CHICAGO — Detroit will head to the market Thursday with a long-stalled $123 million local government loan program revenue bond deal, a borrowing that chief financial officer Jack Martin said will help the city avoid a cash crisis like the one that loomed just two months ago.
The Michigan Finance Authority will issue the bonds on the city’s behalf. The single-A bonds feature the pledge of a piece of the city’s state aid from Michigan, as well as a so-called lockbox structure crafted in part to improve bondholder protection if the city files for Chapter 9 bankruptcy protection.
Roughly $60 million of proceeds will be used to pay off Detroit’s 2012 and 2013 self-insurance claims, which are typically paid from the city’s general fund. Another $80 million will be used to pay off an overdue short-term private placement to Bank of America Merrill Lynch.
The $60 million, combined with $102 million of cuts built into the current 2013 budget, should generate enough of a cushion to get Detroit through the fiscal year without more borrowing, Martin said in a telephone interview Monday. “This should stabilize our cash-flow situation, so I don’t think we will have any cash issues this year going into fiscal 2014,” he said.
In June, Detroit faced the spectre of a “payless payday” and bond default when the state delayed a $35 million payment after the city’s corporation counsel filed a lawsuit challenging the city’s four-month-old consent decree with the state, designed to improve the city’s finances. A judge rejected the lawsuit, and the state released the money a day ahead of the scheduled bond payment, but the incident revealed the Motor City’s extremely thin cash-flow margins.
Since then, Mayor Dave Bing has imposed $102 million of labor and benefit cuts and continued to assemble a team to help try to rebuild the city, Martin said.
“I think we’re on pretty solid ground,” he said. “All of the financial issues that have plagued the city for decades, I think we’ve got the team in place now to bring those under control, though it’s not going to be overnight.”
Martin said the administration is also trying to collect more revenue owed to the city, such as income tax. He estimated that improved collections could bring in $50 million more annually.
For bondholders eying this week’s $123 million deal, the finance team crafted a structure that shifts most risk away from the junk-rated city. The lockbox mechanism requires the state treasurer to send the state aid necessary for debt payments first to the bond trustee. The state pledged to continue to supply sufficient aid to make all future debt payments despite possible future state revenue sharing aid cuts. The state also pledged not to delay payments.
The bonds feature a third lien on the state aid, subordinate to a pair of bond sales issued in 2010. The first lien is closed, though the second- and third-lien pledges remain open, according to an investor roadshow. Despite the third lien, coverage levels are expected to remain strong, according to credit analysts. Based largely on the legal structure, Moody’s Investors Service rates the bonds A3 and Standard & Poor’s assigned an A-plus rating.
The borrowing comes the week after the state’s controversial emergency management law, Public Act 4, was suspended until voters consider a referendum to overturn the law in November.
A repeal of Public Act 4 would mean the loss of the new law’s strongest powers — the ability to terminate or unilaterally amend labor contracts.
The impact on Detroit of a possible repeal is mitigated by the city’s consent decree with the state, most of which is not tied to Public Act 4. The ability to amend labor contracts would be withdrawn, but the Bing administration has already imposed most of the changes it needed for the 2013 budget, according to Martin. “What we wanted to impose, we imposed three weeks ago,” he said. “If a court steps in and tells us we have to stop, then obviously we’d have to stop, but absent that, we’re moving forward to try to get to our numbers.”
Bank of America Merrill Lynch is the senior manager and Loop Capital Markets is the co-senior manager.
Miller, Canfield, Paddock and Stone PLC is bond counsel. Robert W. Baird & Co. is the city’s financial advisor.
The bonds mature from 2014 through 2032.
