12.19.13

Swapping. U.S. Bankruptcy Judge Steven Rhodes abruptly suspended hearings on Detroit’s proposed $350 million debtor-in-possession (DIP) financing and settlement with its interest-rate swap counterparties yesterday and urged the Motor City to use the time to renegotiate the swaps termination agreement. The city is asking the court to enter an order approving motions that allow for the post-bankruptcy petition DIP financing, the pledging of liens, and a super priority claim status, and modifying the bankruptcy’s automatic stay. A pledge of the city’s casino revenues currently backs the swaps, and would be shifted to the DIP deal if approved. City income taxes would also be pledged. The DIP agreement with Barclays expires on Jan. 7, 2014. Judge Rhodes has scheduled a status conference for tomorrow morning, urging Detroit to renegotiate a proposed debt settlement with Bank of America Merrill Lynch and UBS. The city has argued that it must pursue the swaps settlement and bankruptcy financing to free up cash flow and reinvest in city services. The swaps cost the city about $50 million a year, diverting about 5% of the city’s revenue to an expense that has nothing to do with city services. Judge Rhodes urged the city to use today to seek to renegotiate the proposed settlement that would allow the city to terminate swaps tied to its pension certificates for a 75 cents to 82 cents on the dollar payout. The city would use about $230 million from the DIP loan to finance the termination costs. The Motor City has so far been unable to resolve how to address the issue with key objectors in the case — the city’s pension funds and Syncora Guarantee Corp., which insures the swaps as well as a portion of the $800 million of pension certificates that the swaps hedge. The groups have opposed the transactions believing the terms are too favorable to Barclays and the bank counterparties at the expense of other creditors. The city wants the issue resolved in order to free up much needed casino revenues that would be held up should the city and counterparties be forced to litigate the swaps’ status. If the settlement falls through, the counterparties run the risk that the swaps could eventually be lumped into the unsecured category. Ernst & Young consultant Gaurav Malhotra had testified Tuesday that Detroit could exhaust its cash by the end of this year and confront a $284 million shortfall by June of 2015 if the swaps are not terminated. The settlement would generate $1.5 million to $3 million in monthly savings on interest rate payments. At the same hearing, Detroit City attorney Corinne Ball testified the DIP “represents the best feasible financing realistically available to the city in its current condition, when the city is only able to offer limited collateral and insists on remedies that preserve the city’s ability to operate, even in the face of default.” Mr. Orr yesterday testified the city was prepared to pursue litigation challenging the swaps “if we had to,” but the city chose the settlement route to avoid a costly legal battle, stressing the city’s overriding intent behind pursuing the DIP and swap settlement: freeing up casino revenue pledged as collateral to the swaps in order to stabilize city finances: “[The] casino revenue is the single most stable revenue available to the city. Without it the city could not operate.” (The casinos currently ring up about $170 million annually.)

In fact, negotiations have achieved some progress this week, with the number of objectors lessening: some bondholders and two bond insurers dropped their disputes after negotiations with the city resolved their concerns over the agreements’ terms, and the Motor City added language to its proposed order protecting revenues pledged to sewer and water bonds from being used to repay the DIP and property tax revenues that would go to repay GO debt should the court ultimately reject the city’s treatment of most of its GOs as unsecured. The swaps settlement, which was reached days before Detroit filed for municipal bankruptcy last July, have, the city has admitted, “Litigable” issues, as bond insurers have argued, including the characterization of casino revenues as special revenues and the validity of a 2009 agreement that named the casino revenues as collateral.

