Detroit Filing Could Impact Future Rating Analysis

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CHICAGO - As Detroit enters into what would be the largest municipal bankruptcy in the U.S., ratings agencies said the outcome may have a negative impact on unlimited-tax general obligation bonds in future credit analysis.

Detroit emergency manager Kevyn Orr’s restructuring plan treats the city’s unlimited-tax general obligation bonds as unsecured, on par with the its lowest-secured debt, such as retiree health care benefits. 

The move marks a departure from traditional treatment of ULTGOs, typically considered among the strongest municipal debt.

Orr’s plan, if accepted by a bankruptcy judge, may affect the way Fitch Ratings analyzes ULTGOs in the future, the ratings firm said in a comment released Friday.

“There has been little precedent for the classification of ULTGOs as general unsecured debt and the bankruptcy court’s treatment of this issue will inform future credit analysis of ULTGO bonds,” Fitch said in the comment, which warned that the city’s GOs were unlikely to be repaid.

Fitch analyst Amy Laskey said in a telephone interview that it’s still uncertain how broad the impact would be if a bankruptcy judge approved Orr’s plan.

“These are issues we’re talking about internally, how broadly that might extend,” Laskey said. “It would certainly make us reexamine the value to credit quality of having that unlimited-tax pledge versus other tax-supported obligations,” she said.

“Our feeling was that with unlimited-tax general obligation bonds you have the pledge to levy property tax without limitation to pay the debt, and that seemed somewhat more secure [than other tax-supported bonds],” said Laskey. “They do give you a little more financial flexibility because you have the ability and the obligation to pay for them, which you don’t have for limited-tax bonds, certificates of participation, or lease revenue bonds.”

If the city moves into Chapter 9, the case could set precedents when it comes to treatment of ULTGOs, she said.

“Obviously municipal bankruptcies are very rare, and cases of municipal bankruptcy where there are unlimited-tax bonds outstanding are even rarer,” she said. “This would be a pretty landmark case, and whatever decision, assuming that it’s accepted by a bankruptcy judge, would be somewhat precedent setting.”

Fitch maintains a C rating on all Detroit’s general obligation debt, a rating that signals default is imminent or inevitable.

Moody’s Investors Service said the outcome of the case may impact the firm’s credit analysis, but that it’s too early to tell if a precedent will be set, and if so, whether it will be limited to Michigan.

“The outcome of what happens there is likely going to influence our thinking and inform our opinions,” analyst Jack Dorer said. “It seems to us that the laws [regarding ULTGOs] vary from state to state, and what is decided in Michigan is not necessarily how it’s going to pan out in other states,” he said. “We’d have to look at each case depending upon the state laws and the bond documents with respect to the securities in those states.”

The outcome of the Detroit case will likely change the treatment of other Michigan ULTGO debt, said Anne Van Praagh, Moody’s chief credit officer for public sector ratings.

“The federal court is going to look to state law, and that decision and that outcome will have implications for GOs in Michigan that will be strongly precedent-setting for other GO issuers in Michigan,” said Van Praagh. “At this point it would still remain uncertain as to how that outcome would impact general obligation bonds in other states.
“We have very few cases at this point where it’s clear in each state how GO bonds are treated and this case may be important in influencing our view -- but it’s too early to tell,” Van Praagh added.

Standard & Poor’s is taking a wait-and-see approach, said analyst Jane Hudson Ridley.

“Obviously if there is a precedent set, we’d need to take a look at it,” Ridley said. “We’d need to see what the implications were for municipal credits,” she said. “We have to see what happens. It’s too hypothetical at this point.”

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