07.02.14

Pension Debt & Municipal Bankruptcy. U.S. Bankruptcy Judge Steven Rhodes on Monday denied a motion by the Detroit General Retirement System Service Corporation and the Detroit Police and Fire Retirement System Service Corporation, which were seeking to bar the Motor City’s efforts to invalidate $1.4 billion of debt sold to boost funding for the city’s two retirement systems, noting that the pension debt was “a significant factor in later forcing the city into bankruptcy,” and that the corporations were the proper defendants in the case: “While the city does allege that the service corporations were created to the unlawful purpose of enabling the city to avoid debt limitations imposed by state law, nowhere in the pleadings does the city allege that the service corporations are not distinct and separate legal entities.” The issue related to the suit Detroit filed last January seeking to void the city’s obligation to pay off the pension certificates of participations (COPs), because, the city alleged, they had been illegally sold, thereby voiding the city’s obligation to pay them off. In addition, Judge Rhodes ruled that Financial Guaranty Insurance Co (FGIC), which guaranteed payments on some of the COPs and European banks that had purchased some of the debt, can intervene in the lawsuit seeking to void the debt.

Out of Sync. Judge Rhodes’ decision came on the same day the Motor City and a group of hold-out creditors, including bond insurer Syncora Guarantee Inc., were to attend a court-ordered mediation session over the COPs. Syncora is opposing the settlement between Detroit and its unlimited-tax general obligation (ULTGO) bondholders, claiming the agreement violates both Michigan’s laws and the federal municipal bankruptcy law. The insurer, one of the few remaining creditors opposing the most recent plan of adjustment, filed its objections Monday, claiming that plan cannot be approved by the federal court, because the ULTGO settlement, a key part of the plan, violates Michigan laws governing municipal finance [Unlimited Tax Election Act, M.C. L. §§ 141.161–168], because the city’s proposed Plan “leaves a tax levy in place after satisfying the associated debt obligation, diverts a tax-levy millage to purposes not approved by Detroit voters, and impermissibly assigns certain claim holders’ rights to payment.” With regard to the federal issue, the insurer told the court the federal municipal bankruptcy code provides that “a chapter 9 plan [of adjustment] cannot be confirmed if the debtor is legally prohibited from taking any action to carry out the plan,” writing that here, the proposed settlement violates the Revised Municipal Finance Act (RMFA), writing that: “Specifically, the UTGO Settlement’s primary flaws are three-fold: First, although the UTGO Bond Claims are fully and finally satisfied under the Plan, the UTGO (Unlimited Tax General Obligation) Bond Tax Levy (the “Tax Levy”) remains in place. Second, in direct contravention of the UTEA and RMFA, the Plan redirects the Tax Levy millage to recipients and for purposes not approved by Detroit voters. Third, the UTGO Settlement contemplates a forced assignment of UTGO Bond Claim Holders’ rights to payment to the City’s designee—without the UTGO Bond Holders’ consent.” The issue involves Syncora’s challenge to Detroit’s agreement last April with three of its bond insurers which insure most of its ULTGO debt: Assured Guaranty, Ambac Financial Group, and National Public Finance Guarantee Corp. Under the proposed settlement in the current plan, each would recover 74% on their claims, 500% greater than the city’s initial offer of a 15% recovery. In addition, the city is proposing to treat the debt as secured, and to attach an additional lien of state aid to the bonds. The insurers agreed that the remaining 26% of the tax levy created to pay debt on the bonds could be diverted to set up a fund for the city’s lowest-income pensioners. Syncora claims that this agreement has three, key problems: 1) the tax levy that services the bonds remains in place, even though the ULTGO claims are fully resolved; 2) that the agreement redirects a portion of the tax levy to recipients not approved by Detroit voters; and 3) that the settlement forces bond holders and insurers to assign their payment rights — on the remaining so-called stub ULTGOs — to a city designee without holders’ consent—or, as Syncora alleges, the Motor City is “robbing Peter (the city’s taxpayers) to pay Paul (the city’s pensioners).

Foes to the Right, Foes to the Left…With Detroit’s municipal bankruptcy trial just over a month away, the city’s few remaining holdouts are fighting hard. In addition to Syncora, the Motor City’s two interest-rate swap counterparties, Merrill Lynch and UBS AG, have returned to federal court to aver that the Motor City’s plan of adjustment does not conform to the terms of the settlement they reached with the city. The two banks, which act as counterparties on swaps hedging roughly $800 million of the city’s pension COPs, filed their own notice with Judge Rhode’s federal bankruptcy court this week noting that  they only agreed to sign off on a plan of adjustment if such a plan treated the banks’ rights and claims “no less favorably” than the terms of the settlement agreement—but claimed that – as pending – the city’s most current plan requires that approving creditors release a variety of parties from the threat of future litigation, a provision that the banks say is broader than the terms of the settlement: “[C]reditors who vote in favor of the plan are required to provide releases that are substantially broader than the releases set forth in the settlement agreement,” they argued, noting that the most current plan would mandate the swap counterparties to release both Detroit’s and Michigan’s “related entities” and other “released parties,” which include certain non-debtor third parties that the swap counterparties did not agree to release in the extensively negotiated and specifically tailored settlement releases, alleging that: “Creditors voting in favor of the plan are not afforded an opportunity to ‘opt out’ of the plan releases, which the swap counterparties believe render the plan releases non-consensual.”

