Commentaries

APA’s thoughts on Detroit’s Chapter 9

By: admin / July 19th, 2013

Detroit filed its Chapter 9 petition yesterday, making it the largest municipal bankruptcy filing ever.

• This was not unexpected nor part of a larger trend. Detroit has been in decline for decades now, losing 63% of its population since its peak in 1950. The filing will be followed by a 30-90 day process where a judge will determine if Detroit is actually allowed to move forward with Chapter 9 proceedings.
• There is approximately $18-20 billion debt to be restructured and approximately 100,000 creditors to be negotiated with. That makes it the largest municipal bankruptcy ever (Jefferson County, AL was $4.2B) and perhaps the most complicated.
• As muni investors, we are most concerned with the Emergency Manager Kevyn Orr’s proposal to treat the city’s General Obligation debt as “unsecured” debt. While Detroit is a very unique situation, it could set a dangerous precedent in the municipal market. There is approximately $11 billion outstanding in unsecured debt – $6 billion in OPEB (health care and other post-employment benefits), $3 billion in retiree pensions, and $530 million in general obligation bonds.
• Once allowed to enter into Chapter 9 protection it could take years for them to emerge (Vallejo, CA took 3 years). Although, Orr has indicated he would like to manage through the process in under a year.

APA has never purchased Detroit General Obligation debt. However, in general, at APA we have been slowly increasing our allocation to revenue backed bonds instead of general obligation bonds over the past few years. While we fundamentally disagree with Detroit’s assertion that General Obligation debt should be treated as unsecured debt, we do like the additional credit security that bonds backed by dedicated revenue streams and underlying assets offer.

In the near term, we may see market volatility as mutual funds experience outflows driven by Detroit headlines this week. We continue to advise clients to recognize temporary market dislocations and avoid premature selling leading to unnecessary losses. At APA, we are committed to fundamental credit analysis of all bonds held in client portfolios. We view this as one of our highest priorities as your municipal bond portfolio manager.

Amanda Richter
Senior Municipal Analyst
Asset Preservation Advisors
3344 Peachtree Road
Suite 2050
Atlanta, GA 30326
arichter@apabonds.com
main: (404) 261-1333
direct: (678) 504-4863

Disclosures:

Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. Asset Preservation Advisors, Inc. reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. This is not a recommendation to buy or sell a particular security. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

APA is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill of training. More information about the advisor including its investment strategies and objectives can be obtained by visiting www.assetpreservationadvisors.com. A copy of APA’s disclosure statement (Part 2 of Form ADV) is available without charge upon request. Our Form ADV contains information regarding our Firm’s business practices and the backgrounds of our key personnel. Please contact APA at 404-261-1333 if you would like to receive this information. APA-13-205