CHICAGO -- Detroit's high-profile battle with its general obligation bondholders will probably not spark a major shift in the national muni market, Moody's Investors Service said in a report Tuesday.
The outcome of a court fight over whether the city's GOs are secured or not -- the city is treating them as unsecured -- may, however, influence issuer and investor behavior, largely on the fringe of the market, analysts said.
And the outcome will definitely reverberate through the local Michigan market, which already includes large number of distressed issuers, analysts said.
But nationally, it's too soon to predict the fallout, Moody's said.
"The litigation surrounding Detroit's general obligation bonds in bankruptcy is unlikely to provide broad clarity on the meaning of the GO pledge nationwide," Moody's analyst Dan Seymour wrote in the report, "All GO Pledges Are Not Created Equal: Detroit Case Unlikely To Set National Precedent."
"Definitive statements about how Detroit's treatment of GOs would reshape the municipal finance market are premature," he wrote.
There are three reasons why Detroit's influence may be limited, according to Moody's: GO pledges vary widely across the country; most local governments are strong enough that their GO pledges will remain untested; and a court ruling in the Detroit case would not be binding for other issuers.
The city's effort to treat its general obligation bonds as unsecured has sparked a debate among muni market experts over whether it's time to abandon traditional beliefs that GOs are among the safest debt instruments and to start parsing the pledges backing the debt more closely.
All three major ratings agencies have published multiple reports examining the Detroit case and its possible implications.
Fitch Ratings has said a court decision that treats the city's GOs as unsecured could prompt the agency to review its GO rating methodology. Standard & Poor's said it's watching the case closely and reviewing which states have statutory liens and which do not.
Moody's, in its new report, notes that GOs vary widely across the country. General obligation bonds can carry a variety of pledges, including a limited-tax or unlimited-taxes pledge, a dedicated tax levy, a levy held for bondholders only, a government's full faith and credit, and a state-based statutory lien, Moody's notes.
Most municipal credits, moreover, are healthy enough that it's unlikely their GO pledges will ever be tested, the ratings firm said.
"For the overwhelming majority of local governments ... we will never find out how a bankruptcy judge would interpret their GO pledges," Moody's said. "We expect the vast majority of local government issuers to remain solvent and never test the limitations of their GO pledge."
Seymour notes that Detroit might end up reaching a settlement with the bondholders, with no need for a precedent-setting court decision.
U.S. Bankruptcy Judge Steven Rhodes has repeatedly encouraged Detroit and its creditors to use mediation to try to reach out-of-court settlements to ease the bankruptcy process and curtail the chance of lingering appeals litigation.
If Rhodes does end up ruling on the GOs, it would not set a binding precedent for any other court, Moody's notes.
The decision would likely be appealed to the Sixth Circuit Court of Appeals. A decision by that court would be binding for lower federal courts in the sixth circuit, including bankruptcy courts, analysts said. It would not bind any state courts unless it involved federal matters.
An appeal of the Sixth Circuit Court decision would be made to the U.S. Supreme Court which doesn't have to accept such an appeal.
"The matter is a long way from being resolved," Seymour said. "If the parties settle, as the bankruptcy judge has encouraged them to do, it would leave the question unanswered. Also, any decision could be appealed to a higher court, leaving the municipal market in a protracted period of suspense until a final judgement is rendered."
