CHICAGO — A day after Michigan Gov. Rick Snyder unveiled a plan to pledge $350 million to Detroit's pensions, bondholders said it remains unclear how the influx of cash will play out legally.
The $350 million pledge marks the state's first significant intervention in the historic bankruptcy. It is part of a first-of-its-kind proposal that is being hashed out under the oversight of bankruptcy mediator Gerald Rosen, chief federal judge for the Eastern District of Michigan.
A group of foundations announced the plan, which raises money to pledge to Detroit's pensions while protecting the city's prized art collection. The foundations have already raised $330 million in private donations, they said last week.
With the state pledge, the proposal could mean at least $700 million for the city's unfunded pension liability, which is estimated by Detroit emergency manager Kevyn Orr at $3.5 billion and by the pension funds at around $700 million.
"It's a major commitment from the state and from the foundations, and from my perspective that's good for the bondholders, because the more money that you can provide to close the gap for the pensions, the easier it is politically to give more to bondholders," said Richard Ciccarone, president and chief executive officer of Merritt Research Services LLC.
"I think you can take what appears to be a lemon and turn it into lemonade if everybody comes from the standpoint that more has to be done to take care of all the creditors."
Both Snyder and the foundations said they will seal the deal only if the money goes solely to Detroit pensioners. The money is considered "incremental" and outside the city's bankruptcy case, which weakens other creditors' claims to it, Snyder said at a press conference Wednesday announcing the deal.
"This is not a bailout," Snyder said. "This is not geared toward bondholders or Wall Street, but toward Michiganders who worked really hard for our state."
It's still too early to tell how the new money might affect bondholders, market participants said. Nearly all bondholders are considered unsecured, on par with the pensioners.
According to Ciccarone, more money for pensioners should boost the "moral argument" for bondholders.
Noting the relatively high funded ratio of the city's two pension funds, he said it's bondholders and pension certificate holders who are largely responsible for that status.
"The fact is the pension bonds did a lot of the funding for the pensions," Ciccarone said. "Yes, there were risks, and they got paid extra for that, but that doesn't mean they should be treated without some moral obligation to repay that money and to protect the image of Detroit's ability to repay its debts."
To treat unsecured creditors like bondholders and pensioners differently could pose a problem, some market participants said.
"Gov. Snyder's comments could be interpreted to suggest that the state views pension claims as a higher priority among unsecured creditors, effectively subordinating others, including general obligation bonds," Lisa Washburn, managing director at Municipal Market Advisors, said in an email. "But we'll need to see how this impacts city-creditor negotiations and how the plan of adjustment addresses the requirement for the equitable treatment of similar creditors if a large, earmarked source of money is ultimately pledged for a single creditor group."
Bond insurers and holders are expected to challenge the city's treatment of its GO debt, especially the unlimited-tax GOs, as unsecured. How that plays out - whether the court rules the GOs are secured or unsecured - could influence the pensions' deal as well, said one attorney who asked to remain anonymous.
"It has potential problems because they're proposing to pay one class of unsecured creditors a different amount than the others," said the attorney. "If [the GOs] are secured, then you're actually jumping the GOs and paying pension creditors better than secured creditors. Potentially this is going to have problems."
Details of the pensions plan will be unveiled in the city's plan of adjustment, which Orr is expected to file within the next several weeks.
The state may borrow against its annual tobacco settlement payments, or tap the annual payments directly, to raise the $350 million, according to Snyder.
The state funds, which would be delivered over the next 20 years, would come with a number of conditions.
Among them is the requirement that the city and state can reach a settlement with the unions and the retirees on a deal; that the money should go to the retirees only, particularly the lowest-earning ones; and that the city's two pension systems are taken over by an independent financial manager.
Snyder said he considers the state's annual tobacco settlement payments as a "good potential source" of funding. The state may tap the money directly — amending its current law — or securitize it to back a 20-year bond.
Either way, Snyder said he does not want the pledge to be subject to an annual appropriation.
Lawmakers need to pass legislation approving the funding. U.S. Bankruptcy judge Judge Steven Rhodes, who is overseeing Detroit's case, needs to approve the deal as well.
The court mediators put out a statement praising state involvement.
"The mediators wish to express their appreciation for the constructive and positive role the governor has now agreed to play in helping resolve key issues in the bankruptcy case," they said. "We hope that the governor's announcement will further assist the parties in reaching as many agreements as possible which can be included in an agreed-upon plan of adjustment."
Orr said the plan was an "unprecedented" effort to help the city fulfill its commitments and preserve its art.
"It is now time for the remaining parties to set aside the bargaining rhetoric and step forward and join this settlement to help this great city regain its footing and become once again an attractive place to live, work and invest," Orr said.