(Reuters) - Detroit’s blueprint for dealing with $18 billion in debt and emerging from municipal bankruptcy requires cuts to worker pensions and even deeper cuts for bondholders, setting the stage for a new round of negotiations and court challenges.
The potentially precedent-setting plan the city filed in U.S. Bankruptcy Court on Friday would cut retired worker’s pensions by up to 30 percent while owners of bonds deemed unsecured would lose up to 80 percent of their investment.
The fact that voter-approved general obligation bonds were lumped into the city’s $12 billion unsecured debt pile has roiled the U.S. municipal bond market.
Retirees and pension funds argued the proposed cuts go too deep, while bond insurers complained that bondholders were being treated unfairly and forced to bear most of the losses.
Kevyn Orr, the city’s state-appointed emergency manager, acknowledged that the plan is far from final, and will be subject to negotiation in the weeks ahead.
“You’re hearing the yin-yang, the Alpha and Omega of reaction, that’s pretty clear,” Orr said during a conference call with reporters to discuss the plan.
The plan to exit bankruptcy marks a watershed in Detroit’s case, the largest municipal bankruptcy in U.S. history. Creditors must now either accept the settlement or negotiate another solution. The ultimate decision will rest with U.S. Bankruptcy Judge Steven Rhodes who will determine if the final deal Detroit strikes with a majority of creditors is fair and feasible.
In addition to digging Detroit out of debt by Orr’s self-imposed deadline of September, the plan also outlines how to restore the city to place where people want to live and businesses want to operate.
Orr’s plan calls for spending $1.5 billion to improve essential services and public safety over 10 years, with up to $500 million earmarked for blight removal in a city where about 20 percent of the housing stock is abandoned.
Even as Detroit tries to emerge from bankruptcy, the city’s pension funds and unions continue to argue in court that Detroit should not even be eligible for bankruptcy.
On Friday, a U.S. Appeals Court in Cincinnati said it will hear their arguments, although no date was set.
The cuts to worker pensions would have been even deeper except for $815 million pledged by philanthropic foundations, the Detroit Institute of Arts and Michigan Governor Rick Snyder to prop up the pension funds and avoid a fire sale of city-owned artwork.
Police and fire retirees who agree to the plan would see their benefits cut by just 10 percent, but cuts for other retirees would be around 30 percent, according to a statement from the city.
A committee representing retirees says the city’s cuts would go even deeper and reduce some pensions by 50 percent, forcing some retirees below the poverty line.
“The city’s plan, if actually confirmed in its current form, would cause significant harm to retirees, their spouses and dependents,” said Terri Renshaw, chair of the retiree committee. “Many retirees who live on the edge will fall below the poverty line. Everyone else will see major cuts to their pension checks and health care coverage.”
A spokesman for the police and fire retirement fund, Bruce Babiarz, also blasted the pension cuts, but said the fund will continue negotiating with the city.
Orr’s plan also includes changes to the way Detroit’s two retirement systems, the city’s largest unsecured creditors, forecast the rate of return on their investments. Orr proposes reducing the assumed rate of return on investments by the funds from 8 percent to 6.5 percent for the police and fire fund and from 7.9 percent to 6.25 percent for the general retirement system. The reduction is a tacit acknowledgement that overly optimistic prior assumptions led to chronic underfunding of the pension systems.
In the restructuring proposal, Orr formalized earlier plans to treat about $641 million of unlimited and limited tax general obligation bonds outstanding as of June 2012 as unsecured debt. The city has already defaulted on some of the mostly insured debt and the plan would force bondholders to accept an 80 percent cut in their claims, with a 20 percent payout made in the form of notes issued by Detroit.
Some $440 million of general obligation bonds would be considered secured debt.
The significant haircut and treatment of general obligation bonds as unsecured debt likely will upset participants in the $3.7 trillion municipal bond market, where such bonds have long been considered a safe bet for investors. Some have warned investors will demand to be paid more to lend to Detroit and other local Michigan governments and school districts.
“We believe this is contrary to bankruptcy law and will result in costly litigation that will hamper the city’s emergence from bankruptcy,” said Steve Spencer, a financial adviser to bond insurer Financial Guaranty Insurance Co, regarding the uneven treatment of pensions and bonds in the plan.
Lisa Washburn, a managing director at Municipal Market Advisors, said the cuts to the GO bonds are “greater than anything we’ve ever seen and that the market has ever anticipated.”
But Domenic Vonella, an analyst at Municipal Market Data, said the risk has been priced in to Detroit bonds. “That’s why they’d been trading cents on the dollars,” he said.
Under the plan, bondholders and other unsecured creditors would potentially share in any increased revenue that results from Detroit’s revitalization, according to the city.
Detroit’s water and sewer bonds, which Orr considered secured debt, would be replaced with new debt under the plan.
A deal to end costly interest-rate hedges on $1.45 billion of pension debt was not included in the plan. But Orr told reporters that a third proposed resolution will be presented to the bankruptcy judge in the next few days that will have a significantly lower cost for Detroit than the first two deals the judge rejected.
Reporting by Karen Pierog in Chicago, Lisa Lambert in Washington and Hilary Russ, Ed Krudy, Steven Johnson, Nick Brown in New York, Bernie Woodall in Detroit, and Rachel Jackson in Ann Arbor; Editing by David Greising, Steven C. Johnson, James Dalgleish, Matthew Lewis and Lisa Shumaker