Detroit And Other Municipal Bond Markets You Should Know About

The previous governor of Michigan should have placed Detroit in bankruptcy years ago, according to Reuters financial blogger Cate Long.

“It was a really bad move to let it fester as long as it did,” she told Benzinga.

Long writes about retail fixed income markets, including municipal bonds, and was recently a guest on Benzinga's #PreMarket Prep Show show to talk about Detroit, Kentucky and Puerto Rico.

Plummeting Pensions And Shrinking Schools

Now that Detroit has declared bankruptcy, the trick is getting out of it. Secured bondholders with general obligations bonds are taking about 74 cents to the dollar for their investment, Long said. But in that case, the bond insurers will make up the difference.

Bond insurer Syncora is stubborn city rival in Detroit's bankruptcy http://t.co/NJ1GQG9zbU #muniland

— Cate Long (@cate_long) June 26, 2014

The other big place the city is reducing cash flow requirements is in the pension funds.

Because of the city's “grand bargain,” Detroit is not going to make pension payments for about ten years, Long said, which will be a big relief on the budget.

Another slimmed-down area was retiree healthcare, which was $50 million out of a billion-dollar budget. “Once all the court theatrics get done," she said, "the cash flow for the city of Detroit will be in much better shape."

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Long said the city not raising taxes was a disappointment, because it doesn't collect a lot in taxes to begin with. But Detroit's real pivot will rely on fixing the public school system. Bottom line is, you can't attract people into a community if the school system “sucks,” Long said.

The problem is that school system is a separate legal entity from the city. The school system raises money through property taxes and has its own legal control, Long said, which makes it difficult for the city to make any changes to schools.

In addition, students have the ability to leave the public school system and either go to another community's schools or attend a charter school. Students are able to migrate to different schools, but the Detroit schools they leave still have a fixed cost structure, bonds and debt.

Like any situation with a high fixed cost structure and declining revenue stream, Long said, it get's squeezed. “I think there are many positives about this whole reorganization and this bankruptcy, but in the end, it is a question of community viability,” she said.

“And when your schools are a wreck -- and they are still controlled by the state -- I think it's going to be harder for them to really make the progress they would like to make there.”

Pensions and Nonprofits

Long said Kentucky's public pension system is also in devastating shape. That state's general retirement system has about 23 percent of the assets that it needs to cover future liabilities, which is terrible, she said.

What's unique about Kentucky's situation is that there are approximately 50 non-government-affiliated nonprofits providing social services that were allowed to go into the retirement system.

However, Long said, the retirement system has been loading these massive pension costs onto the nonprofits. One even went into Chapter 11 bankruptc. A bankruptcy judge then ruled against the retirement system and said the nonprofit could leave the system and stiff its liabilities there.

“So, this massively unfunded pension system now may have a massive exodus of all these nonprofits that are struggling to be able to carry the pension cost,” Long said.

Great spot. Kentucky appealed the decision. Will be fascinating to watch "@MuniCredit: @cate_long @FrankRullan Ask KY. #sevencounties

— Cate Long (@cate_long) June 30, 2014

Although this will not disrupt the municipal market, Long said it's a messed-up situation on a legal basis and could be devastating.

Decreasing Tax Base, Increasing Debt

Puerto Rico is in worse shape than both Kentucky and Detroit. It has about $70 billion debt outstanding, Long said, and roughly $20 billion is general obligation debt, which is directly insured by the constitution.

The other $50 billion is corporation debt, which includes things like the water and electric systems. Long noted that Puerto Rico has been in recession for about seven years, and is suffering from a shrinking tax base, because people keep leaving the island. I

n March, Puerto Rico did a $3.5 billion general obligation debt offering. It was rated BB, Long said, making it the largest high-yield municipal offering ever in the market. The yield on those bonds is more than seven percent and is moving toward eight percent now, she said.

“Very, very rich yields,” Long said. “All of the Puerto Rico bonds have extremely rich yields and are higher than basically any bonds globally other than Ukraine and Venezuela.”

Flash points if you need to catch up on the story --> Puerto Rico's whirling inferno of news #muniLand http://t.co/SRAdIrX1ZA

— Cate Long (@cate_long) July 1, 2014

Many people are very hesitant to go in and take the bonds down just because there is so much risk both politically and economically, Long said. “I just think that its more of a political situation and the solution has to be a political solution in Puerto Rico, where they can decide they are going to downsize the government and sort of stabilize the fiscal situation,” she said. Check out the full interview here:

Posted-In: bankruptcy Benzinga #PreMarket Prep Cate LongNews Bonds Markets Interview General Best of Benzinga

© 2014 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

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