Detroit Bankruptcy: Bond Insurers Made Last Ditch Counterproposal to No Avail

Representatives of the insurers -- Assured Guaranty Ltd. MBIA Insurance Corp. and Ambac Assurance Corp. -- crafted the plan in response to the proposal Detroit Emergency Manager Kevyn Orr made to creditors in June. The insurers' plan involved refinancing both Detroit's secured revenue bonds and its general obligation bonds with new debt along with uninsured bonds, some of these people said. Central to the proposal is using the AA credit rating of some insurers to refinance debt at a favorable rate over a long time-period, one of these people said. Mr. Orr's proposal entailed refinancing only revenue bonds.

Much of Detroit's municipal bonds were sold with insurance policies, or wraps, from insurers that guarantee interest and principal payments to bond holders if the city defaults. When wrapped bonds fall into default, the insurers step into bondholders' shoes as creditors.

In June, Mr. Orr proposed a restructuring in which unsecured bond holders would recover less than ten cents on the dollars and revenue bonds would be repurchased or swapped for bonds of equivalent value sold by a newly created water and sewer authority. By restructuring the water and sewage bonds under a new authority, Detroit would have been able to dip into excess revenues currently pledged to the existing bonds but it needed agreement from the insurers to make the change, people familiar with the matter said.

The insurers responded this week by proposing to insure new bonds sold by Detroit to refinance both revenue and general obligation bonds they had already wrapped, avoiding defaults on the unsecured debts they had insured, the people familiar with the matter said. The counterproposal also allowed for Detroit to claim surplus water and sewage revenue not needed to service the bonds, some of the people said. Some insurers also pressured the emergency management team to explore auctioning off the city's art collection to help repay creditors, though that was not officially part of the counterproposal, another person familiar with the matter said.

Representatives of the insurers and the city met throughout the week to discuss the counterproposal but Detroit's Chapter 9 filing became public during those negotiation, one of these people said, and they failed to broker a deal in time.

The office of the emergency manager did not return requests for comment. An official at Miller Buckfire, Detroit's financial advisor, declined to comment.

Detroit's bonds break down into two broad categories: About $5.3 billion of the debt is secured by revenues from water and sewage utilities and $1 billion are general obligations of the city, according to the city's restructuring proposal.

The so-called revenue bonds are considered far more valuable, in large part because Detroit's water and sewage services serve surrounding suburban communities that are still solvent, the people familiar and investors said. A bond backed by Detroit water revenues due 2041 traded at 93 cents on the dollar Friday, according to data from the Municipal Securities Rule Making Board, or MSRB.

The general obligation bonds backed only by the city are unsecured and expected to recover far less in bankrutpcy, they said. Ten-year general obligation bonds traded around 39 cents on the dollar Friday, according to pricing service Markit.

Insurance companies guaranteed billions of dollars of revenue bonds but also have significant exposure to the general obligation debt. Assured, for example, had policies on $1.79 billion Detroit revenue bonds and $321 million in general obligation or general fund debts as of May 31, while MBIA had $2.39 of revenue bonds exposure and $101 million of general obligation exposure as of December 31, according to press releases. Ambac Assurance disclosed $170 million of general obligation bond exposure on July 8.