CHICAGO -- The fight over Detroit's proposed treatment of its limited-tax general obligation bonds heated up this week when Ambac Assurance Corp., which insures most of the debt, filed a vigorous challenge to the city's debt plan.
Blackrock, which owns a chunk of the unenhanced and uninsured LTGO debt, joined the insurer in the challenge.
If the parties don't reach a settlement and the battle goes to trial, it would be the first time that a Chapter 9 court has considered or ruled on limited-tax general obligation bonds.
Ambac insures about $93 million of Detroit's $163 million of LTGOs that are not secured by a lien on state aid.
Despite the small size of the debt relative to the Detroit bankruptcy case, the stakes are high for the insurer because the final treatment, determined either in a settlement or a ruling, could serve as an influential example for future recoveries.
Bankruptcy Judge Steven Rhodes, who is overseeing the case, ordered Detroit into mediation with the LTGO holders in early May. Another session is set for this week.
A trial on the city's plan of confirmation is set to begin July 24.
Detroit has reached a settlement with its unlimited-tax GO bondholders that calls for a 74% recovery. Ambac, which also wraps some of the city's ULTGO debt, is part of that settlement, along with National Public Finance Guarantee Inc. and Assured Guaranty.
Limited-tax GO bonds generally differ from unlimited-tax GO debt in that they often aren't secured by a specific tax levy, don't need voter approval, and do not carry a pledge to increase taxes as needed to meet debt service. Some of Detroit's limited-tax GO bonds are enhanced with a lien on state aid, and the city is treating those as secured, with 100% recovery.
With the ULTGO settlement, the limited-tax general obligation debt is now senior to all the city's roughly $11 billion so-called unsecured debt,
Detroit has proposed repaying the LTGO bondholders 10 to 13 cents on the dollar. That treatment is the lowest recovery offered to any claim in the city's debt plan and is "nothing short of offensive," Ambac's attorneys, from Arent Fox LLP, argue in the May 12 filing.
"A plan that takes a senior debt instrument and throws it to the very bottom of the barrel, while elevating other debt to recoveries some five or six times greater, cannot be confirmed," the insurer says.
The bonds have a first-budget obligation granted in state law, and are backed by both the full faith and credit of the city and "an identifiable revenue stream designated specifically for debt payment," Ambac says, referring to property taxes.
That's the "functional equivalent" of a lien, the insurer argues.
"Ambac does not contend that LTGOs cannot legally be impaired, or must be given administrative priority," Ambac argues. "However, state law does define the nature of the claims that are brought forward in bankruptcy for resolution. And here, the state protections for LTGOs define the nature of the LTGO claims as structurally senior to other unsecured obligations of the city."
In a piece posted May 15 on Blackrock's blog, Peter Hayes, the head of the firm's municipal bonds group, noted that LTGOs are the primary financing source for hundreds of local governments across Michigan and that they represent a roughly $5 billion market in the state.
"If no agreement is reached in relation to LTGO debt, and a cram down at the end of the bankruptcy process leaves bondholders with the plan's estimate of 10-13 cents on the dollar ... the implications for Michigan municipalities could be calamitous," Hayes wrote, saying it could drive up local borrowing costs and force issuers to turn to "more speculative" financing sources.
"Our questions: Will the state of Michigan step in and help broker a solution?" Hayes wrote. "Is $160 million in Detroit bonds worth roiling a $5 billion market and risking the health of other municipalities and the future of the state's municipal bond market?"
Ambac's challenge was one of nearly 20 filed this week challenging the city's bankruptcy plan and laying out the arguments they will make at trial.
Like the holders of the city's $5.3 billion of water and sewer bonds and $1.4 billion of pension certificates of participation, who are also fighting the plan, Ambac said it would challenge Detroit's estimate of its unfunded pension liability, its valuation of various city assets and plans to distribute the proceeds to creditors, as well as the $1.4 billion, 10-year capital improvement plan.
