CHICAGO -- Detroit late Tuesday asked the federal judge overseeing its bankruptcy case to approve a controversial $350 million debtor-in-possession financing.
The city needs the approval of U.S. Bankruptcy Judge Steven Rhodes to close the deal, which would allow the city to terminate eight interest-rate swaps and raise money for infrastructure improvements. The court request asks Rhodes to sign off on the extensive terms of the deal, including the city’s ability to grant a super priority lien and permission to vacate the automatic stay to the extent necessary.
A hearing is set for Nov. 14.
Detroit said in the court filing that it would save $50 million by paying off the swaps, which have a current present market value of $290 million. The city also argues that debt-service payments on the DIP loan, which are interest-only for the 2.5 year life of the loan, assuming there is no default, will total $12 million annually. That’s down from $50 million in debt service obligations under the swap agreements.
The city argues that it’s under the gun to execute the loan. A separate agreement with the swap counterparties that allow the city to terminate the swaps has three built-in deadlines after which the discount rate on the termination payment rises. The city is only allowed to trigger the termination agreement once, and must prove that it has the money needed to pay off the counterparties. Bond insurers and other Detroit creditors are fighting the swap termination agreement, saying that it is too favorable to the counterparties.
The DIP agreement with Barclays expires on Jan. 7, 2014.
“Thus, the city believes it is imperative that the post-petition financing be approved as soon as practicably possible, and in any event prior to the issuance of any optional termination notice, to eliminate any risk that the city’s ability to fund its obligations under the forbearance agreement could be in dispute,” the filing reads.
In addition to Rhodes’ approval, the city needs approval from the state Emergency Loan Board for the financing, and it submitted its request to the loan board on Tuesday.
The city said it plans to move forward with the closing of the deal promptly after securing the judge’s approval.
The Detroit City Council rejected the deal two weeks ago, but failed to offer an alternative financing, rendering the rejection moot.
In its court filing, city attorneys argue that the terms of the Barclays loan are competitive and subject to “significant market testing.”
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.
The DIP financing consists of two loans: “Swap Termination Bonds” and “Quality of Life Bonds.”
The size of the discount of the termination payment shrinks as time passes, and the city already missed the Oct. 31 deadline to achieve the largest discount, of 25%. The next deadline, Nov. 15, reduces the discount to 23%. In its court filing, the city appears assume that it’s the smallest discount -- 18% -- that it will achieve if the judge approves the order. The city may also try to negotiate an extension of the discount deadlines with the counterparties, according to the motion.
Proceeds from the quality of life series would be used in part for investments in blight removal, public safety and technology infrastructure, according to the court filing. The city outlines its 10-year restructuring plan, which relies on $1.25 billion in capital improvements, or $125 million in financing a year.
For the first time, the city says it expects to receive resources from the state and federal governments to help finance the 10-year plan.
“Given the financial need, the city has determined that it must look beyond its own coffers and rely on a multitude of sources to facilitate the reinvestment initiatives, including support from the state and federal governments as well as private institutions.”
Orr wants to spend roughly $20 million a month starting in January 2014 on so-called reinvestment activity, and without the DIP loan, the city may have to cut back on that effort.
The deal 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 city plans to use $230 million of the proceeds for termination payments on a series of interest-rate swaps that currently have a lien on the casino revenue. Another $120 million would be used for service improvements.
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.
Moody’s Investors Service Wednesday released a report on the DIP financing, saying it’s too early to gauge the credit impact on the city.
Whether or not Detroit ends up using the casino and income tax revenues as repayment or repay the notes with proceeds from an asset sale or a lease could make a difference in the impact, analyst Genevieve Nolan said in the report.
Tapping money from an asset sale would leave the tax revenues for the general fund, she noted. If the city uses the tax revenue, the impact may be “not immaterial” compared to the city’s estimated 2013 general fund revenues of $1.1 billion.
The use of asset sale proceeds would also lessen the DIP loan’s impact on existing bondholders, Nolan said.
Moody’s also notes that the city’s pension certificates that are hedged with the existing swaps would be left unhedged if the DIP financing is executed, and that may have an impact on any potential settlements during negotiations with its creditors.
“Within the Chapter 9 process specifically, the plan may help illustrate the city’s claim that it negotiated in good faith and is thus eligible to proceed under the federal restructuring framework,” Nolan wrote in the report. “Finally, the city may be exposing itself to refinancing risk should it be unable to repay the notes within the stated time frame.”