7.15.14

Is the Motor City Contagious?  One question that continues to crop up is whether the Motor City’s municipal bankruptcy could adversely affect the cost of capital for other cities and counties across the nation—in effect sharply escalating the interest rates cities and counties will need to offer in order to issue debt. The answer appears to be no. Detroit Emergency Manager Kevyn Orr’s adjustment plan reduces Detroit’s pledged payments to its limited-tax general obligation bondholders by 66% on its $164 million of those municipal bonds not secured by a lien of state assistance—although the details of the final plan are not expected to be revealed until Detroit files its updated plan of adjustment with the U.S. Bankruptcy Court next week. That plan is expected to retain the proposed cut of 36% on the city’s unlimited-tax general obligation bondholders. The ever so prescient Richard Ciccarone, the president of Merritt Research Services, notes that the severity of these cuts is unlikely to be contagious because of some of the unique characteristics of Detroit’s bankruptcy, including its exceptionally low income and property tax collection rates (both at 50% or higher), as well as the lack of voter approval for LTGOs that the unlimited-tax GO bonds enjoy. Therefore, if there is any message for local leaders, it is to be careful in assessing the certainty of the pledge her or his local government is offering to prospective purchasers of the debt, or, as Mr. Ciccarone notes: “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.” Nevertheless, as Municipal Market Advisors has noted, the Motor City’s proposal marks a major loss for an investment that has traditionally been considered safe, so that the unprecedented cuts together with the anti-Wall Street rhetoric running through the bankruptcy reporting could lead investors to be “far more careful before lending fresh dollars to local governments in Michigan.” However, the advisory firm notes there is, to date, little evidence of disaffection, reporting that S&P and other credit rating firms have remained bullish on state and local credits, notwithstanding the municipal  bankruptcies in California and Detroit—or the significant number of Michigan municipalities in distress, adding: “Non-professional investors have been given almost no information on which they might change their behavior with respect to Michigan GO bonds…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.”

Hedging on Motor City’s Future. On the other hand, it appears a number of investors are willing to gamble on the Motor City’s fiscal future. Hedge funds Panning Capital Management, ($219 million), Aurelius Capital Management ($194 million), Bronze Gable ($158 million), Monarch Alternative Capital ($147 million), and Stone Lion Capital Partners ($32 million) yesterday disclosed in a federal court filing they have invested more than $700 million of Detroit’s distressed debt. As the ever fabulous Matt Fabian of Municipal Market Advisors puts it: these so-called “vulture investors,” could be a good omen: “Hedge funds are much easier settlers,” said Matt Fabian, managing director of Municipal Market Advisors. “They’ll be looking for some kind of recovery as soon as they can.” The debt in question involves the swap transaction negotiated during former Mayor Kwame Kilpatrick’s administration in 2005 to finance the city’s pensions—a gamble which assumed interest rates would rise, but instead became a catalyst of both the former Mayor’s conviction and the city’s bankruptcy. Now the financial arrangements have become a key bone of contention between the Motor City and two of the city’s objecting creditors, Syncora and FGIC, with Detroit telling the court that because the original swap was illegal, the city should not have any obligation—whilst the two insurers are at risk in the hundreds of millions of dollars. Now with the hedge funds’ investments, they have a significant stake in the outcome, leading them last Friday night, to file their objections in the federal bankruptcy court.

Shhh! U.S. BankruptcyJudge Steven Rhodes yesterday ordered Detroit to pay $10,000 to bond insurer Assured Guarantee for inadvertently sharing confidential documents about closed-door negotiations among creditors., noting that “Assured should not be required to bear any expenses because of the city’s mistakes.” Nevertheless, the Judge added he was “quite outraged” by Assured’s request for $45,000 and said he nearly denied its request based on the amount even though Detroit’s law firm Jones Day clearly violated a court order preventing disclosure of mediation-related information. The issue involved a hearing to resolve discovery disputes between Detroit and its creditors over information to be used at next month’s trial, when one of Detroit’s bankruptcy attorneys told the court his firm (Jones Day) had inadvertently mailed approximately 120 documents to creditors May 6th that involved closed-door mediation negotiations. A team of mediators is overseeing negotiations between the city and creditors. The city’s bankruptcy law firm, so far, has had to review about 1.2 million documents.

Waiting for Godot. At yesterday’s hearing before Judge Rhodes, the Judge asked whether the tally of the approximately 70,000 votes cast by creditors and being counted by a firm in California could be released to the public next week. He received an unexpected response from one of the city’s bankruptcy attorneys: “No,” testifying that the tabulation was a “little complicated,” telling the judge the ballots are counted two ways: by a simple up-or-down vote, but also by the size of a creditor’s claim. In the case of a retiree, it would be the pension owed. To a large extent, the city’s hopes for emerging from Chapter 9 bankruptcy this fall hinge on whether pensioners vote to accept pension cuts and allow the Detroit Institute of Arts to spin off as an independent institution. The votes, of about 40% of the city’s creditors, include its 32,000 pensioners, in what one of the retiree association’s bankruptcy attorneys, Ryan Plecha termed: “[A]n absolutely historic moment in Detroit’s history…It’s going to determine whether retirees are protected from additional harm, whether the city can rebuild and whether the state can be protected.” The city is not required to publicly release the voting results until July 21, although several creditors expect the official tallies to be revealed sooner. Nevertheless, even if this set of creditors vote in support of the proposed plan of adjustment, several other classes of creditors may vote no. Approval or defeat will become part of the evidence at trial next month on Detroit’s overall strategy to get out of bankruptcy. Approval, however, would make it easier for Judge Rhodes to find the essential element: the Motor City’s plan of adjustment is fair and feasible.

Batter Up! Even as San Bernardino has struggled to reach consensus on getting its new budget adopted, it has been quietly pursuing consensus with its unions and the California Public Employees’ Retirement System (CalPERS) behind closed doors under federal court meditation. As those talks appear to have gained some traction, the California city’s bond insurance companies are prepping in the batter’s box, anticipating their chance to engage next. Ambac Assurance Company and National Public Finance Guarantee Corp., insurers on the municipal bonds on which the city defaulted after it filed for federal bankruptcy protection in August 2012, have agreed to begin negotiations regarding the treatment of the pension obligation bonds as part of the city’s proposed plan of adjustment and are currently in the process of scheduling meetings. Ambac, the insurer of San Bernardino’s pension obligation bonds, has been participating in the confidential mediation for itself, Erste Europäische Pfandbrief-und Kommunalkreditbank AG, the holder of the pension obligation bonds, and Wells Fargo Bank, N.A., the pension obligation bond trustee, according to a filing with U.S. Bankruptcy Judge Meredith Jury. For its part, National Public Finance Guarantee Corp. insures two lease revenue bonds and one sewer revenue bond issued by the city. San Bernardino’s bankruptcy attorney, Paul Glassman, noted: “The city has had discussions with NPFG and continues to provide financial information, but the parties have not yet begun negotiations regarding the treatment of the bond claims under a chapter 9 plan.” Such discussions are now projected to commence in September—in the wake of the city’s tentative agreement with CalPERS last month, although the specifics of that agreement not only have yet to be released, but also the tentative agreement has been hobbled by the request by the San Bernardino firefighters union to be released from the mediation shortly after CalPERS reached an agreement—a request Judge Jury granted. The union reported to Judge Jury in its request that the confidential nature of the mediation was preventing it from protecting employees in budget negotiations.

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