CHICAGO — Detroit will enter the market Thursday with $250 million of state aid limited-tax general obligation bonds that the city will use to erase a chunk of its accumulated deficit.
The debt features a pledge of state aid aimed at attracting investors who might be leery of buying debt from the below-investment-grade rated city. The revenue stream is derived from a 6% Michigan statewide sales tax and is expected to provide strong debt service coverage over the life of the bonds, credit analysts said.
With the state pledge and additional bondholder protections in place, the debt is rated AA-minus by Standard & Poor’s and A1 by Moody’s Investors Service.
The debt is also a general obligation of Detroit, and would be a first budget obligation of the city if state revenue aid falls short.
The bond sale is the culmination of months of negotiations with the Michigan Legislature and state fiscal officials. It is a key part of Mayor Dave Bing’s plan to eliminate an accumulated deficit that could be as high as $400 million and begin to chip away at the current operating deficit.
“With these deficit-elimination bonds, we recognized that we had a cash-flow problem that we had over the years solved with short-term borrowings,” said Norman White, Detroit’s chief financial officer. “We were doing that year after year, and we clearly thought that was risky and we needed a more stable platform to replace the short-term borrowing, then we could make the structure cuts we need to make to make the operational balance that we need going forward.”
Goldman, Sachs & Co. is lead manager on the deal. Bank of America Merrill Lynch, Cabrera Capital Markets LLC, Loop Capital Markets LLC, and Siebert Brandford Shank & Co. round out the underwriting team. Miller, Canfield, Paddock and Stone PLC is bond counsel.
The bonds will mature in 2036. The city will begin making principal payments in 2014, when a chunk of its outstanding debt will be retired, according to Detroit’s financial adviser, Tom Gavin, managing director at Robert W. Baird & Co.
In advance of the borrowing, Michigan lawmakers amended the state’s nearly 30-year-old Fiscal Stabilization Act to push the borrowing cap to $250 million from $125 million.
Legislators also amended the law to allow a pledge of so-called distributable state aid to pay off the debt.
State Treasury officials also agreed to a host of provisions designed to increase bondholder protections. Michigan will send its semimonthly revenue aid payments directly to the bond trustee, which will set aside one-third of the interest payment and one-sixth of the principal due on the next payment date before releasing the rest of the aid to the city.
Treasury officials have agreed to not delay payments even if they withhold part of the aid to the city — as they have done several times in recent years — and to advance debt service payments if needed to cover shortfalls.
Those and other bondholder protections have been a key part of Detroit’s investor road show, officials said.
“There’s a great deal of protection with this state-aid intercept,” Gavin said. “This is a top priority.”
As one of the most economically stressed cities in the U.S., Detroit has been dogged by talk of bankruptcy in recent years, including by Mayor Bing during union negotiations.
For bondholders, the outcome of a bankruptcy remains unclear, as no Michigan city before has filed for protection under the code.
However, bond documents prepared by Miller Canfield note that in the event of a bankruptcy, a judge “should hold” that state aid can continue to go toward debt service on the bonds.
Despite the city’s hardships, officials are not talking about bankruptcy, according to White.
“We understand that we cannot continue to perform as we’ve performed in the past,” he said. “But we don’t have a strategy to go bankrupt, and we’ve worked pretty hard to make sure that we’ve disclosed [in bond documents] as much as possible.”
White said the city is not considering entering the market on its own credit in the near future as its rating would make the transactions too expensive.
The City Council’s fiscal analyst, Irvin Corley Jr., recommended to the council months ago that it approve the debt issuance. But in an interview yesterday he said that it is a tough choice among a series of tough choices.
“We have no choice. Detroit now has a very difficult time issuing short-term instruments,” Corley said. “But obviously you’re just spreading that accumulated deficit out over 25 years, and every year that we have to pay that debt service, it’s less money we have for city services.”
