CHICAGO - The federal bankruptcy court judge overseeing Detroit's historic Chapter 9 filing pressed the city Wednesday for more information on its strategy behind the decision to negotiate a settlement with interest-rate swap counterparties.
The tussle between U.S. Bankruptcy Court Judge Steven Rhodes and lawyers for Detroit came during the second day of hearings this week on the city's proposed $350 million debtor-in-possession financing with Barclays Capital Inc. and the related settlement with its swap counterparties. Rhodes is weighing whether the deal is fair and should be approved.
Detroit is seeking court approval for the transactions that some creditors, including several bond insurers and pension funds, have objected to on the grounds that they treat the counterparties and Barclays too favorably.
The city would use about $230 million from the DIP financing to terminate the swaps in a deal that represents a roughly 75-cent to 82 cent-on-the-dollar payout. The remainder would finance so-called quality of life spending. Detroit Emergency Manager Kevyn Orr has called the transaction central to the city's restructuring efforts.
Orr took the stand Wednesday to defend the deals. During Orr's testimony, he cited attorney-client privilege in declining to disclose details of Jones Day's assessment that the swaps were legal and should be treated as a "secured" debt. The decision led the city to negotiate a settlement with the counterparties. Orr has proposed treating much of the city's general obligation debt and pensions as unsecured.
"How can I decide whether this was a fair settlement without understanding" the city's arguments on the legality of the swaps, Rhodes asked, according to postings on Twitter from reporters from the Detroit News and Detroit Free Press.
Rhodes called the city's reasoning and arguments used in its settlement negotiations "probably the most significant question in this trial," according to reports.
Jones Day resisted pressure from Rhodes to provide documents outlining its position on the swaps' legality, saying that "one of the reasons we haven't disclosed those memoranda is because we may still sue the banks."
The hearing broke for lunch with the question still on the table of whether Jones Day would agree to disclose additional details as to its position over the swaps' legality. Attorneys for the pension funds and Syncora Guarantee Inc., which insures the swaps as well as a chunk of the $800 million of pension certificates that the swaps hedge, are the lead objectors questioning witnesses during the hearings.
During his testimony, Orr said the city was prepared to pursue litigation challenging the swaps "if we had to," but the city chose the settlement route to avoid a costly legal battle. Orr said the bank counterparties initially sought full reimbursement.
Orr stressed the city's aim behind pursuing the DIP and swap settlement - freeing up casino revenue pledged as collateral to the swaps in order to stabilize city finances. "Casino revenue is the single most stable revenue available to the city. Without it the city could not operate," he reportedly said.
Orr was at the table during the latter negotiations on the swaps. "I participated in the negotiations towards the end to finally get to definitive terms," Kevyn Orr testified.
On Tuesday, the city's investment banker Ken Buckfire, of Miller Buckfire, warned that if the city chose a route challenging the status of the swaps over negotiating a settlement, the casino revenues would have been tied up during litigation. That would have hurt the city even if it eventually prevailed. According to reports, Buckfire said if the banks won, they could have captured the much-needed casino revenues for years.
A pledge of the city's casino revenues currently backs the swaps, and will be shifted to the DIP deal if approved. The transactions are key to allowing the city access to the $170 million generated annually by the casinos. City income taxes would also be pledged to the DIP which would hold a super-priority lien over other city creditors.
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 Capital Services Inc.
The hearing opened Wednesday with a presentation from special assistant attorney general Steven Howell on the state's Emergency Loan Board, which hired Orr and must also sign off on the financing transactions.
Rhodes pressed city attorneys Tuesday on why the board had not yet approved the deals. Jones Day attorneys were unable to even name the board's members. Rhodes ordered a report first thing Wednesday.
Howell said the board would consider the financings after the court, since revisions might be made and the review could come as soon as Friday. Rhodes allowed the hearing to resume without explanation after a brief off-the-record conversation with city attorneys, a first in the case.
The number of objectors dwindled this week with some bondholders and two bond insurers dropping their disputes after negotiations with the city resolved their concerns on the deals' terms.
Ernst & Young Capital Advisors LLC consultant Gaurav Malhotra testified Tuesday the city could exhaust its cash by the end of 2013 and face a $284 million shortfall by June 2015 if the swaps are not terminated. The settlement would generate $1.5 million to $3 million in monthly savings on interest rate payments.
City attorney Corinne Ball argued Tuesday the DIP "represents the best feasible financing realistically available to the city in its current condition, when the city is only able to offer limited collateral and insists on remedies that preserve the city's ability to operate, even in the face of default."
During testimony, Rhodes said he was concerned over granting the 75-cents-on-the-dollar payout on the swaps settlement when other creditors face the prospect of a far steeper haircut, and asked how the city arrived at the figure.
Detroit is asking Rhodes to enter an order approving motions that allow for the post-bankruptcy petition DIP financing, the pledging of liens, and a super priority claim status, and modifying the bankruptcy's automatic stay. The hearing resumes Wednesday afternoon. Objectors have yet to lay out their case.
