The bankruptcy plan of adjustment filed Friday morning gives unsecured creditors holding Detroit’s general obligation bonds an unprecedented cut of 80 percent, offering just $33 million for bonds with a value of nearly $163 million.
The loss of about $131 million on the bonds is much greater than the hit city pensioners will take, and could set up a situation where cities, towns and authorities throughout Michigan — and in other states — end up paying higher rates to borrow less money.
“It’s historic,” said Lisa Washburn of Municipal Market Advisors, a Concord, Mass. municipal bond consultant. “If this is approved, issuers in Michigan and in other states that don’t have protection for general-obligation bonds could see their borrowing costs rise.”
Municipal bankruptcies are rare, and none has ever been as large as the Chapter 9 filing in Detroit, which seeks to free the struggling city from $18 billion in accumulated debt. In other municipal bankruptcies, general obligation bonds weren’t a factor and were paid off at 100 percent of their value or, most commonly, were refinanced under new terms. Bankruptcy experts note that, since the Great Depression, the average recovery on such bonds has been 75 percent.
Besides the low rate of recovery for bondholders, investors are galled that while both bondholders and pensioners fall into the same class of unsecured creditors, pensioners are being offered a minimum of 66 percent of their pensions, in the case of general city employees, and 90 percent for police and firefighters.
Companies insuring the bonds, and will have to pay off to cover the reduced payments from the city, objected to the proposed payment levels, as well, and threatened to sue. Emergency Financial Manager Kevyn Orr, who submitted the plan of adjustment, said Friday that the entire plan is based on getting all parties to agree to a settlement.
In a statement, Steve Spencer, an adviser to bond insurers Financial Guaranty Insurance Co., said, “While we understand that favoring pensioners and discriminating against bondholders and other creditors might be politically popular, we believe this is contrary to bankruptcy law and will result in costly litigation that will hamper the city’s emergence from bankruptcy.”