Regional News

Detroit's Swaps, DIP Loan, Up For Court Approval This Week

CHICAGO - There is a busy week ahead in the Detroit bankruptcy case.

The judge overseeing the city's Chapter 9 case will consider the two financing proposals that have sparked the most opposition from the municipal bond market in a mini-trial set to begin Tuesday and last up to three days.

On Monday, Bankruptcy Judge Steven Rhodes will decide whether to allow creditors to appeal his recent decision that the city qualifies for Chapter 9 bankruptcy. Detroit's attorneys argue the creditors challenging the decision, including the city's pension systems, unions, and retirees but no bondholders or insurers, should be required to wait to appeal until after the city files its plan of adjustment. The city is expected to file the plan in January.

Rhodes will also decide at the hearing where creditors can file their appeals.

Bond market participants will likely pay closer attention to the hearing set to begin Tuesday devoted to the city's proposed settlement with its interest-rate swap counterparties as well as its effort to close a $350 million debtor-in-possession financing with Barclays. Bond insurers and holders of the city's pension certificates are fighting both proposals, arguing they're too favorable to the counterparties and Barclays and could diminish creditors' recoveries.

Rhodes at a pre-trial hearing Dec. 13 denied Syncora Guarantee Inc.'s request to delay the hearing for more discovery. The insurer's attorneys said they want the city to disclose the uses of the proceeds from the DIP, and to depose the swap counterparties and other parties to the swap settlement. Syncora insurers the swaps as well as a chunk of the $800 million of pension certificates that the swaps hedge.

Rhodes denied Syncora's request, saying the city's use of the proceeds is not an issue for the court to consider under Chapter 9 rules.

Syncora attorneys said they will need roughly five hours for witness testimony and more than three hours for closing arguments in the trial. Detroit said it plans to call five witnesses, including the city's investment banker, Ken Buckfire, emergency manager Kevyn Orr, and restructuring consultant Charles Moore.

Rhodes warned the city that Orr should be "more responsive" to questioning than he was during the eligibility trial.

"I need to emphasize to him through his counsel here the necessity of him being responsive to the questions," Rhodes said. The judge said he would allow creditors more time to present their case if Orr is not responsive.

The swaps settlement and the DIP financing are closely linked. The city is required under the terms of the DIP to settle with the swap counterparties, UBS AG and Bank of America-Merrill Lynch. More than half of the proceeds from the DIP loan will be used for the swap termination payment.

A pledge of the city's casino revenues currently back the swaps, and will be shifted to the DIP deal if approved.

The DIP agreement with Barclays expires on Jan. 7, 2014.

The swaps settlement, reached days before Orr filed for Chapter 9, calls for Detroit to pay UBS AG and Merrill Lynch 82 cents on the dollar to terminate the swaps, most recently estimated at $270 million. The dispute over the settlement dragged on for months, and the city has already missed the first two deadlines to achieve 25% and 23% discounts. It will now see an 18% discount if the court approves the deal and the city pays the termination fee by March 14.

Detroit may try to negotiate an extension of the discount deadlines, according to earlier court briefs.

The agreement would give the city access to roughly $11 million a month in casino revenue currently used as collateral on the swaps. Access to that money is crucial for the cash-strapped city, Detroit's attorneys argued.

"[The city] must have certain access to the casino revenues in the short-term and in the long-term if it is to move forward with its restructuring," Detroit's Jones Day attorneys argued in an omnibus response to all creditors' challenges to the swaps settlement filed last week. "Upon exercise of this unwind, the casino revenues -- one of the city's largest and, perhaps, most stable revenue streams -- will become unencumbered and free to use for reinvestment in the city for other purposes."

The city admitted in the filing that the swaps themselves have "litigable" issues, as bond insurers have argued, including the characterization of casino revenues as special revenues and the validity of a 2009 agreement that named the casino revenues as collateral.

But, Detroit argued, there's no promise it would win in a court fight with the counterparties and that the casino revenue would be tied up during litigation.

"The 'bad deal' objectors assert that there are potential litigable issues here. The city agrees. However, the city and the objectors do not have to agree on the precise probability of the litigation," the brief says. "And the court need only reach the conclusion that the city's proposed settlement represents the lowest-point in the range of reasonableness."

Detroit also argued that the swaps in reality don't hedge anything because the counterparties would terminate the swaps as soon as they began to owe the city money.

If Rhodes approves both deals, the city would move quickly to close the DIP deal, officials said.

The DIP financing consists of two loans: "Swap Termination Bonds," totaling $230 million, and the "Quality of Life Bonds," totaling $120 million.

Proceeds from the quality of life series would be used in part for investments in blight removal, public safety and technology infrastructure. Orr wants to spend roughly $20 million a month starting in January 2014 on so-called reinvestment activity, and without the DIP loan, has warned that the city may have to cut back on that effort.

The loan features a super-priority lien for Barclays on income tax and casino revenues as well as proceeds of more than $10 million on any sale of the city's assets.

The $350 million notes carry an interest rate based on the London Interbank Offered Rate plus 2.5%, plus a 1% LIBOR floor, translating into an effective rate of 3.5%. If the city defaults, the spread rises by another 200 basis points.

The notes mature in 2.5 years, or when the bankruptcy case is dismissed or a plan of adjustment is accepted, whichever is earliest, according to the term sheet. It's yet to be determined if the loan will be tax-exempt. The city is required to use any proceeds over $10 million from an asset sale to redeem the notes.

As is common in DIP financings, Barclays will get super-priority lien above all administrative expenses, post-petition claims, and pre-petition unsecured claims.

The deal includes a so-called lockbox structure, where the casino and income tax revenues will flow first into a bank account controlled by Barclays. In the event of a default, $4 million of each revenue stream will be set aside, and the city can continue to access the rest.

The term sheet features a lengthy list of events of default. If the city ceases to be under the control of an emergency manager for 30 days, for example, it would be considered a default unless Barclays determines that a transition advisory board or consent agreement ensure continued financial responsibility.

Detroit cannot seek additional borrowing with a senior lien or a lien on any of the notes' collateral.

The city will argue at the hearing that the terms of the Barclays loan are competitive. Miller Buckfire, the city's investment banking firm, approached more than 50 financial entities, including 13 traditional lending institutions and 37 alternative financing sources, the city said. The firm received 16 proposals and whittled those down to four.




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