Key questions about bond security remain outstanding after Detroit’s bankruptcy, says Amanda Van Dusen, head of public finance for Miller Canfield, Detroit’s bond counsel.

CHICAGO — It's later than you think.

That's one lesson that leaders of struggling cities like Chicago should take away from Detroit's historic bankruptcy case, according to the architects of the nation's largest municipal bankruptcy.

By the time the Motor City filed for bankruptcy, it had already tried various restructurings and had enacted fairly deep cuts.

With legacy liabilities eating up 42% of its budget and only eight weeks of operating cash left, it was just too late, said the bankruptcy and restructuring experts who gathered in downtown Chicago Wednesday to reminiscence and offer lessons learned from the nation's largest municipal bankruptcy in a panel organized by Miller Canfield, Detroit's bond counsel.

"The reality on filing day was the city couldn't cut itself out of its legacy liability," said Gaurav Malhotra, a partner at Ernst & Young, which began working with the city in 2012 on cash-flow analysis and revenue projections. "It was choking the city."

Chris Gannon, a managing director at Conway MacKenzie Inc., which began working for Detroit in January 2013, seven months ahead of the Chapter 9 filing, noted that by then the city already had a "wealth of information" about restructuring but lacked the ability to implement most of it.

"Nobody can appreciate how bad it was," said Gannon. "The city was completely dysfunctional. Anything that was getting done was getting done by a consultant."

The lesson, Gannon said, is to start early.

"[Struggling cities] need to start planning much sooner than they think and make tough choices much sooner than they think they do," Gannon said.

Malhotra said cities like Chicago should be crafting five- and 10-year forecasts and facing the painful reality that lies ahead.

"You can't wait too long; it's important there's something in place before Chapter 9," he said.

The differences between Detroit and Chicago are enormous, the participants agreed.

Revenue, population, tax base and employment are all much stronger in Chicago than in the Motor City.

"From an economic standpoint, they are two completely different situations," Malhotra said.

But, he added, Detroit's pension liability heading into bankruptcy totaled $3.5 billion, whereas Chicago's pension liability totals nearly $20 billion.

"You need to have long-term financial planning and the political will to undertake the tough choices," Malhotra said. "I don't think there will be a significant uptick in Chapter 9 …. but we need more comprehensive restructurings until we get through the pension issues."

On the bond side, big questions remain after the Detroit case, said Amanda Van Dusen, head of public finance for Miller Canfield.

In the beginning, it was tough for the bond attorneys and corporate restructuring professionals to find common ground, Van Dusen said.

"We spent months learning to speak each other's language," she said. "We were coming at it from very different perspectives. For example, a pledge is not a security interest - it's just a promise meant to be broken in bankruptcy," she joked. "The question is still out there."

The city treated all its general obligation and certificate debt as unsecured. But the differing final settlements reflected underlying beliefs about strength of security, Van Dusen said.

When it came to the pension certificate holders, one of the most controversial aspects of the case, the 13% recovery, which was boosted by various land and asset deals, reflected the "serious questions about those transactions," Van Dusen said.

The LTGO holders, whose pledge included only a first budget obligation, saw a 34% recovery, far less than the 74% recovery that unlimited-tax GO holders saw. "The conclusion drawn with the limited-tax general obligation bondholders was that you're not going to get paid before [the city] picks up the garbage," she said.

But the ULTGO holders had a relatively strong argument in their assertion that the voter-approved property tax millage should be dedicated solely to debt service and could not be used for any other purpose, said Chief U.S. District Judge Gerald Rosen, chief mediator in the case.

"We felt the millage was dedicated and couldn't be spread around without consent," Rosen said.

Malhotra noted that the conclusion of the case came quickly enough to squash growing speculation on the varying treatment of the same class of creditors.

"It was getting to the point where the disparity between the same class of creditors was becoming more of an issue," Malhotra said.

The case took about 17 months, longer than the 12 months the judges were hoping for but considerably shorter than many expected, said Rosen. The judge said the mediators were able to push negotiations along in part because of the looming resignation of Detroit Emergency Manager Kevyn Orr, who stepped down in late September.

"That was the external pressure because we could do so many things so much more efficiently [under Orr]," said Rosen. "We could also tell the creditors, if we don't come to an agreement, the EM powers will leave soon."

Rosen devised the so-called "grand bargain," an $800 million public-private deal that generated money for pensions by monetizing the city-owned fine art collection. The bargain is considered the key that unlocked the case. Early in the bankruptcy, the attorneys and judges soon realized that the art was the city's only significant asset.

"The creditors were always very polite, but they always ended our meetings with the same question: What about the art?" Rosen said. "I felt very uncomfortable about this."

Malhotra, who helped write the adjustment plan, said the cash in the grand bargain helped push the case along because it allowed the city to finance key settlements.

"The difficulty was developing a feasible plan that worked and still create money to fund the settlements," he said. "Without that pot of money, we'd still be in litigation."

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.