12.18.13

Swapping. The Motor City could run out of cash as early as the end of this month if the U.S. bankruptcy court does not permit it to terminate interest-rate swaps and free up casino revenue, a city consultant testified before U.S. Bankruptcy Judge Steven Rhodes yesterday on the first day of hearings that could last through tomorrow devoted to the city’s proposed settlement with its interest-rate swap counterparts and related $350 million debtor-in-possession financing with Barclays. The city requested Judge Rhodes to consider the city’s request to borrow up to $350 million from London-based Barclays and to pay off an interest-rate deal from 2005 called “swaps,” testifying it could save up to $3 million per month if it were to gain approval to secure bankruptcy financing and pay off a disastrous pension debt deal. Though the parties have been involved in court-ordered mediation for months, the process which commenced yesterday seeks to determine if Detroit can end expensive interest-rate swap deals and secure a $350 million loan, known as debtor-in-possession or DIP financing. Unsurprisingly, a number of groups, including city bondholders and banks, have objected to ending the swaps deal and establishing the financing; however, on Monday the city achieved some progress when bond insurer Assured Guaranty Municipal Corp withdrew its opposition—as Detroit’s retiree committee had previously. If the city gains federal court approval for the deal, it would represent a key step for emergency manager Kevyn Orr. Earning support of at least one class of impaired creditors is one of the minimum requirements for bringing Detroit with its $18.5 billion in debt out of Chapter 9; consequently Emergency Manager Kevyn Orr has made termination of the swaps deal one of his top priorities in order to secure access to the tax revenue from Detroit’s casinos. As Mr. Orr testified last October during Detroit’s bankruptcy eligibility trial, that income is “probably the most stable source of revenue for the city.” About $230 million of Detroit’s loan, provided by Barclays PLC, would be used to terminate the swaps deal, and Mr. Orr hopes to use the remainder to finance quality-of-life improvements, such as the removal of blight, throughout the city. The city is ending the swaps deal by paying UBS and Bank of America’s Merrill Lynch at a discounted rate of as much as 25 percent. Should the city prevail, it would meet one of the minimum legal requirements to request an exit from bankruptcy; yet prevailing faces significant challenges: the proposed swaps deal is opposed by bondholders, unions, retirees and the city’s two pension funds―indeed, nearly a dozen creditors have objected to the effort, urging the court not to let the city proceed with its plans to pay Bank of America Merrill Lynch and UBS about $230 million to exit the swaps, which cost about $45 million a year. But for the Motor City, getting out of the complicated swaps deal could free up the critical casino tax revenue, which amounts to about $170 million annually—it was this revenue stream that was pledged as collateral on the swaps in 2009 to avoid immediate payment of up to $400 million. Detroit wants to use the Barclays cash to get rid of the swaps and invest about $120 million in improved city services, such as police and fire and blight removal. Nevertheless, Judge Rhodes yesterday expressed some concern, noting: “I want to understand — as best you can help me to understand it — what the considerations were that led to the agreement to buy out the swaps at 75% as opposed to some other percentage.” A rejection today or tomorrow by the court would likely delay Detroit emergency manager Kevyn Orr’s plan to exit bankruptcy by September. Ernst & Young consultant Gaurav Malhotra, the Motor City’s first witness, testified that the swaps settlement and Barclays deal would save the city about $1.5 million to $3 million a month―at the same time warning the city could exhaust its cash by the end of 2013 and face a $284 million shortfall by June 2015 if the swaps are not terminated, according to the Detroit News. The settlement would pave the way for the city to access a portion of revenue from its casinos which generate $170 million annually. The settlement would generate between $1.5 million to $3 million in monthly savings on interest rate payments, Malhotra reportedly told the court.

During the hearing yesterday, Judge Rhodes said he was concerned over the 75 cents on the dollar payout the swaps settlement would result in when other creditors face the prospect of a far steeper haircut; he asked how the city arrived at the figure. Indeed, objectors, who include bond insurers and holders of the city’s pension certificates, are expected today to argue against the financing deals, which they believe are too favorable to the swap counterparties and Barclays at the expense of other creditors’ recoveries; however, late yesterday, several insurers and some bondholders agreed to drop their objections after negotiations with the city resulted in changes to the city’s proposed order that eased some of their concerns of the financing and settlement’s impact on their position. During the hearing, the city said that the retiree committee, Assured Guaranty Municipal Corp. and National Public Finance Guarantee Corp. had withdrawn objections.  The swaps settlement, which was reached days before the city filed for Chapter 9 last July, calls for the Motor City to pay UBS AG and Merrill Lynch at least 75 cents to 82 cents on the dollar depending on the timing of the deal. The agreement would give the city access to roughly $11 million a month in casino revenue currently used as collateral on the swaps.

