As many municipal bond market participants warned, Detroit’s Emergency Manager Kevyn Orr’s proposed bankruptcy plan has had a negative impact on the ability of other Michigan issuers to access the market. The effects are being felt in cities, counties and other local governments throughout the state. It has triggered an angry response from investors, rating downgrades for neighboring municipalities and a wholesale rejection of Michigan bonds.
The lightning rod is the provision in Orr’s plan that calls for treating the city’s General Obligation bondholders as unsecured creditors, leaving them on a par with retired municipal workers and at the back of the line for whatever funds remain after secured creditors are satisfied.
Critics contend that this unilaterally abrogates the principle of “full faith and credit” that has been the long-standing foundation of the municipal market since its inception more than 100 years ago.
The fact that Michigan Gov. Rick Snyder sanctioned the bankruptcy plan has been viewed as a reflection of the state’s attitude toward bondholders, should similar circumstances arise in other Michigan municipalities.
Besides individual bondholders exchanging their bonds for those of other states, tax-exempt income investors who have exposure to Michigan bonds through closed-end funds have been liquidating these shares en masse. This torrent of redemptions has caused the majority of these funds to trade at 10% to 15% discounts to their underlying assets.
This investor attitude has been most dramatically exemplified in the new issue market. Last week, Saginaw County opted to postpone the issuance of $61 million in pension obligation bonds because the underwriter said the rate the county would have had to pay was too high to make the borrowing viable.
This was the third in a series of underwritings to be postponed in the last two weeks. The others were from Genesee County and the city of Battle Creek.
The governor’s spokesperson, Sara Worfel, said in an e-mail to the Bond Buyer, “we believe rating agencies should look at each entity individually and judge them on their own credit rating and history.”
Clearly, muni investors don’t agree.
Although the Orr plan has yet to be enacted, investor reaction to Michigan bonds will serve as a warning to local officials throughout the nation regarding the preferential treatment General Obligation bonds should receive relative to other forms of debt.
Borrowing is the lifeblood of state and local governments and “full faith and credit” must mean just that.