Detroit's DIP Deal Could Pave Way for Bankrupt Financing

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CHICAGO – Detroit’s move to secure debtor-in-possession financing marks a first for Chapter 9, one that could pave the way for other bankrupt or cash-strapped cities, municipal bond experts said.

Detroit emergency manager Kevyn Orr announced last Friday the city reached an agreement with Barclays Capital for a $350 million DIP loan to raise money for an interest-rate swap termination payment and improve city services.

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. It’s the only deal of its kind in Chapter 9.

“We’re realizing now, if we didn’t already, the reality that Detroit is going to be setting new precedents along the way on so many issues,” said Richard Ciccarone, chief research officer at McDonnell Investment Management LLC.

“This is beginning to look a lot more like a corporate bankruptcy,” Ciccarone said. “There seems to be movements by those bankruptcy attorneys to incorporate into municipal bankruptcy as much as they can from what they’ve been practicing in the corporate arena.”

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 financing requires approval by the federal bankruptcy court and -- because the loan is structured as fiscal stabilization bonds -- by  the Detroit City Council, among other bodies. The deal also relies on the city’s ability to reach an agreement with Syncora Guarantee Inc. and other bond insurers fighting the city’s swap settlement.

“The state and the restructuring community wants this kind of financing to work so as to facilitate future bankruptcies,” said Matt Fabian, managing director at Municipal Market Advisors. “The state is doing what it can to make sure DIP lenders are protected and repaid.”

If the city fails to close the deal, it could be good for unsecured creditors, Fabian added.

“The failure of the DIP probably would mean better recovery for other creditors,” he said. “In theory it’s going to make the state and city more inclined to settle at better terms for the rest of the city’s creditors, because they’ve put an emphasis on speed.”

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.

Those rate terms are “pretty rich,” said one portfolio manager.

“Two-year muni [paper] is yielding 35 basis points right now, so assuming that it’s tax free, that’s a pretty big number,” said Robert Miller, senior portfolio manager for Wells Capital Management.

The 3.5% interest rate “represents a hefty premium over the two-year Treasury yield, which closed yesterday at a mere 0.35%,” Triet Nguyen, managing partner of Axios Advisors LLC, which specializes in high-yield debt, wrote Monday in anarticle on MuniNet Guide.

“It’s ironic that Kevyn Orr is so anxious to get a release of the casino revenues that he’s willing to turn a 'soft’ liability (i.e. the swaps) into a hard-dollar settlement with the banks, at a time in the interest rate cycle when those swap liabilities could actually start to decline,” Nguyen said.

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 DIP deal could help pave the way toward the Motor City’s long-term recovery if it helps it secure traditional municipal financing in the future, said Joseph Rosenblum, director of municipal credit research for New York-based firm AllianceBernstein.

“Assuming it gets done, it allows the city to do what they want moving forward in line of creating a more viable city,” Rosenblum said. “That will ultimately help with future financing, and the buyers of that debt will feel more comfortable about the security they have.”

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