Unappealing. Yesterday Detroit filed an objection against Judge Rhodes’ decision to allow creditors to seek an expedited appeal to the 6th U.S. Circuit Court of Appeals with regard to the city’s eligibility Chapter 9 and that the city’s two pension plans may be impaired in bankruptcy. In its new filing, the city said the appeal should occur in the “ordinary course following the city’s continued efforts to reach agreement with its creditors.”

 “You want to make sure they’re all rowing in the same direction to help the city reinvest in itself and expand,” said James Spiotto of Chapman and Cutler in Chicago. “That’s the only way to grow the city and growing the city is the only way to recover.”

Transfer of Municipal Power & Power Sharing. Detroit Emergency Manager Kevyn Orr and Mayor-elect Mike Duggan are expected to announce tomorrow they have reached a power sharing agreement or working relationship that will give the Mayor-elect control of roughly two-thirds of city operations. The announcement could help address an issue of concern to city leaders throughout Michigan: How much authority could or should a new mayor have in a city that has been placed under the state’s emergency management?  The perception is that to both Emergency Manager Orr and Michigan Governor Rick Snyder it is important for the Mayor-elect to be deeply involved in the city’s restructuring. That would be critical in order for him to seamlessly take over upon Mr. Orr’s scheduled departure date next September. Since his election, Mayor-elect Duggan and Emergency Manager Orr have been meeting once a week, every Thursday. The new arrangement expected to be announced publicly tomorrow would allow the Emergency Manager to concentrate more of his time on negotiating with creditors as the city moves through bankruptcy—and the Mayor-elect to focus front and center on economic development and governance.

Standards for Municipal Eligibility for Bankruptcy. Anne Stausboll, Chief Executive Officer for the California Public Employees’ Retirement System (CalPERS), issued the following statement in response to a Federal District judge ruling (PDF, 92 KB) that granted the pension fund motion for leave to appeal the eligibility ruling in San Bernardino’s bankruptcy case. The judge ruled that she will soon certify CalPERS appeal directly to the Ninth Circuit Court of Appeals:

“We are very pleased with today’s ruling in the Federal District court. CalPERS believes that it is important to have clarity regarding the standard for admission to bankruptcy for municipalities. Today’s ruling ensures that the federal appellate courts will have an ability to provide guidance on this important policy matter. CalPERS will continue to protect the integrity of the public employee retirement system and champion the public employees who serve the citizens and taxpayers of San Bernardino and hundreds of other cities and public agencies across California.”

Trying to Arrest Municipal Bankruptcy. Less than a month after city leaders declared a fiscal emergency in an effort to avoid municipal bankruptcy, as elected and appointed officials in Desert Hot Springs have been seeking options to avoid reentry into municipal bankruptcy, Desert Hot Springs police officers this week independently put forth their own proposal to save the city from insolvency, issuing a report, “Financial Brainstorming Counter Proposal,” in which the Desert Hot Springs Police Association offered a proposal to retain a police force while still saving the city more than a $1.1 million in expenditures―a proposal city councilmembers were set to begin considering last night. The police union proposal outlines a nine-point plan that includes cuts to the police department, including “eliminating two command staff positions,” instituting a hiring freeze, and halting overtime and compensation pay for 17 months. In addition, the plan proposes adding two new taxes to the ballot and either closing or privately funding the city’s year-old Health and Wellness Center. Last month, the City Council had unanimously approved a fiscal emergency in an effort to cut costs by more than $2 million by next June―an action deemed critical in order to pay city employees and other contractual obligations. City leaders had hoped the move would give them more leeway while negotiating with the city’s various unions, including the Teamsters and Police Officers Association. According to city documents, the city is on course to collect revenues of $13.9 million this fiscal year, and spend $18 million. More than $9 million of that is allotted to police and code enforcement services. Under the plan, cuts would be implemented by a 22.5% reduction in salaries, an incentive/education pay cap at 5%, a $520 monthly payment of health benefits per employee, and a reduction to 100 paid holiday hours each year. But to the police union: “If they do this, not only will the existing officers leave, but anybody that would come take this job at the rate that the city has posted will mean that they can’t get a job any place else.” According to city documents, a rank-and-file Desert Hot Springs police position, without an incentive bonus, costs the city about $78,511. This amount includes pay, benefits and other contributions. Without incentives and stipends, the base salary for a regular police officer position is $34,403. According to city documents, as of early October, the highest paid rank-and-file Desert Hot Springs police officer costs the city more than $200,000 annually, while the lowest-paid officer was on course to make in more than $80,000—including pay, benefits and other contributions. A disputed issue is whether union members are or are not under contract with the city. City officials have said publicly that the city’s contract with the police union has expired and that a new contract was never ratified with a vote from the city council, but union officials have threatened to sue the city if it does not recognize they are under contract—an action which the union acknowledges would almost certainly force the city back into municipal bankruptcy. A study last summer by the California Commission on Peace Officer Standards and Training found that violent crime rates in Desert Hot Springs are more than 250% higher than the national average. The commission study also found that funding to the city’s police department has steadily increased to where it now encompasses more than 60% of the city’s budget.

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