The DIP financing consists of two loans: Swap Termination Bonds, totaling $230 million, and the Quality of Life Bonds, totaling $120 million. The loan features a super-priority lien for Barclays on income tax and casino revenues as well as proceeds of more than $10 million on any sale of the city’s assets. The $350 million notes carry an interest rate based on the London Interbank Offered Rate plus 2.5%, plus a 1% LIBOR floor, translating into an effective rate of 3.5%. If Detroit defaults, the spread would rise by another 200 basis points. The Motor City, in a filing this week, disclosed that Barclays will also receive a nearly 1.25% fee, or $4.4 million, to process the DIP restructuring while the city is in bankruptcy. Half has been paid, even though the court has yet to approve the agreement. The notes mature in 2.5 years, or when the bankruptcy case is dismissed or a plan of adjustment is accepted, whichever is earliest, according to the term sheet. It remains to be determined if the loan will be tax-exempt. The city is required to use any proceeds over $10 million from an asset sale to redeem the notes. The deal includes a so-called lockbox structure, where the casino and income tax revenues will flow first into a bank account controlled by Barclays. In the event of a default, $4 million of each revenue stream will be set aside, and the city can continue to access the rest.

In the midst of the trial this afternoon, a dispute erupted over whether the city should be forced to disclose its assessment of the legality of the swaps, which were brokered under Mayor Kwame Kilpatrick’s administration in 2005 to secure a steady interest rate on a $1.4 billion pension debt deal. Judge Rhodes, expressing dissatisfaction, made clear he needs to better understand why the city agreed to pay 75 cents on the dollar to 82 cents on the dollar — it would be about $230 million today — to get rid of the swaps, noting that that 75 cents on the dollar is typically a great deal for creditors in bankruptcy: “Every transaction — including this one — that the city has entered into in connection with these swaps … has been with a gun to its head…That has to stop…And I think it’s part of a bankruptcy judge’s role to carefully scrutinize a debtor’s request to approve a settlement when that settlement was made with a gun to the debtor’s head.” The city is currently treating the swaps as secured debt, meaning it has to be paid off. But if the city successfully challenged the swaps in court, it could save hundreds of millions of dollars. But in his testimony yesterday, Mr. Orr asserted attorney-client privilege, when he refused to make public internal legal memoranda with regard to why the city chose not to sue the banks. He testified that the city had considered lawsuits against UBS and Bank of America, but decided it would be “costly” and it would take too long with no guarantee of success. Consequently, he said, it would be better to pay them off at a discount. In addition, the city’s investment banker, Ken Buckfire, had testified earlier this week that if the city challenged the legality of the swaps, the banks would trap the city’s casino tax revenue, which was pledged as collateral on the deal in 2009. Mr. Buckfire said that if the banks won the challenge, the banks would be owed up to all of the city’s casino revenue for three to four years, telling the court: “At that time, the city would be dead. It was not a risk worth taken.” Yesterday, Mr. Orr testified that Detroit must rid itself of the swaps to regain direct access to its casino tax revenue, which amounts to about $170 million per year: “Casino revenue is the single most stable source of revenue available to the city and without it the city couldn’t operate.”

Innovative Blight Initiative in the Motor City. Dan Gilbert, a task force co-chairmen of the new Detroit Blight Task Force, yesterday vowed to create an extensive, detailed database of every parcel in the city that will serve as the blueprint to erase all blight, an issue that has defined the city for decades: “This is going to be a massive undertaking…Let me tell you, either we are going to get this done or we are going to die trying.” The task force this week began the awesome task of attempting to count every single parcel in Detroit—an endeavor to track the Motor City’s entire 139 square miles. The unprecedented Google-type mapping involves volunteer surveyor teams—with the Detroit Police Department kept updated about where the team is at any time and contact with the project’s command central, located on the second floor of Wayne State University’s Techtown project. The crews have tablets with programs created by local entrepreneurs at Loveland Technologies that allow them to photograph and take notes on every parcel they view. The goal is to construct the most extensive property database of deteriorating and abandoned structures in history, with the information to be used to create a real time, public database. So far, more than 60,000 properties in Detroit have been documented, task force officials. Subsequently, the task force will produce a report to “make very specific and detailed recommendations to remove all blight.” The report will include an analysis of cost, recommendations on how to reduce the legal and bureaucratic hurdles, and what community organizations can help. The task force was created in September through a federal, state, and city partnership that also includes private foundations and businesses. The task force is directed by three co-chairmen: Quicken Loans Inc. founder Dan Gilbert; Glenda Price, president of Detroit Public Schools Foundation; and Linda Smith, executive director of the east side nonprofit U-Snap-Bac. The database portion of the project is being paid for by the Skillman and Kresge foundations, the Michigan State Housing Development Authority and Gilbert’s Rock Ventures.

