02.03.14

Heading into the End Game. With the presentation of its 99-page draft plan of adjustment to creditors last Thursday, the announcement of a tentative agreement on post-retirement health care benefits late Thursday, the Detroit Institute of Arts $100 million pledge Wednesday, the expiration of the Motor City’s $120 million debtor-in-possession or DIP loan Friday—and, the city’s announcement late Friday that it had filed suit against the Motor City’s two retirement funds, the Detroit General Retirement System Service Corp and the Detroit Police and Fire Retirement System Service Corp., claiming the complex transactions used to finance the two public pension plans – which raised $1.4 billion – were illegal; Detroit is accelerating the pace into the end game. Adding to the frenzied developments, Detroit faced two critical deadlines last Friday: the city’s $120 million debtor-in-possession loan with Barclays was set to expire at 5 p.m., and the city demanded that its interest-rate swap counterparties present an acceptable offer to terminate the swaps, also by the end the day; and Detroit late Friday announced a suit challenging the validity of the bond deal underpinning the swaps, after the 5 p.m. deadline. The city contends in the lawsuit that the original 2005 pension certificate deal was illegal, because it exceeded state debt limits. The DIP loan and swaps settlement are one linchpin to finalizing Detroit’s final, more detailed bankruptcy plan of adjustment, which the city hopes to file by Feb. 17th. Detroit emergency manager Kevyn Orr has described the $120 million DIP loan, which was inked last October, as crucial to the city’s restructuring, because he had counted on and intended to use the proceeds from the financial arrangement to invest in essential public services critical to the city’s long-term recovery. Bill Nowling, a spokesman for Mr. Orr said the Motor City was in negotiations with other banks and hedge funds for alternative loans while still negotiating with Barclays, noting that Detroit was not yet demanding the return of $4 million of fees it had paid to Barclays. The original agreement had provided for a $350 million DIP loan, which included the $120 million and an estimated $230 million loan that was to be used to pay off the city’s interest-rate swap counterparties. The accelerating pace and intensity of negotiations is focused on presenting the U.S. Bankruptcy court with a final plan of adjustment as early as next week.

The Draft.  The draft plan provided to key creditors for this final round of intense negotiations to try and reach some consensus includes many blanks to be filled in—but the infusion of the projected nearly $700 million in revenues from the State and foundations through the Detroit Institute of Art paved the way for the draft, which suggests and hints at Mr. Orr’s proposed priorities. Because the detailed, draft plan is to attempt to reach a consensus amongst the city’s 100,000+ creditors—through a process, which, if some major creditors do not agree, could lead U.S. Bankruptcy Judge Steven Rhodes to impose a so-called “cram-down,” wherein the court would, in effect, sign off on significant reductions in what the city would have to pay to eliminate its debts to certain parties—the process in some ways resembles the old game of Musical Chairs: “The City encourages all of its creditors to read the Plan, the Disclosure Statement, and the other material that has been approved for use in soliciting votes on the Plan before casting a vote to accept  or reject the Plan, and before choosing among available treatment options.” The Plan identifies seventeen different classes of claims—distinguishing between secured and unsecured claims—and notes that “During the period that ends on June 30, 2023, the GRS trustees (pension) of any successor trust or pension plan, shall adopt and maintain an investment return assumption and discount rate for purposes of determining the liabilities and assets of the Detroit Police & Fire Retirement System that shall not be higher than 6.25%.  Thus, for any creditor, everything could be at stake. In addition, it is a process where both Mr. Orr and U.S. Bankruptcy Judge appear to be motivated by creditors who are not legally present amongst the creditors: Detroit’s future, post-bankruptcy economic sustainability, and its very serious children’s crisis. The draft proposes to elevate unsecured pension debt over unsecured municipal bond debt, with the city’s retirees receiving as much as 40 to 50 cents on the dollar, while unsecured general obligation bondholders would receive between 40 and 20 cents on the dollar. The city said it reserves the right to avoid any lien — such as the casino revenue — securing the swap claim. The unresolved regional water and sewer negotiations will also come into play: the creditors’ pool could be enhanced by as much as an additional $339 million if the city is able to close a deal to lease for 40 years its water and sewer system. The proposed offer calls for the municipalities in the region to pay $47 million a year for 40 years for a total of $1.88 billion. The plan depends on water and sewer bondholders agreeing to waive their call protections so the new authority can refinance the bonds at a savings.

