Home>Video>Will Detroit's Muni Breakdown Force Others Off the Road?

Will Detroit's Muni Breakdown Force Others Off the Road?

Tue, 2 Jul 2013

The outcome of the Detroit's distressed-debt situation could be a litmus test for how other municipalities nationwide move forward with their payment obligations.

+

Video Transcript

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Detroit's on the brink of bankruptcy, but what does that mean for the broader municipal market? I'm here with Beth Foos, a municipal credit analyst here at Morningstar, to take a look at some of these questions.

Beth, thanks for joining me today.

Beth Foos: Thanks for having me.

Glaser: So, let's take a quick look back at Detroit's fiscal picture and how they kind of got up to this brink. What's happened recently there?

Foos: Well, it's well-known after decades of budget deficits and an eroding tax base and economy and basic mismanagement, the State of Michigan appointed an emergency manager, Kevyn Orr, back in March of this year to basically take over the majority of the operating and financial functions of the city. So, Orr came in and did his own financial and operational review of the city and called the city insolvent and said it couldn't possibly pay its nearly $19 billion worth of liabilities.

So, a couple weeks ago he called all the city's major creditors back to the negotiating table and unveiled a sweeping and pretty controversial plan to restructure all of that debt. And on the same day, on June 14 of this year, the city missed a nearly $40 million payment on some pension-obligation certificates.

Glaser: So, what are some of the broad strokes of that restructuring? Anything surprising there?

Foos: There was, and I think the key point to note is how Orr treated, what he called, secured debt and unsecured debt. And the unsecured portion is really something to watch. That's $11.4 billion worth of general-obligation unlimited tax debt, limited tax bonds, pension-obligation certificates, unfunded pension liabilities, and retiree health care, and what he's proposing is to exchange all of that for $2 billion worth of notes.

So, with that treatment, he's treating what is generally considered some of the most secured debt in the state, if not the muni market, that general-obligation unlimited tax pledge, which is voter-approved, and a dedicated property tax levy, on par with what's considered much lesser secured debt, those unfunded pension liabilities, those retiree health-care liabilities.

Glaser: Now, is this restructuring going to go through? Is this just kind of a first offering, and then potentially those bonds would be treated more senior? Or do you think that this is really going to set a new precedent for how some of these bonds are handled?

Foos: Well, that's a good point. This is probably the opening act in what could be a very long negotiation between investors and pension boards and the city. So, we're not quite sure. The negotiations will continue for the next couple of weeks at which point the emergency manager has said that they will decide whether or not to file for Chapter 9.

Glaser: So if they do file and they do treat these bonds a little bit differently than maybe many investors have been expecting, what are the broader implications then for the muni market? Does it mean that it's time to kind of rethink your entire position there?

Foos: I don't think it's necessarily paramount that folks rethink their entire muni position, but I do think there are some fundamental questions that will be involved here that will probably get answered in time and probably through the courts.

One of those things is really in fiscal stress when the investors need to rely on that legal security the most for repayment, how strong is that general-obligation unlimited tax pledge? Has that question or that obligation of obligors of those muni issuers lost its paramount importance in that process? Where is the priority in terms of payment? Is it with retirees or is it with investors? And traditionally that's been with investors in times of fiscal stress.

And then you've also got the question that I think will be very applicable to some more stressed folks around the country is how much of that unfunded pension liability can be protected by the state constitution in times of fiscal stress or times of bankruptcy. I think those are going to be questions that are really applicable to the broader muni market moving forward.

Glaser: So even if you don't own any Detroit bonds, it sounds like if you have some other potentially stressed situations, this is going to be a case that you are going to need to keep a close eye on?

Foos: Absolutely. I think it highlights the need to really do your due diligence in terms of your credit analysis, understanding what those obligations are and understanding how stressed or how close to the brink your particular municipality is. And moving forward I think a lot of these questions will help answer how those obligations get treated.

Glaser: Beth, thanks for joining me today. We're looking forward to future updates.

Foos: Absolutely. Thanks for having me.

Glaser: For Morningstar, I'm Jeremy Glaser.

  1. Related Videos
  2. Related Articles
  3. Comments
  1. Muni Investors Should Keep an Eye on State Pensions

    With vast differences in funding levels across states, muni investors need to carefully consider the impact of pension obligations when assessing muni -credit worthiness, says Morningstar's Rachel Barkley.

  2. Looking for Distress

    Some of the best opportunities are when people are trying to run away from situations that are uncertain, says Third Avenue's Tom Lapointe.

  3. Muni CEFs Still Safe Source of Income

    Despite risks in the muni - bond market, defaults are isolated, and the diversification in muni CEF portfolios helps protect against credit problems.

  4. Avoiding Potholes in Municipal Bonds

    Although some opportunities are available today, muni investors should be sure they are getting compensated for the risks they are undertaking, says Fidelity's Mark Sommer.

  5. Keep an Eye on Muni Calls

    As the Fed intends to keep interest rates low for the next few years, muni -CEF investors should maintain a close watch on their funds' call exposure.

  6. Muni Defaults Not the Start of Broader Trend

    Although several U.S. municipalities have declared bankruptcy , muni bonds overall remain extraordinarily safe in terms of default risk, says Morningstar's Jeff Westergaard.

  7. Second Quarter in Bonds : A Damage Check

    Many managers are of the mind that rates have gone about as far as they're going to go for a while, so investors probably don't want to exit the bond market while their funds are down, reports Morningstar's Eric Jacobson. Plus, get an update on fund category performance in the second quarter as well as updates on fund leaders and laggards, including PIMCO Total Return.

  8. Muni Market Greatly Improved, but Do Your Homework

    The muni market has seen a strong recovery since 2009, though these tax-advantaged products are much safer in some regions than others, says Morningstar's Jeff Westergaard.

blog comments powered by Disqus
Upcoming Events
Conferences
Webinars

©2014 Morningstar Advisor. All right reserved.