Detroit Bankruptcy Not Indicative of Credit Trends
Detroit filed for bankruptcy on July 18, making it the largest municipality to file for bankruptcy, as well as the first time a state’s largest city has filed. While this is a historic event, it’s definitely not unexpected — Detroit’s declining finances date back to the 1960s. A 50-year trend is a pretty telling metric.
Detroit’s Emergency Manager Kevyn Orr stated four weeks ago that he would try to negotiate with creditors for roughly a month before making the decision to file for bankruptcy. When he offered a very unpalatable debt-restructuring plan amounting to less than 10 cents on the dollar, it was, not surprisingly, less than cordially received by creditors. Many market participants opined that a bankruptcy battle — which could possibly result in a more equitable solution from an impartial bankruptcy judge — would be preferable to Mr. Orr’s restructuring plan. Probably the most controversial feature of his plan was the treatment of general obligation debt as unsecured credit.
Water and sewer debt downgraded in June
Invesco municipal funds don’t hold any general obligation or unsecured Detroit debt. Our only exposure comes through two issues involving Detroit’s water and sewer system. The city has about $5.9 billion of water and sewer bonds,1 most of which are insured, including Invesco’s bond holdings, which have Assured Guaranty Municipal Corp. insurance. These revenue bonds have carried an investment-grade rating for years, as they were considered relatively isolated from the city’s financial problems.
The water and sewer bonds hold a statutory lien on one of Detroit’s healthiest assets, making bondholders secured creditors. Most bankruptcy attorneys believe the water and sewer debt will be treated as special revenue bonds not subject to automatic stay in a bankruptcy court. Although this isn’t guaranteed, there is precedent with the bankruptcy of Stockton, Calif., where the water revenue bonds are being paid in full and on time.
Idiosyncratic, not indicative
We view the Detroit filing as an exception to municipal credit trends overall. True first-time municipal defaults for the first half of 2013 totaled $291 million, excluding Detroit.2 That figure is much lower than the $499 million and $775 million in the first halves of 2012 and 2011, respectively.2
This downward default trend supports our view: We don’t expect a significant decline in municipal credit quality outside of Detroit. While we may see some downward credit rating pressure — as was recently seen in Chicago due to unfunded pension liabilities — we don’t anticipate an accelerated trend toward bankruptcy or default.
1 Source: Fitch Ratings Press Release, June 14, 2013
2 Source: J.P. Morgan
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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Invesco Distributors, Inc. is a US distributor for retail mutual funds, exchange-traded funds, institutional money market funds and unit investment trusts. Van Kampen Funds Inc. is a sponsor of unit investment trusts. Both entities are wholly owned, indirect subsidiaries of Invesco Ltd.
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