CHICAGO -- Detroit's negotiations this week with holders of the city's nearly $6 billion of water and sewer bonds went well enough that one investor said a settlement is likely.
The city held mediation sessions with holders and insurers of its unlimited-tax and limited-tax general obligation bonds and water and sewer bonds in New York on Monday and Tuesday.
On Monday, the city, represented by investment banking firm Miller Buckfire and law firm Jones Day, met with bondholders only. On Tuesday, it met with bondholders and insurers.
Like all mediation sessions so far in the city's historic Chapter 9, the talks were confidential.
But one water and sewer bondholder, who spoke on the condition of anonymity, described the tone as more productive than earlier negotiations and said a settlement was possible in the next several days.
The city would like the water and sewer bondholders to, at the very least, give up their call protections, allowing for a current refinancing of the bonds to achieve savings.
Without an agreement, the city threatened a never-before-used in Chapter 9 cram-down plan that would impose new interest rates on the bondholders.
"They don't have a lot to negotiate with, but they're trying to pretend they do," the source said. "We're in a much stronger position -- there's never been an impairment of special revenue. But it would be nice to get out from underneath all of this."
Detroit hopes to file a plan of adjustment on about $18 billion of debt with the court by mid-January in the biggest municipal bankruptcy.
The $5.7 billion of water and sewer revenue bonds is considered Detroit's most secure debt. Even Detroit emergency manager Kevyn Orr has said he won't ask for a reduction in principal.
Key to negotiations with the bondholders and insurers is the city's plan to lease the massive water and sewer operation to a new authority that would be run by Detroit's three adjacent counties.
The city's opening salvo to the bondholders was that it wants the lease to generate $70 million a year for the city's general fund.
The payment would come ahead of debt service and operational costs.
"The city is currently being unreasonable thinking they can get $70 million off the top before the bondholders," the investor said. "Why would we, just out of the goodness of our hearts, give them that when our pledge says 100 cents on the dollar?"
But the "tone" of the mediation was "more reasonable" than a few months ago, and the plan to lease the system to the counties seemed more solid, the source added.
There were roughly 15 people in Monday's meeting and more than 30 in Tuesday's, including the mediator, Chief District Judge Gerald Rosen. The meetings were held in Jones Day's New York offices.
The city wants bondholders to either take an interest rate cut over time or waive their call protections on the water and sewere special revenue pledge.
Bondholders rejected the idea of a reduced interest rate, but expressed some willingness to waive their call protections, according to the source.
That would allow the new authority to immediately refinance the debt.
The refinancing is key to the overall plan, as officials contend the new authority would win a higher bond rating than the current one, once the counties take over.
"There's two major problems," the investor said. "One is their assumption of the interest rates their new debt would pay is not realistic because rates have moved, and two, they're not going to be an A-rated authority on Day One. It will take some time."
The proposed $70 million annual payments would come in part from debt-service savings and in part from labor cuts the counties would impose; cuts in pension and other post-employment benefit liabilities; and cuts in the current system's payments for the city's pension certificates, estimated at $11 million a year.
"They're saying give up your juicy coupons so we can have the money today," as opposed to over time, as the debt becomes callable, the investor said. A counterproposal would be "somewhere higher than zero and less than $70, and probably not anywhere near the middle," the source said.
"I'm supposed to take money out of my shareholders' pockets because somebody ran their city poorly?"
If investors won't agree to waive call protections, the city's main threat, according to the source, is that it would try to cram down a plan that would repay principal in full while forcing a reduction in interest.
The move has never been tried in Chapter 9 but has been successful in Chapter 11. The provision requires the new rate to reflect the market. With interest rates on the rise, the cram-down rate could end up being higher than the current rates, the investor said.
"We all just kind of chuckled," the source said.
Bond insurers were reportedly much more opposed to any kind of structural changes to the water and sewer bonds. "The precedent would set back Chapter 9 special revenue pledge by 100 years," the investor said, adding that bond insurers wrap hundreds of millions of dollars of special revenue debt that could be affected.
The city's hope to speed through the bankruptcy process is a chief reason why litigation is unattractive. For bondholders, it would mean uncertainty and attorney fees.
There's also the appeal of being the first creditor to settle, assuming the swap counterparties' deal remains unsettled.
"They're appealing to our sensibility to be the first done with this, and there is some value to that," the investor said. "But it's not $70 million-a-year value."
If the city agrees to come down on its annual payment -- or put it behind debt service in the "waterfall" -- then a deal may be struck, the investor said. "The fact is, as long as they don't try to pick our pockets, there's no reason why we wouldn't do it."
Parties to water and sewer mediation included bond trustee US Bank NA; bond insurers Assured Guaranty Municipal Corp., Financial Guaranty Corp., and Berkshire Hathaway Reinsurance Group; and bondholders Black Rock Financial Management, Fidelity Management and Research Co., Eaton Vance Management and Nuveen Investments, according to court filings.
Parties to mediation on the city's unlimited-tax GO bondholders were National Public Finance Guarantee Corp., Assured Guarantee Municipal Corp., Ambac Assurance Corp., Syncora Capital Assurance Corp. and Syncora Guarantee Inc.
The city met with Black Rock and Ambac Assurance for talks over the limited-tax GO bonds.
The city is treating both its ULTGOs and its LTGOs as unsecured, on par with pensions and OPEBs, with proposed recovery rates of around 10 cents on the dollar.
