NEW YORK (TheStreet) -- A Michigan judge's decision not to challenge the City of Detroit's petition to enter bankruptcy capped a banner day for bond insurers Ambac, MBIA (MBI) and Assured Guaranty (AGO), according to BTIG analyst Mark Palmer.
Detroit's Chapter 9 bankruptcy petition and an Illinois State House of Representatives decision to approve a sweeping pension reform bill "capped off a day that surely warmed the hearts of the bond insurers' risk managers," Palmer said in a Wednesday note to clients.
The pension bill in Illinois, which has the support of Governor Pat Quinn, could materially improve the risk profile of the state, according to Palmer. With a $100 billion pension shortfall, Illinois is perceived to be in one of the weakest fiscal positions of all of U.S. the states. Illinois carries the lowest current credit rating of any state.
"The legislation is expected to save $160bn and would fully fund the state's retirement system over 30 years. While Puerto Rico has received much more attention as a problem area for the bond insurers given the sheer magnitude of its debt and the size of their exposures to it, we have heard some bond insurer executives express more concern about their exposures to Illinois and Chicago," Palmer wrote.
Illinois' pension bill could provide Chicago and other municipalities with an outline to solve fiscal shortfalls in a manner that would be positive for the financial community. "Consider that Illinois, a state with a Democrat-controlled legislature and a Democrat governor, essentially crammed down pension reform on its state employee unions," Palmer added.
The Illinois bill wasn't the only positive development for the municipal bond market and the insurers who provide guaranty protection to bondholders, according to Palmer.
On Tuesday, Judge Steven Rhodes of the U.S. Bankruptcy Court for the Eastern District of Michigan ruled Detroit was eligible for Chapter 9 protection. The decision moves forward Detroit's July bankruptcy petition and undercuts efforts by the city's pension and retirement system to keep it out of Chapter 9 protection.
"The real takeaway from Judge Rhodes' ruling, we believe, is that pensions can no longer count on getting 100 cents on the dollar in every municipal bankruptcy due to their recognized super-senior status as they have in the past," Palmer wrote.
"Now, they may be subject to cuts or to being treated as unsecured creditors in the same claim pool as the bond insurers. This new state of affairs could translate into significantly improved recoveries for MBI, AGO and AMBC going forward," he added.
Detroit's pension funds sued the city moments after its July 17 bankruptcy petition, arguing the filing would violate Michigan's constitution if it aimed to impair pension payments. Detroit's emergency manager Kevyn D. Orr and Michigan Governor Rick Snyder maintained their case Chapter 9 case a day later.
"It was the first time ever that a federal judge had ruled that state pension obligations are equivalent to other debt even if they are explicitly protected by a state constitution," Palmer wrote.
On Tuesday, Detroit's pensions said they would challenge Judge Rhodes' confirmation of the city's bankruptcy petition.
Michigan Council 25 of the American Federation of State, County and Municipal Employees filed a notice that it would appeal the decision on Tuesday, as did The General Retirement System of the City of Detroit and the Police and Fire Retirement System of the City of Detroit.
"We're disappointed; we think it's devastating for the retirees," AFSCME counsel Sharon Levine said of the judge's decision. "Unlike in a private company, there is no Pension Benefit Guaranty to protect the retirees. So our retirees, who on average earn $19,000 per year and who run the risk of losing a substantial amount of their pensions, have no safety net," TheDeal's Kelsey Butler reported.
Detroit emergency manager Kevyn Orr said on Tuesday: "We are pleased with Judge Rhodes' decision today, and we will continue to press ahead with the ongoing revitalization of Detroit. We look forward to working with all our creditors, pension funds, unions and lenders to achieve a consensual agreement on a restructuring plan that balances their financial recoveries with the very real needs of the 700,000 citizens of Detroit."
Shares MBIA and Assured Guaranty were little changed on Tuesday, reflecting Palmer of BTIG's belief that " investors have already accounted for the impact of the bankruptcy."
--Written by Antoine Gara in New York