Detroit & San Bernardino Race to the Last Lap

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September 12, 2014

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Getting Ready for the Checkered Flag. Chief U.S. Judge Gerald Rosen yesterday afternoon ordered Detroit, Syncora, UBS, Merrill Lynch, Ambac, Black Rock, the city’s Official Committee of Retirees, FGIC, and other financial creditors into continued mediation this morning, “continuing day-to-day, as deemed necessary, until released by the mediators,” as the city’s efforts to work out agreements with its key creditors before emergency manager Kevyn Orr’s likely exit on October 1st nears—and the key obstacle to resolution hinging on whether Syncora is able—in these closed door, mediated negotiations—to obtain concessions from other creditors, including Bank of America Corp. and the city’s retirees. Judge Rosen said negotiations will continue every day until a deal is reached or he sends them home. The closed-door negotiations are, theoretically, to go around the clock until Detroit and its outstanding holdout creditors can negotiate an end to the biggest municipal bankruptcy in U.S. history. After the momentous agreement reached Tuesday between the Motor City and Syncora, FGIC is the last and only major creditor opposed to the city’s proposed plan of adjustment pending before the U.S. Bankruptcy Court. Tuesday’s agreement calls for Syncora to get $23.5 million from the $162 million pool of settlement funds. Now Syncora wants banking giants UBS AG and Bank of America to drop their pursuit of a nearly $200 million insurance claim against Syncora tied to Detroit’s troubled pension debt and has indicated its deal with the city hinges on getting the banks, retirees and bondholders to forgo a potentially better recovery of what they’re owed, a likely topic of negotiation in mediation. Syncora is apprehensive that without an agreement by Bank of America’s Merrill Lynch unit and UBS to modify their rights to collect their insurance payments from Syncora on the soured swap deals that put the Motor City’s former mayor in prison, the plan still cannot proceed. Detroit’s representatives take the position that Syncora can still drop its objections to the city’s plan and go ahead with the settlement no matter what UBS, Bank of America and other creditors decide. If Syncora is unsuccessful in obtaining an ok from the banks to forgo the insurance, it will have to choose whether to continue to oppose the city’s proposed plan of adjustment and put its fate in the hands of Judge Steven Rhodes. But, in the complex negotiations being mediated by Judge Rosen, the Judge is pressing to obtain consent from a committee of retired workers and investors who hold tax-backed bonds.

Under Syncora’s settlement, Detroit would give Syncora new debt, renew a lease on a tunnel to Canada that the bond insurer controls, turn over a parking structure and give an affiliate of the company land for development. The fight lasted 14 months. During that time, Syncora fought to liquidate the city’s art collection, tried to block repairs to miles of broken streetlights and leveled a “blistering” personal attack on federal mediators that drew a rebuke from the judge. Under the deal, the city agreed to extend a lease of the Detroit-Windsor tunnel with a Syncora-controlled firm for 20 years. Syncora also gets to lease a city-owned parking lot underneath Grand Circus Park for 30 years, according to a city term sheet released Wednesday. The package of incentives is worth about $70 million, according to a source familiar with the deal. In return, Syncora has pledged to help Detroit fight bond insurer Financial Guaranty Insurance Co., which is still objecting to Detroit’s debt-cutting plan. Syncora and FGIC were two of the biggest opponents in the bankruptcy trial. Both firms claim the city’s debt-cutting plan pays them as little as 6 cents on the dollar for the $1.4 billion in troubled pension debt they insured to help former Mayor Kwame Kilpatrick prop up the city’s pension funds in 2005. FGIC has claims of more than $1.1 billion — three times the size of Syncora’s. The firm’s negotiators walked out of closed-door talks with the city two weeks ago.

