CHICAGO — With a default looming next year on nearly $17 million of junk-rated tax-increment financing bonds issued by a development authority in Troy, Mich., the bonds’ insurer is threatening to pursue litigation or state intervention if the city does not step in to ensure the obligation is repaid.

The bonds are limited obligations of the Troy Downtown Development Authority payable solely from TIF revenue. They lack a pledge from the city of Troy, a triple-A rated municipality in top-rated rated Oakland County.

The debt matures in 2018, but the Downtown Development Authority projects it will run out of money for debt service by November 2013.

The insurer, National Public Finance Guarantee Corp., a subsidiary of MBIA Corp., told city and Michigan officials it would file a lawsuit or seek state intervention if Troy or the DDA does not pledge to repay the insurer over time if it is forced to cover the obligation.

Troy officials said they are weighing their options ahead of the default, with meetings on the issue set for the next two weeks.

In 2001 and 2002, the development authority issued roughly $34 million of TIF bonds insured by MBIA and featuring a senior lien on TIF revenues. The authority in 2003 issued $4 million of uninsured, junior-lien bonds.

As with many TIF districts across the country, the Troy district has since failed to generate projected revenue due to falling property values.

The district has seen 12% drops over the last two years with more expected in the future. The city’s own five-year forecast has projected that the DDA will not have sufficient money to cover the debt by November 2013.

The problems have sparked a trio of downgrades in the last two years from Standard &Poor’s and Fitch Ratings, and the bonds, along with the junior-lien bonds, are now in junk-bond territory.

On Aug. 14, NPFG sent city and state officials a strongly worded letter that warns it will file a lawsuit or ask the state to intervene — suggesting that an emergency manager could be brought in — if the insurer is not paid back.

“As a bondholder, NPFG will not be denied the payments it will be owed by the DDA,” the insurer says in an italicized section of the letter. “The bonds mature in 2018, but they are not retired until they are fully paid.”

The city says the authority, created in 1993, is set to expire in 2018, the same year that the bonds mature.

“There’s no way for the DDA as a separate legal entity to raise the kind of money to pay off all of these debts,” city attorney Lori Bluhm said. “Even if the economy rebounds, there’s not going to be enough revenue generated.”

NPFG says failure to repay the insurer would be “legally wrong,” “morally offensive” and “unconscionable,” as well as lead to higher borrowing costs, a damaged reputation, and restricted market access for the city and the DDA in the future.

“As the economy improves, the ability of the DDA to collect tax revenues will increase proportionately,” the letter said. “Knowing this, the DDA still insists that its repayment obligations end in 2018, an unconscionable position in view of its own bond resolutions and the aforementioned provision of the DDA act.”

The insurer also suggests that the authority put the $6.6 million remaining in its general fund and debt-service reserve fund to help pay down the outstanding debt and refund the remainder. “Unfortunately the DDA sleeps while the city burns,” the letter says.

NPFG said it will pursue litigation if necessary to argue its position that if it takes over payments it becomes, in effect, a bondholder that must be paid. The insurer also said it would be forced to go to the Michigan treasurer, where the currently suspended emergency management law allows the treasurer to declare a fiscal emergency and take over the DDA.

“Discussions could lead to the consideration of the more drastic measures such as under Act 4 or its predecessor to ensure payment on the bonds,” the letter suggests.

A spokesman for Treasurer Andy Dillon confirmed the state received the letter, but said it was “not clear what authority or obligation the firm is referring to” when it said default could precipitate a state intervention.

One industry expert said the insurer’s response to the expected default is understandable. “The guarantor provides a service to the noteholder, but that doesn’t absolve the issuer of liability,” said the expert, who asked to remain unnamed. “At the end of the day, somebody borrowed money and didn’t pay it back.”

Troy officials have not responded to the letter or decided their next action, Bluhm said. The DDA is set to meet Sept. 19 to discuss the matter and the City Council will convene Sept. 24.

“It’s our goal to give the DDA our analysis of the issues and the legal options that they have,” Bluhm said. “We want to make sure that our elected officials as well are fully apprised of the situation. We don’t expect any immediate action.”

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