Detroit Floats Plan to Resolve Swap Payment

CHICAGO - Detroit has presented a proposal to its swap counterparties that would allow it to avoid a possible $400 million swap termination payment tied to recent downgrades of the city's ratings.

While declining to release details of the proposed payment resolution, Mayor Ken Cockrel Jr. said in a statement that it was "within the financial capabilities of the city."

The two counterparties, UBS AG and SBS Financial Products Co., which is part of Siebert Brandford Shank & Co., had apparently not responded to the proposal as of Friday afternoon. A UBS spokesman declined to comment and SBS did not return phone calls.

The proposed resolution comes a few weeks after the city hired advisers from the law firms Lewis & Munday and Orrick, Herrington & Sutcliffe LLP to help deal with fallout from the loss of its investment-grade credit, including the possible swap-termination payments.

In January, all three rating agencies downgraded Detroit's roughly $900 million of outstanding general obligation debt and $1.5 billion of pension certificates of participation to junk status. Analysts cited a slew of economic and financial problems, chief among them a roughly $300 million deficit and chronically late financial audits.

The downgrades triggered events of default that give the counterparties the right to demand termination payments on swaps tied to about $800 million of pension COPs. Under the swap agreements, the counterparty can terminate the agreements in the event that the certificate's ratings are withdrawn, suspended, or stripped of their investment grade by one of two rating agencies, and at least one rating agency drops the insurers' ratings to below the low single-A category.

City officials and its financial advisers said they have been negotiating with UBS and SBS since the downgrades to reach a resolution that would allow it to avoid a full termination payment, which could total $400 million based on current interest rates, according to city estimates.

"While no assurances can be given regarding the response or the outcome of negotiations in general, city officials have reason to believe that the swap counterparties were receptive to the approach set forth in the city's proposal," Cockrel spokesman Daniel Cherrin said in a statement released last week.

Saying the city expects a response shortly, the statement added that "the swap counterparties will be submitting their proposals to some of the particulars of the city's proposal."

Detroit entered into the floating-to-fixed-rate insured swap agreements as part of the Detroit Retirement System Funds' issuance that includes $948.5 million of taxable COPs from a 2006 transaction and $536 million of taxable COPs that it sold in 2005.

Fitch Ratings, which downgraded the city's GO debt and COPs to junk territory on Jan. 22, has warned of another downgrade, depending on how the swap termination payment issue is resolved.

"A payment of the magnitude of the current valuation [$400 million], if required, would increase notably the city's already considerable financial pressures," Fitch said in a recent report. "Resolution of the rating watch negative will depend on resolution of the swap termination payment and its impact on the city's cash levels, as well as the city's ability to access the capital markets to issue needed cash flow notes this spring."

Fitch said it expects Detroit will need to increase its cash-flow borrowing to $200 million for fiscal 2010 from $130 million for fiscal 2009 to deal with a cash crunch. In his statement, the mayor said the city is current on all its payment obligations relating to the swaps.

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