Detroit bankruptcy could change muni market, Chicago Fed says

CHICAGO | Fri Oct 4, 2013 4:24pm EDT

CHICAGO Oct 4 (Reuters) - Detroit's historic bankruptcy filing could upend long-established market views on the high standing of general obligation bonds, the form of debt sold most frequently in the U.S. municipal bond market, Chicago Federal Reserve Bank researchers said Friday.

The city's move in July to seek protection from creditors so far has had only a modest effect on the overall muni market, apart from driving up borrowing costs for issuers in Michigan.

But how the bankruptcy court rules on the treatment of different debt classes could profoundly alter market perceptions of their risk, particularly for issuers with mushrooming pension obligations like Detroit's, two of the bank's economists wrote in a monthly research note, the "Chicago Fed Letter."

A key issue in the city's pending Chapter 9 bankruptcy is whether Detroit's state-appointed emergency manager, Kevyn Orr, may treat certain general obligation bonds as unsecured debt on a par with its pension obligations, and repay them at just pennies on the dollar.

General obligation, or GO, bonds have long been viewed as the muni market's gold standard, and none of the handful of municipal bankruptcies since 1970 has resulted in a writedown of GO debt. Since 2003, GO bonds accounted for nearly 60 percent of new debt deals in the $3.7 trillion muni bond market, where cities, states, hospitals, school districts and others raise cash for capital projects and other needs.

Orr's proposed cuts to retirement benefits, which are being challenged in the bankruptcy case by labor unions, retirees and pension funds, conflict with strong protections in the Michigan Constitution against impairing those benefits.

The judge in the Detroit case has not yet determined if Detroit is eligible to formally enter bankruptcy protection, as hearings in that phase begin later this month.

A successful challenge by unions and retirees, on the basis of the U.S. Constitution's Tenth Amendment regarding states' rights, could impact the pricing of bonds issued by cities with large unfunded pension liabilities, according to the Fed report.

"If the court agrees with pension creditors that state protections hold supreme, this could change market expectations with respect to the relative standing of municipal debt issued by cities located in states with such protections," the Fed report said, pointing to Chicago, Los Angeles, and New York City.

Overall, large U.S. cities in a recent Pew study have funded only 57.5 percent of the $511.2 billion of retirement benefits they promised.

Orr has lumped about $411 million of unlimited tax GO bonds into the unsecured debt pile even though Detroit voters approved a special property tax levy to pay off the debt.

That pile also includes limited tax GO debt, secured only by Detroit's general fund revenue, and pension debt - neither of which was approved by voters.

"This issue will be ultimately settled by the court, and it might have wide-reaching consequences for the pricing of voter-approved GO debt," the report said.

Detroit defaulted on its "unsecured" GO bonds this week by skipping debt service payments due on Tuesday.

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UPDATE 2-Ormet says shutting Ohio aluminum smelter immediately

Fri Oct 4, 2013 7:12pm EDT

NEW YORK Oct 4 (Reuters) - Ormet Corp will immediately close its 270,000-tonne-per-year aluminum smelter in Hannibal, Ohio, a casualty of historically low metal prices and "uncontrollable" power costs, the company said on Friday.

The move follows a ruling on Wednesday by the Public Utilities Commission of Ohio (PUCO), which approved some major changes to Ormet's power contract with energy supplier American Electric Power Co Inc.

The state power regulator listed a number of conditions, including requiring the company, which filed for bankruptcy protection in February, to employ at least 650 full-time workers through 2018.

Under those terms, costs would have increased by some $108 million next year, rather than falling by $54 million as outlined in Ormet's plan.

"Due to the decision, Ormet cannot emerge from bankruptcy and must immediately shut down operations," Ormet said in a statement.

Hannibal, which uses as much energy as the city of Pittsburgh, is one of the smaller plants in the global aluminum market, but it is the region's largest employer and Ohio's largest energy user.

This closure will affect about 600 people, Ormet said.

Securing a new power deal was the final hurdle in he company's efforts to emerge from Chapter 11 protection, although it will still be unprofitable unless aluminum prices also recover, management has said previously.

London Metal Exchange prices are languishing close to or below the cost of production for many makers.

Aluminum producers, including Rusal OAO and Alcoa Inc have cut output to reduce the excess, which could be as high as 10 million tonnes, analysts said.

Ormet's suspension might provide some support to prices in the United States, but it is unlikely to make a big dent in the 40-million-tonne-per-year market.

