Detroit - Analysis and Clarification

Transcription

1 Detroit - Analysis and Clarification Morningstar Municipal Research Elizabeth Foos, Sr. Credit Analyst Rachel Barkley, Sr. Credit Analyst Jeff Westergaard, Dir. Municipal Analytics Aug. 1, Morningstar, Inc. All rights reserved.

2 Agenda Timeline of events Liabilities and the Emergency Manager s plan Concerns for bondholders- highlighting different security pledges Detroit and bond insurance Analyzing pension liabilities Mutual fund exposure to Detroit obligations Market reaction- observations of recent trades Conclusion Appendix 2

3 The Detroit Credit Crisis: A Brief Recap Detroit experienced decades of economic and fiscal stress and mismanagement March 14, 2013: State of Michigan assigns Emergency Manager to Detroit, Kevyn Orr June 14, 2013: Orr publishes Proposal For Creditors July 18, 2013: Detroit files for bankruptcy protection 3

4 Outstanding Liabilities ($ in millions) Estimated Liabilities from Emergency Manager Report Parking Revenue Bonds Water Revenue Loans Other** GO-ULT Sewer Revenue Loans GO-LT Pension Swaps Pension Certificates Water Revenue Bonds Sewer Revenue Bonds Pension Unfunded Liability Unfunded OPEB* $8 $21 $265 $469 $473 $540 $879 $1,400 $2,400 $2,900 $3,500 $5,700 4 *Other post employment benefits; **Miscellaneous liabilities

5 Concerns for Bondholders: Security Pledge General Obligation Unlimited Tax (GO-ULT) Bonds: Voter-approved full faith and credit general obligation of the city. The city is authorized and required to levy ad valorem taxes without limitation as to rate or amount upon all taxable property to pay principal and interest on the bonds. General Obligation Limited Tax (GO-LT) Bonds: Payable as a first budget obligation from any available funds including any collections from property taxes. Levy rates are subject to constitutional, statutory and charter limitations. GO-LT & GO-ULT Distributable State Aid (DSA) Bonds: Provides a statutory lien on certain state revenue sharing payments Detroit expects to receive from Michigan under provisions of Act 140 in each city fiscal year. Pension Obligation Certificates (POC): The city has an unconditional obligation to pay all service payments related to the POCs per contractual agreements with its two retirement service corporations. That obligation is not subject to appropriation. 5

6 Concerns for Bondholders: Security Pledge (continued) POC Swap Agreements: Secured claims arising under service agreements related to POCrelated interest rate swaps. Detroit directs the revenue received from wagering taxes on a daily basis to a trustee for collateral for the quarterly payment to counterparties. Water Supply System Revenue & Sewage Disposal System Revenue Bonds & Loans: The city issued bonds and received loans from the State of Michigan s Revolving Loan Funds to finance capital improvements which are secured by liens on net revenues of each respective system. Pension Liabilities: Maintains two single-employer pension plans. Michigan s Constitution Section 24 of Article IX states that financial benefits of these plans are contractual obligations and shall not be diminished or impaired. Other Post-Retirement Benefits (OPEB) Liabilities: Maintains the Health and Life Insurance Benefit Plan and the Supplemental Death Benefit Plan for retirees. There is no specific article referencing OPEB in Michigan s Constitution lending additional protections in bankruptcy. 6

7 Detroit- Bonded Debt Liability Profile ($ in millions) GO-ULT Distributable State Aid $100 GO-ULT $369 Parking Revenue Bonds $8 GO-LT $161 GO-LT Distributable State Aid $379 Pension Certificates $1,400 Water Revenue Second Lien $638 Water Revenue Senior Lien $1,718 Sewer Revenue Second Lien $981 Sewer Revenue Senior Lien $1,848 7

8 Secured and Unsecured Liabilities ($ in millions) Unsecured Secured Notes and Loans $34 GO-LT $161 Other $265 GO-ULT $369 Pension Certificates $1,400 Unfunded Pension Liability $3,500 Unfunded OPEB Liability $5,700 Parking Revenue Bonds State Water Loans Distributable State Aid GO-ULT Distributable State Aid GO-LT State Sewer Loans Pension Swap Agreements Water Revenue Bonds Sewer Revenue Bonds $8 $21 $100 $379 $473 $879 $2,400 $2,900 8

