CHICAGO — Grim but not surprising: that's the verdict of municipal bond experts on Detroit's settlement with its limited-tax general obligation bondholders to pay 34 cents on the dollar.
"Those of us who have paid attention are not surprised," Joe Rosenblum, director of municipal research at AllianceBernstein, said.
The settlement calls for a 34% repayment on the $164 million of limited-tax general obligation bonds not secured by a lien on state aid.
The bulk of those LTGOs are insured. The city struck the deal with insurer Ambac Assurance Corp. and Blackrock in early June, but has not publicly disclosed the terms. The 34% recovery rate was revealed in a court report filed by Detroit's investment banker, Ken Buckfire.
Final terms of the settlement remain unclear. The city plans to file an updated plan of confirmation next week that includes detailed terms of the settlement, city attorneys said in a Monday court hearing.
Detroit in April reached a deal with unlimited-tax general obligation bondholders that calls for a 74% recovery and treatment of the debt as secured going forward.
"It's not surprising there was a haircut and, given the direness of the situation, a rather severe haircut," Rosenblum said of the LTGO deal. "The market has already incorporated all the implications, and, given the very limited amount of debt and since most of it is insured, there are not significant broader implications."
Fitch Ratings analysts said they too were unsurprised by the haircut.
"Detroit's treatment of LTGO and other bondholders strains the boundaries of what most creditors would have expected to be entitled to in a bankruptcy," analyst Amy Laskey wrote in a comment on July 14. But the settlement is in line with Fitch's expectations at this point, and it's not expected to set a precedent, Laskey said. "Fitch expects situations like Detroit's to continue to be rare as few governments are as severely stressed as Detroit, and there is a long-demonstrated willingness of most municipal governments to avoid default and bankruptcy," she wrote.
The low recovery may have been driven by a few factors, said Richard Ciccarone, president of Merritt Research Services LLC. One is Detroit's anemic property tax collection rates — which the city last year estimated at 50% — as well as the lack of voter approval for LTGOs that the unlimited-tax GO bonds enjoy.
For investors, the settlement should be a warning of the uncertainty of pledges in a distressed situation.
"If the security is deemed to be inferior, as it appears to now be, then one shouldn't get comfortable with a limited-tax bond issue in which the amount you can collect on a limited basis nudges up against the amount you need for debt service, which is obviously what's happened in Detroit," Ciccarone said.
Advisory firm Municipal Market Advisors warned that the settlement should spark more fallout than the market has shown so far. The deal marks a major loss for a security traditionally considered safe, the firm said.
The haircut, along with anti-Wall Street rhetoric running through the bankruptcy and the depiction of the city's pension certificates as illegal, should prompt investors to be "far more careful before lending fresh dollars to local governments in Michigan," MMA wrote.
That's not been the case so far, the firm said. That's partly because rating agencies like Standard & Poor's are overall bullish on state and local credits, despite Detroit's default and the hardship of other Michigan cities. Other factors include a lack of critical press coverage of Detroit's bankruptcy, the "silence" among underwriters about local Michigan risks, and low supply in the market overall, MMA said.
"Non-professional investors have been given almost no information on which they might change their behavior with respect to Michigan GO bonds," the firm said. "So while we can attribute at least some of investors' un-dulled enthusiasm for non-Detroit MI paper as a strength of tax exemption, credit analysts looking for a better, more disciplined industry response are likely to be disappointed."
Industry analysts continue to say that Detroit, like other post-2008 lessons, proves the importance of doing your homework.
"You may think you have a strong pledge but it really has to make sense in terms of the economy," Rosenblum said.
"Detroit reminds you that this is a very safe market but there are always pockets of distress," he said.
The city has treated $5.3 billion of water and sewer bonds as secured, though Detroit emergency manager Kevyn Orr seeks to impair the debt with various structural amendments in a refinancing deal to achieve savings. The Detroit water and sewer bondholders, along with the holders of $1.4 billion of pension certificates of participation, are the two financial creditor groups who have still not reached a deal with the city.