The smelter is currently producing about 90,000 tonnes per year. The plant has a total of six potlines with an annual capacity of about 270,000 tonnes per year.

Ormet would not reopen the plant unless it secured lower-priced power and aluminum prices recovered, the company said.

Aluminum prices on the London Metal Exchange are around $1,850 per tonne, below the cost of production for a large portion of the global smelting capacity.

The company also has an alumina refinery in Burnside, Louisiana, which feeds the smelter. The status of the refinery was not known.

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Detroit union wins victory worth 'refund on deck of Titanic'

By Joseph Lichterman

Fri Oct 4, 2013 10:37pm EDT

Oct 4 (Reuters) - Detroit's largest public sector union scored a symbolic victory Friday when a Michigan administrative law judge reinstated an extra annual pension check for city workers and retirees, although the judge in the city's bankruptcy case has prohibited enforcement of the ruling.

Bankruptcy Judge Steven Rhodes earlier this week allowed Administrative Law Judge Doyle O'Connor to rule on the so-called 13th check before O'Connor's retirement on Friday. But Rhodes forbade the parties from pursuing the matter further.

Rhodes has stayed all existing litigation against the city since taking charge of the bankruptcy case, the largest municipal bankruptcy in U.S. history. Yet on Tuesday Rhodes ruled O'Connor could proceed because a ruling would not injure Detroit.

O'Connor himself granted that the limitations imposed might offer "little more solace than an assurance of a full ticket-price refund offered while still on the sharply tilting deck of the Titanic."

Earlier this year O'Connor read a verbal opinion supporting the case brought by the American Federation of State, County and Municipal Employees, claiming Detroit shortchanged its members beginning in November 2011 when the City Council stopped paying a bonus pension check.

For decades prior, the city's General Retirement System would give bonuses to retirees and active employees when it earned more than 7.9 percent on its investments.

That payment and others cost the pension fund $1.92 billion from 1985 to 2008, a 2011 report to city council said.

AFSCME argued the city violated labor laws by unilaterally ending the extra checks. O'Connor said in February that "the change directly affected an existing and fundamental condition of employment."

Detroit's state-appointed Emergency Manager Kevyn Orr has said the policy contributed to the underfunding of the city's two pension funds, which he says have $3.5 billion in unfunded liabilities. The city's unions and pension funds dispute that figure.

O'Connor on Friday estimated the bonus money in question at roughly $174 million. He urged the city and union to seek a negotiated settlement of the matter.

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Detroit bankruptcy could change muni market, Chicago Fed says

CHICAGO | Fri Oct 4, 2013 4:24pm EDT

CHICAGO Oct 4 (Reuters) - Detroit's historic bankruptcy filing could upend long-established market views on the high standing of general obligation bonds, the form of debt sold most frequently in the U.S. municipal bond market, Chicago Federal Reserve Bank researchers said Friday.

The city's move in July to seek protection from creditors so far has had only a modest effect on the overall muni market, apart from driving up borrowing costs for issuers in Michigan.

But how the bankruptcy court rules on the treatment of different debt classes could profoundly alter market perceptions of their risk, particularly for issuers with mushrooming pension obligations like Detroit's, two of the bank's economists wrote in a monthly research note, the "Chicago Fed Letter."

A key issue in the city's pending Chapter 9 bankruptcy is whether Detroit's state-appointed emergency manager, Kevyn Orr, may treat certain general obligation bonds as unsecured debt on a par with its pension obligations, and repay them at just pennies on the dollar.

General obligation, or GO, bonds have long been viewed as the muni market's gold standard, and none of the handful of municipal bankruptcies since 1970 has resulted in a writedown of GO debt. Since 2003, GO bonds accounted for nearly 60 percent of new debt deals in the $3.7 trillion muni bond market, where cities, states, hospitals, school districts and others raise cash for capital projects and other needs.

Orr's proposed cuts to retirement benefits, which are being challenged in the bankruptcy case by labor unions, retirees and pension funds, conflict with strong protections in the Michigan Constitution against impairing those benefits.

The judge in the Detroit case has not yet determined if Detroit is eligible to formally enter bankruptcy protection, as hearings in that phase begin later this month.

A successful challenge by unions and retirees, on the basis of the U.S. Constitution's Tenth Amendment regarding states' rights, could impact the pricing of bonds issued by cities with large unfunded pension liabilities, according to the Fed report.

"If the court agrees with pension creditors that state protections hold supreme, this could change market expectations with respect to the relative standing of municipal debt issued by cities located in states with such protections," the Fed report said, pointing to Chicago, Los Angeles, and New York City.

