A common question we get is how the market determines the YTM on a
bond. One thing that investors do is look at history to see how the
corporation or municipality has treated its investors. A recent bankruptcy proposal
in the Detroit bankruptcy may increase the future YTM for Michigan
municipalities and possibly all U.S. municipalities. Investors have
generally believed that a municipality would increase the tax rate in
order to repay outstanding bonds. The proposal made by Detroit's
emergency manager calls for:
- Paying pension funds at a rate of 45 to 50 cents on the dollar.
- Paying retiree healthcare liabilities at 13 cents on the dollar.
- Paying $1.4 billion of loans made to fund the pension fund at 20 cents on the dollar.
- Unlimited-tax general obligation bondholders would receive 45 cents on the dollar
- Limited-tax bondholders would receive 28 cents on the dollar.
If
the plan is permitted by the bankruptcy judge, future municipal
bondholders will likely demand a higher interest rate since they would
effectively be classified as subordinated creditors.
