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Deal in Focus

Michigan City, Under State Receivership, Set to Bond

CHICAGO — Following passage of a new state law aimed at assuaging investor fears of bankruptcy, the city of Ecorse next week will sell $9.3 million of financial recovery bonds, making it one of Michigan’s only municipalities to enter the bond market while under state-controlled receivership.

Located in Wayne County about 10 miles outside Detroit, Ecorse is a small, lower-income suburb that came under state-mandated emergency financial management in October 2009.

Proceeds from the bond issue will pay off a series of lawsuits that otherwise would have forced the struggling city of about 9,500 residents to nearly double its property tax rate.

Prior to the borrowing, the city’s emergency financial manager argued that on its own, Ecorse was not creditworthy enough to enter the market unless the state amended its financial recovery bond law in a way that would “calm prospective bondholders’ anxieties about lending to this cash-strapped city,” according to information given to legislators about the bill.

Provisions in SB 318, signed by Gov. Rick Snyder two weeks ago and paving the way for the Ecorse issue, are modeled after those that allowed Detroit to ­issue financial stabilization bonds in 2010.

The city relied on the same intercept feature that carves out revenue pledged to the bonds and directs it to a bond trustee without the city handling the money.

In Detroit’s case, the pledged revenue came from state revenue aid, not property taxes.

It was sent directly to a trustee, who then set aside the amount necessary to cover debt service before releasing the rest of the aid to the city.

The recent law was written specifically for Ecorse, but could create a model for other issuers that are considered risky credits.

The state treasurer is reportedly considering ways the legislation can be expanded to apply to other cities, like Highland Park, that want to retain market access despite major financial problems.

“Clearly, access to the market for municipalities that are in receivership is going to be an important tool in their box, so I suspect that we’ll see others,” according to a market participant familiar with the Ecorse transaction who asked not to be named.

The $9.3 million of financial recovery dedicated-tax bonds are expected to sell next week. Robert W. Baird & Co. is the underwriter. Miller, Canfield, Paddock and Stone PLC is acting as bond counsel and helped craft the legislation paving the way for the deal.

Standard & Poor’s assigned an A rating with a stable outlook to the bonds, based largely on the level of protection included in the structure.

The rating reflects the legal protections in place as well as Ecorse’s inability to file for bankruptcy without state approval, analyst Jane Hudson Ridley said in a report on the issue.

The bonds mature from 2012 through 2035. They are secured by a pledge of property taxes from the city, which includes a judgment levy and an operating levy.

The primary payment will come from the judgment levy, requiring the city to raise its property taxes by roughly four mills, compared to the projected 40-mill increase that would have been required without the borrowing.

As outlined in the new law, the bonds feature a statutory lien on two property tax levies to support debt service and a so-called lockbox structure that ensures that 100% of pledged revenues will be held with the trustee until debt service obligations are met.

Ecorse hired Comerica Bank to collect and distribute all property tax revenue to the bond trustee before releasing the remainder to the city and its subdivisions. It has also hired an agent to ensure that the levies provide at least three times coverage on the bonds at all times.

The statutory lien on the property tax revenue dedicated to the bonds cannot be pledged to any other obligations.

The structure is aimed at assuring potential investors that, in the case of a municipal bankruptcy, a judge could rule that the property tax revenue segregated for the borrowing is protected because it was never under the city’s control, said Kevin Smith, a principal at Miller, Canfield, Paddock and Stone.

“The significance of this amendment is it creates a structure that gives bondholders additional assurances in the case of bankruptcy, which the underwriters said was a concern,” Smith said.

No local government in Michigan has declared bankruptcy, and state officials have refused to allow the option for those municipalities that have pushed for it, like the long-ailing city of Hamtramck.

“While the option hasn’t been tested, we believe that if the provisions of the statute are applied to the revenues that are pledged to the bonds, that a bankruptcy court would reach a conclusion that the revenues are not considered property of the city,” Smith said.

The lockbox structure “adds a small level of comfort,” said Brad Reynolds, chief investment officer for Troy, Mich.-based investment firm LJPR LLC, which buys local Michigan debt.

“But it would not make me look at it and say, 'Okay, this issue is going to be fine,’ ” he said. “The underlying problems are still there. Someone holding the tax receipts rather than the actual city, it’s not going to add that much — a little but not a factor that will sway my decision to buy or sell.”

The city’s effort shows “an attempt at fiscal responsibility, as opposed to playing the fiddle while Rome burns, and that adds a level of comfort,” Reynolds added.

The bonds will be strengthened by their A rating, but Reynolds speculated that Ecorse will still have to pay a penalty for being in receivership, and could see interest rates as high as 7%.

There are currently seven governments under emergency financial management in Michigan.

A new law pushed by Snyder increased the criteria that triggers state review and intervention, and there are now dozens of local governments — including Detroit itself — that could be taken over by the state.

Lawmakers pushed through SB 318 over the course of only 15 session days in order to meet Ecorse’s deadlines, but could end up expanding the law to accommodate other “unique circumstances that communities are facing,” according to Andrea Cascarilla, chief of staff for Sen. Hoon-Yung Hopgood, D-Taylor, who sponsored the legislation.

“As we were working on the bill, there were discussions of at least one other community being included,” Cascarilla said. “I know what we passed for Ecorse is not sufficient to address their situation. The department of treasury indicated they may be amending the bill to address other communities.”

It could prove to be a problem if more issuers begin to adopt similar models, Reynolds warned.

“People could start saying these munis can’t float straight debt — they have to go to these new types of structures and get third parties involved,” he said. “That could make people start shying away from the muni market. Perception is everything.”

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