http://blogs.marketwatch.com/thetell/2013/08/12/detroit-other-bankruptcy-exits-face-pressure-from-rising-rates-moodys/
Detroit, other bankruptcy exits face pressure from rising rates: Moody’s
August 12, 2013, 12:37 PM
The nation’s two biggest bankrupt municipalities have indicated that they plan to issue bonds as part of their plans to exit court protection. But the recent sharp rise in interest rates could make that difficult, say analysts at Moody’s Investors Service.
Detroit, which filed a Chapter 9 bankruptcy petition last month, said in a restructuring proposal handed to creditors before the bankruptcy filing that it would issue $2 billion worth of notes with a 1.5% interest rate to pay a recovery on its $11 billion of unsecured creditor claims. That plan has put the municipal bond market on edge.
Meanwhile, Jefferson County, Alabama, which entered court protection in 2011 largely because of the failure of a bond-backed sewer project, plans to issue debt to fund a bondholder recovery. The $1.9 billion in bonds would have yields ranging between 4.5% and 7.0% depending on maturity, according to Moody’s.
Issuing debt to pay creditors in bankruptcy is relatively rare in the Chapter 9 process, where recoveries are usually generated through operations. Accessing the market for that purpose may provide quick cash for a recovery, but it also exposes municipalities to potential market turbulence.
- Moody’s Investors Service
Treasury rates moved sharply higher for much of May and June as bond investors fretted over a wind-down in the Federal Reserve’s easy monetary policies, dragging municipal bond yields higher as well. After Detroit filed for bankruptcy, the muni market continued to weaken as investors demanded a greater risk premium to own muni bonds.
Those higher yields could make it difficult for Detroit and Jefferson County to issue the bonds they would use to repay their creditors, write Moody’s analysts Silvio Zanardini and Dan Seymour in a Monday report. They explain:
“Rising rates could require [Jefferson County] to revise the plan further and seek agreement from investors and from the judge. Either scenario could delay sewer warrant holders’ ultimate recovery by several months. Detroit bondholders may face similar recovery risks dependent on refinancing.”
In Jefferson County, which is seeking to exit bankruptcy by the end of the year, rising interest rates may be a pressing concern, which even the attorneys leading the county’s case concede merit attention. Barnett Wright of AL.com reports:
“‘If we went to market today the rates and yields that are currently in the market today are too high to be able to consummate the refinancing plan,’ [Jefferson County bankruptcy] attorney Ken Klee said. ‘But, nevertheless the county believes in good faith that there is an ability to go forward to consummate this plan.’”
Detroit, however, is in the infant stages of its Chapter 9 case, which is known to be a long and fraught process. If the city is found to be eligible for court protection, much may change by the time it proposes an in-court restructuring plan (though that hasn’t stopped other Michigan municipalities from running into difficulty accessing the muni market in the meantime).
But even if Detroit doesn’t move forward with a plan to sell bonds to pay its unsecured creditors, the city will likely need to access the bond market, say analysts at Municipal Markets Advisors led by Matt Fabian. In a Monday note, they point out that the city’s revenue projections don’t ensure enough cash-flow to keep the city running on its own:
“Very likely, the city will need lenders in the next few years. [Detroit emerging manager Kevyn] Orr’s 10 year revenue projections nonsensically predict stable annual receipts (at around $1 billion per year) where actual receipts have dropped by 40% in the last five years alone.”
– Ben Eisen
http://www.freep.com/article/20130811/NEWS01/308110055/Detroit-Kevyn-Orr-bankruptcy-pension-Truth-about-Detroit
The truth about Detroit: Did Detroit really
need to file for bankruptcy?
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Aerial View of Lafayette Park, Downtown Detroit, The Renaissance Center and the Detroit River on Thursday June 14, 2012. / Romain Blanquart/Detroit Free Press
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Did Detroit really need to file for bankruptcy? Today we examine an argument, published in a prominent Wall Street publication, that it did not.
The Bond Buyer, a publication tracking Detroit’s troubles from the standpoint of the municipal bond market, published a provocative column last week by Richard Larkin, a senior vice president and director of credit analysis
at the Herbert J. Sims investment advisory firm.
at the Herbert J. Sims investment advisory firm.
Larkin’s claim that Detroit did not need to file for bankruptcy is based on financial assumptions that are, needless to say, much rosier than those of Detroit emergency manager Kevyn Orr. To take the most obvious point of contention, Larkin proclaims that the city’s two pension funds are not underfunded by more than $3 billion, as Orr stated in his June 14 plan of reorganization.
Rather, Larkin says the funds are financially sound and assumption of a long-term 8% rate of return is realistic, despite Orr’s concerns that it’s too optimistic. “Stock market returns are indeed volatile, and yet the 25-year average of annualized returns for theS&P 500 has not been below 8% since 1954,” Larkin wrote.
has not been below 8% since 1954,” Larkin wrote.
In his column, he outlined a 10-point plan that he contends could have kept (and may yet keep) Detroit out of bankruptcy.
