CHICAGO - As Detroit embarks on a massive restructuring of its debt, its earlier decision to buy insurance to wrap nearly all of its bonds could prove as much a benefit to the city as to its bondholders.
All eyes are on the Motor City as its state-appointed emergency manager completes his first month in office and prepares to release his restructuring plan, expected in early May.
Gov. Rick Snyder in mid-March appointed bankruptcy attorney Kevyn Orr to take over the long-troubled city, the largest in Michigan, and the ninth local government under state control. In addition to an estimated $380 million deficit at the end of fiscal 2014, Detroit faces nearly $15 billion of long-term liabilities. Orr has said publicly that he expects all creditors to take a cut to help bring down the obligations.
Orr has yet to launch negotiations with creditors. But the fact that nearly all of Detroit’s nearly $8.6 billion of bonds and certificates carry insurance from monoline bond insurers could ease at least the initial round of negotiations and possibly help avoid a Chapter 9 filing, market experts said.
“It gives the city a bit more flexibility to negotiate,” said Matt Fabian, managing director, Municipal Market Advisors. “In theory, the insurance companies could agree to a delay in repayment, which is still a full par recovery, or other kinds of easing of terms that can be done without impairing the payment to the end user.”
For municipalities facing default on bonds or possible bankruptcy, the requirement that it get 100% agreement from all bondholders can be a significant obstacle, Fabian said, much more difficult than talking to a few bond insurers.
“Municipalities file for bankruptcy because they can’t get 100% approval,” Fabian said. “This gives you just a few companies to negotiate with rather than lots of investors.”
The six insurers that insure the city’s bonds will be among the first invited to the table when Orr tackles the debt, sources say.
“The city is of the impression that the insurers have all the rights to act for the bondholders, and within limits they’re right,” Rick Frimmer, a partner and restructuring specialist with Schiff Hardin LLP. Frimmer represents a bondholder who holds a piece of the city’s $1.5 billion of pension certificates, which are insured by Financial Guaranty Insurance Corp. and Syncora Guaranty Inc. “I think as a first line of communication and negotiation, the city will negotiate with the insurers and if the city uses that as a benefit because there are fewer people around the table, it will be easier to get the message across.”
But Frimmer added that until Orr unveils a plan for the bondholders, it’s too early to stake out a position. “We will eventually have a dialogue with the insurers when the time comes,” he said. “You have some very large bondholders and it’s appropriate to discuss the situation with them.”
Depending on Orr’s proposal, he added, “some form of bondholder consent may be required.”
It remains unclear how Orr will handle the obligations, as the state’s emergency management law forbids the impairment of debt service payments. But Orr’s main negotiating tool will be the threat of Chapter 9.
“That give and take, the horse-trading, if it hasn’t already started is going to be starting soon,” said Stephen Grow, a Michigan-based bankruptcy attorney with Warner Norcross & Judd, which represents the interest-rate swap counterparties on $800 million of hedged pension certificates. “The touchstone will be Chapter 9. That’s the acid test Kevyn is going to use, saying ‘I can’t give you a better deal than I would get in Chapter 9’.”
Detroit has nearly $15 billion of long-term debt, of which $5.7 billion is made up of other post-employment benefits, generally considered the least-secured debt. On the bond side, the city carries $963 million of unlimited-tax and limited-tax general obligation bonds. Of that, roughly $205 million of bonds issued in 2008 are uninsured. There is additional debt issued in 2010 and 2012 that is also uninsured -- the junk-rated city could not buy insurance by that point -- though those are backed by a pledge of state aid payments.
The city also has $5.9 billion of water and sewer bonds, all of which is insured except for $476 million with a 2041 maturity. Another roughly $200 million of insured revenue bonds, including parking and convention center debt, is outstanding, as well as the $1.5 billion of pension certificates.
The collapse in the monoline bond insurance business since the 2008 financial crisis will play a role in the city’s negotiations and the ultimate impact on bondholders. The sector’s crisis left Assured Guaranty Ltd. as the only active insurer until the recent launch of Build America Mutual. Moody’s Investors Service in January downgraded Assured to A2 from Aa3, but noted that its capital adequacy remained strong.
Of the six insurers that wrap Detroit debt, only Assured and National Public Finance Corp. a subsidiary of MBIA Inc., returned calls by press time. Assured would not comment on whether it has met with the city, while a National spokesman said the firm has yet to do so.
“Mr. Orr was only recently appointed to the emergency manager role, so we have not yet had an opportunity to meet with him,” National spokesman Kevin Brown said in an email. “However we look forward to working with him and other interested parties toward a plan that puts the city of Detroit on a path toward long-term fiscal stability.”
National wraps nearly $2.5 billion of Detroit debt, including $2.5 billion of revenue bonds -- most of them water and sewer -- and $101 million of unlimited-tax GO bonds.
National in March put out a statement assuring its bondholders of full and timely debt-service payments if Detroit misses a payment for any reason, including a Chapter 9 filing.
Assured insures $2.2 billion of the city’s debt, the bulk of which is water and sewer bonds, and $355 million of GO bonds. The firm said in an email to The Bond Buyer that the $1.8 billion of revenue bonds are “secured by a pledge of ‘special revenues’ and therefore timely payment of debt service should be insulated from any financial difficulties of the city.”
For some investors, insurance gives some comfort against principal cuts, but the insurers’ own financial problems as well as the trade value of the Detroit debt raise concerns.
“We think the bond are money good; we’re not worried about principal,” said Robert Miller, senior portfolio manager at Wells Capital Management, which holds $32 billion of municipal bonds. “We’re more worried about valuation. We’re mark to market daily, so that’s what we worry about.”
“Nothing is trading off the insurance, it’s all trading off the underlying,” added Miller, whose firm holds roughly $200 million of Detroit water and sewer debt. Like most market participants, Miller said he considers the water and sewer revenue bonds among the city’s most-secure debt.
Frimmer, who represents the pension certificate holders, noted that FGIC is still under supervision in the New York state court system.
“Everybody is kind of concerned that the insurers aren’t as well off as they used to be,” Frimmer said. “Obviously everybody is going to closely watch what the insurers will do with their powers. The insurers are pretty sophisticated, but there can be some honest debate over certain things they can do,” he said. “It’s a complicated situation, so we’re all going to be watching and we hope there’s a rational plan to put Detroit back on its feet, and we hope with no damage to bondholders and insurers.”