Last Friday, Detroit’s public workers, retirees and bondholders finished voting on a plan which would impose $7.4 billion in cuts on investors and pensioners. The plan, if approved, would result in current and former city employees, as well as investors, to take less than the $10.4 billion they are owed if U.S. Bankruptcy Judge Steven Rhodes approves the city’s plan after a trial set to begin next month. Investors owed more than $1.4 billion on pension obligation bonds and the insurers that backed the debt are fighting the plan, arguing that it is unfair.
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Last week, according to an internal report from the City of Detroit indicates that the bankrupt city plans on paying investors who own its $164 million of limited-tax general- obligation bonds 34 cents on the dollar. The 34-cent recovery differentiates limited-tax bonds from their unlimited-tax counterparts, which are considered to have a stronger revenue pledge. Detroit in April agreed to pay unlimited-tax general obligation bondholders about 74cents on the dollar versus the $388 million which they are owed.
We have read external reports which spoke as if this was a done deal. Calls to knowledgeable municipal bond professionals around the Street indicate that the plan to exchange “impaired” bonds for new bonds is not yet official and may not come to fruition. Approximately 70% of Detroit Water and Sewer’s customers reside outside of Detroit. Thus far, Detroit’s suburbs have been resistant to plans which would impair bondholders. We will keep readers posted as to new developments.
Last month, Detroit expressed the desire to selectively (arbitrarily) “impair” holders of some Detroit Water and Sewer bonds. Detroit’s plan, for some bonds, but not others, would be to give investors a choice between holding a bond which would have the same coupon and maturity as the bonds they hold, but would have no call protection (currently callable) and a bond with the same maturity, but lower coupon, as the bond they currently hold and several years of call protection. Although the choice between bonds would be voluntary, the exchange would not.
The recent round of troubling news has resulted in retail capital outflows from the municipal bond market. As much municipal-focused retail capital is invested in vehicles other than actual municipal bonds, portfolio managers have been forced to sell municipal bonds other than those issued by Puerto Rico when the sell requests come in. This might be setting the stage for another summer of wider spreads and higher yields in the municipal bond market. We have already seen signs of spread widening. If babies are once again thrown out with the bathwater, we will once again be there to catch at least some of them.
We have been of the opinion that investing in fixed income other than by purchasing actual bonds is a poor way to gain access to fixed income assets. We will go so far as to say; if one does not have the resources to invest in actual bonds then one probably needs growth more than income and might wish to avoid fixed income altogether. If one needs income and the certainty only a final maturity can provide, then one should consider building a portfolio of bonds. Although we hope our readers heed our advice, we understand that there are bound to be investors who choose not to buy actual bonds. They will probably continue to provide value to bond buyers in an otherwise sleepy bond market.
By Thomas Byrne – Director of Fixed Income – Investment Consultant
Thomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.
- November 2012 – Present, Wealth Strategies & Management LLC, Stroudsburg PA
- December 2011 – November 2012 – Bond Squad, Kunkletown, PA
- April 1988 – December 2011, Citigroup and predecessor firms, New York, NY
- June 1986 – March 1988 – E.F. Hutton, New York, NY