9 Insured Coverage - $7.65 Billion Total Debt Outstanding % Uninsured All Issuers, 13.8 % Insured All Issuers,

10 Insurer Exposure by Security Provision ($ in millions) Ambac Assured Guaranty Corp. Assured Guaranty Municipal Berkshire Hathaway Financial Guaranty (FGIC) MBIA Insurance National Public Finance Syncora Capital Syncora Capital ,000 1,200 1,400 1,600 National Public Finance MBIA Insurance Financial Guaranty (FGIC) Berkshire Hathaway Assured Guaranty Municipal Assured Guaranty Corp. Millions GO-ULT 34,380,000 88,245, ,665,000 87,190,000 77,635,000 GO-LT 0 92,705,000 Water Revenue 296,105, ,830, ,735, ,555,000 Sewer Revenue 474,215, ,160, ,160, ,635, ,930,000 Pension Certificates 1,250,155, Ambac 10

11 Ratings for Detroit Insurers Insurer Moody's Investor Service Standard & Poor's Ratings Service Ambac Assurance Corp. NR NR A3 Assured Guaranty Corp. AA- A2 AA- Assured Guaranty Municipal Corp. Aa1 Berkshire Hathaway Assurance Corp. AA+ NR Financial Guaranty Insurance Corp. NR Baa1 MBIA Insurance Corp. A Baa1 National Public Financial Guarantee Corp. A Syncora Capital Assurance, Inc. Ca CC 11 Ratings information is taken from sources considered to be accurate.

12 Uninsured Debt Profile Water Revenue-secured $489 GO-LT Distributable State Aid $379 GO-ULT Distributable State Aid $100 GO-LT $69 Sewer Revenue-secured $17 12

13 Detroit s Pension and OPEB Liabilities: Why They Matter Another precedent setting issue in the Detroit bankruptcy case is how pension and postretirement health care (OPEB) benefits will be treated. Included in the city s unsecured liabilities under the Emergency Manager s plan are an estimated $3.5 billion of unfunded pension liabilities and $5.7 billion of unfunded OPEB liabilities. Under the proposed restructuring plan, bondholders and city retirees are pitted against each other for a limited amount of resources. Both are being offered pennies on the dollar of their pledged payments. 13

14 Detroit s Pension and OPEB Liabilities: Why They Matter The state constitution provides a potential hurdle to the Emergency Manager s plan. Michigan s Constitution Section 24 of Article IX states that The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof and shall not be diminished or impaired thereby. Even with that, the question remains unclear whether that protection must remain in a federal bankruptcy court. OPEB benefits do not benefit from constitutional protection. 14

15 Detroit Pensions: Where They Stand Now Pension benefits are accounted for in two single-employer plans, the General Retirement System (GRS) and the Police and Fire Retirement System (PFRS). The funded status of each plan as of June 30, 2011 (the most recent actuarial valuation date) is as follows: 15 GRS PFRS Total Amortization period 30 years 30 years Asset valuation method 7-year smoothed market 7-year smoothed market Investment rate of return (net) 7.9% 8.0% Projected salary increases 4.0% - 8.9% 5.0% - 9.2% Inflation Rate 4.0% 0% for 4 years; 4% thereafter Cost-of-living pension adjustments 2.25% 2.25% Actuarial value of assets ($000s) Actuarial accrued liability (AAL) ($000s) $ 3,080,296 $ 3,804,760 $6,885,056 $ 3,720,167 $ 3,808,643 $7,528,810 Unfunded AAL (UAAL) $ 639,871 $ 3,883 $643,754 ($000s) Funded ratio 82.8% 99.9% 91.4%

16 Detroit Pensions: What s the Real Liability? Despite the data on the preceding slide, the city s actual unfunded pension liability is highly contested. Combined UAAL as of last actuarial valuation: $643.8 million. The city s total estimated UAAL for fiscal year 2012 is $977 million. The Emergency Manager has estimated the UAAL to be $3.5 billion. Orr states that the actuary s numbers are understated due to: Aggressive and unrealistic assumed annual rates of return on investments Smoothing of funding levels over seven years Its lengthy 30 year amortization period. 16

17 Detroit Pensions: What s the Real Liability? Some of the city s actuarial assumptions and asset valuation methods are within industry norms and others are outliers. With the exception of the assumed rate of return (7%), Orr hasn t disclosed what assumptions were used for his calculations. Actual investment returns for the city have fluctuated greatly over the past few years. Pension liabilities are considered to be soft liabilities as they are based on a series of assumptions. 17

18 Key Pension Takeaways Pension and OPEB liabilities account for a significant segment of the city s unsecured liabilities. Under the proposed restructuring plan: Retirees benefits would be reduced significantly. The level of protection from constitutionally protected benefits will be tested. Retirees and bondholders are being pitted against each other. The actual liability is unknown and contested. How these benefits are treated in bankruptcy court may set a precedent for how pensions are treated by other distressed localities. 18

