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Last week on July 18, 2013, Detroit Michigan filed for Chapter 9 bankruptcy protection. Although Detroit's downward spiral has been widely publicized, the bankruptcy filing has generated widespread media attention. Detroit's bankruptcy filing is the country's largest-ever municipal bankruptcy case and the first time the State of Michigan has allowed a local government to file Chapter 9. However, the next day, Friday, July 19, a Michigan judge declared that Detroit's Chapter 9 bankruptcy filing violated the state's constitution and ordered Governor Rick Snyder to withdraw it, almost guaranteeing delays that will prolong Detroit's predicament.
Whether bankruptcy is allowed to proceed or not, it appears Detroit is lacking the resources to repay its obligations. When it comes to municipal bankruptcy, Chapter 9 is different than a corporate liquidation or reorganization. Detroit will continue to provide some level of services. The bankruptcy protection would be used as a tool to restructure the city's impacted liabilities, estimated to be about $18 billion. The bond market will undoubtedly focus on Detroit's general obligation issues, estimated to be about $1.1 billion.
The municipal bond market has recently experienced some challenges including softening demand. The Detroit bankruptcy could extend this effect. In particular, Michigan-specific issuers could experience some price pressure simply due to geographic association. Also, depending on how the bankruptcy judge interprets the law, credit spreads may widen.
CITY NATIONAL'S VIEW
City National has no direct exposure to Detroit. Importantly, we believe this bankruptcy is not indicative of broader credit stress in the markets. As we have been saying for some time, general municipal credit trends are improving along with the strengthening U.S. economy.
Strategically, the news in Detroit reinforces our managed account focus on revenue bonds, which have dedicated repayment sources, versus local general obligation bonds, which rely on the taxing authority of the issuer as the primary source of repayment.
In Detroit's case, the tax base has been shrinking for decades as the urban population declined and the manufacturing base shriveled. Believing that dedicated repayment sources provide better protection to bondholders, we have avoided significant exposure to local general obligation debt. While maintaining credit quality, our municipal bond strategies are well-positioned in the short to intermediate part of the yield curve, providing us with more flexibility to take advantage of any volatility or dislocations that provide opportunity for enhanced return.
We carefully monitor the markets and will be watching closely for short-term opportunities that help provide longer-term results. Please contact your City National advisor if we may answer any questions or provide insights on fixed income investment opportunities.
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City National Asset Management is the investment management department of City National Bank. This article is for information and education purposes only and does not constitute a personal recommendation or take into account the particular investment objectives, financial situations or needs of individual clients. Clients should evaluate the merits and risks associated with relying on any information provided.