Overall, large U.S. cities in a recent Pew study have funded only 57.5 percent of the $511.2 billion of retirement benefits they promised.

Orr has lumped about $411 million of unlimited tax GO bonds into the unsecured debt pile even though Detroit voters approved a special property tax levy to pay off the debt.

That pile also includes limited tax GO debt, secured only by Detroit's general fund revenue, and pension debt - neither of which was approved by voters.

"This issue will be ultimately settled by the court, and it might have wide-reaching consequences for the pricing of voter-approved GO debt," the report said.

Detroit defaulted on its "unsecured" GO bonds this week by skipping debt service payments due on Tuesday.

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UPDATE 2-Ormet says shutting Ohio aluminum smelter immediately

Fri Oct 4, 2013 7:12pm EDT

NEW YORK Oct 4 (Reuters) - Ormet Corp will immediately close its 270,000-tonne-per-year aluminum smelter in Hannibal, Ohio, a casualty of historically low metal prices and "uncontrollable" power costs, the company said on Friday.

The move follows a ruling on Wednesday by the Public Utilities Commission of Ohio (PUCO), which approved some major changes to Ormet's power contract with energy supplier American Electric Power Co Inc.

The state power regulator listed a number of conditions, including requiring the company, which filed for bankruptcy protection in February, to employ at least 650 full-time workers through 2018.

Under those terms, costs would have increased by some $108 million next year, rather than falling by $54 million as outlined in Ormet's plan.

"Due to the decision, Ormet cannot emerge from bankruptcy and must immediately shut down operations," Ormet said in a statement.

Hannibal, which uses as much energy as the city of Pittsburgh, is one of the smaller plants in the global aluminum market, but it is the region's largest employer and Ohio's largest energy user.

This closure will affect about 600 people, Ormet said.

Securing a new power deal was the final hurdle in he company's efforts to emerge from Chapter 11 protection, although it will still be unprofitable unless aluminum prices also recover, management has said previously.

London Metal Exchange prices are languishing close to or below the cost of production for many makers.

Aluminum producers, including Rusal OAO and Alcoa Inc have cut output to reduce the excess, which could be as high as 10 million tonnes, analysts said.

Ormet's suspension might provide some support to prices in the United States, but it is unlikely to make a big dent in the 40-million-tonne-per-year market.

The smelter is currently producing about 90,000 tonnes per year. The plant has a total of six potlines with an annual capacity of about 270,000 tonnes per year.

Ormet would not reopen the plant unless it secured lower-priced power and aluminum prices recovered, the company said.

Aluminum prices on the London Metal Exchange are around $1,850 per tonne, below the cost of production for a large portion of the global smelting capacity.

The company also has an alumina refinery in Burnside, Louisiana, which feeds the smelter. The status of the refinery was not known.

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Detroit union wins victory worth 'refund on deck of Titanic'

By Joseph Lichterman

Fri Oct 4, 2013 10:37pm EDT

Oct 4 (Reuters) - Detroit's largest public sector union scored a symbolic victory Friday when a Michigan administrative law judge reinstated an extra annual pension check for city workers and retirees, although the judge in the city's bankruptcy case has prohibited enforcement of the ruling.

Bankruptcy Judge Steven Rhodes earlier this week allowed Administrative Law Judge Doyle O'Connor to rule on the so-called 13th check before O'Connor's retirement on Friday. But Rhodes forbade the parties from pursuing the matter further.

Rhodes has stayed all existing litigation against the city since taking charge of the bankruptcy case, the largest municipal bankruptcy in U.S. history. Yet on Tuesday Rhodes ruled O'Connor could proceed because a ruling would not injure Detroit.

O'Connor himself granted that the limitations imposed might offer "little more solace than an assurance of a full ticket-price refund offered while still on the sharply tilting deck of the Titanic."

Earlier this year O'Connor read a verbal opinion supporting the case brought by the American Federation of State, County and Municipal Employees, claiming Detroit shortchanged its members beginning in November 2011 when the City Council stopped paying a bonus pension check.

For decades prior, the city's General Retirement System would give bonuses to retirees and active employees when it earned more than 7.9 percent on its investments.

That payment and others cost the pension fund $1.92 billion from 1985 to 2008, a 2011 report to city council said.

AFSCME argued the city violated labor laws by unilaterally ending the extra checks. O'Connor said in February that "the change directly affected an existing and fundamental condition of employment."

