The City of Detroit filed for bankruptcy on July 18, 2013. In this note we analyze the bond market view of City of Detroit bonds from the perspective of one large size, long maturity bond issued in 2010. We analyze the evolution of credit spreads from the issue date through yesterday, that is, both before and after bankruptcy. We note that the credit default swaps on the City of Detroit have never traded according to the data provided by the Depository Trust & Clearing Corporation, so the bond market is the dominant source of information on the market's view.
Conclusion: City of Detroit bonds show the expected widening of credit spreads around the July 18, 2013, bankruptcy date. Even so, credit spreads have been well below the credit spread levels for bonds issued by various Puerto Rico-related entities. Moreover, recent developments in the City's bankruptcy proceedings have driven credit spreads lower by 0.80% in just two weeks.
Analysis of City of Detroit Bond Issues
We analyze all of the 765 trades from the issue date in March 2010 through February 27, 2014, in this City of Detroit bond:
The original issue documentation and current financial information is available from the EMMA website of the Municipal Securities Rulemaking Board ("MSRB").
The early redemption provisions on the bonds are described in this paragraph:
Although some of the bonds issued by the City of Detroit are insured, the offering memorandum makes no mention of any provisions for bond insurance on the notes due in 2035.
We now turn to the market's view of both bonds.
City of Detroit Municipal Bond Issue Yields and Credit Spreads
The MSRB website EMMA includes recent trading activity on a vast array of municipal bond issues in the United States. We use that data to derive the credit spreads of the 5.25% bonds due November 1, 2035, issued by the City of Detroit. From March 18, 2010, through February 27, 2014, there were 765 trades for a total principal value of $271.1 million of the 5.25% City of Detroit bonds due 2035. The average dollar amount per trade during this period was $354,333, with a maximum trade of $28 million. This large trade occurred on March 12, 2010, (March 18, shown above on the EMMA website, is presumably the date that the documentation was finalized), immediately after the bond issue was launched. The histogram of trade sizes is shown here:
(click to enlarge)More than 95% of the trades were very small in size. The median trade size was just $20,000. There have been only 34 trades of $1 million or more. There were 12 trades of $10 million or more, the most recent of which occurred on October 30, 2013 (after bankruptcy). We remind the reader that there were zero transactions in the credit default swaps of City of Detroit during the same period.
On each day for which a trade was reported, the yields to maturity for each trade were collected from the MSRB website. The remaining maturity of the bonds was calculated and the matched maturity U.S. Treasury yield was calculated using Treasury rate information from Kamakura Risk Information Services and the U.S. Department of the Treasury. The credit spread was calculated simply as the bond yields minus the matched maturity U.S. Treasury yields. Because of the current trading levels on the bonds, we ignore the impact of early redemption in what follows. We turn now to those results.
City of Detroit
Distributable State Aid General Obligation (Limited Tax) Bonds, Series 2010
The evolution of yields to maturity and matched maturity Treasury yields on the 5.25% general obligation bonds due 2035 are shown in this graph:
All trades during this period are reflected on this graph with no omissions or smoothing. For the readers' convenience, we have added a smooth line to the reported yields on the 5.25% bonds due 2035. Obviously, the spreads versus matched maturity Treasuries widened significantly around the July 18 bankruptcy filing, as shown more clearly in this graph:
Surprisingly, the credit spreads on the 5.25% bonds due 2035, even after the filing of bankruptcy, are much lower than credit spreads for the Puerto Rico-related bonds that we analyzed recently.
Recent Trades in the City of Detroit 5.25% Bonds Due 2035
The recent trades in the City of Detroit bonds have shown a dramatic narrowing in credit spreads due to recent developments in the City's bankruptcy proceedings:
City of Detroit bonds show the expected widening of credit spreads around the July 18, 2013, bankruptcy date. Even so, credit spreads have been well below the credit spread levels for the bonds of Puerto Rico. Moreover, recent developments in the City's bankruptcy proceedings have driven credit spreads lower by 0.80% in just two weeks.
Regular readers of these notes are aware that we generally do not list the major news headlines relevant to the organization in question. We believe that other authors on Seeking Alpha, Yahoo, at The New York Times, The Financial Times, and the Wall Street Journal do a fine job of this. Our omission of those headlines is intentional. Similarly, to argue that a specific news event is more important than all other news events in the outlook for the organization is something we again believe is inappropriate for this author. Our focus is on current bond prices, credit spreads, and default probabilities, key statistics that we feel are critical for both fixed income and equity investors.
Additional disclosure: Kamakura Corporation has business relationships with a number of organizations mentioned in the article.