Honest answers to your bankruptcy questions

[BankruptcyGuy]

I have quite a bit of experience in the bankruptcy field. You guys and gals have been supporters of Detroit for many years. I'm hoping I can provide some honest and unbiased answers to your questions. Fire away.

[FEO]

Assuming that city workers would have their pensions slashed under bankruptcy, would they revert back to their original pensions once Detroit came out of bankruptcy?

[313WX]

How much of an impact do you think a Detroit bankruptcy would have on the credit ratings of the state and surrounding suburbs?

[BankruptcyGuy]

Assuming that city workers would have their pensions slashed under bankruptcy, would they revert back to their original pensions once Detroit came out of bankruptcy?

Probably not. Once the court makes a determination, the liability is deemed resolved.

On the other hand, the issue of cutting accrued pension benefits will likely go to the U.S. Supreme Court. Stockton, CA and San Bernadino, CA are facing the same issue, and one has decided to pay into CALPERS, and one refuses. State law requires the payments, but the City [[can't remember which one, thinking it's SB) is claiming that federal bankruptcy laws allow them to get out of the payments.

[BankruptcyGuy]

How much of an impact do you think a Detroit bankruptcy would have on the credit ratings of the state and surrounding suburbs?

That depends on the outcome. Secured bonds can and will be paid. Actually, DWSD bonds will likely be spun off into some sort of authority, and that will likely lower credit costs. For unlimited tax obligations, if they really get crammed down [[i.e. the principal reduced or the interest rates reduced), then costs may go up. But that won't be limited just to the metro area or the State of Michigan--it may have a ripple effect across the country. Either way, I wouldn't imagine more than a 100-200 bp difference.

Detroit will be out of the credit markets for a while, but that was true before BK as well.

[Todd]

In what ways do you think this might effect the real estate market? What kind of short term opportunities might there be? thanks

[downtownguy]

Before we start quoting what you say as gospel, and in light of the fact that you're a new poster, would you mind giving us some idea of your credentials? Also, is your bankruptcy experience with individuals, corporations or municipalities? From what I understand, there is quite a difference with a municipal bankruptcy.

[stevenh]

Are previous tax abatements/property tax reductions for businesses/developments in a Chapt 9 rescinded?

[BankruptcyGuy]

In what ways do you think this might effect the real estate market? What kind of short term opportunities might there be? thanks

I'm hoping that it helps clear the real estate market up in Detroit. Put another way, it's taken some work for title companies to really dig into the chain of title and tax/lien issues on properties. Detroit's not really efficient that way. It can be cleared up.

I'd like to see [[not holding my breath) strict enforcement of code with more money allocated to inspectors. That would certainly help as well.

[BankruptcyGuy]

Before we start quoting what you say as gospel, and in light of the fact that you're a new poster, would you mind giving us some idea of your credentials? Also, is your bankruptcy experience with individuals, corporations or municipalities? From what I understand, there is quite a difference with a municipal bankruptcy.

I have been an attorney for [[sigh) over 15 years, with the last 5 in workouts/troubled debt restructuring. Most of my experience is with commercial bankruptcy, 11 and 7.

Here's a tip: when you hear someone described as a municipal bankruptcy law expert, they have likely handled exactly 0 cases. We all have. There haven't been Chapter 9 cases anywhere near here in the last 20 years.

Other than that, UM law grad, licensed in two states, and huge DCFC fan.

[BankruptcyGuy]

Are previous tax abatements/property tax reductions for businesses/developments in a Chapt 9 rescinded?

Tax abatements are combined creatures of the state and municipality, so no, they would not be impacted. In fact, more of them may be encouraged, if you're using increment financing [[like for the proposed new hockey arena). It is when the DDA and city pension funds start investing that they got into trouble. That practice should be discontinued immediately.

[Danny]

BankruptcyGuy,

Explain to me what is Chapter 9 Municipal Bankruptcy? What will effect Detroit's city services? Please give a full answer in details.

[BankruptcyGuy]

BankruptcyGuy,

Explain to me what is Chapter 9 Municipal Bankruptcy? What will effect Detroit's city services? Please give a full answer in details.

Ok, let's start from the beginning. People or entities who are insolvent have, by federal legislation exclusively granted to the feds through the constitution, the right to file for bankruptcy. Most people have heard of Chapter 7, where assets are liquidated and debts forgiven after the proceeds are distributed. Chapter 13 is a personal reorganization, where debts are restructured but not necessarily forgiven, and assets aren't liquidated. The parallel to Chapter 13 for an entity is a Chapter 11, although the rules are quite different.

Very, very infrequently [[in fact, probably no more than 8 or 9 times in the past 20 years) a municipal body files for bankruptcy. That filing is governed by Chapter 9. The process is similar to a Chapter 11, but with some different rules. There are a bunch of nuances in each situation which can't be captured in a short response. I could answer a more specific question if you've got one.

