03.25.14

Readying an Exit Strategy. Amid uncertain negotiations with its neighboring jurisdictions over the creation of a regional water and sewer authority—negotiations which appear to be making little headway, the Detroit Water and Sewerage Department has made public plans to issue $150 million in sewer bonds this June in order to access capital to finance improvements. The move comes not only amid the on-again, off-again discussions with the city’s neighbors, but also as Detroit contemplates restructuring the water and sewer system’s $4 billion in outstanding debt, because of its municipal bankruptcy proceedings. It remains unclear whether the decision might help re-open regional discussions, which ruptured amid disputes over lack of information provided by the city to its suburban neighbors, capital costs, uncollected bills, and other disagreements. Emergency Manager Kevyn Orr’s original, proposed regionalization plan had been a cornerstone to Detroit’s overall bankruptcy exit plan. That plan had contemplated a restructuring of all outstanding debt, under which the debt costs would have been less than the annual lease payments to the city—so that the proposal would have enabled not just greater efficiency and lower costs for users throughout the metropolitan region, but also revenues to the cash-strapped city. Detroit’s RFP for the new proposal requests that underwriters consider various options such as an interim or long-term transaction, a public offering, or private placement. The state also asks the banks to present any recommendations on restructuring the system’s current debt, “taking into consideration the city’s filing for bankruptcy protection under Chapter 9 and its anticipated exit in fall 2014 for both the creation of a regional water authority and DWSD remaining as a department of the city,” according to the city’s RFP. Resources from the State Revolving Fund are also being considered.

Rolling the Dice, or Are the Dice Loaded? Or, will the third roll of the dice be a charm? With still another hearing in federal court next week before U.S. Bankruptcy Judge Steven Rhodes over the Motor City’s interest rate swaps deal, UBS AG and Merrill Lynch Capital Services, Inc. submitted a nearly 2,000 page filing with the court late Friday—the same day the city filed an omnibus response to its creditors’ objections to the deal. In their filing, the two bank counterparties claimed the derivatives at issue were legally secured; they gave notice that the ongoing litigation and failure to settle would, moreover, be, as the Bond Buyer noted: “costly and painful” for the city and its hopes for a sustainable future. Judge Rhodes has scheduled a hearing for Thursday next week on the issue, which calls for Detroit to pay UBS and Merrill Lynch $85 million in exchange for access to casino revenues that serve as the swaps’ collateral and the banks’ approval of the debt adjustment plan. The Motor City and the banks agree the $85 million is a 70% discount off the current cost of terminating the swaps, currently estimated at $288 million. As with other potential agreements with other parties in this complex case, the banks’ agreement of this portion of the city’s plan of adjustment would constitute one avenue to permit Detroit to seek a cramdown for the rest of its creditors. The fate in the federal courtroom, however, is uncertain: Judge Rhodes has rejected the two prior proposed agreements as constituting an unreasonable burden for the Motor City’s future; nevertheless, Detroit on this third roll of the dice argued to the federal court that this time its proposed settlement is “well above the lowest point in the range of reasonableness.” In their March 21st filing, the banks urged approval for multiple reasons, telling the U.S. court:

• Under the Settlement, the City will make payments to the Swap Counterparties totaling 70 percent less than the secured $288 million termination payment the City would owe the Swap Counterparties.

• The 70 percent discount appropriately credits all the City’s potential claims.

• The Settlement allows the City to pay over time, eliminating the City’s need for incremental post-petition financing to settle its differences with the Swap Counterparties.

• The Settlement definitively frees up the City’s wagering taxes and developer payments, improving the City’s cash flow and providing needed certainty.

• If the Settlement is not approved, costly and hotly contested litigation will ensue that will likely take years to resolve.

The two banks warn that if the deal is not approved, the resulting litigation would be “costly and hotly contested.” They warned it would consume years to resolve, otherwise. Nevertheless, the third time might well still not prove to be a charm: Detroit’s retirees and pension funds, and Syncora Guarantee Inc., which insures the swaps, have sharply contested Detroit’s proposed payments since before the bankruptcy was filed last July. But, anticipating both the opposition and the likely reluctance of the federal court, the banks incorporated a grim warning: “The objections ignore both the risks and the costs of complex and lengthy litigation…Moreover, the city’s residents have a compelling interest in seeing a resolution of this bankruptcy and certainty as to the city’s cash flows, which is unlikely to happen in the near term absent a settlement of the claims — and of the many counterclaims that could be asserted by the swap counterparties.” Further, the two banks claim the swaps are legally secured by Detroit’s casino revenue, because Michigan law allows the revenue to be used to improve the city’s quality of life: “The gaming act permits casino revenues to be used to avoid tax increases that would have negatively impacted the quality of life in the city and that would have placed the city’s residents under a severe financial burden.”

The Art of Resolving Municipal Bankruptcy.  If there turns out to be a game-changer resulting in a sustainable future for Detroit, it is likely to be due in great part to the indelible, artful contributions of U.S. Bankruptcy Judge Steven Rhodes and Chief U.S. District Judge Gerald Rosen. Judge Rhodes, who long ago graduated to a Martin steel string, which is the guitar he used to break into the Indubitable Equivalents, now hammers on a Taylor T5, a very sweet instrument, more suited to playing 3 straight hours, anytime of the day or night—that is when he is not trying to obtain syncopation between the 170,000 creditors of the Motor City, or working his guitar magic on his granddaughter, Ava, or his research as vice president of research for the ABI (The American Bankruptcy Institute). His selection of Chief U.S. District Judge Gerald Rosen was critical to the artful, if not musical, plan to rescue the Detroit Institute of Arts’ collection by bolstering city pensions in the city’s bankruptcy, even if foundation leaders initially thought he was nuts. That $815 million plan, including the leveraged proffer of $365 million — as well as $350 million in proposed state aid and $100 million from DIA benefactors — remains the single most innovative and critical element in determining whether Detroit will emerge successfully from its Chapter 9 bankruptcy. The unprecedented proposal would be vital to both creating a state stake in the city’s future, preservation of its world class art institute, and a livable future for its retirees. Yet, almost like a game to see who will dare commit first—and with the legislative clock winding down in Lansing—there is no deal—yet. The foundation boards have approved the outlays to the proposed Detroit Institute of Art fund, and their executives are heeding Judge Rosen’s musical counsel to be patient and let the bankruptcy process unfold under the sweet electric guitar gavel of Judge Rhodes. It seems more as if each of the other parties is waiting for others to act first, like in the old cereal commercial where the bigger brothers and sisters say: ‘Let’s have Mikey try and see if he likes it…’ before stepping up. As the Detroit News put it: “It’s very clear some foundations are a little nervous that these folks are not jumping at the deal,” said a source close to the process. “There’s more than enough patience that no one is going to bolt. The foundations don’t want to be in the position of threatening pensioners.”

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