Detroit's state-appointed Emergency Manager Kevyn Orr has said the policy contributed to the underfunding of the city's two pension funds, which he says have $3.5 billion in unfunded liabilities. The city's unions and pension funds dispute that figure.

O'Connor on Friday estimated the bonus money in question at roughly $174 million. He urged the city and union to seek a negotiated settlement of the matter.

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UPDATE 1-Stockton, Calif. and Assured Guaranty reach bankruptcy exit deal

Thu Oct 3, 2013 9:19pm EDT

By Jim Christie

STOCKTON, Calif. Oct 3 (Reuters) - Stockton, California and Assured Guaranty have reached an agreement to restructure more than $150 million of outstanding debt to help the city exit from bankruptcy, a top city official and the bond insurer said on Thursday.

Under the terms of the agreement, Assured will take possession of a city building and receive the revenue it generates to service about $35 million in outstanding bonds that Stockton had sold to acquire it.

"The settlement includes a unique and innovative instrument that enables Assured to participate in the city's future revenue growth," the bond insurer said in a statement confirming the agreement.

It also allows Stockton, which filed for bankruptcy last year, to make payments on about $120 million in outstanding pension obligation bonds until 2052 from their original 2038 term.

At a Stockton city council meeting to take up the city's plan to adjust its debts to exit from bankruptcy, City Manager Bob Deis said the deal should put Stockton on track to exit Chapter 9 municipal bankruptcy in about six months.

"Now we have deals with every bond insurer that's involved in the bankruptcy process," Deis said.

Stockton's deal with Assured is subject to conditions, notably that city voters approve a measure to increase the city's sales tax in November to raise additional revenue and that the bankruptcy court hearing Stockton's case confirms its plan to adjust its debt.

Assured and fellow bond insurer National Public Finance Guarantee led efforts by Stockton's so-called capital markets creditors to block the city's bankruptcy case, saying city pensions managed by the California Public Employees' Retirement System should have been treated like other debt.

Last week Stockton released a draft plan for adjusting its debt that disclosed a deal with National over about $45 million in outstanding lease revenue bonds for the city's arena whose payments will be cut by 3 percent. Other bonds insured by National and related to parking garages will be cut by 12 percent, while a third bond for a city building will be paid in full.

With about 300,000 residents, Stockton set itself apart in bankruptcy proceedings from Detroit, which has filed the largest U.S. municipal bankruptcy, and smaller San Bernardino, California, which filed for bankruptcy last year, because it has insisted on leaving pension payments intact.

Stockton defended its pensions, and California's $268 billion pension fund for public employees was prepared to back that in bankruptcy court, by stressing that cuts to services, its payroll and benefits would help restructure its finances.

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Stockton, Calif. city council approves plan to exit bankruptcy

STOCKTON, Calif. | Thu Oct 3, 2013 10:52pm EDT

STOCKTON, Calif. Oct 3 (Reuters) - Stockton, California's city council approved a plan on Thursday for the city to adjust its debt to exit from bankruptcy after reaching a deal with bond insurer Assured Guaranty to restructure more than $150 million of outstanding debt.

The deal marks the end of a long and often bitter fight between Stockton and its biggest bond insurers since the city filed for bankruptcy last year and stunned the U.S. municipal debt market with threats of forcing losses on bondholders while leaving pension payments intact.

"Now we have deals with every bond insurer that's involved in the bankruptcy process," Stockton City Manager Bob Deis said, adding he is hopeful the city is on track to exit bankruptcy in about six months.

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UPDATE 1-Stockton, Calif. city council backs plan to exit bankruptcy

Thu Oct 3, 2013 11:21pm EDT

By Jim Christie

STOCKTON, Calif. Oct 3 (Reuters) - Stockton, California's city council approved a plan on Thursday for the city to adjust its debt to exit from bankruptcy after reaching a deal with bond insurer Assured Guaranty to restructure more than $150 million of outstanding debt.

The deal marks the end of a long and often bitter fight between Stockton and its biggest bond insurers since the city filed for bankruptcy last year and stunned the U.S. municipal debt market with threats of forcing losses on bondholders while leaving pension payments intact.

"Now we have deals with every bond insurer that's involved in the bankruptcy process," Stockton City Manager Bob Deis said, adding he is hopeful the city is on track to exit bankruptcy in about six months.

"We've got deals with almost everybody," Deis told Reuters, noting the city now has struck deals with all but three of its 19 major creditors.

Talks with the three will continue, Deis added.

