Detroit Judge Suspends Trial Over Proposed Swaps Deal

Detroit’s bankruptcy judge suspended a three-day trial over a proposed $350 million loan and related interest-rate swaps settlement so the city can try to negotiate changes that opponents of the deal would accept.

U.S. Bankruptcy Judge Steven Rhodes canceled tomorrow’s scheduled court session in Detroit and told the city to use the time to try “to renegotiate.” The trial is set to resume Dec. 20. Detroit was in the second day of the trial, which had been scheduled to end tomorrow.

Earlier, Rhodes questioned why the city, which filed a record $18 billion municipal bankruptcy in July, was willing to pay UBS AG (UBSN) and Bank of America Corp. (BAC) about $230 million to end the swaps contracts. Proceeds of the loan, provided by Barclays Plc’s investment-banking unit, would be used to finance the settlement.

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

The judge has also asked why Michigan officials chose to put off considering the loan until after the three-day trial.

“Someone made the decision to waste court time and attorneys’ fees?” he asked an attorney for the state.

Board Waited

The Michigan loan board thought it best to wait in case the terms were changed by the court, Steven G. Howell, the state’s lawyer, told the judge. The board wasn’t trying to waste time or money, he said.

“It wasn’t our intention but that was the risk,” Howell said. “We are confident that it will be approved, but I can’t give any guidance.”

The interest rate swaps have cost the city about $4 million a month since July 2009. Buying out the swaps contracts will keep casino taxes, one of Detroit’s best sources of revenue, from going to the banks, Corinne Ball, a lawyer for the city, told the judge.

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

Days before Detroit filed for bankruptcy, 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.

Internal Reports

Stephen Hackney, a lawyer for Syncora, demanded that the city provide objectors with copies of internal legal reports about the swaps deal. City attorneys have refused, saying the documents are protected by attorney-client privilege and could be wrongly used by creditors in confidential negotiations that Detroit is conducting to resolve the entire bankruptcy.

Rhodes said those documents would be made public should the swaps deal be rejected and the city sue to avoid paying UBS and Merrill Lynch.

The judge said that it’s his job to determine whether Detroit is overpaying to end the swaps.

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 rates, 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.

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 a filing this month.

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.

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).

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

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

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