Detroit defaulted on a $39.7 million debt payment last Friday, but the move was all part of the city's restructuring plan, put forth last week by Emergency Manager Kevyn Orr.
In an effort to save cash, Orr's plan has the city set to miss payments on billions in unsecured municipal debt. Friday's default was only just the beginning. Should Orr's plan make its way, intact, through what are expected to be tough negotiations with creditors of all classes, unsecured creditors will end up taking a pro rata share of $2 billion worth of non-recourse participation notes, payable as the city's financial station improves. These would be issued by Detroit to replace $11 billion worth of unsecured obligations consisting of bond debt, pension certificates, the pensions' underfunding claims and retiree healthcare claims.
Orr stressed sustainability in his announcement of the city's latest effort to avoid filing Chapter 9 bankruptcy. "The city and its creditors and constituents will have worked too hard and sacrificed too much for the gains of the restructuring to go for naught," he said. "We will need an oversight structure to ensure that the tough decisions and the compromises we make today are sustainable and allow Detroit to become a vibrant and growing American city once again."
But the severity of the haircut proposed for creditors has many thinking they'd be better off in bankruptcy. For his part, Orr has said that he would prefer to avoid filing Chapter 9, but pegged the city's chances of a successful out-of-court workout at 50-50.
Ratings agencies reacted to Detroit's default with further downgrades of the city's already beleaguered debt quality. Standard & Poor's (S&P) cut Detroit to CC from CCC-, while maintaining a negative outlook on the city's potential bankruptcy filing. Moody's beat S&P to the punch, downgrading several classes of Detroit debt to Caa2 with a negative outlook while also acknowledging the boldness of Orr's plan. "The structuring plan is unconventional and precedent-setting in the municipal market," said Moody's in a statement. "It builds a strong case for insolvency, girding the city for a tough fight with creditors of all types."
Several observers have noted that the actions Detroit takes to dig its way out of its $17 billion hole will ripple through the world of municipal bankruptcy. Bruce Nathan, Esq., of Lowenstein Sandler LLP predicted at last month's Credit Congress that a Chapter 9 filing by a tier-one, household-name city like Detroit would be huge news for practitioners, as well as for other municipalities on the brink of their own filing. Similarly, the reception of Orr's controversial restructuring plan will be a bellwether for other efforts by cities and towns to scrape by without having to file.
- Jacob Barron, CICP, NACM staff writer