CHICAGO - A federal bankruptcy court judge abruptly suspended hearings on Detroit's proposed $350 million debtor-in-possession financing and settlement with its interest-rate swap counterparties Wednesday and urged the city to use the time to renegotiate the swaps termination deal.

U.S. Bankruptcy Court Judge Steven Rhodes suspended the hearing Wednesday and scheduled a status conference for Friday at 10 A.M. Eastern Time, according to a Rod Hansen, a court spokesman. It's unclear when the hearings, which had been scheduled to continue through Thursday, might resume.

Rhodes urged the city to use the break to try to renegotiate the proposed settlement that would allow the city to terminate swaps tied to its pension certificates for a 75 cents to 82 cents on the dollar payout. The city would use about $230 million from the DIP loan to finance the termination costs.

"I would encourage that as strongly as I can," Rhodes was quoted in published reports as saying.

The swap counterparties are UBS AG and Bank of America Merrill Lynch Capital Services Inc. UBS AG declined to comment as the "hearing is still ongoing," said spokeswoman Karina Byrne.

Bank of America Merrill Lynch spokesman Bill Halldin also declined to comment.

The development came during the second day of hearings on the proposed deals the city is asking the court to approve. It followed a standoff between Rhodes and city attorneys over Rhodes' demand for more detail on the city's strategy to characterize the swaps as a "secured" debt.

Instead of challenging the legality of the swaps' secured status as the city has done with its pensions and most general obligation bonds, emergency manager Kevyn Orr opted to negotiate a settlement to free up access to city casinos which are pledged as collateral.

Rhodes insisted Wednesday he needed insight into the city's thinking to resolve the central question of whether the deal represents a fair one for the city and should be approved.

"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 tweets from reporters from the Detroit News and Detroit Free Press.

Rhodes reportedly told city attorneys from Jones Day: "The burden is on you" to prove the swaps settlement is fair.

Orr had cited attorney-client privilege initially in withholding the information and the tussle ensued with Rhodes. The city also could not resolve how to address the issue with key objectors in the case — the city's pension funds and Syncora Guarantee Corp., which insures the swaps as well as a chunk of the $800 million of pension certificates that the swaps hedge.

The groups have opposed the transactions believing the terms are too favorable to Barclays and the bank counterparties at the expense of other creditors.

The city offered to present Jones Day attorney Corinne Ball to testify on the firm's swaps strategy but Syncora attorneys rejected that offer noting it was the city's investment banker Ken Buckfire who led the settlement negotiations.

City attorney Thomas Cullen of Jones Day suggested that the hearing be delayed in an attempt to negotiate an arrangement with the objectors to resolve their issues. The objectors' attorneys agreed, prompting Rhodes' decision to suspend the trial and his comment urging the city to use the time to renegotiate the swap settlement.

While Wednesday's developments throw a wrench in the city's efforts to advance the two intricately-linked financing deals Orr has called central to the city's restructuring efforts, they also give the city leverage to possibly strike a better deal.

The city wants the issue resolved to free up much needed casino revenues that would be held up should the city and counterparties be forced to litigate the swaps' status. If the settlement falls through, the counterparties run the risk that the swaps could eventually be lumped into the unsecured category.

Rhodes offered a frustrated assessment of the city's deals tied to the swaps, including the settlement. "Every transaction, including this one, that the city has entered" tied to the swaps "has been made with a gun to its head…that has to stop," he reportedly said.

It's unclear when the hearings might resume. Rhodes said during the hearing Wednesday he is not available between Dec. 22 and Jan. 1.

Orr testified earlier in the day in defense of the deals, saying 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. The casinos generate about $170 million annually.

Orr and Jones Day attorneys resisted pressure from Rhodes to provide more information outlining the city's position on the swaps' legality, with Jones Day attorneys saying that "one of the reasons we haven't disclosed those memoranda is because we may still sue the banks."

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.

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. The city added language to its proposed order protecting revenues pledged to sewer and water bonds from being used to repay the DIP and property tax revenues that would go to repay GO debt should the court ultimately reject the city's treatment of most of its GOs as unsecured.

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."

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.

A pledge of the city's casino revenues currently backs the swaps, and will be shifted to the DIP deal if approved. City income taxes would also be pledged. The DIP agreement with Barclays expires on Jan. 7, 2014.

The swaps settlement was reached days before Orr filed for Chapter 9 in July. The city admitted in a court 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.

"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."

The DIP financing consists of two loans: "Swap Termination Bonds," totaling $230 million, and the "Quality of Life Bonds," totaling $120 million. 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 city disclosed in a filing this week that Barclays will also receive a nearly 1.25% fee, or $4.4 million, to process the DIP restructuring while the city is in bankruptcy. Half has been paid even though the court has yet to approve the deal.

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.

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.

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