Bloomberg News

Detroit Yielding 16% Drives Nuveen Bet on Repayment: Muni Credit

June 12, 2013

Nuveen Asset Management, the second-biggest owner of Detroit’s debt, is betting emergency financial manager Kevyn Orr will come up with a recovery plan that repays bondholders in full.

The money manager oversees $95 billion of municipal bonds, including at least $190 million of all types of Detroit debt, data compiled by Bloomberg show. That’s second to Franklin Resources Inc. (BEN:US) Orr, 55, a lawyer who has said bankruptcy is an option for the city of 701,000, will call for “staggering” concessions from creditors in a meeting tomorrow, said his spokesman, Bill Nowling.

John Miller, co-head of fixed income at Nuveen in Chicago, said he’s comfortable holding uninsured Detroit general obligations, some of which have seen yields rise to a record 16 percent. In Jefferson County, Alabama, which reached a deal last week to exit bankruptcy, investors will get back about $1.8 billion of $3.1 billion.

The uninsured bonds “are speculation about the ability of the emergency manager to succeed with what he’s charged with doing,” Miller said by telephone. He cited the state’s emergency-manager law, which calls for full repayment of the scheduled debt service on all muni debt. No Michigan locality has had to seek Chapter 9 bankruptcy protection.

Creditor Meeting

Should Detroit wind up in bankruptcy, federal law may trump the Michigan statutes designed to protect bondholders. Detroit, where officials are struggling to provide public safety and street lights, would join California cities Stockton and San Bernardino in trying to stick bondholders with a loss. Moody’s Investors Service said last month that a May report from Orr on the city’s finances makes a Chapter 9 filing “a real option.”

Orr plans a hearing tomorrow with more than 100 creditors, union leaders and bond insurers on his preliminary proposal, which paints a picture of a government that since 2008 has spent an average of $100 million more each year than its revenue and has borrowed to stay afloat. Orr would cut debt costs by lengthening payback terms, lowering interest rates or obtaining forgiveness on some obligations, according to his report.

Orr, who worked on the 2009 bankruptcy of the former Chrysler LLC, said last week he’s preparing for possible Chapter 9 bankruptcy if he can’t strike deals to restructure $15.7 billion in long-term obligations. Negotiations could extend into August or beyond, he said.

Franklin’s Holdings

Stacey Johnston Coleman, a spokeswoman for San Mateo, California-based Franklin, declined to comment. The company has the most Detroit debt, at $232 million, Bloomberg data show.

The holdings data include the city’s $7.5 billion of combined general-obligation bonds, water and sewer debt, pension borrowings and securities backed by state aid. It is based on regulatory filings and data provided by the companies for some funds, and may not capture all of their holdings.

For example, Nuveen said its total holdings tally $539 million as of yesterday, according to Kathleen Cardoza, a spokeswoman.

The burden of the liability would fall on insurers if debt payments are reduced. They back about 80 percent of the $2.5 billion of Detroit general-obligation and pension bonds, according to Lisa Washburn, a managing director at Concord, Massachusetts-based Municipal Market Advisors.

Historic Levels

Some bonds without insurer guarantees are trading at record-high yields.

Tax-exempt Detroit general obligations that are backed by the city’s limited taxing power and mature in April 2015 traded June 10 at an average yield of 16.3 percent, data compiled by Bloomberg show. That’s double levels from last month and the highest since the uninsured debt was sold in 2008. It’s also equivalent to about 83 cents on the dollar.

The securities have a CCC- rating from Standard & Poor’s, nine levels below investment grade. The New York-based company cut Detroit’s rank by four levels yesterday, saying Orr “may take steps to adjust payments to bondholders.”

Nuveen holds about $16 million of the bonds of the $21 million outstanding, Bloomberg data show. About $12 million is in its high-yield fund (NHMAX:US), which is run by Miller and has beaten 95 percent of its peers this year.

“There’s a lot more risk in the unenhanced G.O.s, no question about it,” Miller said, referring to uninsured bonds. Still, “depending on the dollar price, where they’re trading today and what the emergency manager comes up with in terms of workout, restructuring and recovery plans, they could generate positive returns.”

