Detroit Bankruptcy (largest in US municipal history) Casts a Shadow on Municipal Bond Market

Barron’s Michael Aneiro spoke this week with Eric Friedland, head of municipal credit research at Schroders, and asked his take on what the Detroit bankruptcy means for the muni market. So far he says it has exacerbated recent market-wide weakness, but it remains a unique case.

“There are no other municipalities that we see that are in a similar situation, with population fleeing from the city and demographics that are pretty weak,” Friedland says. “Ahead of this event there was already a big Treasury rate move, and we’ve seen significant [fund] outflows, and since this is a retail-driven market it kind of feeds on itself and can be hard to get out of. This event has added a little more fuel to the fire.”

The biggest longer-term impact on the market will likely come from how the bankruptcy court views Detroit emergency manager Kevyn Orr’s attempt to lump general obligation (GO) bondholders in with other unsecured creditors. A general obligation (GO) bond is a municipal bond backed by the credit and “taxing power” of the issuing jurisdiction rather than the revenue from a given project.

“GO bonds… have always been viewed as being secured by an unlimited pledge of property taxes,” Friedland says, calling Orr’s gambit “a game changer” that “scared a lot of people” but that ultimately it’s up to the bankruptcy judge to decide. “That could have some pretty wide implications for how the market and how rating agencies view GO bonds. That to me is where the biggest impact to the muni market may come.”

Notes from our conference call with Nuveen Asset Management:

  • Potential treatment of GO debt is the most controversial area of emergency managers’ plan
  • ½ states don’t allow Chapter 9 bankruptcy filing
  • Detroit is an unusual case with decades of economic decline, population decline, single focused industry + union and political mismanagement
  • we believe we’re looking at 18-24 month case resolution
  • As a fiduciary to several Detroit creditors, Nuveen Asset Management will seek to obtain the best possible outcome for our investors. As a large municipal investor, we also have a strong interest in the legal issues to be considered in this case and will continue to impress upon the State of Michigan the negative implications of Detroit’s bankruptcy for communities throughout Michigan.

Clearview Wealth Management’s exposure is extremely low with regard to Detroit Michigan muni bonds and limited to 3 ETF/mutual fund holdings. We’ll keep a close watch on the proceedings of the case and be prepared for whatever the outcome.  Often times “headline” risk garners the most attention and yet can often generate attractive entry points for patient, long-term investors. Muni bonds (again) look attractive after Detroit bankruptcy headlines.  Per Nuveen Asset Management “there are striking parallels to late 2010 when municipal bonds where last spooked which set-up a strong rally for 2 years.”