The Suit. After U.S. Bankruptcy Judge Steven Rhodes rejected a $165 million settlement with the Motor City’s swap counterparties, UBS AG and Merrill Lynch Capital Services, saying terms of the deal were too rich. The size of the original DIP deal was ultimately trimmed to $120 million after U.S. Bankruptcy Judge Steven Rhodes rejected a $165 million settlement with the swap counterparties, UBS AG and Merrill Lynch Capital Services, saying terms of the deal were too rich; the Motor City late Friday filed suit to invalidate some complex transactions it had used under former Mayor Kwame Kilpatrick to finance its pensions, contending they were illegal from the very beginning. In a complaint filed in United States bankruptcy court, the city argued that deals with special entities set up in 2005 and 2006, which raised $1.4 billion, were aimed only at circumventing a ceiling on the amount of debt it could take on. The Motor City is asking the federal court to hold that it has no obligation to make payments on its certificates of participation issued to raise the money. In addition, the Motor City is also seeking to cancel some costly long-term contracts that were part of the original financial deal, potentially eliminating any of its original debt obligation of $165 million to the two large banks. In the wake of Judge Rhodes’ earlier ruling that the $165 million proposal was “too much money,” Judge Rhodes had suggested Detroit could bring suit contesting the legality of the transactions. Thus, instead of proposing to pay a smaller amount to terminate the swaps, Mr. Orr is now asking Judge Rhodes to rule the financial deal was illegal from the outset, noting that in 2005, the city was in no position to borrow, so that any capital borrowing was illegal under Michigan law—and that the two banks had, in effect, led a team that created sham corporations in order to make it appear as if those corporations, rather than the City of Detroit, had issued the debt, or, as Mr. Orr noted: “This deal was bad for the city from its onset despite reassurances it would adequately resolve the city’s pension issues…We have tried without success to negotiate a resolution to this dispute and to allow the city and its taxpayers to move forward and unwind these illegal transactions.” As part of its draft Plan of Adjustment (please see above), the draft plan provides that the Motor City would set aside $4.2 million a month in a special reserve in case its suit against the banks failed. If the judge finds that the swaps were not only valid but also a secured credit, then the draft reports the City would use the funds to pay some portion of the claim on the swaps. In case of a partial victory, with the court deciding that swaps were valid, but unsecured, the plan notes that the city would to take back all the funds in the proposed reserve and use them to provide services: in lieu of cash, the plan suggests the city would provide Bank of America and UBS with portions of some notes that the city proposes to issue to unsecured creditors. The swaps have been a big sticking point in the bankruptcy case, because Detroit had previously pledged some casino tax revenue to the two banks to secure the stream of payments the contracts called for it to make. In bankruptcy, Detroit wanted to get the casino money back to use as collateral for a special new loan it needed to finance its activities in bankruptcy. The suit names as defendants the service corporations and trusts that were set up in 2005 to enter into contracts with the city to issue the debt, with Mr. Orr‘s office stating: “This deal was bad for the city from its onset despite reassurances it would adequately resolve the city’s pension issues…We have tried without success to negotiate a resolution to this dispute and to allow the city and its taxpayers to move forward and unwind these illegal transactions.”  The lawsuit names as defendants the four non-profit corporations and trusts which the city itself set up in 2005 to issue and service the debt, with the four corporations comprised of various city officials. Detroit avers in its suit that it was led astray by investment bankers into the financial arrangements not in the public interest, noting the city had only $660 million remaining under its state debt limit as of May 2005, when it issued $1.44 billion of the taxable certificates. In order to fund its two under-funded pension funds, the city therefore had begun “searching for a means” of borrowing over its limit: “In the end, the city – at the prompting of investment banks that would profit handsomely from the transaction – decided to embark upon transactions to sell so-called ‘certificates of participation (COPS)’ to investors…The purpose, design and effect of the 2005 service contracts was to allow the city to borrow money in violation of [state debt law] and other state laws by characterizing the city payments as ‘contractual obligations’ rather than debt service.” Moreover, the suit claims that Detroit failed to seek or receive the approval of the Michigan Department of Treasury before issuing the debt, as required under state law: “City officials turned a blind eye to the requirements of state law and to the city’s desperate financial condition.” The suit notes the financing put “very fatal strain” on the city’s finances.

