CHICAGO -- Detroit reached a settlement with the three bond insurers that wrap its unlimited-tax general obligation bonds calling for a 74% recovery, up dramatically from the bankrupt city's most recent 15% offer.
The deal marks the first major settlement since the city filed for bankruptcy last July. It represents only a fraction of the city's $18 billion of outstanding debt, but could advance confirmation of the overall bankruptcy plan by giving the plan the approval of a major impaired creditor.
The deal comes several weeks after the three insurers sued Detroit over its proposed treatment of the ULTGOs as unsecured. After the February hearing, U.S. Bankruptcy Judge Steven Rhodes urged the parties to hammer out an out-of-court settlement because his ruling would likely be "all or nothing."
The settlement asks Rhodes to rule that the ULTGOs are secured, and would make clear distinctions favoring the ULTGOs over limited-tax GOs.
If the judge approves the settlement and issues the ruling, it could boost the treatment of ULTGOs in Michigan, which have suffered since the city declared it would treat the debt as unsecured last June.
"It would be instructive and it may be determinative," James Spiotto, managing director of Chapman Strategic Advisors LLC said. "It's something where the insurers who looked at it made some concessions for the sake of the city because it's going to be determined that the bonds are secured," Spiotto said. "That's the beginning of a consensus that may allow the plan of confirmation to proceed."
Research firm Municipal Market Advisors noted that because the deal is a settlement, a ruling would not necessarily mean a precedent for treatment of the ULTGOs.
Even so, "going forward, ULTGO lenders to other Michigan issuers will have a better argument for par recovery out of a Chapter 9," MMA said. "This may thus be an important improvement in the security feature for other Michigan locals."
After the announcement, Detroit emergency manager Kevyn Orr on national television urged pensioners and unions to settle with the city. He said the deal with the bond insurers means significant gains for the pension funds because of a provision that sets aside to pensioners the 26% of the bond levy revenue left over after the insurers are paid 74%.
But one source familiar with the settlement said the levy for the bonds was only generating about 80% of the property tax dollars required for debt service, so the 74% recovery is near the available ceiling anyway. MMA also noted that this provision could spark opposition from parties who challenge the use of the levy for anything other than the voter-approved debt service.
The settlement is with bond insurers Ambac Financial Group, National Public Finance Guarantee Inc., and Assured Guaranty, who together insure $388 million of the city's unlimited-tax general obligation debt.
The terms of the deal call for the Michigan Finance Authority to issue new bonds to refinance the outstanding debt on or before the city's exit from bankruptcy.
The new bonds would feature a lien on the city's state aid as additional collateral. That would ensure the bonds are treated as secured in the future and have a backup revenue source in case the city's fiscal situation deteriorates further.
Proceeds from the MFA deal would be used to repay $288 million of the $388 million of the outstanding claims, with key market terms, including interest rate, maturity date and amortization remaining the same.
All three insurers said they would cover the full payments to their bondholders, who will see a 100% recovery.
"Given Detroit's unique circumstances, Ambac has accepted a settlement with the city for the unlimited tax general obligation bonds," Ambac said in a statement. "Nevertheless, we are disappointed that Detroit chose not to fully meet its obligations for responsibly incurred debt, weakening its capital market access, which is a key ingredient to any revitalization and return to self-sufficiency."
The settlement requires the court to confirm the existence of a lien in favor of the ULTGOs and find that the ad valorem millage is considered special revenue under the bankruptcy code. The city has agreed to set aside all the millage revenue weekly.
The deal requires that the ULTGO insurers recover more than the limited-tax GO and pension certificate holders, who are considered unsecured.
If the LTGO or COPs holders see final recoveries of 69.5% or more, then the city will pay the bond insurers "an amount equal to the percentage recovery ... that exceeds $69.5 million multiplied by $100.5 million," according to the term sheet. For example, if the LTGO or COPs holders were to see a 70% recovery of their allowed claims, then the city would have to pay the insurers $502,000.
"Under no circumstance shall any impaired unsecured financial creditors recover more than the ULTGOs," the settlement says.
If the bankruptcy is not resolved by Sept., 30, 2014, the city has agreed to pay the October 2014 debt service payments and any payments after. Detroit stopped making all GO debt payments last June.
The city is expected to file an updated bankruptcy plan Monday. Rhodes has set an April 17 ruling on objections to the disclosure statement.
