CHICAGO — Michigan should pass a law to protect local general obligation bonds after Detroit treated its GO debt as unsecured during its bankruptcy, bankruptcy expert James Spiotto said.
Entering a Chapter 9 process that is expected to wrap up as early as next month, Detroit last year decided to treat its general obligation bonds as unsecured and stopped making payments on the debt.
Gov. Rick Snyder supported the move, which rattled the market. Spooked investors shunned local Michigan debt, and several local governments had a hard time selling bonds in the months after the city's bankruptcy.
The Motor City has since reached settlements with its unlimited-tax and limited-tax GO bondholders, which call for a 74% and 34% recovery, respectively, and for treating the ULTGOs as secured in the future.
But Detroit's initial actions and the subsequent lack of any legal clarity could hurt local Michigan governments in the future, said Spiotto, managing director of Chapman Strategic Advisors.
"Hopefully there will be an effort to reassure, for the sake of municipalities in Michigan, either through new legislation or through other actions taken, to reaffirm that ULTGOs should be unlimited-tax GOs without limitation and without fear," Spiotto said. "Because municipalities are going to need that flexibility and that funding."
A handful of states feature statutory liens for GO bonds aimed at protecting bondholders in case of bankruptcy or fiscal stress. That includes California, which allows its locals to file for Chapter 9, and Rhode Island, which enacted a statutory lien on GOs after the city of Central Falls filed for Chapter 9.
"It would help in Michigan, through legislation or otherwise, to reassure the market, because you don't want competition from, for example a city in California, where ULTGOs get paid without impairment or interference," Spiotto said. "So they may command a lower cost to the municipality than in Michigan."
If you don't do it, in the beginning you may not see the disconnect but over the long term you will pay the price," he said.
Detroit continued to make payments on its water and sewer revenue bonds throughout its bankruptcy. But the city's final settlement with the bondholders featured a massive tender request and refinancing at lower rates that many in the muni market consider an impairment of a bond previously thought sacrosanct.
"In hindsight, the travails over the water and sewer bonds: was there a there there?" Spiotto asked. "Why threaten revenue bond financing and in redeveloping and reinvesting in the infrastructure of Detroit, there should be a real clarity that these are unimpaired," he added. "I think there's also a need now to reaffirm the strength of these [revenue bonds]."