Wolverine Local Leaders & The Motor City. The Michigan Public Policy Survey found 56% of local officials agree bankruptcy was the right decision for Detroit, while only 11% opposed it. (The full report is available on the CLOSUP homepage: http://closup.umich.edu.), with most saying the Motor City was right to file for bankruptcy. However, more than half said retiree pensions should not be cut as part of Detroit’s exit from municipal bankruptcy. The poll, from leaders of the Wolverine state’s leaders of its 1,353 units of local government was conducted from Oct. 7 to Dec. 13; it was released a few days after Detroit distributed to creditors its draft plan of adjustment. The poll found that 57% of the leaders believed Detroit should not receive any financial aid from either the state or the U.S. 65% of Michigan’s local leaders believe Detroit’s fiscal health is important to the state of Michigan’s fiscal health, and 59% say they are closely following issues surrounding the city’s bankruptcy. Overall, 57% of Michigan’s local leaders believe bankruptcy proceedings will help Detroit cut costs, restructure its operations, and come out of the process in a better financial position for the long term―the bad news: only 24% believe the bankruptcy will help bring about better long-term local policymaking and/or management for the city of Detroit. When asked about a variety of potential impacts—positive, negative, and mixed—that Detroit’s bankruptcy might have on Michigan as whole and on other individual local governments around the state, over half (54%) of local leaders say they expect the state of Michigan’s reputation to suffer, 43% expect costs to rise for other local governments to borrow money, and 41% think the chances will increase that other struggling Michigan jurisdictions will end up in bankruptcy, too. On specific issues related to Detroit’s chapter 9 filing, majorities of local officials generally agree that the top strategies a jurisdiction should pursue during bankruptcy proceedings include cutting costs by increasing service sharing agreements with neighboring jurisdictions (79%), cutting or privatizing services (64%), raising revenue by selling some of the jurisdiction’s assets (62%), and cutting compensation (pay and/or fringe benefits) for current employees (58%). However, 51% of local leaders think that cuts to current retirees’ pensions should be prevented during bankruptcy proceedings, including 15% who think this action should never be taken under any circumstances. The MPPS is conducted by CLOSUP in partnership with the Michigan Association of Counties, the Michigan Municipal League, and the Michigan Townships Association. The survey program is unique in the country as the only ongoing survey targeted at every unit of general purpose local government across an entire state.

Abridge Not Too Far. Despite the lack any firm financial commitment from the U.S. government, Canada Friday confirmed plans to begin buying land in Detroit’s Delray district for the New International Trade Crossing, despite the lack of assurances the U.S. will pay more than $200 million for a needed customs plaza―keeping the critical infrastructure project on track for a 2020 opening. The new bridge would span the Detroit River from southwest Detroit to Windsor: with the construction project projected to create thousands of jobs on both sides of the border. The construction requires right-of-way purchase of about 1,000 parcels of land to be taken in the Delray neighborhood, already one of the most distressed and abandoned districts in the city. The proposal would also begin to assure residents of Windsor — who have long battled with Ambassador Bridge owner Manuel Moroun over truck traffic on Windsor streets and his desire to demolish houses near his bridge — that those battles may ease in the future. Notwithstanding Canadian doubts about the federal commitment of the U.S. government, Roy Norton, Canada’s outgoing consul general in Detroit, told the Detroit Free Press the project was too important not to move ahead despite his country’s doubts about U.S. participation. Canada is paying nearly all of the more than $2-billion cost on both sides of the river and recouping the U.S. share from future tolls. Michigan Governor Rick Snyder, a strong supporter of the project, provoked controversy last month when he told the Free Press editorial board that U.S. officials were stalling on committing to pay for the plaza. The most recent cost estimate for the plaza work, which includes connectors to I-75, was $325 million in 2010.

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