01.17.14

No Checkered Flag. U.S. Bankruptcy Judge Steven Rhodes yesterday rejected the City of Detroit’s agreement brokered last week in New York City behind closed doors to pay off the Motor City’s disastrous debt deal, stating it was “reasonably likely” the city would succeed in a legal challenge to the transaction. Judge Rhodes described the proposed agreement as “just too high a price to pay for the city to put this issue behind it…It is higher than the highest reasonable number. If it were close, the court would approve it. But it’s not close. The court looked for every way it could to approve this settlement. It could not find a way. It’s just too much money.” Further, Judge Rhodes warned the city must stop making poor financial decisions, making clear it was his federal, judicial responsibility to ensure it emerges from municipal bankruptcy as a financially sustainable municipality: “The court … will not participate in or permit the city to perpetuate the very kind of hasty and imprudent financial decision-making that led to the” original deal. Nevertheless, the judge said he “strongly encourages” the city and banks to renegotiate the deal. The judge also rejected Detroit’s accompanying proposal to borrow $165 million from London-based Barclays to finance the settlement, but he did approve a proposal to permit the Motor City to borrow $120 million to fund improved services — with conditions. By rejecting the agreement worked out in New York City, Judge Rhodes also went against the advice of his own municipal bankruptcy mediator, U.S. District Chief Judge Gerald Rosen, who had both overseen the negotiations in New York and recommended approving the settlement.

The rejection of the swaps settlement could delay the city’s proposed plan of adjustment―which Emergency Manager Kevyn Orr had originally intended to submit to the bankruptcy court last week, because it increases the uncertainty over the city’s future cash flow. Judge Rhodes yesterday made clear the court will carefully scrutinize any plan of adjustment and not allow the Motor City to pursue the same hasty decision-making that led to the swaps agreement, which, he noted, ultimately hurt the citizens of Detroit. Further, the judge said the City of Detroit has convincing arguments that its 2009 decision to pledge its casino taxes as collateral on the transaction was illegal under the Michigan Gaming Act, which limits how the money can be used. He also said the city has a strong argument that the swaps were invalid altogether. In allowing the city to borrow $120 million from Barclays to finance improved services, Judge Rhodes made clear the funds may not be used as “working capital” and can only be used for functions approved by the Michigan Gaming Act. When the city wants to use the money, the judge warned, it must provide details by filing a notice with the court, giving creditors 14 days to object. Detroit currently pays about $50 million a year to the banks in exchange for the swaps, which provided a steady interest rate of about 6% on a $1.4-billion pension funding deal―or the equivalent of nearly 5% of the city’s general fund budget. In addition, Judge Rhodes ruled that Detroit can pursue a debtor-in-possession (DIP) financing with Barclays. The DIP loan was originally for $285 million, but without the need for the $165 million swap termination payment, the new loan will be $120 million. The rejection means the city will have to fight or negotiate anew with counterparties for access to roughly $15 million a month in casino revenues, which emergency manager Kevyn Orr says are crucial to the city’s regrowth. The casino revenue is currently used as collateral on the swaps. The ruling was a shock to global banks UBS and Bank of America Merrill Lynch, which had agreed to accept $165 million to settle the so-called “swaps” deal, but it represented a major win for Detroit retirees, city residents, the pension funds, several European banks, and a bond insurer Ambac Assurance―all of whom aggressively fought the settlement. Because of the court’s decision, all stand to take less of a “haircut.” The ruling increased the likelihood that the city and banks will engage in a high-stakes legal battle over the fate of the deal — a pension debt interest-rate transaction that helped plunge the city into bankruptcy. The judge’s ruling could prompt Detroit to sue the banks, although Judge Rhodes urged the city to continue negotiations. If the city wants to sue, “so be it,” he said. The rejected settlement would have ended a pension deal backed by ex-Mayor Kwame Kilpatrick and generated cash that would have financed $120 million worth of improvements to city services and public safety. Consequently, Judge Rhodes said he would let the city borrow $120 million for quality of life improvements. The city wanted to pay UBS AG and Bank of America’s Merrill Lynch Capital Services $165 million to end an interest rate swaps arrangement tied to $1.44 billion in money borrowed in 2005-06 to prop up Detroit’s pension funds. If it had been approved, Detroit would have paid off the banks from a $285 million loan and spent the balance on city services.

Exiting Municipal Fiscal Distress. Pennsylvania officials yesterday filed an application in the Commonwealth Court of Pennsylvania to vacate the receivership for the steel state’s capital city, Harrisburg, and for the appointment of a coordinator to continue working with the city’s leadership to implement the “Harrisburg Strong” recovery plan. That plan, approved in court last September, had successfully eliminated some $600 million of debt primarily, through the sale of the city incinerator and a long-term lease of parking assets. In the application, attorneys for C. Alan Walker, Secretary of the Department of Community and Economic Development, requested the appointment of Frederick Reddig as coordinator, telling the court: “Vacating the receivership and appointing a coordinator is a necessary and critical step in moving the Harrisburg Strong Plan forward…After decades of financial difficulties and nearly three years of fiscal emergency, this action represents the next step in Harrisburg’s path to fiscal stability.” The state’s application on behalf of Harrisburg cited the statutory conditions that no longer exist which mandated a receiver to direct the city on all fiscal decisions in the wake of Gov. Tom Corbett’s declaration of a state of fiscal emergency in August of 2011 after the City Council three times rejected a state-sponsored workout plan, known commonly as Act 47. The Governor’s action came in the wake of the U.S. Bankruptcy Court’s dismissal of the city council’s municipal bankruptcy filing in the fall of 2011, to which then-Mayor Linda Thompson objected. Mr. Reddig currently serves as acting administrator for the Office of the Receiver, where he works closely with General Lynch—the main author and overseer of the Harrisburg Strong plan, city officials and creditors in the development, negotiation, and support of the plan. General Lynch notes: “Harrisburg is well on its way to full recovery, and I believe Mr. Reddig will serve brilliantly as Coordinator, should the Court authorize his appointment to oversee the implementation of the remaining aspects of the plan.”

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