipal securities, backed by the full faith and credit of the local government. Image: Thinkstock
Once the nation's fourth most populous city, the home of Motown and big automakers, Detroit now has a population of about 700,000, an unemployment rate nearly double the national average, and the highest homicide rate in 40 years. Image: Thinkstock
"I don't think anyone is as distressed as Detroit is. Detroit has been headed down for 50 years. It is the basket case of America
. This was very likely an inevitable development. There is such a massive mismatch between what they spend and what the receive," Matt Fabian, managing director of Concord, Mass.-based Municipal Market Advisors, said. "What is unexpected from the market is how Detroit will treat bondholders: wipe them out."
"Enough is enough for the downward spiral of Detroit," said Michigan Gov. Rick Snyder, who was required to authorize the bankruptcy filing under state law. Bankruptcy "will give us one coordinated central place to do this, and to work with creditors in an organized fashion to say. 'Here are the debts that realistically can't be paid'
.. Bankruptcy can be positive." Image: Bloomberg News
"We are concerned that this development could raise borrowing costs for Detroit and other municipalities in Michigan over a long period because investors could perceive Michigan local government bonds as considerably less secure going forward," Ira Hammerman, senior managing director and general counsel of the Securities Industry and Financial Market Association, said. "We are particularly concerned about Detroit's general obligation bonds.
. Investors expect that, as usually provided in bond contracts, principal and interest on general obligation bonds will be paid before other expenses and that taxes will be increased to pay debt service if necessary. The treatment of those bonds by the bankruptcy court could affect how investors' view those types of securities issued by all Michigan municipalities and potentially could have nationwide implications."
"I am surprised by the lack of participation by the state of Michigan in trying to solve the city's problems," Dick Larkin, senior vice president and director of analysis at HJ Sims & Co., said. "In the past Michigan had a good reputation of a state helping out its localities when they were difficulties - not just Detroit, but other cities as well. But this time it seems they are washing their hands out of Detroit and investors will remember that.""Do I expect a major impact sending shockwaves and seeking prices falling and yields spiking? No I do not because most people had expected [the bankruptcy], but I could be wrong," he said, adding. "I firmly believe, however, that investors will begin exacting a premium from any borrower that has Michigan's name on it, and from this point, Detroit's name in the muni market in the muni market is probably mud." Image: Bloomberg News
"Many believe that federal bankruptcy protection would strengthen the city's ability to execute the restructuring, provided Mr. Orr and his team can get a bankruptcy judge to agree," said Frank Shafroth, director of the Center for State and Local Leadership at George Mason University. "To some degree, there is a non-Detroit casino gamble at stake for both sides: is Mr. Orr's plan to swap $2 billion of 'nonrecourse participation notes' for $11.45 billion in unsecured claims, a payout that equals less than 20 cents on the dollar, better than bringing in a federal bankruptcy judge to act as a single referee?"
"We expect that this will be a long, contentious bankruptcy," said Tom Weyl, director of municipal research at Barclays.
"Hopefully [bankruptcy] will be a step in the right direction," James Spiotto, a bankruptcy attorney at chapman and Cutler LLP in Chicago, said. "The challenge is not just the adjustment; the challenge is the recovery plan
. Generally Chapter 9 is measured by years, not weeks or months. Vallejo took three years and that's a far smaller city."
Pauline Schneider, special counsel at Ballard Spahr LLP, noted, "I think this is going to be difficult and painful for the residents of Detroit."
