Commissioners OK buyback of $1.5 billion in Detroit water bonds
Detroit’s water commissioners voted to accept offers to buy back about 28 percent of outstanding water and sewer bonds at a special meeting Friday afternoon.
The move — if approved by bankruptcy Judge Stephen Rhodes — will remove water bondholders from the bankruptcy process, taking the wind out of ongoing litigation over the water and sewer bonds.
At the same time, the bond refinancing will eliminate a huge class of creditors from the bankruptcy process, silencing their objections and adding to the likelihood that the city’s post-bankruptcy plan of adjustment will be approved by Rhodes.
The Board of Water Commissioners accepted the proposed buyback after slightly more than 28 percent of $5.2 billion in outstanding water and sewer bonds was offered by the 5 p.m. Thursday deadline. The city issued a surprise tender offer on Aug. 7, saying it had indications that a majority of bondholders would accept the offer to sell back their bonds in exchange for new 30-year bonds. The move would lower the water department’s debt costs and could free up as much as $50 million in bond reserve money.
By Thursday’s close, $1.5 billion of the $5.2 billion in outstanding water department debt was offered back to the city, which was about what was expected, according to Bill Wolfson, chief administrative officer, chief compliance officer and general counsel to the water department.
Noting that two-thirds of the bonds are held by non-institutional investors, Wolfson said the timing of the bond offer in August probably came when many investors were on vacation. “The response we got was certainly in the ballpark of what we were expecting,” Wolfson said.
In addition to the water department taking back $1.5 billion in tendered bonds for new debt, the city will drop its original plan to impair the rest of the untendered shares, which were facing an interest rate cut and the loss of a provision that prevents the city from paying them off early and lowering the overall yield to investors. Investors are usually compensated for such “call options,” but would’ve gotten nothing from the city in this case.
Instead, those bonds will continue to be paid at their original interest rates and on the original schedule, and leaves those bondholders with no standing to challenge the bankruptcy. Meanwhile, the bondholders who tendered their shares will, in many cases, receive more than the original face value of the old bonds, and get new ones running another 30 years at interest rates of up to 4.75 percent. Investors who tendered their bonds likewise gave up their ability to object to the treatment of their bonds.
“Whether or not you tendered your bonds, you benefited from this,” Wolfson noted.
Overall, the tender offer will save the water department more than $107 million in today’s dollars over the life of the bonds, Wolfson said. General principles of municipal finance would make the deal a good move — in or out of bankruptcy — if it brings a net present savings of 3 percent to 5 percent. In this case, the savings are more than 6 percent.
The mutually agreed-upon settlement of the bonds could also help boost the water department’s bond ratings for new debt issues. Right now, Detroit water bonds are classified at 8 levels below investment grade, putting them squarely in the junk category.
“Even if there were no bankruptcy case, saving of this magnitude for the customers make it something we would give serious consideration to,” Wolfson said.
The bond tender offer must get final approval from Judge Rhodes to become final, which is widely expected.
Once that happens, replacement bonds from the tender offer will be issued around Aug. 26, and close by Sept. 4. Besides refinancing existing bonds, the deal would also issue $190 million in new bonds to pay for capital improvements to the water system. At least some of the debt would be backed by bond insurance, which would allow the water department to tap reserve funds for the old bonds, which total as much as $50 million. That money would be used to reduce the water department’s overall debt and further lower its costs.