Because FGIC is in the same bankruptcy creditor class as Syncora, for Judge Rhodes to approve Detroit’s proposed plan of adjustment—which is being modified to reflect Tuesday’s Syncora deal—he would have to find that the plan proposed equity amongst classes of creditors—i.e., in this instance, FGIC and Syncora. Detroit had been trying to get the entire $1.4 billion in swap debt Syncora and FGIC insured erased from its balance sheet, claiming the debt illegally exceeded the city’s statutory borrowing limits; the deal (see box above) changes that claim. What this all means is that now one of the most serious obstacles to the Motor City’s emergence from the largest municipal bankruptcy in U.S. history is dependent on the unique and gifted Judge Rosen.

Property Disposal. Detroit Emergency Manager Kevyn Orr yesterday notified the City Council he plans to transfer up to 45,000 city-owned properties to the Detroit Land Bank Authority, which auctions off and demolishes vacant, abandoned and foreclosed properties. Mr. Orr’s plan provides the council 10 days to approve or disapprove of the transfer. In addition, Mr. Orr’s proposal includes a provision requiring all tax-foreclosed properties that revert back to the city instead go to the land bank―all part of what his office reports is an effort to “speed up the process to redevelop that land.” If the Detroit City Council rejects the transfer, it has seven days to come up with a proposal that would yield substantially the same financial result, under provisions of Michigan’s Public Act 436 of 2012, the state’s emergency manager law. If the council develops its own version, that version would be reviewed by the state’s three-member Emergency Financial Assistance Loan Board, which would have 30 days to approve one of the proposals.

Progress in San Bernardino. U.S. Bankruptcy Judge Meredith Jury, in an interim ruling yesterday, agreed to the city of San Bernardino’s proposal—as part of its bankruptcy plan of adjustment—to reject the current bargaining agreement between the municipality and its firefighters. The firefighters’ contract is a burden on the city’s finances in at least two ways, Judge Jury found: pension contributions by the city cost too much, and overtime rules are too generous. Should she adhere to her preliminary ruling, San Bernardino would be free to impose pay and benefit cuts, and the city will have the authority to impose a new contract of its own choosing. In its filing with the federal court, the city wrote that part of the reason to reject the existing contract was so it could replace a constant staffing model with minimum staffing, a proposal which would give the city the flexibility and authority to leave some firefighter positions unfilled for a shift if a firefighter does not come to work—a change critical to the city’s efforts to reduce the more than $4 million in overtime it pays firefighters most years. Another expected reason was continuing to make firefighters pay the retirement contributions the city handled until a year ago last January, reducing the employees’ take-home pay by nearly 14 percent. In a separate ruling, Judge Jury rejected the firefighter union’s motion for relief from the stay preventing anyone from suing the city while it is in bankruptcy. Firefighters’ attorneys want to argue in state court that the city had not followed state law in its negotiations. Judge Jury did not rule on separate, pending motions for relief from the stay from the police and fire unions after contracts were imposed on those unions in January of last year; she made clear that she was not agreeing to the specifics of any potential imposition, advising the parties San Bernardino cannot violate “substantive law,” including the city charter provision that prevents cutting public safety salaries—an issue which is on November’s ballot for possible repeal, adding that previous cases have not established how long the imposed contract can be used, advising the parties: “I said it’s interim, but I don’t how long interim is…I think until a new collective bargaining agreement is negotiated or the plan (to exit bankruptcy) is approved.” San Bernardino’s attorneys will submit proposed wording of the order today, giving firefighters’ union attorneys until midweek to object or file an alternative proposal before a hearing on September 19th to finalize the order. Judge Jury made clear she would provide the firefighters’ attorney an opportunity to question a key city witness before making her final ruling, but noted: “It is very unlikely they are going to convince me” that the contract is not a burden on the city’s recovery. Yesterday’s actions come as the Southern California city has either reached agreements with or is in negotiations with almost all its major creditors. After filing for municipal bankruptcy in 2012, San Bernardino had enmeshed in negotiations with unions and its biggest creditor, the California Public Employees’ Retirement System (CalPERS), to which the municipality owes about $143 million, according to court filings.

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