Internet Explorer 11 is not supported

For optimal browsing, we recommend Chrome, Firefox or Safari browsers.

Detroit's Bankruptcy Exit Plan Threatens Its Financial Credibility

Detroit's plan of adjustment out of bankruptcy pays creditors pennies on the dollar, a move that could hurt its ability to borrow in the future.

Bankruptcy exit strategies are designed to put a downtrodden entity on better financial footing. But some say Detroit’s proposed plan of adjustment could place it in an even more precarious financial position by severely eroding its already-damaged credibility with investors, thus increasing its borrowing costs.

Detroit’s plan, introduced last month, includes proposals to invest $1.5 billion in improving city services, technology and economic development; cut pension payments by 10-30 percent and nix cost-of-living pension increases; and repay its creditors 20 cents on the dollar. While unions have been fighting any proposed pension cut, financial analysts say the treatment of the city’s creditors is even more alarming.

"This disregard for the rights of bondholders will factor into higher borrowing costs for local issuers, and ultimately for local property taxpayers, in Michigan," a recent analysis by Fitch Ratings Agency said.

 Detroit's proposal sends a signal to investors that its guarantee of payment has limits. The Motor City is proposing skipping out on 80 percent of its payment for two types of General Obligation (GO) bonds. (One type can be paid entirely from a specific tax, the other type has limits on what funds can be used to service the debt.) Legally speaking, GO bonds are backed by the full faith and credit of the government issuing the bonds, this is the highest standard for bonds. It would be one thing if all creditors were getting 20 cents on the dollar. But Detroit is proposing to pay some creditors better than others.

“You are favoring one creditor over another,” said Howard Cure, director of municipal bond research at Evercore Wealth Management. “There’s a big concern about it. ... Unless the state steps in to guarantee some of Detroit's debt, it’s hard to imagine that the city's going to have access to credit markets in any economical way."

The bond insurers who have insured Detroit’s GO debt argue that the debt should be classified as secured bonds because voters approved the property tax levy, which pays the debt service. (Detroit's bonds are at junk status and without insurance the city would pay a much higher interest rate on its debt because of the risk associated with lower-rated municipalities.) But the city argues that voter approval does not mean bondholders automatically receive favor. The judge is expected to issue an opinion this month on the argument.

Ratings agencies have also slammed the proposal while noting that the version proposed by Detroit is not likely to remain intact as the city’s bankruptcy trial proceeds.

Moody’s Investors Service notes that the “city’s workers and retirees are treated far better than [other] creditors,” while Fitch calls the plan downright “hostile to bondholders.” Making matters worse is the fact that Detroit is also proposing not paying back at all creditors holding Certificates of Participation. The city issued COPs to shore up its pension fund in the mid-2000s. Now it's saying it does not have to pay the debt on the basis that the COPs were illegally issued; creditors are challenging that assertion in court.

Unions have also promised to challenge Detroit’s plan, calling the cut to pensions and the more severe, 70 to 80 percent, cut to retiree healthcare an “abomination." Pensioners are being asked to give up a significant portion of their annual income in Detroit’s plan.

Detroit’s approach toward its plan is unlike any other city’s approach but that’s partly because municipal bankruptcy has been so rare. Each case has been unique. Still, one other city bankruptcy has also had to deal with GO debt and retiree obligations but took the opposite approach. In 2011, Central Falls, R.I., sought and won approval for a plan that cut its pension payments in half while keeping its creditors whole. Unions decried the plan but it was heralded in capital markets as a move that saved the city’s credibility and borrowing ability.

In Detroit, the city does have the option of “cramming down” its plan, meaning it can ask the court to approve its plan over the objections of creditors. Otherwise, a plan of adjustment must be endorsed by at least the largest creditor group.

But if Detroit wants to be able to borrow money after bankruptcy, Cure says sticking with its initial plan is a bad idea.

“It’s hard to imagine that, if there’s a cram down with pennies on dollar being paid,” he said, “I don’t think investors would forget that any time soon.”

Liz Farmer is a former GOVERNING fiscal policy writer.
Special Projects
Sponsored Stories
Sponsored
Workplace safety is in the spotlight as government leaders adapt to a prolonged pandemic.
Sponsored
While government employees, students and the general public had to wait in line for hours in the beginning of the pandemic, at-home test kits make it easy to diagnose for the novel coronavirus in less than 30 minutes.
Sponsored
Governments around the nation are working to design the best vaccine policies that keep both their employees and their residents safe. Although the latest data shows a variety of polarizing perspectives, there are clear emerging best practices that leading governments are following to put trust first: creating policies that are flexible and provide a range of options, and being in tune with the needs and sentiments of their employees so that they are able to be dynamic and accommodate the rapidly changing situation.
Sponsored
Service delivery and the individual experience within health and human services (HHS) is often very siloed and fragmented.
Sponsored
In this episode, Marianne Steger explains why health care for Pre-Medicare retirees and active employees just got easier.
Sponsored
Government organizations around the world are experiencing the consequences of plagiarism firsthand. A simple mistake can lead to loss of reputation, loss of trust and even lawsuits. It’s important to avoid plagiarism at all costs, and government organizations are held to a particularly high standard. Fortunately, technological solutions such as iThenticate allow government organizations to avoid instances of text plagiarism in an efficient manner.
Sponsored
Creating meaningful citizen experiences in a post-COVID world requires embracing digital initiatives like secure and ethical data sharing, artificial intelligence and more.
Sponsored
GHD identified four themes critical for municipalities to address to reach net-zero by 2050. Will you be ready?
Sponsored
As more state and local jurisdictions have placed a priority on creating sustainable and resilient communities, many have set strong targets to reduce the energy use and greenhouse gases (GHGs) associated with commercial and residential buildings.