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Detroit crisis meets euro crisis (Talk about a perfect storm)

These are stories Report on Business is following Monday, July 22, 2013.

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Perfect storm
Euro crisis meets Detroit crisis: You almost couldn't ask for a more perfect storm.

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Dexia SA, the basket case Franco-Belgian bank, said today that it's exposed to Detroit's bankruptcy to the tune of $305-million (U.S.).

Some $75-million is covered by a reinsurer, the nationalized bank said today, and the rest is insured by an insurer now in the midst of a restructuring.

"The group's exposure has been provisioned over time by Dexia such that it will take an additional adjustment of €59-million in its accounts as at 30 June 2013," the bank said.

"Given the expected recovery rate, the amount of the provision equals 48 per cent of the total unpaid principal balance of the Detroit exposure as at 30 June 2013," it added.

"Dexia also has $148 million (U.S.) of additional exposure to municipal entities, related to the City of Detroit which however do not fall under the debt restructuring within the frame of the Chapter 9 filing."

As The Wall Street Journal reports today, European banks could be affected by the Detroit bankruptcy in the wake of a syndicate selling more than $1.4-billion of bonds for Detroit in 2005.

A German bank is also sitting on some $200-million in Detroit debt, the Journal said.

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"Just goes to show how deeply intertwined the global financial system is and doesn't bode well for future transparency in European banking," said senior analyst Michael Hewson of CMC Markets in London.

"Given Germany's reluctance to allow [European Central Bank] oversight of its smaller banks it does make you wonder what other nasties are sitting on bank balance sheets in Europe."

Why Detroit is not alone
Detroit may be a unique basket case, but it's not the only case.

Which is why its bankruptcy is being watched so closely.

One of the key issues in the looming legal battle is the high cost of pensions, which is why unions and pension funds are gearing up for a major battle as Detroit goes through Chapter 9 bankruptcy proceedings.

Indeed, in an interview with the Detroit Free Press, the chief of Detroit's Police and Fire Retirement System put it this way: "Welcome to war."

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Many other cities are watching how this all plays out, with several facing some of the same issues if not the same dire straits.

"The era of 7 per cent to 8 per cent actuarial interest rate assumptions to deflate the value of these pension obligations is, thankfully, over," said chief economist David Rosenberg of Gluskin Sheff + Associates.

"And Detroit is only the opening act even if its problems are unique to a city in secular decline and dilapidation (35 per cent of its residents are on food stamps, the population is down some 2/3 since the city's peak as an industrial powerhouse in 1960)," Mr. Rosenberg said in a report today.

"Chicago is the next culprit, underlined by its huge credit rating downgrade last week (three notches to A3 due to, surprise, surprise, 'very large and growing pension liabilities'). Not to mention various municipalities in California."

Mr. Rosenberg said he wouldn't make a call on a similar bankruptcy filing by Chicago, because of the unique nature of Detroit's troubles. But, he added, "Chicago has too many similarities to ignore."

Last Wednesday, a day before Detroit's emergency manager Kevyn Orr filed for the biggest city bankruptcy in U.S. history, Moody's Investors Service downgraded Chicago, citing its general obligation debt of $7.7-billion (U.S.) and its "large adjusted net pension liability."

"The downgrade of the [general obligation] rating reflects Chicago's very large and growing pension liabilities and accelerating budget pressures associated with those liabilities," Moody's said as it announced the downgrade, noting a total unfunded liability, as reported by the actuaries of the four pension plans, of $19-billion.

Using its own "more conservative assumptions," however, Moody's pegged the amount at $36-billion.

"The negative outlook is based on the dramatic spike in annual pension payments scheduled to take effect in the 2015 budget year (payable in 2016) under state law, which will place material strain on the city's operating budget," Moody's said.

In 2015, according to Moody's, state laws will mean the city must boost its pension contributions to $1.2-billion, from just $467-million in 2014.

"The outlook incorporates the likelihood of continued growth in unfunded liabilities in the city's four pension plans given currently suppressed contributions from the city. The outlook also reflects the States of Illinois' … constitutional protection of pension benefits."

It was referring to the fact that the state constitution protects pension benefits, and move to cut benefits would thus face a court battle. Add to that the "limited political appetite" to hike taxes to help cover those costs.

Chicago Mayor Rahm Emanuel has called for "comprehensive pension relief" from the state.

In Detroit on Friday, a state judge ordered Detroit to withdraw its application because of similar constitutional guarantees of pension benefits.

