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Detroit's First Settlement: 25% Haircut

CHICAGO — Detroit emergency manager Kevyn Orr has reportedly reached an agreement with counterparties on the city’s interest-rate swaps that has the creditors taking a 25% haircut.

If finalized, it will be the first settlement with a creditor since Orr announced a massive restructuring off the city’s debt in June.

The deal, which has not been publicly released, relies on a $255 million debtor-in-possession loan to pay off Bank of America Corp. and UBS AG, according to local reports. The value of the swaps is estimated at $344 million.

The agreement gives the city access to $11 million a month in casino revenue that is currently pledged to the counterparties.

The interest rate swaps are considered among the city’s most secured creditors, along with the water and sewer bonds. The swaps hedged about $800 million of $1.4 billion of pension certificates.

The city has negotiated with the counterparties for years to avoid a payment tied to various termination events that have been triggered by a series of downgrades.

The swaps were put in place in 2006 along with the issuance of the original pension certificates, and later renegotiated in 2009. The new agreement gave the counterparties a lien on revenue from the city’s three casinos.

The swap settlement may not be indicative of subsequent agreements because the creditors are banks, said Howard Cure, director of municipal credit research for Evercore Wealth Management LLC.

“By contract they shouldn’t have to take a haircut, but they may foresee more direct dealing with the city in terms of future debt issuances or restructuring they that may benefit from,” Cure said. “They may be willing to take more of a haircut than expected with the anticipation of more transactions to come to make up for part of that.”

The reported settlement comes four weeks into Orr’s negotiations with creditors. He has proposed issuing $2 billion of notes to pay off $11.5 billion of so-called unsecured debt and has asked secured creditors, including the swap counterparties and water and sewer holders, to negotiate for more favorable terms for the city.

Despite the swaps’ secured position, the settlement doesn’t necessarily mean bad news for other secured creditors, especially the water and sewer holders, Joseph Rosenblum, director of municipal credit research at AllianceBernstein, said.

“I don’t see a monetary haircut for the water and sewer bonds,” Rosenblum said. Orr has proposed restructuring the water and sewer debt with a subordinate lien and lower interest rate, which will be considered an impairment but is less than a 25% haircut, he said.

“In Chapter 9, the water and sewer bonds are entitled to their revenue,” said Rosenblum. “And we will still see whether in fact the general obligation unlimited tax bonds are unsecured or secured,” he said. “That’s far from final.”

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