Detroit’s contentious swaps

September 24, 2013

The proposed settlement between Detroit’s emergency manager Kevyn Orr and the city’s swaps counterparties, UBS and Merrill Lynch, is on the docket this week in federal bankruptcy court where the case is being heard. The Bond Buyer reported:

Key hearings on #detroit‘s swap settlement originally set for this week may be delayed … parties in mediation.

— Caitlin Devitt (@Devitt_BB) September 23, 2013

Mediation could be a good alternative for the parties because this is a complex element of Detroit’s bankruptcy. Circling around the perimeter of this bankruptcy litigation and mediation is the bond insurer Syncora, which insured both the underlying pension obligation bonds and the interest rate swaps that are part of the negotiations between Orr, UBS and Merrill Lynch. Orr has worked to force Syncora, the bond insurer, out of the picture and essentially leave it responsible to pay off the pension obligation bonds without access to Detroit’s casino tax revenues. Syncora believes that it is legally entitled to access the casino revenues because it insured the pension obligation bonds, which have a cross-default covenant with the swaps.

The Detroit News does an excellent job of threading the story together:

[Orr’s] proposal to pay UBS AG and Bank of America [Merrill Lynch] at least $250 million to terminate an interest rate swap arrangement that went bad for the city during the recession is opposed by insurers of the debt who stand to lose millions of dollars and retirees owed billions of dollars in promised retirement benefits.

Some legal and financial experts also question why Orr is trying to settle with the two big banks so quickly in the bankruptcy process.

Orr rushed to settle with UBS and Merrill Lynch before he filed for bankruptcy. These swap counterparties were the only creditors that he actively negotiated with before filing for bankruptcy on July 18th. Some are wondering why. More from The Detroit News:

‘He gave the banks a big, wet sloppy kiss,’ said Michael Greenberger, a financial derivatives expert at the University of Maryland law school. ‘Why should the banks get 75 to 82 cents on the dollar, but the Detroit workers get 10 cents on the dollar? Whose life is destroyed by this?’

A committee of retirees also is urging U.S. Bankruptcy Judge Steven Rhodes to reject the settlement, which will be litigated over three days of hearings set to begin Tuesday.

‘Once (the banks) take this money, that’s money that’s not available to satisfy the claims of the other claimants,’ said Peter Shapiro, a South Orange, N.J., financial consultant who advises cities and states on interest rate swaps.

Orr defended his rush to settle with the swaps counterparties as a need to free up casino tax revenues. From Detroit News again:

Orr has said he has no choice but to pay UBS and Bank of America a large chunk of what they’re owed because the banks control access to $15 million a month in casino tax revenues through another deal that staved off bankruptcy for the Motor City in 2009.

‘The city needs the casino revenue badly,’ Orr said last month in a sworn deposition. ‘Every day that we don’t have access to casino revenue, we cannot make the necessary reinvestment in this city to provide for the health, safety and welfare of the citizens.’

Orr obtained control of the casino revenues in mid July through a temporary restraining order against Syncora from a Michigan State Supreme Court. The bankruptcy court affirmed Orr’s control of the revenues on August 28. It’s been reported that Orr wants to use these casino revenues as collateral for a loan to pay off the swap counterparties.

This is the big-boy money fight in the Detroit bankruptcy. Much of it is happening in the dark. The few glimpses we can catch are like distorted images in a fun house mirror.

Syncora is suing UBS in federal court in Manhattan over the Detroit swaps. Detroit officials tried to involve themselves in that case, but federal judge Lewis A. Kaplan said they are not welcome.

Every move that Orr makes seems to be to trying to pay off UBS and Merrill Lynch before anyone else is repaid.

Why the rush?

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