February 24, 2014 / 9:27 PM / 5 years ago

Detroit's debt adjustment plan hostile to bondholders -Fitch

Feb 24 (Reuters) - Detroit’s plan to deal with its $18 billion of debt and emerge from municipal bankruptcy would set a troubling precedent for the U.S. municipal bond market, Fitch Ratings said on Monday.

Under the plan Detroit filed in U.S. bankruptcy court on Friday, owners of certain general obligation (GO) bonds would take an 80 percent haircut on their investments.

The city’s two pension funds, meanwhile, would see higher recovery rates, aided by pledges worth about $830 million from philanthropic foundations, the Detroit Institute of Art and Michigan Governor Rick Snyder, who still must win legislative approval for the state’s $350 million share.

“Fitch considers Detroit’s plan of adjustment to be hostile to GO bondholders,” the rating agency said in a statement. “If this priority of creditors is upheld, Fitch expects that this disregard for the rights of bondholders will factor into higher borrowing costs for local issuers, and ultimately for local property taxpayers, in Michigan.”

The rating agency took particular issue with the treatment of voter-approved unlimited tax GO bonds as unsecured. Insurance companies that guaranteed debt service payments on those bonds have sued the city over this treatment.

Judge Steven Rhodes, who is overseeing Detroit’s bankruptcy case, said last week he would rule on the matter in two to three weeks but urged the insurers and the city to settle their dispute before that.

Fitch said it was also troubled by the lawsuit Detroit filed last month aimed at invalidating $1.45 billion of certificates of participation (COPS) it sold in 2005 and 2006 to raise money for its pension payments.

“The plan includes reducing COPs recovery to zero while remaining silent on whether or not the pension system, which benefited from the sale of the COPs, would return any of the borrowed assets,” Fitch said.

Moody’s Investors Service, another major U.S. ratings agency, issued a separate report Monday that noted Detroit workers and retirees fared better in the plan than bondholders.

Moody’s also said the blueprint, which is subject to bankruptcy court approval, would make “significant changes” to the terms of outstanding water and sewer bonds, including the ability to call all of the debt without having to pay any premium or penalty.

One option cited in Detroit’s plan would have the city issue new bonds in the same outstanding principal amount but with lower interest rates.

Standard & Poor’s Ratings Services said on Friday it will review the plan to determine if its treatment of water and sewer debt affects the BB-minus rating on the bonds.

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