Among those points:
Claim: The State of Michigan could restore prior levels of state aid to Detroit. Larkin wrote that this would not be considered “new money” or a state bailout but just a return to pre-recession aid levels. If it happened, this would generate additional annual revenue to Detroit of about $56 million.
Claim: Larkin praises elements of Orr’s reorganization plan that envision better collection of revenues already due the city, as for example through better tax collection. These are estimated at about $22 million to $25 million annually.
Claim: Larkin wrote that the city could refinance its existing general obligation bonds and retire 63% of principal in 10 years, which he considers “unusually fast,” and convert debt service to a 30-year debt service. “This would reduce Detroit’s debt costs by nearly $257 million over the 10-year plan, and make its debt repayment period similar to many other solvent cities in the U.S.,” Larkin wrote.
Claim: Larkin likes Orr’s plan to spend $500 million on blight removal in Detroit, but he thinks Orr should pay for it differently. Orr would use money saved by stiffing bond holders and pensioners to pay for blight removal. Larkin would raise the $500 million immediately by selling tax-increment bonds. Then, as formerly blighted sites came back on the tax rolls through new development, the additional revenue could pay off the bonds.
tax-increment bonds. Then, as formerly blighted sites came back on the tax rolls through new development, the additional revenue could pay off the bonds.
Claim: Larkin urges city and suburban voters to approve a regional tax (on either wages, property, or sales) “to help fund Detroit facilities that truly provide value to the suburbs, such as museums, parks or other operations that truly provide benefits to suburban residents that use them.” Larkin wrote that a “regional tax for regional facilities” is a concept that was successfully implemented by Pittsburgh and that it could help Detroit’s general fund by about $50 million to $52 million per year.
Analysis: These and other assumptions in Larkin’s column might, in fact, work, provided his math is correct. But getting state lawmakers and suburban voters to send more money Detroit’s way might prove to be a hard sell. With Detroit facing massive budget deficits each year, it might be too late in the game to try to implement such measures. And there is no guarantee that cleaning up sites through blight removal would generate enough new development to pay off bonds.
However, Larkin’s assertion that the city’s pension funds are not underfunded, paired with a similar recent claim by the Morningstar investment advisory firm, highlights what is sure to be a major point of contention in Detroit’s bankruptcy.
Orr’s claim helps him justify reducing pension benefits. The health of the funds therefore becomes a battleground in what looks like a long legal fight.
In a broader sense, Orr must still persuade U.S. Bankruptcy Judge Steven Rhodes that the city is eligible to file for Chapter 9 municipal bankruptcy. To do that, Orr must demonstrate that the city is insolvent. Larkin’s column and his financial assumptions shows that a claim of insolvency is by no means a slam dunk.
How screwed might municipal workers actually be in Detroit ?
How screwed might municipal workers actually be in Detroit ?
TUESDAY, AUGUST 13, 2013
Municipal Workers in Bankrupt Cities Facing Financial Nightmare
Georgetown law school professor and bankruptcy expert Adam Levitin in a must read article in Salon parses how municipal workers, who on paper should actually be well protected in the event of a municipal bankruptcy, are likely to be butchered.
Before we get to the legal and negotiating issues, it’s important to deal with some of the ugly myths and jealousies that an organized effort in the 1970s by what then was the extreme right wing has succeeded in making hatred of all things government, including government workers, a mainstream view. I have to say I don’t get it. I live in high tax New York, and I’ve lived in higher tax Sydney. Guess what? Taxes aren’t objectionable if you get services. In Sydney, you got really good infrastructure. Here, one of the bennies is I have a state insurance regulator which I can get to bust the chops of my health insurer when it tries denying claims for dubious reasons or otherwise not honoring contract terms. By contrast, unless you are in a low density area where you can’t provide public services efficiently, low taxes almost guarantee crap services and as a result, public dissatisfaction. It virtually insures a vicious spiral.
Getting various elements of the working classes in petty fight over scraps serves to divert their attention as the wealthy continue their plunder. And no, this depiction is not an exaggeration, just look at the increase in concentration of wealth and income of the top 0.1% over the last 20 years. It’s not an exaggeration to call it rapacious. Admittedly, not all members of the 0.1% were actively involved in either the PR campaign to move the country to the right nor were they all necessarily backers or funders of the policies that facilitates this wealth transfer, particularly changes in tax policies. But they most assuredly have been beneficiaries.
As much as it has become fashionable to pin the blame for municipal bankruptcies on municipal workers, Levitin reminds us that the collapse in tax revenues was the result of the financial crisis. The weaker municipalities may still have gone critical, but less catastrophically. As he points out:
Municipal finance problems are not due only to pensions. The collapse of the housing bubble seriously damaged many cities’ finances. Property tax and income tax revenue suffered, while municipalities were saddled with increased costs of tending to abandoned properties. While the banks that fueled the housing bubble got bailed out, local governments had to bear the costs of the crisis on their own. Now, with cities in their weakened state, the fair-weather pension promises that cities made to their employees are coming home to roost. It seems that unlike banks, cities will not get bailed out. The banks came first in the bailouts, and again they will come first in the bankruptcies.
