(Corrects name of firm to Wells Capital Management instead of
Well Capital Management, sixth paragraph from bottom)
By Karen Pierog
Feb 21 Detroit's much-anticipated blueprint for
dealing with $18 billion in debt and emerging from municipal
bankruptcy requires cuts to worker pensions and even deeper cuts
for bondholders, according to a plan the city filed in federal
court on Friday.
The potentially precedent-setting plan drew immediate rebuke
from a variety of parties ranging from union groups to bond
insurers, some of which vowed to go to court to prevent
implementation. Retirees and pension funds argued the proposed
cuts go too deep, while bond insurers complained that
bondholders were being treated unfairly.
Kevyn Orr, the 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 of adjustment, delivered to the federal bankruptcy
court by Orr, a former corporate bankruptcy lawyer, marks a
watershed in Detroit's case, the largest municipal bankruptcy in
In the plan, Orr presents two parallel imperatives: putting
the city on a path toward long-term financial stability, and
emerging from bankruptcy as soon as possible, perhaps even by
Orr's self-imposed deadline of September 2014.
Orr's plan calls for a $1.5 billion program to improve
essential services and public safety over 10 years, with up to
$500 million earmarked for blight removal. It also includes
changes to Detroit's two retirement systems, the city's largest
unsecured creditors, that would reduce investment assumption
rates from 8 percent to 6.5 percent for the police and fire
funds and from 7.9 percent to 6.25 percent for the general
The cuts to unsecured creditors such as the retirement
systems and owners of certain Detroit bonds ranged from 10
percent to as much as 80 percent in the plan.
Orr acknowledged that pensions will be reduced even though
philanthropic foundations and the Detroit Institute of Arts have
pledged $465 million and Michigan Governor Rick Snyder has asked
the state legislature to approve $350 million to ease the hit on
retirees. And he noted that without a negotiated solution to
Detroit's bankruptcy, the private funds are at risk.
"We really don't have time for a lot of acrimony and
litigation," Orr said.
Police and fire retirees who agree to the plan would see
their benefits cut by just 10 percent, while cuts for the
general retirement system's retirees would be around 30 percent,
according to the statement.
But a retirees' committee formed for the bankruptcy case
contended that many retirees would be hit with as much as a 50
percent reduction in their pensions under the plan, forcing some
below the poverty line.
"The city seeks to use assumptions regarding the health of
the pension plans that are significantly different than those
used by the State of Michigan and hundreds of cities across
the state and around the country," said Ron Bloom, vice chairman
of Lazard, the committee's financial adviser.
"This difference is then used to attempt to justify
substantial reductions in pension benefits that are simply not
A spokesman for the city's police and fire retirement system
said the plan "contains debilitating and unnecessary cuts to
accrued pension benefits." However, spokesman Bruce Babiarz
added the fund will continue to negotiate with the city.
Investors in debt that Orr has deemed to be unsecured,
including some voter-approved unlimited tax general obligation
bonds, would fare worse than pensioners under the plan.
BIG HAIRCUT FOR BONDS
In the plan, Orr provided additional details on his intent,
first released in June, to treat about $641 million of unlimited
and limited tax GO bonds outstanding as of June 2012 as
unsecured debt. Orr intends to default on that debt, which was
mostly guaranteed by insurance companies on the hook to make up
any missed payments.
Unsecured bondholders would see an 80 percent cut in their
claims with the 20 percent payout made through a note sale by
Some $440 million of general obligation bonds would remain
The significant haircut for general obligation bonds now
declared to be unsecured debt likely will upset participants in
the $3.7 trillion municipal bond market, where general
obligation bonds have traditionally been considered a safe bet
"While we understand that favoring pensioners and
discriminating against bondholders and other creditors might be
politically popular, 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
He also criticized Detroit for not seeking to sell
city-owned works at the Detroit Institute of Arts as well as
"Given the importance of the DIA art as a catalyst for
Detroit's overall recovery, it is vital that the full value of
the collection be explored in order to generate potentially
billions of additional dollars for the benefit of all creditors,
Some have warned that if these cuts are accepted, investors
will demand to be paid more to lend to Detroit and other
Michigan local governments and school districts.
"Should the proposal represent the ultimate plan, investors
may need to reassess fair value when buying local general
obligation debt in Michigan, particularly when the municipality
has large pension and (retiree healthcare) liabilities," said
Gabe Diederich, a research analyst at Wells Capital Management.
Domenic Vonella, an analyst at Municipal Market Data, said
the risk has been priced in to Detroit bonds. "There aren't many
people who own Detroit bonds who aren't expecting a haircut on
the bonds. That's why they'd been trading cents on the dollars.
Where they're going to trade now is closer to that recovery rate
if not lower, 20 cents on the dollar."
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.
A deal to end costly interest-rate hedges was not included
in the plan. U.S. Bankruptcy Judge Steven Rhodes, who is
overseeing Detroit's case, has twice rejected proposals to
terminate the so-called swap deals at a discounted cost.
But an attorney representing the city told Rhodes this week
that a new deal would be presented to the court within days.
The swaps were used to hedge interest rate risk for some of
the $1.45 billion of pension debt Detroit sold in 2005 and 2006.
The swaps soured when both interest rates and the city's credit
ratings dropped. Money owed to swap counterparties UBS AG
and Merrill Lynch Capital Services was a major
element that drove Detroit to bankruptcy court.
(Reporting by Karen Pierog in Chicago, Lisa Lambert in
Washington and Hilary Russ, Ed Krudy, Steven Johnson and Nick
Brown in New York; editing by James Dalgleish and Matthew Lewis)