CHICAGO -- Investors' appetites for bonds carrying Detroit's tarnished name will be tested next week for the first time since the city filed for Chapter 9 when the Public Lighting Authority of Detroit brings $185 million of new money bonds to market.
The sale will mark the first public borrowing backed by Detroit tax revenue since the city filed its historic Chapter 9 case last July.
It will also mark one of the only borrowings from a bankrupt entity that is not an exit financing or a debtor-in-possession private placement, muni market experts said.
Investors said the deal would likely attract buyers due to the bondholder protections built into the deal. A low-rate market that has buyers hungry for yield will also benefit the issuer, investors said.
The authority, created by state law in 2013 to take over the city's notoriously troubled lighting department, is the borrower. The Michigan Finance Authority is issuing the bonds on the authority's behalf. The sale is set for June 25.
A utility user tax -- a 5% tax tacked on all of the city's utilities, including telephone, gas, and electric -- is backing the bonds.
The lighting authority and finance team will do an Internet road show to promote the deal. They will tout the structure of the bonds, which includes a so-called intercept feature. That calls for the utilities to send the tax revenue directly to the bond trustee, which will set aside debt service before sending the remainder of the revenue to the city. The feature means the city will not have control or possession of the revenues until after the debt obligations are paid, which also boosts the case that the debt would be considered special revenue in the event of a future bankruptcy.
Legal opinion from the deal's bond counsel that the bonds would be "bankruptcy remote" will also be a part of the sales pitch, as will a ruling from U.S. Bankruptcy Judge Steven Rhodes, who oversees Detroit's case, that affirms the lighting authority is a separate entity from Detroit and the city cannot claim the pledged portion of the utility tax revenue in the future.
Syncora Guarantee, Inc., a bond insurer who has been one of the most persistent opponents to Detroit's bankruptcy, has appealed Rhodes' ruling.
Odis Jones, executive director of the lighting authority, said investors should be interested in the paper because of the strong statutory protections and the belief that the utility tax is a strong, reliable revenue stream.
"Also, it's a good cause," Jones said in a telephone interview. "Here in Detroit, lighting is all about a sense of purpose and a sense of place," he said. "It's about safety, and purpose and community."
It's the authority's first public borrowing, but it completed a $60 million private placement with Citi last December. This deal will roll over those notes into long-term bonds, and also include an additional roughly $120 million of new-money debt to finance repairs to the troubled street lights.
Citi is the senior manager, and Robert W. Baird & Co. is financial advisor. Miller Canfield LLP is bond counsel.
Standard & Poor's has rated the deal A-minus. The bonds will be fixed-rate with a 30-year final maturity. They likely will not carry insurance.
Standard & Poor's analysts compared the structure to Detroit bonds that carry a pledge of state aid, which are being treated in the city's bankruptcy plan as secured with full repayment.
The state law creating the lighting authority allows for a maximum annual pledge for debt service of $12.5 million, with a minimum $1.04 million monthly transfer to the bond trustee. The transfer to the trustee constitutes the revenue's first and only lien, which state law calls "paramount and superior to all other liens and interests."
Detroit generally collects around $40 million annually from the utility users tax.
Preliminary bond documents were not released as of Tuesday, but are expected to include a lengthy section on dozens of possible risks.
Despite the structure and legal protections, which helped win the A-minus S&P rating, the issuer will still need to offer significant yield, investors said.
"The most persuasive things have to do with block size and coupon and spread," said Josh Gonze, portfolio manager with Thornburg Investment Management.
"It's a great time for any issuer to come to market," Gonze said.
But when it comes to the credit fundamentals of the deal, Gonze said he was skeptical.
"We'll give it a good look," Gonze said, but added that he thought the deal had several weaknesses that "we're not willing to live with."
"It sounds really persuasive because the judge says that, but someone still has to actually pay the tax," Gonze said, noting that it's been declining for the last 10 years. "There's all sorts of opportunities for something to go wrong."
Others said the intercept feature and legal protections built into the deal would likely carry significant weight.
"I think there will be interest by us and other folks," said Howard Cure, managing director, municipal bond research, at Evercore Wealth Management LLC. "You have to have the right client to understand and not get spooked by Detroit's name, and then it's a matter of what kinds of spreads there are," he said.
Cure's firm buys Detroit school district notes, which are secured by an intercept feature similar to the one built into the lighting deal.
"You want to make sure there's a minimum economic base, to make sure there's enough utility revenue generated," said Cure. "Just from an investor point of view, I think they should be doing some sort of road show or conference call with the various counsels involved, to give people comfort on this to make it as secure as it can."
Like Cure, Alan Schankel, a managing director at Janney Capital Market's fixed-income team, said the intercept feature and "bankruptcy remote" issue will help make the bonds saleable.
"If it goes out with an A-minus rating, and it's got a pretty strong structure, it will probably be on the yieldy side, but it will benefit from the market because of the hunt for yield," Schankel said.
Schankel noted that Standard & Poor's expects debt coverage levels to be just under three times based on the $12.5 million pledge, based on 2013 collections.
"Coverage is good, but not great," he said. "The revenue source, even if cut in half, still seems adequate to pay the bills. I think it'll find an audience and plenty of buyers."
Schankel added that the deal continues to show that there are plenty of second acts in the muni market. Bankrupt or serious stressed credits like Jefferson County and Harrisburg have found themselves able to access the market despite seriously negative headlines.
"Everything gets a second life," said Schankel.
