MuniLand: Detroit’s Proposed Bankruptcy Settlement is Unfriendly to Bondholders

A week ago, the City of Detroit submitted its restructuring plan to the Federal Bankruptcy Court.  In the plan, pension obligations are treated as senior to both voter-approved unlimited tax general obligation and limited tax general obligation debt, while certificate of participation debt was treated as the least secure.  The outcome and recovery rates of the plan are not final.  Nonetheless, the preliminary treatment of voter-approved general obligation debt is unsettling because it says debt measures voted on at the ballot would be less secure than non-voted liabilities for pension obligations.  This is an important distinction because the voting public directly approved the additional bonded debt burden whereas, in the case of nonvoter-approved debt, the public assumes officials were effectively managing all other long-term liabilities.  If the restructuring plan stands, then the treatment of bonded debt as subordinate to pension obligations would signal a sea change in the municipal marketplace.  For our clients, this means credit analysis focused on balance sheet strength and leverage becomes even more important.  Supporting this focus is Moody’s recent revision to its local jurisdiction general obligation rating methodology, whereby reduced importance is placed on economic and tax base factors and increased weight is placed on contributed bonded debt and pension liabilities.  The municipal market is beginning to wake up and take notice of balance sheet strength and excessive leverage. In this new light, our clients will continue to benefit from our rigorous credit analysis and risk-aware investment process, as we have always taken into account the off balance sheet liabilities for pensions and post-employment healthcare benefits when assessing credit quality.