Below are several credit research notes related to the City of Detroit. Our goal with this commentary is to frame the relevant general obligation bond issue and clearly articulate our credit perspective.
- Detroit HAS NOT been on our firm’s list of approved credits for decades. As a result, our portfolio managed clients have ZERO exposure to Detroit. Detroit’s deteriorating credit quality has been discernible for decades. For instance, since 1988, Detroit has run a deficit in the city’s total governmental funds (including transfers and bonds proceeds), SEVENTEEN TIMES. During that same period Detroit has been able to string together two consecutive surpluses only TWICE.
- Missteps. The emergency manager (EM) declared in June that the city’s unlimited tax, general obligation (UTGO) bonds were considered “unsecured”. By placing bondholders in the same pool as other general creditors it sent a clear message that a bankruptcy filing was imminent. Perhaps the EM’s posturing was a negotiating ploy, but in our view it represented a serious misstep. Consider the following: outstanding UTGO bonds total an estimated $500 million, while pensioners and other creditors holding special revenue obligations, pension related certificates of participation and swaps are owed approximately $16 billion. This disparity demonstrates that unlimited tax, general obligation debt is not the root of Detroit’s financial problems. Yet, the EM has indicated there is a willingness to spurn UTGO bondholders. Offering UTGO bondholders a recovery rate of 20 cents on the dollar, while maintaining a coveted art collection worth an estimated $2.5 billion is alarming.
- Bankruptcy. Detroit’s decision to petition a FEDERAL bankruptcy judge to decide which creditors have superior liens suggests local political leaders lack the fortitude to address the city’s financial issues. Furthermore, the city’s diminished view of “unlimited tax, full faith and credit, without limitation…” has forced bondholders to question the true definition. In our view this necessitates a Chapter 9 filing in order to answer (and re-affirm) the question on a legal basis, rather than political. That said the Chapter 9 process will be long and costly for the city. Recoveries aren’t blossoming in Vallejo, California, Stockton, California or Jefferson County, Alabama. Personal bankruptcies are demoralizing and have lasting financial affects, municipal bankruptcies are no different.
- Michigan credit view. The EM’s position regarding Detroit’s UTGO debt does affect how we view ALL other Michigan LTGO and UTGO bonds. We are mindful that it is only the EM’s “opinion”. However, as a consequence and until a federal bankruptcy judge opines or state legislature takes specific actions re-affirming the elevated security status of UTGO and LTGO bonded debt relative to other creditors, we have pulled back from the Michigan G.O. market. We expect a legal authority to address the security priority of various creditors. To that end, it is disappointing that the Governor and Michigan legislators have not led on this issue; contrast Detroit’s Chapter 9 filing with Central Falls, R.I. and Governor Chafee and the Rhode Island legislature which enacted a law stating general obligation bonds have a priority status on Chapter 9 filings.