19 Mutual Fund Holdings Analysis Analyzed most recent holdings data available to Morningstar for both open end and closed-end mutual funds Holdings reports are from a period beginning 3/31/2013 to 6/30/2013, therefore the data is historical in nature Over 200 funds were found to have Detroit obligation exposure 19

20 Mutual Fund Exposure to Detroit Obligations (% of total MV) Putnam- PXMIX Wells Fargo- WHYMX Eaton Vance- EMI AllianceBernstein- AMIAX Nuveen- FMITX Nuveen- NUM Fidelity- FMHTX First Investors- FTTMX First Investors- FTMIX Oppenheimer- ORMIX

21 Mutual Fund Exposure Secured vs. Unsecured (% of total MV) Secured Unsecured Putnam- PXMIX Wells Fargo- WHYMX Eaton Vance- EMI AllianceBernstein- AMIAX Nuveen- FMITX Nuveen- NUM Fidelity- FMHTX First Investors- FTTMX First Investors- FTMIX Oppenheimer- ORMIX

22 Mutual Fund Exposure Insured vs. Uninsured (% of total MV) Total Insured Total Uninsured Putnam- PXMIX Wells Fargo- WHYMX Eaton Vance- EMI AllianceBernstein- AMIAX Nuveen- FMITX Nuveen- NUM Fidelity- FMHTX First Investors- FTTMX First Investors- FTMIX Oppenheimer- ORMIX

23 Detroit - Trading Analysis Analyzed trades reported to the MSRB between 5/1/2013 and 7/30/2013 Divided into two periods- prior to Emergency Manager report on 6/14/2013 and after Acknowledging that this is a period of rising rates for the municipal market with record amounts of mutual fund outflows we still see clear evidence of yield impact Analyzed various security pledge backed issues to judge market implied credit risk and yield levels 23

24 Unlimited Tax General Obligation Bonds 50 Trading Activity May 1- July 30, Pre-Event Post-Event Poly. (Pre-Event) Poly. (Post-Event) 24

25 Limited Tax General Obligation Bonds - Insured 14 Trading Activity (May 1-July 30, 2013) Pre-Event Post-Event Poly. (Pre-Event) Poly. (Post-Event) 25

26 Limited Tax General Obligation Bonds - Uninsured DSA 7 Trading Activity (May 1-July 30, 2013) Pre-Event Post-Event Poly. (Pre-Event) Poly. (Post-Event) 26

27 Limited Tax General Obligation Bonds - Uninsured Non-DSA 60 Trading Activity (May 1-July 30, 2013) Pre-Event Post-Event 27

28 Insured Water and Sewer Revenue Bonds Insured Water Insured Sewer Pre-Event Post-Event Pre-Event Post-Event Poly. (Pre-Event) Poly. (Post-Event) Poly. (Pre-Event) Poly. (Post-Event) 28

29 The Market is Differentiating Among Bond Insurers 9 Post-Event Water & Sewer Trading By Insurer Assured Guaranty Berkshire Hathaway MBIA Poly. (Assured Guaranty) Poly. (Berkshire Hathaway) Poly. (MBIA) 29

30 Our Conclusions - Is this a Watershed Event for the Municipal Market? Potentially momentous implications for sovereign rights of states versus power of federal bankruptcy laws over constitutional protection of pension benefits Potentially watershed revision of opinion regarding the fundamental security offered by unlimited tax general obligation pledge Critical determination of the value that bond insurance may provide in the aftermath of the financial crisis Emphasis on differentiating the source of security backing bond issues becomes acutely important 30

31 31

32 32 APPENDIX

33 Mutual Fund Exposure by Security Provision (% of total MV) Fund Sewer Revenue Water Revenue Unlimited Tax G.O. Limited G.O. Limited G.O. With DSA Parking Revenue Oppenheimer- ORMIX First Investors- FTMIX First Investors- FTTMX Fidelity- FMHTX Nuveen- NUM Nuveen- FMITX AllianceBernstei n- AMIAX Eaton Vance- EMI Wells Fargo- WHYMX Putnam- PXMIX

34 Mutual Fund Exposure by Insurer (% of total MV) Fund Ambac Assured Gty. Berkshire Hathaway MBIA/National Syncora Oppenheimer- ORMIX First Investors- FTMIX First Investors- FTTMX Fidelity- FMHTX Nuveen- NUM Nuveen- FMITX AllianceBernstein- AMIAX Eaton Vance- EMI Wells Fargo- WHYMX Putnam- PXMIX

35 Uninsured Water Revenue Bonds 12 Trading Activity (May 1- July 30, 2013) Pre-Event Post-Event Poly. (Pre-Event) Poly. (Post-Event) 35

36 Pension Certificates of Participation (Insured) 25 Trading Activity (May 1- July 30, 2013) Pre-Event Post-Event 36