Municipal bond investors get a surprise from Detroit

In a rather unexpected development, the emergency manager for Detroit announced an updated agreement for the city’s bankruptcy. Unlimited tax general obligation (GO) bondholders have agreed to a recovery of 74% of par. This amount is well above the previous recovery amounts of 10% to 20% of par that had been proposed at various stages prior to and during the bankruptcy. According to Kevyn Orr, the emergency manager, the unlimited tax GO recovery improvement is driven by the claim those bondholders have on $388 million in property tax millage receipts. The 26% not provided to bondholders would be conceded to increase recoveries for the city’s employee and police and fire pension plans.

The existing securities would be replaced by bonds supported not only by the existing tax receipts pledge but also a pledge of distributable state aid, thereby enhancing the future bonds despite the upfront concessions. Insured bonds would retain protection providing bondholders a full par recovery. Unlimited tax GOs rallied following today’s announcement.

This agreement modestly improves our view of GOs issued within the state of Michigan. While these GO bonds may not emerge completely unscathed from the bankruptcy given the scope of the city’s woes, it does align with our belief that a capital structure should differentiate various claims payable from the general fund. Furthermore, the new agreement certainly highlights an understanding that the taxes pledged to bondholders may in fact be a stronger security pledge than the emergency manager had previously portrayed them. Still, we recognize that these bankruptcy proposals in Detroit are extremely fluid and that each credit situation in the municipal market will be evaluated in light of its own unique circumstances.

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