Detroit Bankruptcy Judge Questions Timing of Loan Request

The judge overseeing Detroit’s bankruptcy asked why the city came to his court for permission to borrow $350 million to settle swaps contracts without first getting approval from a Michigan loan board.

At the start of a three-day trial over whether to permit the loan, U.S. Bankruptcy Judge Steven Rhodes today told lawyers for the city to explain the board’s involvement in the proposed loan, which would be used to buy out interest-rate swap contracts that have cost Detroit about $4 million a month since July 2009.

“How does the board perceive its role?” he asked lawyers for the city today. He told the attorneys to tell him by tomorrow morning who sits on the board and when it will act. The trial might be for nothing if the board hasn’t made a decision, he said.

The city’s wants to make a $230 million payment as part of a settlement with UBS AG (UBSN) and Bank of America Corp. (BAC) to cancel the swaps contracts. Buying out the swaps will keep casino taxes, one of Detroit’s best sources of money, from going to the banks, Corinne Ball, a lawyer for the city, told the judge.

“Cash is the lifeline for the city,” she said today.

Creditors led by bond insurer Syncora Guarantee Inc. oppose the settlement, saying it costs too much. The city hasn’t proved it would lose if it sued to cancel the contracts instead of settling with the banks, Syncora said.

“The swap counterparties -- who have already made hundreds of millions of dollars off the city over the last seven years -- stand to make hundreds of millions more in one fell swoop,’” Syncora said in court papers.

Buckfire Challenged

Days before Detroit filed for bankruptcy in July, listing debt of about $18 billion, it reached a deal with the banks to terminate swaps contracts that a city service corporation signed with Zurich-based UBS and SBS Financial Products Co. Merrill Lynch, a unit of Charlotte, North Carolina-based Bank of America, took over the SBS position in July.

Stephen Hackney, a lawyer for Syncora, today challenged the expertise of Kenneth Buckfire, a financial adviser for the city who helped negotiate the swaps settlement. Hackney said Buckfire is an expert in corporate debt financing, not municipal finance.

Buckfire said today that the settlement was “the best deal” he could make at the time.

Under the contracts, the city pays the banks when interest rates fall below a set threshold. When rates exceed the threshold, the banks must pay the city. Originally designed to protect the city from rising interest, the swaps backfired when rates fell after the 2008 financial crisis.

Collateral Rights

The contracts give the banks collateral rights that threaten about $15 million a month in casino taxes, one of Detroit’s most stable revenue sources.

Borrowing money to buy out the banks would be cheaper than paying the banks an average of $4 million a month on the swaps, according to the city.

The city service corporations defaulted on the 2009 swaps contracts, giving UBS and Merrill the right to demand a termination payment, the banks said in court papers.

The banks can demand a $270 million termination payment “whenever they wish,” the city said in the Dec. 10 filing.

The swaps are linked to $1.4 billion in pension obligation bonds the city issued in 2005 and 2006. New York-based Syncora has claimed the right to reject any settlement because it insured the swaps and some of the bonds. The bond insurer said that if the settlement doesn’t give the banks everything they are owed, Syncora would have to pay instead.

Insurance Payments

The banks have agreed to give up any insurance payments they may be entitled to, according to court documents.

In court papers, the banks accused Syncora and other objectors of trying to disrupt the settlement to gain leverage in other aspects of the bankruptcy, including proposed cuts to the pension bonds. Syncora and other bond insurers would be forced to pay bondholders should the city persuade Rhodes to cut the bonds as part of any debt-adjustment plan.

The annual $12 million payments on the proposed $350 million loan would be less than what the city pays annually under the swaps.

The case is In re City of Detroit, 13-bk-53846, U.S. Bankruptcy Court, Eastern District of Michigan (Detroit). For Related News and Information:

To contact the reporters on this story: Steven Raphael in Detroit at sraphael5@bloomberg.net; Steven Church in Wilmington at schurch3@bloomberg.net

To contact the editor responsible for this story: Andrew Dunn at adunn8@bloomberg.net

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.