Marc Levinson, Stockton's lawyer, also said the talks would continue. But he said the city is eager to file its plan for adjusting its debt to exit from bankruptcy and anticipates it will do so next Monday or Tuesday.

The deal with Assured follows Stockton's release last week of a draft plan for adjusting its debt that disclosed a deal with bond insurer National Public Finance Guarantee over about $45 million in outstanding lease revenue bonds for the city's arena.

Payments for the arena bonds will be cut by 3 percent. Other bonds insured by National and related to parking garages will be cut by 12 percent, while a third bond for a city building will be paid in full.

Stockton's agreement with Assured allows the bond insurer to take possession of a city building and receive revenue it generates to service about $35 million in outstanding bonds the city had sold to acquire the building.

The agreement with Assured also allows Stockton to make payments on about $120 million in outstanding pension obligation bonds until 2052 from their original 2038 term.

"The settlement includes a unique and innovative instrument that enables Assured to participate in the city's future revenue growth," the bond insurer said in a statement confirming the agreement.

The deal with Assured carries two key conditions: that the judge hearing Stockton's bankruptcy case confirm its plan to adjust its debt and that city voters approve a tax measure in November.

The measure would raise Stockton's sales tax to raise revenue to help the city bolster its finances and hire additional police officers. A top reason Stockton's city council approved a bankruptcy filing was that it feared making deeper cuts to police services amid a spike in violent crime.

Without revenue from the tax increase, Stockton would need to cut $11 million in spending, which could fall on libraries, community centers and fire houses, according to Deis.

Assured and National led efforts by Stockton's so-called capital markets creditors to block the city's bankruptcy case, contesting the city's defense of its pension spending.

The insurers wanted that spending, which is broadly of rising concern in the municipal debt market, restructured along with city debt.

With about 300,000 residents, Stockton set itself apart in bankruptcy proceedings from Detroit, which has filed the largest U.S. municipal bankruptcy, and smaller San Bernardino, California, which filed for bankruptcy last year, by insisting on defending its pension payments.

The $272 billion California Public Employees' Retirement System, the biggest U.S. public pension fund, was prepared to help the city battle its bond insurers in court.

U.S. Bankruptcy Judge Christopher Klein in April found Stockton eligible for bankruptcy protection and said the showdown the insurers sought over payments to the pension fund would have to wait until the city filed its plan for adjusting its debt to exit from bankruptcy.

The deals with Assured and National mean that fight won't take place and Stockton's pension plan remains whole. But the city will see savings on pension spending due to concessions from employee groups and changes in state law, according to Deis.

Stockton officials have defended the city's pension program as necessary for retaining and recruiting employees after slashing the city's workforce in the run-up to filing for bankruptcy while revenue was plunging due to the recession and a crash in the local housing market.

The officials have also defended pension spending by pointing to pay and benefit concessions by employees to help repair Stockton's finances and to the elimination of the city's subsidy for healthcare for about 1,100 of its retired employees.

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UPDATE 2-S&P cuts Detroit GO bond ratings to D following default

Wed Oct 2, 2013 5:46pm EDT

Oct 2 (Reuters) - Standard & Poor's said it cut its rating on Detroit's general obligation debt to D from C on Wednesday because the city missed payment on its bonds, making S&P the second ratings agency to downgrade Detroit this week.

Fitch Ratings cut its rating on Monday, citing the city's imminent debt default.

"The downgrade reflects the nonpayment of debt service to the paying agent for the scheduled principal and interest payment date of Oct. 1," S&P credit analyst Jane Hudson Ridley said in a statement.

S&P said the downgrade affects about $411 million of unlimited-tax GO bonds and $197 million of limited-tax GO bonds.

Detroit on Tuesday skipped a payment on more than $600 million of general obligation debt that the city's emergency manager, Kevyn Orr, had determined to be unsecured.

In June, Orr announced a moratorium on paying debt service on unsecured debt, including certain GO bonds and $1.45 billion of pension debt that the city defaulted on that month.

With Detroit sinking under more than $18 billion of debt and other obligations, the city on July 18 filed what would be the biggest Chapter 9 municipal bankruptcy in U.S. history.

The city is continuing to make payments on its water and sewer revenue bonds, which Orr had deemed secured, Moody's Investors Service said on Wednesday.

However, the rating agency warned that the revenue debt still faces risks, including Orr's assertion that the debt was subject to negotiation with bondholders and his plan for creating a new authority to operate water and sewer systems and restructuring the outstanding bonds.

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