Now, as to your question about city services, they should actually improve. During a bankruptcy, the order of payment gives superpriority to what are called "Administrative Expenses"--this includes attorneys, consultants, and post-petition operating expenses. The costs of the first two will be offensive, just as it was for GM and Chrysler. But the costs of running the city come first--before secured and unsecured creditors alike. So, depending on how detailed the Conway Mackenzie [[the City's consultant) plan is, the EM could implement those plans and carve out whatever dollars he needs, right off the top. He's indicated that public safety and blight removal are his priorities. He can include those dollars in his budget, and creditors can object, but my experience is that unless there is something glaring [[fraud, waste, self-dealing), the court will approve the operating budgets. So my guess is that city services should improve. That's kind of the point.

When you hear on national media that the filing will mean a cut to city services, that's premature when I'm being generous, and reactionary bs when I'm not. The City makes enough in tax revenue to pay operating expenses, but not operating expenses, pension benefits, and debt service.

[Honky Tonk]

Hey man, I just wanted to say it's nice of you to take your time to answer peoples questions.

[BankruptcyGuy]

Hey man, I just wanted to say it's nice of you to take your time to answer peoples questions.

No problem. I love this city, and I love what all of you do and have done for it.

[Jason]

My question is, why has anyone been loaning money to Detroit? It's been known that bankruptcy was probably inevitable for a long time now. Were they just betting that it wouldn't happen, that the city would be bailed out, or that they'd get lucky in court? Or even though they won't be getting everything they were "supposed to", will their investment still be worthwhile? This isn't really a question about bankruptcy itself, but more about why anyone would go anywhere near a Detroit bond.

[AuburnSpeedster]

Throughout this whole process [[and after for that matter)... how much power will the city council and many of the other govt. officials who landed the city in this mess have?

[corktownyuppie]

No problem. I love this city, and I love what all of you do and have done for it.

Seriously, this is much appreciated. The public is way too confused right now, and we need clarity when there are clear answers, and we need frank conversations when the answers are ambiguous. Thank you.

[corktownyuppie]

My question is, why has anyone been loaning money to Detroit? It's been known that bankruptcy was probably inevitable for a long time now. Were they just betting that it wouldn't happen, that the city would be bailed out, or that they'd get lucky in court? Or even though they won't be getting everything they were "supposed to", will their investment still be worthwhile? This isn't really a question about bankruptcy itself, but more about why anyone would go anywhere near a Detroit bond.

I'm gonna answer this from the investment advisor perspective, as this is my profession. Detroit bonds have always come in two flavors...secured and unsecured.

The "safety" of any bond is based on what risks there are along side of it. For people who are unhappy that water/sewer bonds aren't settling for 10-cents on the dollar, you need to know that the bond contracts place the revenue from the water system as first lien collateral for unmade payments. Although the bonds aren't risk-free, per se, their only real risk is litigation risk...the fact that Detroit might try to withhold payments and somehow lose ownership of the water/sewer revenue in the process.

Although my clients don't own a lot of them anymore, specifically with the added risks of trying to sell the bonds on the market during a time where no one is willing to buy them [[liquidity risks), they're considered very safe bonds because the revenue backing them is highly predictable.

General Obligation bonds, on the other hand, are a totally different animal. Yes, these have generally been considered very safe as a class because they are backed by the taxing ability of the municipality. But, if you need to raise your income tax rate to 18% just to be able to maintain operating expenses + debt expenses, you're going to have a bigger problem: people will leave the city. And then no matter how much you raise taxes, you just end up raising the percentage on an ever-shrinking number of people.

In my 12 years in the investment industry, not a single one of my clients has ever owned a Detroit General Obligation bond. In fact, I would go as far as to say that my firm wouldn't even bring them into inventory for our clients to purchase. The credit problems have been so far gone for so long, that the risk associated with them was very, very high.

The people who were buying these bonds were:

a) either buying them at a steep discount to normal value, in order to mitigate their risk [[buying a $5,000 bond for $2,500 but still getting interest payments based off the $5,000)

b) being speculative in exchange for higher rates of return

[[The above 2 are actually different ways of saying the same thing, but that's a whole other post on bond math).

That's why I find the whole Blackrock perspective disingenuous. These bonds weren't sold in 1955 with 70-year maturities. They were sold in 2005 with 30-year maturities. If you bought them then, you should've known what you were getting into.

[mwilbert]

I'm gonna answer this from the investment advisor perspective, as this is my profession. Detroit bonds have always come in two flavors...secured and unsecured.

The "safety" of any bond is based on what risks there are along side of it. For people who are unhappy that water/sewer bonds aren't settling for 10-cents on the dollar, you need to know that the bond contracts place the revenue from the water system as first lien collateral for unmade payments. Although the bonds aren't risk-free, per se, their only real risk is litigation risk...the fact that Detroit might try to withhold payments and somehow lose ownership of the water/sewer revenue in the process.

Although my clients don't own a lot of them anymore, specifically with the added risks of trying to sell the bonds on the market during a time where no one is willing to buy them [[liquidity risks), they're considered very safe bonds because the revenue backing them is highly predictable.

