CHICAGO -- A long list of daunting financial challenges, topped by $15 billion in long-term liabilities, awaits any Detroit emergency manager should Michigan Gov. Rick Snyder impose that option on the city, as most expect he will.

The option is open to Snyder after a state review team determined a fiscal emergency exists in Detroit with no plan to resolve it.

Snyder will hold a press conference Thursday to discuss the city’s finances, though he is not expected to make an announcement about an emergency manager.

During the state team’s two-month review of the city’s books that culminated Tuesday in the financial emergency finding, Snyder asked the team to take a close look at the city’s long-term debts, said Michigan Treasurer and team member Andy Dillon. Under the state’s emergency management law, the governor has several options following such a finding but most expect the city is now on the path to the appointment of an emergency manager.

“We’ve crystallized some of the city’s long-term liabilities,” Dillon said Tuesday during a press conference announcing the team’s report. “We have a much better handle on what those are, and how the [city] charter can impede the ability to renegotiate and reestablish the city going forward.”

The state report notes city projections that health care benefits for active and retired employees, pension benefits, principal and interest for pension certificates, and debt service will total $1.9 billion through 2017.

That puts an unsustainable strain on city operations, Dillon said.

Of $14.9 billion in long-term debt and obligations, the largest component is Detroit’s $5.7 billion other-post employment benefit liability. Under the state’s new emergency management law, set to take effect in late March, an emergency manager would be able to overhaul the benefits outside of the city charter or without union consent.

An emergency manager would have more power than elected city officials to reform the OPEBs, as well as eight interest-rate swaps that hedge more than $800 million of pension debt, both of which exist as contractual obligations of the city, experts said.

A central advantage for EMs is the singular power the position holds, allowing them to cut through the politics. A troubled relationship between Mayor Dave Bing and the City Council has blocked progress on implementing much of an existing consent agreement with the state under which the city currently operates.

“The main thing --- 90% of the advantage -- would simply be the singularity of management,” said one source close to the city who asked to remain anonymous. “You could focus on a particular type of remedy and would not have the ping-pong ball effect.”

The other advantage is the state law for distressed governments, the source said. “The manager exists in an environment of a law that says the manager has the powers to restructure the obligations and work with creditors, and you don’t get that unless you’re in fiscal distress,” the source said. “The manager brings a bit greater legal authority because of the fact that there is an emergency.”

Dillon said the Detroit charter poses its own obstacles to reforming items like OPEBs. The charter, for example, requires that before making any changes in future retirement benefits, the city council must first obtain an independent actuary’s report reviewing the impact of the change, and then wait at least three months after the report is done to take action.

Large retirement liabilities are not unique to Detroit, but a charter restricting changes outside of the labor contract poses a unique challenge, Dillon said.

“It would be very, very challenging to adjust [OPEBs] under this current governance structure,” Dillon said.

The state team’s report added that obstacles to reforming the OPEBs would impact all the city’s debts and creditors.

“Because retirement health care is the city’s single largest liability, any restructuring would require certainty with respect to this liability, and any uncertainties and delays relating to adjusting this obligation would greatly impede the ability of city officials to negotiate with other creditors of the city,” the state review team wrote in the report.

The city’s two pension plans are relatively well funded -- the liabilities total $7.5 billion, of which only $644 million are unfunded.

A $1.5 billion debt issue helped fund the city’s pension obligation. Detroit’s eight interest-rate swaps hedging more than $800 million of the pension debt have created an ongoing headache for the city for years due to a series of ratings downgrades that have triggered termination events. The swap counterparties could demand termination payments of up to $440 million under the existing  agreements.

The city is continuing to negotiate with UBS AG and Siebert, Brandford, Shank & Co., the two counterparties on the swaps, Detroit Chief Financial Officer Jack Martin said Wednesday in an email response to The Bond Buyer. The city has been negotiating with the banks since last spring to stave off a $440 million upfront termination payment.

“There is no new information to report regarding the city’s position on the swaps,” Martin said. “For the past several months, weekly status conference calls have been held with the counterparties. These calls continue.”

The city is reportedly considering ways to refinance the bonds to shed the swaps.

The current swap agreement requires the city’s casino revenue to be sent directly to a trust and held as collateral for the quarterly payments and the termination payments to the providers. That has given the city some breathing room for negotiations, officials said.

The city brought in $181 million of casino revenue in 2012, according to its most recent audit.

Under the state EM laws, a Chapter 9 filing is eventually an option but such a move would pose a myriad of complications and new expenses and several steps remain before such a dramatic move could be undertaken. Under such a scenario, the banks would be secured creditors because they have a lien on the casino revenues.

The swap termination payments, however, would be subordinate to the swap payments and the debt payments on the pension debt in the case of a bankruptcy, an expert said.

“The bankruptcy court would try not to disturb the priority as far as cash flow between the bondholders and the swap providers,” said Mark-David Adams, a partner with Edwards Wildman Palmer LLP.

“If the documents provide that swap payments are paid with or at the same priority level as debt service on the bonds, the court would respect that,” he said. “The issue would come if the counterparties try to push for a termination payment. Those are typically subordinate.”

The city’s debt also includes $6.1 billion of non-general obligation bonds -- most of which is water and sewer bonds -- and $963 million of GOs.

 The banks so far have been willing to work with the city, so the question of an EM’s power to amend the swap contract has not been on the table, said another source familiar with the ongoing negotiations. “If it was an adversarial relationship, that would be a question that would percolate to the top,” the source said. “Nobody wants this stuff in court. I think that’s why they’re engaged.”

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