On Friday, the City of Detroit’s Emergency Manager laid out a plan to restructure liabilities and place the City on strong footing to deliver better public safety, more street lighting and blight removal. The City’s Emergency Manager clearly documented the dilemma in early May, which we reported on in our note “Orderly vs. Disorderly Dissemination of Municipal Finance Data.” News of the City’s insolvency should not come as a surprise as taxing capacity was constrained, economic and demographic fundamentals have trended down and off-balance sheet liabilities have grown exponentially over the past few years. Friday’s proposed restructuring includes defaulting on all unsecured debt, asking secured debt holders to accept a haircut on principal and a spin-off of the regional water and sewer authority into an independent enterprise.
What is interesting to SNW is not so much Detroit’s need to restructure its liabilities but how surprised the credit rating agencies and analysts were to the news. One credit rating agency was reported by Bloomberg News as issuing a “Super Downgrade” just two days before the restructuring proposal. Other municipal credit analysts were more concerned about the impact on the City’s unlimited tax general obligation pledge, which is an obligation to tax at whatever rate or amount is necessary to meet bond payments. While the unlimited tax general obligation pledge is an important security feature in municipal debt covenants, it should not be the sole decision factor for owning a credit. It is as if the rating agencies and analysts failed to consider the other components of credit analysis. As a fiduciary for our clients we analyze each credit we purchase to meet our standard for quality and relative value in all facets. The risks associated with owning City of Detroit obligations were very clear and avoidable in our minds.