(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 U.S. history.
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 retirement system.
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 necessary."
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 the city.
Some $440 million of general obligation bonds would remain secured debt.
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 for investors.
"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 Co.
He also criticized Detroit for not seeking to sell city-owned works at the Detroit Institute of Arts as well as other assets.
"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, including pensioners."
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)