Full Payment

The emergency-manager law says the financial operating plan must provide for “payment in full of the scheduled debt service requirements on all bonds, notes, and municipal securities of the local government.”

Miller may be relying on a legal position that hasn’t been widely tested -- that state law trumps the U.S. bankruptcy code.

“It’s an open question at best,” said Dale Ginter, a bankruptcy attorney in Sacramento, California, at Downey Brand LLP who represented retired workers of Vallejo, California, when the city filed for bankruptcy in 2008.

Because there have been so few major Chapter 9 cases, there aren’t binding precedents to settle the question, though U.S. bankruptcy judges have tended to favor federal law, he said.

Chapter 9 of the U.S. Bankruptcy Code was written to avoid conflicts between state and federal power, and one way it does that is by acknowledging that states have authority to decide whether their localities can file bankruptcy, Ginter said.

Legal Principle

A state “can say no, but once you say yes, you take the entire bankruptcy law,” he said.

Upholding Michigan’s requirement that bondholders be repaid in full would put all the burden of cutting a city’s debt onto its employees, Ginter said. It would also contradict one of the most important principles of bankruptcy law, which says that creditors holding debt that has similar repayment priorities must be treated the same, he said.

Detroit bonds such as those for the water and sewer system will have a better chance of being fully repaid, while others will have interest or principal reduced, said Robert Amodeo at Western Asset Management Co., a unit of Legg Mason Inc. (LM:US), the third-largest holder of Detroit bonds.

“There is uncertainty, but you have to understand what you have and what’s securing and supporting your debt,” said Amodeo, head of munis in New York. “Investors hopefully will be made whole.”

Detroit Comfort

Michael Camarella at OppenheimerFunds Inc. in New York said he will get paid no matter what Orr does, because the company has only general obligations that are backed by the city’s unlimited-tax pledge and also by insurers. He expects those companies “to make payments so bondholders don’t miss a beat.”

Chris Alwine, Vanguard’s head of muni funds in Valley Forge, Pennsylvania, said he’s “comfortable” holding Detroit general obligations insured by units of Assured Guaranty Ltd.

OppenheimerFunds ranks fourth in Detroit muni holdings, followed by BlackRock Advisors LLC and Vanguard, Bloomberg data show.

“Should the city of Detroit fail to make a required debt-service payment for any reason, including a bankruptcy filing, National’s insured bondholders are guaranteed their scheduled interest and principal payments on time and in full,” said Adam Bergonzi, National Public Finance Guarantee Corp.’s chief risk officer, in a March 5 statement.

‘Irrevocable Guaranty’

Assured Guaranty “is committed to honoring its unconditional and irrevocable guaranty to holders of its insured obligations,” according to a statement from Ashweeta Durani, a company spokeswoman.

Michael Fitzgerald, a spokesman for Ambac Assurance Corp., declined to comment. Michael Corbally, a spokesman for Syncora Guarantee Inc., didn’t return an e-mail.

The Massachusetts Educational Financing Authority is among issuers set to sell a combined $3.3 billion next week, down from $7.2 billion this week.

At 2.36 percent, yields on benchmark 10-year munis are the highest since March 2012. The interest rate compares with 2.23 percent (USGG10YR) for similar-maturity Treasuries.

The ratio of the two yields, a gauge of relative value, is about 106 percent, compared with an average of 92 percent since 2001. The greater the figure, the cheaper munis are compared with federal securities.

To contact the reporters on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net; Darrell Preston in Dallas at dpreston@bloomberg.net; Steven Church in Wilmington, Delaware at schurch3@bloomberg.net

To contact the editors responsible for this story: Stephen Merelman at smerelman@bloomberg.net; John Pickering at jpickering@bloomberg.net


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Companies Mentioned

  • BEN
    (Franklin Resources Inc)
    • $57.09 USD
    • 0.29
    • 0.51%
  • NHMAX
    (Nuveen High Yield Municipal Bond Fund)
    • $16.7 USD
    • 0.02
    • 0.12%
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