Getting Ready to Rumble in the Motor City & Fitch Likes Chapter 9 Fix for Puerto Rico

August 7, 2014
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Trial Delay. Rhythm guitar playing Steven Rhodes of the Indubitable Equivalents (see photo from the Wall Street Journal), who last month was strumming old band favorites for attendees at the American Bankruptcy Institute’s annual meeting in Vermont (classics for you to croon like: “Born to Be Wild,” “Honky Tonk Women,” and “Running on Empty”), yesterday played a different tune at the bar, where, as the U.S. bankruptcy judge overseeing the pending trial to determine whether to approve the Motor City’s proposed plan of adjustment, Judge Rhodes rejected Syncora Guaranty’s motion to delay the commencement of the trial scheduled to start on August 21st. Syncora, with some $7 billion at stake, and one of the few remaining holdout creditors of the city, argued before the bench that Detroit has missed critical deadlines to provide it with key documents. The judicial action came as Toyota yesterday pledged $1 million towards the so-called grand bargain—helping the Detroit Institute of Arts sum up some $80 million—or 80% of its announced goal of $100 million—with the funds, including $195 million from the State of Michigan, to be directed towards ensuring that no Detroit retiree falls below the federal poverty level and that the Detroit Institute of Arts could become a foundation—remaining a key institution in the Motor City.

Bonds on Tap? After weeks of confidential mediation sessions with the city’s major bondholders and insurers, the Detroit Water and Sewerage Department yesterday confirmed it had reached an agreement by which it will be able to refinance up to $5.2 billion in debt, possibly helping to accelerate resolution of the Motor City’s successful exit from municipal bankruptcy and enabling the department to reduce rates to customers—an issue where, because of shutoffs for non-payment—the federal bankruptcy court has raised concerns. The Michigan Finance Authority would issue the debt. In a statement the authority released, it wrote: “This transaction has the potential to significantly lower the interest rate on existing DWSD bonds, reduce DWSD’s debt service costs, reduce risks and transaction costs, and enhance the department’s future cost of borrowing…The savings to DWSD customers could be in the millions.” Under the DWSD plan, effective today through the 21st, the day Judge Rhodes currently intends to open the confirmation trial for the City’s proposed plan of adjustment, holders of the water and bonds will have ten days in which to accept the offer to tender their debt to help the city embark on a massive refinancing of the water and sewer department debt portfolio―with the offer serving as an alternative to Detroit’s current proposals seeking to have its water and sewer bondholders either waive their call protection, allowing for a refinancing, or to accept a lower coupon rate. Under the proposal, bondholders may their bonds or tender them at a fixed tender offer price—a price which was not, as of yesterday, made public. The tender price will be financed either by a bridge loan from Citi, a public offering of exit tender bonds through the Michigan Finance Authority, or a combination of both. Under the plan, bondholders that do tender the bonds would have to agree to drop all objections to the Motor City’s plan of adjustment, and they would be deemed to have permitted debt to be described as “unimpaired” under the plan. Yesterday’s deal raises a legal question with regard to whether the so-called “special revenue” doctrine of chapter 9 would remain because of the voluntary nature of the proposed tender. In addition, the plan raises an issue with regard to whether insurers of the old, outstanding bonds might be afforded the opportunity to claim that their originally insured security is extinguished—so that they would no longer be obligated to pay the old interest amount. What is clearer is that emergency manager Kevyn Orr’s team believes the proposal could be a significant breakthrough, with Detroit’s attorney Heather Lennox yesterday alluding to a major agreement in the offing before Judge Rhodes in the federal bankruptcy court yesterday that could have a major impact on the length of the plan of adjustment confirmation hearings set to begin Aug. 21st. In the tabulation of creditors on the city’s proposed plan of adjustment, 119 out of 151 sub-classes of DWSD voted to reject Detroit’s plan of adjustment—upset that the Motor City was seeking to replace their current bonds without paying all future interest: ergo, a settlement with the DWSD bondholders and insurers would surmount a critical obstacle to Judge Rhode’s favorable approval of the city’s hopes to exit bankruptcy.

The Impact of Congressional Approval of Chapter 9 for Puerto Rico. Fitch Ratings yesterday wrote that the extension of Chapter 9, municipal bankruptcy protection “would be a positive and important development for Puerto Rico and holders of debt of its public utilities and public instrumentalities,” referring to the possibility of Congress approving legislation, HR 5305, the Puerto Rico Chapter 9 Uniformity Act of 2014, which would amend the municipal bankruptcy law to extend to the Commonwealth of Puerto Rico the authority to use Chapter 9 proceedings in federal bankruptcy court to adjust debts of its municipalities and public instrumentalities, or, as Fitch noted: place Puerto Rico on an equal footing with the 50 States, who can currently use Chapter 9 to achieve debt adjustment for their municipalities. The bill, which could be taken up by the House Judiciary Committee, is supported by the National Bankruptcy Conference—which has recommended the amendment be modified so that it would be retroactive. As we have reported, the island is confronted with grim fiscal challenges—leading it to enact a Recovery Act last June—with Fitch yesterday noting: “Given the economic and fiscal pressures facing the Commonwealth itself and its need to provide proper service levels for its citizens, its ability to continue to provide meaningful ongoing financial support to its public corporations going forward would be challenging, in Fitch’s view.” Fitch described the Commonwealth’s recovery act as “an effort to fill the void resulting from the absence of a federal bankruptcy alternative. The Commonwealth has attempted to forge its own framework for orderly debt restructuring applicable to its public corporations, including the Puerto Rico Electric Power Authority (PREPA) and Puerto Rico Aqueduct and Sewer Authority. While the Recovery Act is intended to restore solvency over the long-term, it entails debt restructuring that would trigger suspension of debt payments and preclude the timely payment of principal and interest during the pendency of the proceedings.” But the rating agency noted that the Recovery Act “specifically excluded the Commonwealth’s general obligation debt and certain instrumentalities of the Commonwealth, including the Puerto Rico Sales Tax Financing Corporation,” adding that “the adoption of the Recovery Act and the absence of any preemptive federal bankruptcy alternative, in Fitch’s view, suggest a degree of legal uncertainty regarding how the Commonwealth might act at a time of more severe financial stress to extend the same or a similar act to debt obligations of the Puerto Rico Sales Tax Financing Corporation.” Fitch added that the “adoption of the Recovery Act also spawned litigation and market volatility, potentially increasing the challenge to market access for the Commonwealth and its public corporations. The litigation challenging the Recovery Act will likely be costly to the Commonwealth, a distraction from more important governance activity and will continuously shroud the outcome of any proceedings or agreements entered into under the terms of the Recovery Act with uncertainty.” Fitch noted that while Puerto Rico’s Recovery Act has provisions that “mimic to a degree those in Chapter 9 (municipal bankruptcy),” there are also key distinctions; nevertheless, Fitch wrote: “[C]larifying the rules for restructuring and aligning them to a federal standard with understandable precedent, albeit limited, and providing a federal forum for the proceeding would benefit bondholders. It would also protect the Commonwealth from claims it is acting unjustly or arbitrarily and contrary to accepted norms,” adding that the “range of options available to the Commonwealth and its municipalities and public instrumentalities would be the same as those available in other states.” Fitch added that were Congress to able access to chapter 9 for Puerto Rico, it expected the Recovery Act would be withdrawn.

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