03.18.14

Playing for Swaps. Financial Guaranty Insurance Co., or FGIC, yesterday, along with Detroit’s two pension funds, filed objections in U.S. Bankruptcy Court to Detroit’s proposed plan to end a troubled pension-related debt, challenging a Motor City lawsuit that attempts to repudiate $1.4 billion of pension certificate debt. The challenge involves the proceeds from the issuance in 2005 of so-called certificates of participation or COPs, issued to fund Detroit’s two pension systems. FGIC noted that if the city were successful in overturning the debt, it could expose the pension systems to claims of “unjust enrichment,” which, it wrote to the court, would raise “significant questions about the city’s future, including the feasibility of the city’s existing proposed Chapter 9 plan.”  FGIC insures $1.1 billion of the pension debt; Syncora Guarantee Inc. insures $329 million. In its court brief, filed late yesterday, FGIC claimed it needed to intervene, because its claims would not otherwise be adequately represented. The issue involves the Motor City’s suit filed with the federal court in January to repudiate the pension certificates, or “pension obligation certificates of participation,” naming the two service corporations set up in 2005 to issue the pension certificates as defendants. FGIC argues that the service corporations, which are made up of city officials, will not adequately protect the insurer’s interest if the issue goes to court, claiming in its filing that the city’s efforts the certificates of participation or COPs is “opportunistic and revisionist: “Courts have not looked favorably on financially troubled municipalities that regret and then seek to unwind past promises, years after such promises were lawfully made, and with the knowledge that innocent third parties have relied to their detriment on such promises.”

Last January, Detroit had sued in the federal bankruptcy court against two quasi-legal subsidiaries called service corporations and two trusts created by the city and its two pension funds to handle the complex arrangements brokered in 2005 and 2006, under former Mayor Kwame Kilpatrick, whereby the Motor City sold the pension obligation certificates of participation or COPs to boost funding of the city’s General Retirement System and Police and Fire Retirement System to nearly 100%. In addition, Detroit had also purchased so-called swaps, or derivatives, to permanently lock in steady interest rates around 6% on the arrangement. That swap, however, backfired in a massive way—as happened to Jefferson County, Alabama, when interest rates plummeted. Thus, one critical key to Detroit’s exit from bankruptcy has been to seek to negotiate an end to the swaps agreement with Bank of America Merrill Lynch and UBS—an effort now awaiting U.S. Bankruptcy Judge Steven Rhodes’ decision, after his rejection of two earlier settlement offers, which the federal judge found too generous to the banks—and became one of the most critical factors driving the Motor City into the nation’s largest municipal bankruptcy in U.S. history. Nevertheless, yesterday FGIC told the federal court that Motor City officials knew exactly what they were getting into: Facing enormous pension underfunding which they could no longer honor through conventional means, Detroit had created the complex financial arrangement that ultimately backfired, telling the court: “The city’s opportunism and revisionist history have broad repercussions, not the least of which being the impact on the funded status of the city’s retirement systems, which will be subject to claims of unjust enrichment and the like” if the original deal is voided…“This, in turn, raises significant questions about the city’s future, including the feasibility of the city’s existing, proposed Chapter 9 plan. The issues are complicated and there is much at stake.” FGIC would be on the hook for about $1.1 billion of $1.4 billion and the insurer Syncora about $329 million.

Gambling their stakes? In their parallel filings before Judge Rhodes yesterday, Detroit’s Police and Fire Retirement System and General Retirement System wrote that while they are not opposed to the “economic terms” of the settlement agreement, they do not support the plan, because, they claimed, the city pledges its casino tax revenue as collateral. The unions allege such a pledge is “impermissible” under state law and prohibited by the Gaming Act, adding that Judge Rhodes had previously questioned the validity of the swap counter-parties’ liens on gaming tax revenue under the collateral agreement, in light of the Gaming Act, noting: “It is therefore puzzling that … the city now seeks to have this court approve a new settlement which again pledges the gaming tax revenue as security for its obligations to the swap counter-parties.” Instead the two systems urged that Detroit’s income tax revenue could be used to secure the city’s obligations under the settlement, if approved.

Little Detroit Running out of Gas. The Connersville, Indiana Board of Works and Safety declared a fiscal emergency last week after revenue estimates showed the city would not be able to meet its payroll and claims as of May 1. Mayor Leonard Urban says the city, once known as “Little Detroit,” has lost more than $3 million in revenue since he took office in 2008, and now he warns the town could be insolvent as early as May 1st. The declaration comes after years of persistent general fund deficits in Connersville, a town of 13,000 about 60 miles east of Indianapolis that is the seat of Fayette County. Police officers in Connersville will reduce the amount of gas they use and lose some training opportunities as part of an effort to close a budget shortfall that has forced city leaders to declare the financial emergency―the Board of Works and Safety declared the emergency last week after revenue estimates showed the city would be unable to meet its payroll and claims as of May 1st. Clerk-Treasurer Julie Greeson estimates the municipality’s general fund will have less than $15,000 in the bank as of May 1, yet its monthly payroll and claims typically exceed $700,000. Mayor Urban stated: “After May 1, we won’t have any money to pay anybody.” The Mayor stated the city of 13,335, located 55 miles east of Indianapolis, has lost more than $3 million in revenue since he took office in 2008; he attributes a double cause: the loss of about $100 million in assessed value with the closure of a Visteon plant and the statewide property tax caps that took effect in 2009, noting: “I knew this was coming, but I never dreamed it would come upon us this quick…We’ve been watching our budget, we’ve been not spending, we’ve been trying to be careful….We’ve done everything we know to save money, but when you get these kinds of losses and you still have the same expenses, this is where we are.”

The city hopes to make up $300,000 before its June tax draw by making sweeping cuts and limiting spending to fixing city vehicles that might break down. It also may borrow from another fund. Those austerity steps will affect the police department, where officers will lose their clothing allowance and outside training opportunities for the foreseeable future. Overtime will be limited, and Chief David Counceller said he may have to reduce the number of officers working a shift during peak vacation times. Mayor Urban noted: “We found that if we took away the clothing allowance for everybody, we save $100,000…If we take away all the overtime, just wipe it out, we can save $150,000, and we think if we cut the consumption of diesel fuel and gas, I’m hoping by a third, we can make it to where we need to be in June.” A key issue, according to the Mayor, is the decline in property tax revenues since 2008—some of which Mayor Urban reports, stem from the 2007 closure of a major automobile supply plant, which led to the loss of $3 million in property tax revenue, but then the statewide property tax caps implemented in 2009 under then-Gov. Mitch Daniels amounted to a singular state preemption of local revenues.

Under Indiana law, the declaration of a financial emergency enables the mayor and the city treasurer greater authority to make cuts. Officials said they plan to impose a series of reductions, including limits on public safety overtime, and that they may borrow from a capital development fund in order to make the May payroll. Many Indiana local governments have reported feeling the pinch since the enactment of statewide property tax caps. Local revenue could be further cramped by recent passage of legislation that could mean a decline in personal property taxes, a $1 billion a year revenue stream that flows to municipalities. The city has roughly $12 million of bond debt outstanding. Most of it appears to be unrated.

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