Motor City Gets Ready for Confirmation Trial

Getting Ready to Run. The attorney for Detroit bond insurer Syncora sought to continue to attack the integrity and impartiality of federal mediators appointed by U.S. Bankruptcy Judge Steven Rhodes involved in crafting the so-called grand bargain — in a hearing yesterday before Judge Rhodes—with the attorney, Stephen Hackney, telling the federal court that the discussions and negotiations behind closed doors were tainted by hidden conflicts of interest—specifically that there exists a conflict because the wife of mediator Eugene Driker is a former member of the Detroit Institute of Arts board, accusing the city’s municipal bankruptcy mediators, U.S. District Judge Gerald Rosen and Mr. Driker of “naked favoritism.” The Motor City responded by filing a motion with the court to seek Judge Rhodes’ consideration of an order to the insurer’s attorneys to apologize formally or otherwise to impose sanctions. Judge Rhodes yesterday stated he would decide on the issue prior to the commencement of the confirmation trial scheduled to commence a week from today. In its allegations, Syncora claimed the mediators conspired to protect pensioners and the Detroit Institute of Arts at the expense of financial creditors. Citing Judge Rosen’s public statements — especially his remark that the deal is “about Detroit’s retirees who have given decades and decades of their lives devoted to Detroit.”

Drip. The Motor City is planning to sell, via the Michigan Finance Authority, $1.8 billion of water and sewer bonds today in a key transaction that will permit the city to finance the purchase of $1.5 billion of tendered bonds, including not only currently outstanding callable bonds, but also to raise revenues for wastewater projects, in the wake of the U.S. Bankruptcy’s court’s ok yesterday. Under Judge Rhodes’ approval, Detroit can exchange at least $1.67 billion of its water and sewer debt for new bonds, sufficient for the Motor City to buy back or pay off early about 92 percent of the water and sewer bonds it was targeting with a repurchase offer. Should Detroit succeed this week in selling bonds to finance the deal, a group of bond insurers and investors will drop their opposition to the plan when the trial opens a week from today on Sept. 2nd. If the sale fails, the Motor City can still proceed by borrowing money from a unit of Citigroup Inc., according to the Motor City’s attorney, Heather Lennox. Under the proposal, the water and sewer department would buy back or redeem $1.67 billion of about $5 billion in bonds, according to the city, and the municipal bonds not repurchased would be honored and repaid without any change. The entire deal should close by Sept. 4th if investors buy the new bonds. The city expects the sale will enhance the city’s accelerating efforts to exit municipal bankruptcy, because the Motor City projects it will gain debt service savings of at least $240 million―as well as remove a key class of creditors who objected to Detroit’s proposed plan of confirmation, thus removing the potential risk of the federal court ruling on the status of the water and sewer revenue pledge which could set a legal precedent: U.S. Bankruptcy Judge Steven Rhodes’ approval of the tender and refinancing overcame the final hurdle in the wake of yesterday’s testimony by Kevyn Orr, senior investment bankers, and water and sewer department officials, when Judge Rhodes overruled a bid by bond insurer Syncora Guarantee Inc. (please see above), which insures some non- water and sewer city bonds, to secure the right to object. However, some other municipal experts see it another way, questioning whether the tender and refinancing might, instead, represent a default. Since the bonds that are not tendered will continue to receive scheduled principal and interest payments, Fitch Ratings said it does not consider the tender offer a distressed debt exchange; whilst Municipal Market Advisors has called the tender in which some bondholders agreed to less than par prices a default. If the refinancing scheduled to lift off this a.m. is completed as planned, four insurers with exposure on the bonds and investors will drop their objection to the Motor City’s plan of adjustment. The sale of the bonds is also intended to help refund some callable bonds for traditional present value savings and include $190 million of new money sewer revenue bonds to raise at least $150 million for projects, according to information for investors attached to the offering statements, and it comes in the wake of last Friday’s vote by the Motor City’s Water and Sewerage Department commissioners to accept the tender results, as well as the approval by the Detroit City Council and the Michigan Finance Authority (which will serve as issuer for the bonds). The city hopes to achieve both significant savings for its customers of the water and sewer system as well as “an open market alternative to the impairment in the city of Detroit’s plan of adjustment.” Under the terms of today’s sale, Detroit expects to realize an estimated savings over the next 27 years of $107 million or 6.2% on the refunded bonds, the equivalent of $11.4 million annually over the first 19 years, and it expects Detroit will have future refunding opportunities as more than a $1 billion will become refundable within the next two years. The Motor City yesterday indicated that if the refinancing is completed and holders of the tendered bonds are paid off, Detroit will amend its plan of debt adjustment and treat all the debt as unimpaired, with the untendered bonds continuing to receive the scheduled principal and interest payments. In addition, the city warned prospective purchasers that the Motor City remains at risk of filing for federal bankruptcy protection again―in which case, the documents note that the water and sewer bonds are subject to extraordinary optional redemption at par. The transaction could have other benefits: bondholders also agreed that the Detroit Water and Sewer District can pay $24 million annually to Detroit’s general employee pension fund as part of its operation and management expenses, with the payment coming from a pension liability payment fund that will be funded after payments are made into the state revolving fund junior-lien bond and interest redemption fund, according to the documents. The bonds are secured by pledged assets which include net revenues that come various sources such as payer rates. Moody’s termed the tender program a credit positive and, like Fitch Ratings, said it does not consider the tender and refinancing a distressed debt exchange; rather, Moody’s wrote, “This transaction diminishes the risk of an economic loss to water debt bondholders in the near term, though the system’s rating is constrained by its ongoing linkage to Detroit as it remains a department of the city,” adding that its rating also reflects the system’s large and diverse service area that spans an eight-county region, along with an improved financial position bolstered by recently enacted operational efficiencies and new management and governance best practices—adding that Moody’s had a third central consideration: it expects the rating to increase as the city “pursues its existing capital plan and continues to undertake an in-depth assessment of its long term capital needs, some of which remain unknown at this point.” The refinancing transaction is expected to achieve debt service savings of at least $240 million.

Rethinking. Detroit is on the brink of eliminating seniority as the sole criteria for firefighter promotions, likely leading to the overhaul of its old and traditional promotion formula: Motor City officials proposed the change during ongoing contract negotiations with the fire department union, which represents some 1,200 firefighters as part of discussions as the union’s contract expired June 30th, with negotiations intensifying over the summer. Detroit leaders have pushed for work rule changes within the fire and police departments, claiming that modernizing promotion rules will result in more efficiencies because they can hire the most talented firefighters, with the city’s Financial Advisory Board having previously cited “strict seniority promotions” as an impediment to the department’s progress; Detroit’s Police Department has used testing as a requirement for promotions for nearly two decades. While U.S. Bankruptcy Judge Steven Rhodes has ordered negotiations to remain confidential, the union reports it is negotiating on major sticking points that “ensure the integrity of our work and livelihood, our safety, our pensions, and our health care.” (Under Michigan’s Public Act 436, Emergency Manager Kevyn Orr can impose the contract terms on the union.)

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