One More Lap. U.S. Bankruptcy Judge Steven Rhodes yesterday after nearly an 8-hour hearing announced he would issue his decision a week from today on the Motor City’s request to end costly interest-rate swap agreements, a key issue as the city seeks to exit bankruptcy later this year. Since filing for bankruptcy last July, Detroit Emergency Manager Kevyn Orr has sought to rid the city of the banks’ on $170 million in annual casino revenues, testifying yesterday that he “continue(s) to believe that resolving the swap agreement was in the best interest of the city,” as opposed to the cost of challenging the swap agreements in court: “It was significant. It could be millions of dollars a month.” The issue is whether he will approve Detroit’s proposal to pay UBS and Bank of America $85 million for the debt — after previously rejecting two more generous settlements over the complex interest rate swap tied to $1.4 billion Detroit borrowed in 2005-06 to prop up its ailing pension funds. This third try yesterday for a settlement approval would pay the two banks about 31 cents on the dollar, a significant drop from the 75 percent recovery Detroit originally proposed paying the banks in July. Judge Rhodes earlier rejected settlements of $230 million last December and then $165 million in January—leading Mr. Orr yesterday to testify he was able to get a “steep discount” on the banks’ claim against the city after Rhodes ruled the $165 million settlement was “higher than the highest reasonable number.” In testing whether this a third time would be a charm, Detroit bankruptcy attorney Corinne Ball told Judge Rhodes he has “the authority to compromise disputed liens as secured claims.”

To exit municipal bankruptcy, Detroit has proposed steep cuts to its estimated $18 billion in debt and liabilities, including a $288 million obligation called “swaps.” The swaps — complex pension debt interest-rate bets — were brokered by former and now convicted Mayor Kwame Kilpatrick’s administration in 2005 and 2006 to secure a steady interest rate of 6% on a $1.4 billion pension debt deal. That arrangement went south in the wake of the Great Recession, when U.S. interest rates plummeted, abruptly rocking the Motor City with a surging $50 million-per-year bill.

Rolling the Dice Thrice. During yesterday’s day-long hearing, attorneys for a bond insurer, bondholders, and the public retirees opposed the Motor City’s request, in part arguing that this most recent offer would still be more generous to the two banks than what the city has offered to its other creditors—in addition to raising the threat of further litigation against the banks, because of ongoing concerns with regard to the legality of a lien on casino tax revenues which Detroit granted to the banks in 2009 to stop them from forcing the city to pay as much as $400 million to terminate the swaps. Carole Neville, an attorney for the court-appointed committee representing city retirees, pointedly testified to the court: “The city is asking the court to bless a pledge that’s in direct violation of state law.”

Ms. Neville’s testimony echoed concerns raised by Judge Rhodes, who devoted much of yesterday’s session on the validity of a 2009 lien that UBS AG and Bank of America’s Merrill Lynch Capital Services secured on city casino tax revenues as part of a deal that helped the Motor City originally avoid bankruptcy, repeatedly questioning the validity of the lien, because Michigan law prohibits such pledges involving gambling revenues: “Because the settlement involves the court in blessing this lien, the court has to find that that’s legal under state law…Legally, it raises the lien from the status of arguably invalid to valid.” In his Jan. 16th ruling, Judge Rhodes had written he would not let Detroit continue to make “hasty and imprudent” financial decisions, forcing the banks to make even deeper concessions. In that regard, Mr. Orr testified yesterday he had been prepared to file a 17-count lawsuit in January against the banks, charging them with allegations of “fraud” and “misrepresentation” if they did not agree to settle the debt for less than $100 million, but he told the court he backed off the legal threat when the banks offered to settle for $85 million, pegging their nearly 30 percent “closer” to the 85 percent cuts general obligation bondholders face in the bankruptcy.

In addition, the two banks have pledged to vote in support of Mr. Orr’s plan of adjustment—an important commitment, because it could open the door for the federal court to impose a cram-down on other creditors, or, as Ms. Neville told the court yesterday: “This agreement is still being used as a threat to all of the parties to move to a settlement, because if we don’t, we’ll be crammed down by a $85 million claim.”

Moody Blues. Moody’s yesterday reported that the Motor City’s revised plan of adjustment, which proposes even lower recoveries for creditors than its original proposal, “is a reminder that post-default recoveries for bondholders are likely to be especially low when a defaulter’s economic base is depressed or declining.” Genevieve Nolan, an analyst for Moody’s, noted: “Security standing is a key factor, but even bonds supported by strong security pledges will suffer losses when economic conditions become overwhelmingly negative.” Ms. Nolan wrote that Detroit is seeking to reward those creditors who help expedite the bankruptcy process, and punish those who continue to challenge it, but was apprehensive that the city’s negotiating position could be “eroded” by upcoming litigation, including whether the expected court decision on whether the city’s general obligation bonds are secured, noting: “GO creditors would likely receive higher recovery rates than what the city is offering if the court rules that the GO bonds are secured…Mediation between the city and insurers of the GO bonds resumed in an effort to reach a settlement, possibly precluding the need for the court to rule.”

Toodles. Detroit emergency manager Kevyn Orr, during yesterday’s marathon hearing, testified he wants the city to emerge from bankruptcy by Oct. 15th — about a month after he can be voted out of office by the City Council. Under Michigan’s emergency law, the Motor City Council can vote the emergency manager out of office after 18 months, which, in Mr. Orr’s case, will be mid-September. The action would also require the approval of the mayor, albeit the state law would continue to bar resumption of local control unless and until Gov. Rick Snyder allows it.

Making the Grade in Harrisburg. Harrisburg, Pa. Mayor Eric Papenfuse, with his city back on its feet in the wake of its successful Harrisburg Strong efforts, has urged the state to remove Gene Veno as chief recovery officer for the city’s school district, noting: “My concern is that Mr. Veno does not believe Harrisburg schools will meet academic benchmarks under the plan he devised. This is unacceptable and compromises the future of our children.” The Mayor did say he supports the application of Key Charter School to open a school in the former Bishop McDevitt High School site to stimulate an overhaul of the city’s school district. The announcements and pleas yesterday came in the wake of the state determination late last year the state’s capitol city’s school system was in “moderate financial recovery,” and naming Mr. Veno to the position, after the district’s deficit had scaled up to $16—an escalation of debt that had led to Gov. Tom Corbett’s signing into state law a provision providing for intervention systems for early detection of financial strain and the crafting of financial recovery plans.

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