U.S. Markets

Detroit leads 2013 U.S. bond defaults: Moody's

WASHINGTON (Reuters) - Detroit accounted for three of the seven defaults last year on municipal bonds rated by Moody’s Investors Service, the credit rating agency said on Wednesday.

Pigeons are seen near graffiti in Detroit, Michigan, December 3, 2013. REUTERS/Joshua Lott

Even before the cash-strapped city filed the largest municipal bankruptcy in U.S. history in July 2013, it began skipping payments on pension debt it deemed to be unsecured. Detroit subsequently missed payments on unlimited and limited-tax general obligation bonds it also labeled as unsecured debt.

The seven defaults in Moody’s annual survey is in line with the yearly average of five defaults since the 2007-09 recession began. The 2013 defaults also included one by a Detroit charter school and by the Pontiac School District, located about 30 miles from the Motor City, which became the first school system Moody’s rates to miss a bond payment.

“The Detroit bankruptcy, by virtue of its scale and the range of credit and related legal issues it poses, is shaping up as a major watershed event, and the evolving bankruptcy cases in Stockton and elsewhere in California also will establish industry benchmarks for ‘service insolvency’ where governments are forced to choose between essential services and honoring debt and other long-term obligations,” said Moody’s in the report.

Detroit also made history last year by becoming the largest municipal default in U.S. history, with $8.4 billion of bonds outstanding. The city is trying to repudiate $1.4 billion of certificates of participation sold for its pensions, the first attempted repudiation since the 1970s, according to Moody’s.

Another default involved Jefferson County lease rental bonds. The Alabama county had held the title of largest U.S. municipal bankruptcy until Detroit declared itself broke after years of population loss, steep manufacturing declines, fiscal mismanagement and mounting pension costs.

The final default involved West Penn Allegheny Health System revenue bonds.

Before 2008, the average default rate for municipal bonds rated by Moody’s was only 1.3 per year stretching back to 1970. Even though defaults have increased, they “remain very low, especially compared to other sectors like corporate finance,” Moody’s said.

Detroit is inching closer to exiting bankruptcy and is about to send out an important disclosure document that creditors must vote on.

Its final debt-adjustment plan will likely only set legal precedent within Michigan but will create expectation throughout the country about creditors’ recoveries in bankruptcies and defaults, Moody’s said.

Moody’s found that on average the ultimate recovery for defaulted municipal bonds was 64 percent from 1970 through 2013, but the historically the individual recovery rates ranged from 2 percent to 100 percent. In 2013 alone the range was 31 percent to 100 percent. Detroit’s proposed recoveries “vary widely based on creditor class.”

“Municipal recovery rates are trending lower and more variable in range, yet municipal recoveries are still higher than corporate recoveries,” the rating agency said.

Reporting by Lisa Lambert; additional reporting by Karen Pierog in Chicago; Editing by Prudence Crowther