Finance

Detroit's Recovery Plan Increases Default Risks, Says Moody's

Moody's, the credit ratings agency, has warned that Detroit’s preliminary financial operating plan opens the door to place bondholders on the hook for the city’s debts, a move that would further damage the city’s already low credit rating.
May 16, 2013

A major credit ratings agency warned Thursday that Detroit’s preliminary financial operating plan opens the door to place bondholders on the hook for the city’s debts, a move that would further damage the city’s already low credit rating.

The plan, released earlier this month contains “a clear indication that a default or bankruptcy is a real option” because it specifically notes that the city requires significant and fundamental debt relief to help shore up its finances, Genevieve Nolan, a Chicago-based analyst for Moody’s Investor Service wrote in her report.

“The recovery plan indicates that it will use a ‘fair and equitable’ standard to determine how to restructure payments for all stakeholders,” Nolan concludes. “While not specifically defined in the recovery plan, this language has been used in relation to other bankruptcy proceedings to manage creditors’ expectations on recovering their assets in bankruptcy, setting the stage for reductions to all stakeholders, including bondholders.”

Nolan cites that reason for counting the financial plan as a credit negative for Detroit, meaning if it does end up hurting bondholders, it could hurt the city’s credit even more. Moody’s rates Detroit’s general obligation bonds Caa1 negative -- below investment grade and a high credit risk.

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In his report released May 12, Emergency Manager Kevyn Orr said the city will finish its current budget year with a $162 million cash-flow shortfall. Retiree costs are eating up about one-third of the city’s budget and Orr also painted a dark picture of the health of the city’s pension fund.

On the day he released the report, Orr said during a press conference that he would know more in the coming six weeks whether Detroit would be faced with filing bankruptcy. "We'll get a gauge on whether we have a true partner for an out-of court solution in that sort of time frame," he said.

The plan is a starting point for Orr to begin addressing the city's $15.6 billion in debt and long-term liabilities, including unfunded liabilities in health care and pensions and crippling debt service payments. According to Orr’s report, debt service payments total $246 million for fiscal year 2013, or 19.3 percent of the entire general fund budget. Detroit’s labor issues are also muddled and complicated to navigate, thanks to 48 separate bargaining units.

The recovery plan lists four options for restructuring debt: pay back debt over a longer period of time, reduce the principal amount of debt outstanding, lower interest rates or issue new debt to pay back to creditors.

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