It is also worth stressing that even though current poster child Detroit has been charged with having rosy forecasts for its pension funds’ performance, it turns out its assumptions fell within private sector norms. In addition, there’s a robust debate as to how sick the Detroit pension funds are, with skeptics saying that the emergency manager is making a bad situation look even worse than it is. From the Detroit Free Press:
Kevyn Orr, the city’s emergency manager, has estimated the underfunding of the city’s two pension funds at $3.5 billion. The pension fund managers disagree, saying the funds are more than 90% funded, meaning that there are adequate resources to pay almost all future liabilities.The Bond Buyer reported Friday that Morningstar, a major investment adviser, found that the actuarial assumptions made by the two pension funds to come up with their more optimistic assessment were in line with industry practice…..The Bond Buyer reported Friday that Detroit’s pensions funds have long been considered relatively well funded, at around 91%, largely because of a $1.5-billion pension certificate borrowing in 2005 and 2006.The question is far from academic. The size of the unfunded obligations has major implications for the bankruptcy case. On Friday, Orr’s legal team was in federal bankruptcy court to argue that the city was insolvent and needed to be allowed to file for Chapter 9 municipal bankruptcy. Creditors can argue that the city is not eligible to file for a number of reasons — among them that the city is not really insolvent.
Another issue for Detroit that we discussed in an earlier post that is likely to come up with other stressed municipalities is that the city did an extend and pretend funding in 2005. That refinancing involved the heavy use of swaps. Guess what? Swaps are secured, and hence senior to a normal bond issuance or bank borrowing. So the swaps counterparties moved themselves to the head of the line in a restructuring or bankruptcy.
Now to Levitin on the pensioner mess. Municipal pensioners aren’t terribly well protected in a municipal bankruptcy because historically they pretty much never happened and contractually, pension holders can’t be crammed down. But we are entering uncharted waters. Levitin explains:
No city has ever reduced its pension obligations in bankruptcy without pensioner consent…Few of the local government units that have filed for bankruptcy since the 1930s have even been true municipalities. Most have been sewer, water and hospital districts plus oddballs like county fairs and NYC Off-Track Betting or the Las Vegas Monorail…The new wave of municipal bankruptcies — Detroit, Stockton and San Bernardino being the leading cases — are all set to test the question of whether pensions can be cut in bankruptcy, particularly in the face of state laws protecting those pension obligations. If municipal pensions can be cut in bankruptcy, we should expect to see more cities eyeing bankruptcy as a possibility, and other cities using the threat of bankruptcy as negotiating leverage to wring concessions from pensioners and employees.
And the problem is public pensions were based on the assumption that they were inviolate:
Absent special protection in state law, pensioners are already behind most other creditors in municipal bankruptcies. Banks that enter into derivates transactions with cities, such as interest rate swaps, get paid first. Then come most of the bondholders. Most bondholders hold so-called revenue bonds rather than “general obligation bonds.” Detroit, for example, has $6.4 billion in revenue bonds outstanding, but only $650 million in general obligation bonds. These revenue bonds give bondholders first dibs on particular municipal revenue streams, such as tolls or sewage taxes. General obligation bonds are a generic unsecured claim against the city. Pensioners have to compete with general obligation bondholders for repayment after the swaps and revenue bonds get paid.Pensioners are not well positioned for this contest. They have little negotiating leverage. Bondholders can threaten the city with higher borrowing costs going forward or even being shut out of capital markets if they aren’t repaid as promised. There is a lot of bluster to bondholder admonitions, but pensioners cannot credibly make similar threats of withholding labor.
And here is the real kicker (emphasis mine):
What really distinguishes the impact of bankruptcy on public pensions from private sector pensions is that the
What really distinguishes the impact of bankruptcy on public pensions from private sector pensions is that the
public pensions are uninsured, whereas there is a solid pension insurance system for private sector guaranteed-benefit pension plans. Since 1974, federal law has required private employers with defined-benefit plans to maintain certain funding levels for their pension plans and to pay insurance premiums to a federally run insurance fund called the Pension Benefit Guaranty Corp. (PBGC). In exchange, the PBGC provides partial insurance of the private sector defined-benefit pension obligations — up to nearly $57,500 annually for a 65-year old retiree. The PBGC provides a critical safety net for pension obligations (although not for other retiree benefits, such as healthcare). The lack of PBGC insurance for municipal employees is particularly acute because many do not participate in Social Security; their retirement security rests solely on their uninsured pensions.
Levitin argues for expanding PBGC coverage to municipal employees. Thats a great idea going forward, but since the municipalities haven’t participated heretofore, it’s not a remedy for existing obligations.
It’s going to be an interesting next few months. While conventional thinking is that the pension-holders will lose their court fight, if they were get a favorable ruling (that their pensions indeed can’t be raided), I have to say I’m going to very much enjoy the spectacle of Wall Street going on tilt. But regardless of how these struggles resolve, it’s simply astonishing to see the bland acceptance in the media of major cities hitting the wall financially. This is yet another reflection of how the US has descended into third-world status, and yet somehow our domestic religion of American exceptionalism hasn’t shown much in the way of losses of adherents.
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