Detroit Defaults on Some Debt to Avoid Bankruptcy Filing

Image: Detroit Defaults on Some Debt to Avoid Bankruptcy Filing Detroit emergency manager Kevyn Orr speaks with reporters after a meeting with creditors in Romulus, Mich. on June 14.

Friday, 14 Jun 2013 05:49 PM

 

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Detroit defaulted on some debt on Friday and proposed most creditors receive just pennies on the dollar owed by the "insolvent" city in order to avoid the largest municipal bankruptcy filing in U.S. history.

In a forceful opening salvo of negotiations with holders of as much as $18.5 billion of debt, Detroit Emergency Manager Kevyn Orr announced a moratorium on some principal and interest payments, including one due on Friday.

Under his proposal, Orr said unsecured debt holders would be paid less than 10 cents on the dollar, but some creditors would get a bit more based on city revenue. Some $11.5 billion of the debt is unsecured and $7 billion secured, according to figures presented by Orr.

Orr said secured creditors would get better treatment, although how much better was not specified.

"We may try to get a discount from them, but the reality is they are secured," Orr said. Secured credit means an asset is pledged to back the debt, for example Detroit has secured its interest rate swap agreements with casino revenue.

He said the city would skip a $34 million payment due on Friday on $1.43 billion of pension certificates of participation, to allow the city to conserve cash needed to provide services to residents.

Fitch Ratings said this amounted to a default which would result in a downgrade of the credit rating on that debt.

"If the payment doesn't get made, we would downgrade the rating ... for default," said Arlene Bohner, a Fitch analyst.

"Financial mismanagement, a shrinking population, a dwindling tax base and other factors over the past 45 years have brought Detroit to the brink of financial and operational ruin," Orr said in a statement.

Orr said the city was "insolvent," unable to pay its debts, and needed shared sacrifices from everyone including debt holders, to have any hope of a revival.

Insolvency and inability to pay debts are two tests a government must meet for a judge to accept a Chapter 9 municipal bankruptcy.

"It looks and feels like a pre-packaged bankruptcy plan," said Richard Ciccarone, managing director at McDonnell Investment Management, in reaction to the proposal.

Orr, a bankruptcy attorney brought in by the state of Michigan to clean up the city's finances, repeated after the meeting that he sees a 50/50 chance of a bankruptcy filing.

It would be a first for a major U.S. city as New York, Philadelphia and Cleveland all avoided formal bankruptcy filings during their financial difficulties.

New York also declared a moratorium on some debt payments in the 1970s, but creditors were ultimately paid in full under a restructuring agreement, said Jim Spiotto, municipal bankruptcy expert at law firm Chapman and Cutler in Chicago.

In addition to the financial details, the 134-page document presented on Friday describes collapsing city services, rising crime and falling tax receipts.

Detroit is the poorest large city in the United States with more than a third of its residents living below the official government poverty line, while its population has shrunk to about 700,000 people.

The city has the highest violent crime rate of any major U.S. city, some 78,000 abandoned and blighted structures, and 40 percent of street lights do not work, the document said. Only about a third of the city's ambulances were in service in the first quarter of 2013. Just 53 percent of owners paid their 2011 property taxes, it said.

Orr said unsecured creditors, including bondholders and pension funds, will receive a pro rata share of $2 billion of notes the city would issue and pay off as its financial circumstances improve.

An oversight board could be created for Detroit, similar to one created after New York City's financial difficulties, that would ensure reforms are sustained, Orr said.

City workers and retirees would also face changes to their pensions and health care coverage "consistent with available funding."

At the same time, Orr proposes investing $1.25 billion over the next 10 years to improve the city's infrastructure, remove or repair crumbling houses and update computer systems.

Initial reaction to the proposals from debt holders and labor unions was negative.

Emerging from the meeting, one bond holder who asked not to be identified, said of Orr's proposal to pay them only pennies on the dollar: "It's just too much. It is an unprecedented amount to ask."

In the past, bondholders have not lost the principal amount owed them as a result of financial restructurings of major cities.

Much of Detroit's debt is insured, giving bondholders protection against defaults. Two of the insurers, MBIA, Inc and Assured Guaranty, confirmed they attended the meeting.

Leaders of some of Detroit's 48 public sector unions were upset by Orr's proposals, which included spinning off the water and sewer services into an independent authority as well as making the changes to pensions and health care coverage.

"When you're backed into a corner, the only thing you can do is fight and the only way we can fight is to strike," said Mike Mulholland, secretary and treasurer of AFSCME Local 207, the union which represents water and sewer workers.

© 2014 Thomson/Reuters. All rights reserved.

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