CHICAGO – Local credits in Michigan could be hurt if a proposal to give their unlimited tax general obligation bonds a statutory first lien falls through, Fitch Ratings said in a special report.
“In our view, failure to enact this law would be a credit negative for Michigan local issuers, as it indicates lawmakers desire to place bondholders on equal footing with ordinary creditors rather than providing additional security for bondholders,” Fitch said in a report published Tuesday weighing in on the pending legislation.
“This would suggest that bondholders’ claims should be subject to full re-evaluation in a bankruptcy proceeding,” Fitch’s analysts said.
The legislation would bolster recoveries after a default and could better investors’ regard for local government credits, but it won’t help stave off the risk of default, Fitch added.
“If enacted, Michigan’s statutory lien bill will significantly improve recovery value if a municipality defaults, compared to other general creditors, including employees,” the rating agency said in the commentary authored by analysts Amy Laskey, Arlene Bohner, and Rob Rowan.
The new support could help repair some of the damage inflicted on investor views of local government credits in the aftermath of Detroit’s Chapter 9 bankruptcy. Detroit eventually settled with ULTGO insurers for a 74% recovery rate.
“Had this bill been in place, recoveries could have been higher,” Fitch says.
In addition to the statutory lien on taxes, the legislation would require that a portion of pledged revenues be held in trust for the bondholders. It its current form, the protections would apply to outstanding bonds as well as future issuances.
The bill was previously approved by the House and is pending before the Senate but it is not scheduled to be called up for a vote this week, according to Senate Majority Floor Leader Mike Kowall’s office.
While the Republican-led Legislature appears to favor the legislation, its fate is unclear as Gov. Rick Snyder, also a Republican, has questioned whether it is needed.
In its report, Fitch notes that a statutory lien does not protect timely payments in the event of bankruptcy filing.
The bill is part of a larger national debate over statutory liens for GO bonds to strengthen bondholders’ positions in a municipal workout. Similar legislation has been approved in California, New Jersey, and Rhode Island after local bankruptcies rattled investors.
Detroit in 2013 became the largest city to default on its ULTGOs, when it treated the bonds as unsecured, a move that Snyder supported at the time. Supporters of a statutory lien say that without it the state’s local governments continue to pay a market penalty for Detroit’s move, and that a statutory lien would mean savings for taxpayers.
The Michigan Treasury is strongly opposed to the legislation for various reasons, testifying against its passage during legislative hearings. Treasury officials told lawmakers that the statutory lien would not translate into significant interest savings and local governments and school districts would incur new costs to set up bond trusts, as the law would apply retroactively to all outstanding debt.
The law would also pit pensioners against bondholders in a restructuring, the state officials said.
The House passed the legislation 248-108. The Senate Finance Committee approved it 6-0.