General Obligation bonds, on the other hand, are a totally different animal. Yes, these have generally been considered very safe as a class because they are backed by the taxing ability of the municipality. But, if you need to raise your income tax rate to 18% just to be able to maintain operating expenses + debt expenses, you're going to have a bigger problem: people will leave the city. And then no matter how much you raise taxes, you just end up raising the percentage on an ever-shrinking number of people.

In my 12 years in the investment industry, not a single one of my clients has ever owned a Detroit General Obligation bond. In fact, I would go as far as to say that my firm wouldn't even bring them into inventory for our clients to purchase. The credit problems have been so far gone for so long, that the risk associated with them was very, very high.

The people who were buying these bonds were:

a) either buying them at a steep discount to normal value, in order to mitigate their risk [[buying a $5,000 bond for $2,500 but still getting interest payments based off the $5,000)

b) being speculative in exchange for higher rates of return

[[The above 2 are actually different ways of saying the same thing, but that's a whole other post on bond math).

That's why I find the whole Blackrock perspective disingenuous. These bonds weren't sold in 1955 with 70-year maturities. They were sold in 2005 with 30-year maturities. If you bought them then, you should've known what you were getting into.

Also, it seems as if a lot of these bonds were insured, which means that the buyer can recover from the bond insurer if the city fails to make its payments. So people may not have been so worried about the underlying creditworthiness of the city. And of course the insurers are paid to provide the insurance, so that explains how that happens, although you have to wonder if the insurance was properly priced. Presumably that is where the disconnect is.

[erikd]

Bankruptcyguy,

I am interested to hear your opinion on the possible sale of city assets.

When GM went through Chapter 11 reorganization, GM's productive assets were transferred to the "new GM", and other assets were transferred into Motors Liquidation Company for the purpose of liquidation and disbursement to creditors. From what I understand, GM was not required to liquidate any assets that would hamper its ability to operate as a going concern or generate future growth and revenue generation.

While the definition of "productive assets" may be a bit more grey in the case of a municipality, it seems clear to me that city assets such as the DIA art collection, Belle Isle, the zoo collection, etc., certainly qualify as productive assets, even though they do not directly generate revenue for the city.

I would assume that these type of assets would not be subject to liquidation, but other "unproductive" city assets [[such as vacant lots, decommissioned fire stations, shuttered city recreation centers, etc.) would be subject to liquidation to satisfy creditor claims.

What is your opinion on this aspect, and where do you think the line will be drawn concerning asset liquidation?

[BankruptcyGuy]

Bankruptcyguy,

I am interested to hear your opinion on the possible sale of city assets.

When GM went through Chapter 11 reorganization, GM's productive assets were transferred to the "new GM", and other assets were transferred into Motors Liquidation Company for the purpose of liquidation and disbursement to creditors. From what I understand, GM was not required to liquidate any assets that would hamper its ability to operate as a going concern or generate future growth and revenue generation.

While the definition of "productive assets" may be a bit more grey in the case of a municipality, it seems clear to me that city assets such as the DIA art collection, Belle Isle, the zoo collection, etc., certainly qualify as productive assets, even though they do not directly generate revenue for the city.

I would assume that these type of assets would not be subject to liquidation, but other "unproductive" city assets [[such as vacant lots, decommissioned fire stations, shuttered city recreation centers, etc.) would be subject to liquidation to satisfy creditor claims.

What is your opinion on this aspect, and where do you think the line will be drawn concerning asset liquidation?

I think the sale of City assets is unlikely, with one exception. The DWSD may be spun off into an authority [[like the zoo), and the authority may pay to the City a chunk of money every year [[$50MM a year is what I heard). If the secured creditors agree [[and they likely will), this may happen.

The Belle Isle lease deal will likely happen as well.

I don't see the DIA art going anywhere. I would imagine most of the art donations had restrictive covenants attached.

This is one of the biggest differences between Chapter 9 and Chapter 11. Because the state is a sovereign, the federal court cannot demand that assets be sold. Neither can creditors.

[BankruptcyGuy]

My question is, why has anyone been loaning money to Detroit? It's been known that bankruptcy was probably inevitable for a long time now. Were they just betting that it wouldn't happen, that the city would be bailed out, or that they'd get lucky in court? Or even though they won't be getting everything they were "supposed to", will their investment still be worthwhile? This isn't really a question about bankruptcy itself, but more about why anyone would go anywhere near a Detroit bond.

Great question. Corktownyuppie's perspective is of course spot on. But I'll add this: the problem with muni bonds is not limited to Detroit. Meredith Whitney [[a big-time analyst) called it, what, three years ago? The entire State of Illinois has the same problem, only an order of magnitude larger.

[BankruptcyGuy]

Throughout this whole process [[and after for that matter)... how much power will the city council and many of the other govt. officials who landed the city in this mess have?

During the pendency of the bankruptcy case, they'll have no more power than they had under the EM law, which isn't much. They can hold meetings, discuss issues, etc. They just can't spend a dollar.

[Blueidone]

Let me add my THANK YOU to you and all those who help us understand this process. Taking the time to post your answers to questions we have is very generous of you. It certainly has helped me understand the process.