Not Water over the Dam. Almost as if ganging up, holders of $5.3 billion of Detroit water and sewer revenue bonds joined in the filing party at the federal courthouse in downtown Detroit this week, filing a brief arguing that the municipal bankruptcy code bars the Motor City’s proposed treatment of the debt in its proposed plan of adjustment—in which the city is proposing to repay principal in full, but to restructure the debt with a lower interest rate and strip it of call protections. Thus, the bond’s trustee, US Bank, and the Ad Hoc Committee of Holders of Certain DWSD (Detroit Water and Sewer District) bonds, argued that the proposals were illegal under the federal municipal bankruptcy code, arguing their claims are protected by the code’s absolute priority or order of payment rule requiring “fair and equitable” treatment of all creditors. In addition, the bond insurers of the water and sewer bonds and Detroit’s unlimited-tax general obligation bonds asked the federal court to approve their exclusive right to vote on the confirmation plan above individual bondholders.

But Who Gets the Water? Unpaid water bills have become an epidemic in Detroit― threatening not just the system’s bondholders, but also the viability of the entire water and sewerage system―and, now, making for very hard choices: whose water to cut off amongst those who have failed to pay their bills in months: at least half the system’s customers. Those non-payments have forced the system to impose an 8.7 percent increase in water bills this year—likely meaning even more of the system’s lower income families cannot afford them. For the system, it is the delicate task of ferreting out: In May, the water department sent out 47,000 shut-off notices, but only had to cut off 4,500 meters—of which a majority involved vacant buildings. For families who cannot pay, the water department has a variety of ways to help, from payment plans to bill subsidies. Currently, 17,000 customers are enrolled in payment assistance plans. A new program for indigent customers is set to launch next month.

Another Detroit? My colleague,the effervescent and exceptional writer and analyst, Natalie Cohen, a senior analyst at Wells Fargo, Tuesday wrote:  “Like many other states, July 1 is a critical date for the beginning of Puerto Rico’s fiscal year (and yet-to-be budget adoption) and for a payment from the electric power authority (PREPA). Last week, as many have read, the government passed the ‘Puerto Rico Public Corporation Debt Enforcement and Recovery Act,’ which provides a dual pathway for three of the largest corporations to restructure: the electric authority, or PREPA; the water authority, or PRASA; and the highway authority, or PRHTA. Two large mutual funds have sued, claiming that the act is unconstitutional. Attorneys Bill Kannel and Len Weiser-Varon of Mintz Levin point out that a key element is missing from the legislation compared to the U.S. Bankruptcy code for municipalities. The legislation allows a borrower that impairs the contractual rights of a creditor to demonstrate that the impairment is reasonable and necessary ‘to advance a legitimate government interest’ but ‘fails to mention a key element of that judicial test (U.S. code), namely the requirement that the government establish that no less burdensome alternatives exist for achieving the legitimate government interest.” Indeed, some fear the possibility of the biggest municipal bond default ever in the wake of the adoption of the new law, passage of which spurred Fitch Ratings to call a default “probable.” Moody’s said the law “suggests the possibility of a restructuring of some kind.” A default on that much debt could dwarf the record $2.4 billion default that preceded Detroit’s bankruptcy last year. Puerto Rico’s restructuring law comes three months after the commonwealth issued $3.5 billion of general obligation debt in a record setting municipal junk bond sale. The territory—neither a state, nor a municipality eligible for federal bankruptcy protection under chapter 9, is caught between a rock and a hard place—and now two Wall Street investment firms are challenging Puerto Rico’s new law allowing some public agencies to restructure their debt, charging that the law violates the U.S. Constitution. Thus, the funds have asked the U.S. District Court for the District of Puerto Rico to block the law, arguing that only Congress is allowed to create bankruptcy rules. The funds hold about $1.7 billion combined in debt from the Puerto Rico Electric Power Authority, which they say they believe will seek to restructure its debt under the act “imminently.” Under the new legislation, some agencies, such as the territory’s power, water, and transportation authorities are provided authority to restructure their debt―those agencies have a combined $19.4 billion in bonds outstanding. (The law does not apply to Puerto Rico’s general-obligation or sales-tax bonds, which are backed by the territory’s taxing authority.) Puerto Rican officials have said no restructuring is imminent, and the Government Development Bank said it stands behind the Public Corporations Debt Enforcement and Recovery Act and will defend it, stating: Puerto Rico has a “sovereign’s right to pass its own debt enforcement statutes in areas not covered by federal law…The Recovery Act was designed to fill a gap in the existing federal insolvency regime and ensure the continuity of critical public services.” But the firms responded that the act is a bankruptcy law and “treads on Congress’s exclusive province in enacting such legislation,” because, they wrote, it allows the power authority to seize the collateral securing its bonds, it also provides for an unconstitutional taking of property. Puerto Rico has about $73 billion in total obligations, including that owed by its public corporations, and has been struggling with high unemployment and a sluggish economy. Its debt is widely held by mutual funds and individuals. The power authority has about $8.8 billion in debt outstanding, while the Highways & Transportation Authority has about $7 billion, and the Aqueduct and Sewer Authority about $3.5 billion, according to a March report by Barclays. Those bonds are separate from the territory’s general obligation debt, and in more immediate trouble, because the agencies behind them are heavily indebted and face mounting deficits and liquidity problems. Fitch Ratings has warned that “bondholders now face a probable financial restructuring or default” by the power authority. Bonds from that agency maturing in 20 years or longer fell 15% last week, while those coming due sooner fell as much as 40%, according to the filing.

 

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