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Wall Street Weighs Detroit's Bankruptcy

Updated with additional information throughout.

NEW YORK ( TheStreet) - Detroit, once the nation's fourth-largest city, has filed for a Chapter 9 bankruptcy after out-of-court restructuring efforts failed on Thursday. Wall Street is now weighing the potential impact of the city's financial problems.

Some analysts said a prominent municipal bankruptcy could pressure the shares of municipal bond insurers such as Assured Guaranty (AGO - Get Report), MBIA (MBI) and Ambac (ABK). However, Mark Palmer of BTIG Research said such concerns could turn out to be unfounded.

" We believe any material weakness in the bond insurers' shares due to Detroit's filing represents an opportunity," Palmer wrote in a Thursday client note.

Ratings agency Moody's said the filing was negative for Detroit's creditors and said benefits of the in-court restructuring are unclear.

"If we're taking a very, very long-term view this could be the point whether the city turns around, but at this time it is a credit negative," Genevieve Nolan, a Moody's assistant vice president wrote in a note.

"It's too early to tell what benefits - if any - come from this action."

While Wall Street looks for spillover effects of the filing, Detroit's worsening financial condition is expected to cause significant hardship for the city and its blue collar workers.

Some key issues precipitating the filing and which will be sorted out in courts are the city's $9.2 billion in unfunded pension and retiree health care liabilities. Meanwhile, Detroit will need to work to gain financing to maintain services to the city's residents, as it negotiates with creditors.

"Before issues like bondholder recovery levels and what level of services city residents will experience become clear, the bankruptcy is likely to be a complicated and protracted process," Moody's said.

"What this does is give the city breathing room," Paul Maco, a partner in the public finance group at Bracewell & Giuliani said in a Thursday evening interview. Maco, who worked with the Orange County, California bankruptcy as a director of the SEC's Office of Municipal Securities, said Detroit's Chapter 9 could take as long as several years.

It remains unclear what role, if any, the state of Michigan or the federal government will play in helping the city emerge from bankruptcy.

A Michigan circuit court judge, Rosmarie E. Aquilina, temporarily barred any further action on Detroit's bankruptcy and asked for the filing to be withdrawn. The state, however, is appealing the ruling and it is to be seen how Michigan or federal law will impact the city's filing.

In bankruptcy, Detroit's pension holders are likely going to be asked for concessions that may have once seemed unthinkable. General obligation bondholders, meanwhile, may see the value of their claims fall to just cents on the dollar.

According to emergency manager Kevyn D. Orr, the city sought bankruptcy after asking creditors to trade in $11 billion in claims for $2 billion in new notes. Detroit's retirement system is the city's largest unsecured creditor with a $2.04 pension claim, while a pension for the city's police and retirement is owed $1.44 billion, the filing bankruptcy shows.

"There might be other defaults to come. Some other General Obligation (GO) bonds might get hit," Peter Tchir, head of TF Market Advisors, said in a Friday note discussing Detroit's filing. Still, Tchir highlighted a nationwide recovery in real estate values is likely to stabilize city and state finances, a positive for the overall municipal market.

Thursday afternoon, as Detroit's filing hit newswires, ratings agency Moody's upgraded its outlook on the credit rating of the United States, a sign of changing times for the city.

Elected officials, corporations and legal experts hold out hope Detroit's bankruptcy could lead to debt and liability reductions that could allow the city to grow once more.

The auto industry characterized Detroit's filing as a shock but a possible new beginning for the city. Detroit's so-called "Big Three" automakers General Motors (GM - Get Report), Ford (F - Get Report) and Chrysler also said the city's plight wouldn't impact their operations.

"GM has assessed the potential implications of Detroit's bankruptcy and we do not anticipate any impact to our daily operations or business outlook," the company said in a Thursday statement. "GM is proud to call Detroit home and today's bankruptcy declaration is a day that we and others hoped would not come," the company added. GM characterized Detroit's filing as a "clean start" that it hoped could allow the city to rebuild services for its 700,000 citizens.

The city's filing comes just four years after the bankruptcy of GM and Chrysler. While both firms emerged from bankruptcy stronger than ever and are part of a burgeoning economic recovery in the U.S., Detroit's finances have continued to deteriorate.

"We believe a strong Detroit is critical for a strong Michigan and our industry. The city has a difficult job ahead, and we are optimistic that governmental leaders will be successful in strengthening the community," Ford said in a statement.

If Detroit's bankruptcy process drags on for many months or years it would contrast with the quick and federally-assisted exits that GM and Chrysler had in 2009.

Orr, the emergency manager appointed by Michigan governor Rick Snyder, has forecast that a restructuring could help the city spend about $1.25 billion in restarting critical services and rebuilding fallow infrastructure.

Orr estimated Detroit may have debts of between $18 billion and $20 billion. Both Orr and Snyder approved the bankruptcy filing, which was made in a U.S. Bankruptcy Court in the Eastern District of Michigan.

"Detroit's broke," Snyder said in a video posted on YouTube. The governor characterized bankruptcy as a 'fresh start' that will allow the city to restructure its debt load and legacy costs, while working to improve services for its residents.

In addition to a long list of creditors, highlighted by a near $10 billion in unfunded pension claims, Detroit also faces significant swap contracts with Wall Street banks that will complicate its bankruptcy.

Bloomberg reported earlier in July that Bank of America (BAC - Get Report) and Swiss banking conglomerate UBS AG (UBS) had agreed with emergency manager Orr to accept 75 cents on the dollar for $343.6 million in swap liabilities, citing anonymous sources.

According to the Bloomberg report, Detroit would refinance remaining debts and would pay about $11 million a month in casino-tax revenue to its swap counterparties.

Prior to its bankruptcy filing, Detroit had said it settled disputes with some large creditors. Earlier in July, the city had sued its bond insurer Syncora for withholding payments on its casino-tax revenue.

The 2011 bankruptcy of Jefferson County, Alabama was the largest in U.S. history before Detroit's filing.

"It is clear that the financial emergency in Detroit cannot be successfully addressed outside of such a filing, and it is the only reasonable alternative that is available," Michigan governor Snyder said in the letter granting his state-required approval.

-- Written by Antoine Gara in New York

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