That was the first salvo in what is bound to be a lengthy fight in Detroit.

Michigan, which authorized the move, is appealing that ruling, posing the first issue for Steven Rhodes, the U.S. bankruptcy judge who's overseeing what has fast become a case that will set a U.S. standard.

Judge Rhodes will hear the first arguments on Wednesday related to Detroit's bid to suspend retiree lawsuits over the pension issue.

As Detroit Mayor Dave Bing noted yesterday, more than 100 American cities are in trouble, which is why all eyes are on the Motor City.

"We may be one of the first," Mr. Bing told ABC. "We are the largest. But we absolutely will not be the last. And so we have got to set a benchmark in terms of how to fix our cities."

Mr. Orr wants it done by next fall, but that seems a long shot. It's the equivalent of a corporate restructuring, but far more complex.

As for the creditors, who face substantial haircuts, Michigan Governor Rick Snyder fired a warning shot over the weekend.

"Realistically, if you step back, if you were lending to the city of Detroit in the last few years, didn't you understand there were major issues and problems?" he told CBC.

CN profit climbs
Canadian National Railway Co. today reported a profit of $717-million, or $1.69 a share, in the second quarter of 2013, surpassing analysts' expectations as the company continued to move increasing volumes of fuel and chemicals.

The report marked a sharp increase from the year-earlier period, when CN posted a profit of $631-million, or $1.44 a share, The Globe and Mail's Richard Blackwell reports.

Chief executive officer Claude Mongeau said the company showed strong execution in the second quarter.

"Looking forward, despite slower volume growth than anticipated, the CN team will maintain a keen focus on growing revenues faster than the overall economy as well as on tightly managing costs to meet our full-year financial outlook," he said.

Apple takes down developer site
Apple Inc. has taken down its developer site after an attempt by a hacker to breach it.

Apple stressed in a statement on the site that "sensitive" information could not have been stolen, but some information may have been.

"Last Thursday, an intruder attempted to secure personal information of our registered developers from our developer website," the tech giant said.

"Sensitive personal information was encrypted and cannot be accessed, however we have not been able to rule out the possibility that some developers' names, mailing addresses, and/or email addresses may have been accessed," said Apple, which reports earnings tomorrow.

"In the spirit of transparency, we want to inform you of the issue. We took the site down immediately on Thursday and have been working around the clock since then."

Apple said it is "completely overhauling" its systems.

Intact to book losses
Intact Financial Corp. says it will book $257-million of catastrophe losses as a result of several recent freak storms, floods and the deadly Lac-Mégantic oil train crash.

Toronto-based Intact, which bills itself as Canada's largest provider of property and casualty insurance, says it plans to record after-tax losses of $123-million or 92 cents per share, net of reinsurance, in its second-quarter results, out July 31, The Globe and Mail's Bertrand Marotte reports.

The company said it also expects to book a further $134-million after-tax or $1.01 per share, net of reinsurance, in the third quarter.

The losses are related to damages resulting from the Alberta flooding, Lac-Mégantic derailment, severe rain storm in the Greater Toronto Area and early July hail storms.

McDonald's sees challenges
McDonald's Corp. today warned of challenges in the fast-food market as its quarterly results disappointed investors.

The burger chain posted a jump in profit to $1.4-billion (U.S.) or $1.38 a share from $1.35-billion or $1.32 a year earlier, while revenue rose to $7.1-billion from $6.9-billion.

"While the informal eating out market remains challenging and economic uncertainty is pressuring consumer spending, we're continuing to differentiate the McDonald's experience by uniting consumer insights, innovation and execution," said chief executive officer Don Thompson.

Mr. Thompson projected that same store sales would be flat in July and that "our results for the remainder of the year are expected to remain challenged."

Maple Leaf, Domtar in deals
A couple of corporate deals to note today: Maple Leaf Foods Inc. is selling its turkey operations, and Domtar Corp. its U.S. Ariva unit.

Maple Leaf announced deals to sell its commercial turkey farms to Ernald Enterprises Ltd., while its breeder farms and hatchery operations go to Cuddy Farms Ltd.

No financial details were disclosed. Among the provisions is a long-term supply commitment from Ernald.

"The transaction ensures a long-term supply of high quality turkeys at competitive prices," said chief executive officer Michael McCain.

Domtar, in turn, is selling its U.S. Ariva unit to a division of Central National-Gottesman, which in turn will sell the Midwest part of that business to The Millcraft Paper Co.

The Canadian operations of Ariva will be folded into Domtar's pulp and paper operations.

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