The Heavy Costs of municipal bankruptcy.  A perspicacious reader yesterday inquired about perspectives on the cost of municipal bankruptcy for the Motor City. Detroit, to date, has spent $41.6 million so far on its restructuring, owes $16.4 million more in outstanding consulting bills, and could spend another $37.6 million, according to the most recent summary of costs provided by Emergency Manager Kevyn Orr’s office―or nearly $100 million in a city with an annual budget of close to $1 billion that has made cuts of $250 million. From a human perspective and comparison, last year the Detroit City Council voted to cut the city’s police department budget by $93 million to an annual level of $339 million—despite a 10% increase in the city’s murder rate, with a high number involving children. The largest chunk of Detroit’s expenses for the bankruptcy has gone to Jones Day, the law firm handling the city’s municipal bankruptcy case, which has been paid $8.2 million and has billed the city for another $7.5 million. Conway MacKenzie, which consults the city on operational restructuring, has been paid $4.6 million, with another $3.4 million in outstanding bills. Ernst & Young, for financial advising, has been paid $3.9 million and has billed for another $1.5 million. Plante Moran provided accounting services for $2 million, and Miller Buckfire has added restructuring advice for $1.2 million, according to the document. Other firms have been paid under $1 million for services ranging from public relations consulting to the appraisal of the Detroit Institute of Arts collection. The total amount spent so far for “core restructuring advisors” is $22.4 million. Another $19.1 million is listed under “other restructuring.” The city is trying to shed $18 billion in debt in bankruptcy court. The total amount that could be spent under approved legal and consulting contracts is $94.6 million. The state could reimburse some of the costs, but only up to $5 million.

Less Harried in Harrisburg. The city of Harrisburg, having opted not to go through chapter 9 municipal bankruptcy, appears to be poised to exit its severe fiscal distress and on a road to recovery after a half-decade of accumulating debt and deficits and political paralysis—and without the wrenching steps of going after promised pension and health care benefits. The city expects to price $286 million of tax-exempt bonds to finance a lease of its parking system this week in order to capitalize repayment of its accrued liabilities. By negotiating with creditors and unions out of court, the city avoided many of the costs of municipal bankruptcy while building the framework for a sustainable future. Harrisburg owes $362.5 million, or about seven times its general-fund budget, because of debt guarantees on a 2003 overhaul and expansion of an incinerator―an incinerator which burned cash instead of generating enough revenue to cover the debt. The proceeds of the sale and the lease of its parking system will be used to meet obligations to the city’s creditors—but also to economic development and infrastructure in the city, with the sale set to close early next week, according to the office of the city’s state-appointed receiver. As in San Bernardino and Detroit, this is happening during a change in city leadership: Eric Papenfuse will be inaugurated as mayor next month. Under the capitol city’s recovery plan, Mayor-elect Papenfuse will be required to have balanced budgets for the next three years. The mayor-elect notes the challenges he will face, because the threat of municipal bankruptcy had made it difficult to attract business: “We haven’t been able to do that over the past several years because of the uncertainty in the air…With that lifted, the future of the city is bright.” As in San Bernardino and Detroit, Harrisburg has disproportionate percentages of its citizens in proverty―31.6% compared with 12.6% statewide, according to Census data, and a 9.2% jobless rate compared with the state average of 7.5%. In October 2011, before Harrisburg was placed under state receivership, the city council filed a bankruptcy petition that was thrown out within a month by a federal judge: it was not authorized by state law. As part of its recovery plan, Harrisburg’s unions agreed to receive less than they are due, though pensions will be intact. In Harrisburg, police officers and municipal employees will not receive the raises this year and next that were originally in their contracts. Officers hired after January will no longer receive longevity pay.

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