Mon Jan 27, 2014 2:23pm EST
Jan 27 (Reuters) - Michigan Governor Rick Snyder's proposal to allocate $350 million in state funds towards Detroit's pensions is another troubling sign for bondholders that could ultimately hurt the state and its local governments in the municipal debt market, Fitch Ratings said on Monday.
The credit rating agency said the move "demonstrates continued weak support for bondholder security and repayment stemming from Detroit's bankruptcy."
"In Fitch's opinion, action that suggests pensions' claim on limited resources should be given priority to that of bondholders could establish a troubling precedent, at least in Michigan and perhaps beyond, given the paucity of significant municipal bankruptcy filings historically and the resulting focus on the Detroit case," Fitch said in a statement.
Michigan's largest city filed for Chapter 9 municipal bankruptcy in July with an eye toward treating pensions and certain general obligation bonds approved by Detroit voters as unsecured debt with creditors receiving only pennies on the dollar.
On Oct. 1, Detroit defaulted on a $9.37 million interest payment for those bonds.
The city's treatment of bonds backed by a full-faith and credit pledge roiled the $3.7 trillion U.S. municipal market. General obligation bonds traditionally are considered secured debt, making them one of the safest bets for investors.
Snyder last week pitched a plan that would need legislative approval to raise $350 million to aid Detroit's retirees after a group of foundations pledged more than $330 million to protect the city's pensions and art museum. Michigan's money would come from the state's share of a multi-state settlement with U.S. tobacco companies.
Comments by Snyder that state funds will not bail out bondholders or Wall Street "suggests an 'us versus them' orientation to debt repayment that undermines willingness to pay public debt in Michigan," Fitch said.
Fitch also noted that unlike Michigan's implicit support for Detroit's treatment of GO bonds as unsecured debt, Rhode Island in the Central Falls bankruptcy case decided "to protect GO bondholders by applying a statutory lien to all such local government debt in the state."
Detroit's October bond default led a trio of bond insurers that guaranteed payments on the bonds to sue the city in November, claiming the city violated Michigan law by paying operating expenses using property taxes that had been levied exclusively to pay off the bonds. Detroit has asked the U.S. Bankruptcy Court to dismiss the lawsuits.
The next payment date for the bonds is April 1 when nearly $47.6 million in principal and interest is due to bondholders, according to the lawsuits.
On Dec. 3, Judge Steven Rhodes ruled that Detroit is bankrupt and that its pensions could be subject to cuts as part of the city's restructuring. Kevyn Orr, Detroit's state-appointed emergency manager, has pegged the unfunded pension liability at $3.5 billion.
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