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Buffett Insurer Wrap Firms Up Detroit Debt

CHICAGO — Et tu, Buffett?

In the sea of junk-rated Detroit debt trading for 30 to 40 cents on the dollar, a small piece of the city’s defaulted pension certificates continue to see retail bids of nearly 90 cents on the dollar.

The higher valued  debt features an insurance pledge from Berkshire Hathaway Assurance Corp., the government bond insurer controlled by financier Warren Buffett.

In late June, just four days after Detroit emergency manager Kevyn Orr announced the city would default on its pension certificates, the Berkshire-wrapped debt traded for just under 96 cents on the dollar, with a 6.3% yield.

Though Buffett has repeatedly expressed caution about insuring tax-exempt bonds, BHAC has about $400 million in  exposure to Detroit’s tainted debt, most of which is sewer bonds. All the BHAC insurance is a wrap on top of an original guarantee from Financial Guaranty Insurance Co.

BHAC’s secondary insurance gives additional comfort to investors and means BHAC would only have to pay if the issuer defaults and then the original insurer can’t meet the obligation — a scenario not too far off for Detroit creditors.

Traders say Detroit debt is pricing largely on underlying fundamentals like maturity and coupon, but that unlike many insurers, a BHAC pledge makes a difference. “If you’re looking at the water and sewer that’s wrapped by one of the highest-rated insurers out there, that’s factored into the pricing,” said Robert Miller, senior portfolio manager at Wells Capital Management, which holds Detroit water and sewer debt.

Another manager agreed. “If it was backed by Berkshire Hathaway that’s one thing, because people view them as a strong insurer,” said the senior portfolio manager who wished to stay anonymous. “But if it was backed by one of the failed bond insurers that is no longer really active, I would imagine it’s going to be difficult.”

Detroit defaulted on its pension certificates in June and Orr wants creditors of the $5.9 billion of water and sewer bonds to take a haircut.

FGIC, meanwhile, is in the midst of its own recovery workout plan that has it covering only 30% of its claims up front, with the balance paid off after the claim matures.

BHAC, which had no comment on the Detroit debt, stepped into the muni bond insurance business in early 2008, when the rest of the monoline bond insurers were on the edge of collapse.

Detroit bought BHAC insurance to wrap $384 million of FGIC-guaranteed sewer bonds in May 2008 as part of a larger refinancing of after FGIC was downgraded earlier in the year. That marked BHAC’s first primary market deal.

A few months later, in July 2008, an investor in the secondary bought BHAC insurance to wrap a piece of the pension certificates. The amount of the BHAC-wrapped pension certificates is uncertain. Standard & Poor’s rates the Berkshire-insured pension COPs AA-plus, with a negative outlook, based on its BHAC rating.

The pension certificates wrapped by BHAC have a Cusip of 251228AD4. All recent trades were in the high 80-cents-on- the-dollar range, according to the Municipal Securities Rulemaking Board’s EMMA disclosure website.

The trades are small, around $10,000 to $30,000. The BHAC-wrapped COPs have a 2035 maturity and 5.89% coupon. In recent trading, on July 9, some sold for 88 cents on the dollar, with a 7% yield.

Some of the non-BHAC wrapped COPs with a 2025 maturity and 4.98% coupon, in contrast, were trading for 38 cents on the dollar the same day, the website shows.

Trading on July 8 showed the BHAC-wrapped debt going for 91 cents on the dollar with a 6.78% yield, with non-BHAC wrapped debt going for just over 30 cents on the dollar.

A floating-rate piece of the non-BHAC COPs maturing in 2034 was selling for 50 cents on the dollar during its most recent trading, which was in May, a month before Detroit’s default.

A piece of fixed-rate COPs with 2035 maturity and 5.9% coupon was trading for 76 cents on the dollar in May.

The BHAC-wrapped sewer bonds are also trading relatively well, data indicates.

Sewer debt with a 2028 maturity, 5.25% coupon and BHAC wrap on top of the FGIC guarantee was getting between 103 cents and 99.8 cents on the dollar in recent trading.

Sewer bonds with a 2032 maturity and 5% coupon that are insured by Assured Guaranty were trading 90 cents on the dollar with a 5.85% yield on July 11.

The same bonds sold for 98 cents on the dollar with a 5.1% yield on June 20, four days before Detroit defaulted.

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Comments (2)
The detailed CUSIPs allows us to see the "market" perception. That view dosen't often align neatly with the story as it does here.
Posted by cavanalhill | Wednesday, July 17 2013 at 10:18AM ET
Thanks, Caitlin Devitt and Mike Stanton for today's very informative Detroit/BHAC article.

Your including specific trade sizes, coupons, maturities, and CUSIPs, especially on the taxable pension fund bonds, made it enjoyable to read.


Wilson White

Municipal bond expert witness
Posted by wwilson | Wednesday, July 17 2013 at 7:02AM ET
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