There are a lot of moving parts in the Detroit story as it goes through the largest municipal bankruptcy in U.S. history. The strangest part of the story has been the interest rate swaps that were layered onto the city’s 2005 and 2006 pension obligation bonds.
The purpose of the swaps was to lower the city’s borrowing costs by using interest-rate arbitrage. Theoretically, if financial conditions had remained “normal,” the swaps would have been beneficial for the city. Instead, Detroit’s credit rating was downgraded and the financial crisis upended the delicate conditions that underpinned the swaps.
On July 18th, when Detroit’s Emergency Manager Kevyn Orr filed for municipal bankruptcy, he also filed a proposed settlement with the swaps counterparties. Orr’s proposal would pay the counterparties – UBS and Bank of America Merrill Lynch – between 75 and 82 cents on the dollar to terminate the swaps and move them out of the picture. This action insulates UBS and Bank of America from the hatchet job that Orr plans to give to other creditors in the course of the bankruptcy process. Those unprotected creditors include bond insurer Syncora, which insured the interest-rate swaps and the underlying pension obligation bonds.
In the end it comes down to who has legal control of the city’s $15 million per month of casino tax revenues. About $4 million per month has been used since 2009 to pay UBS and Bank of America on their swaps deals. Federal bankruptcy judge Steven Rhodes ruled that the city has control of the excess $11 million. Reuters reports:
Syncora had tried to block Detroit from accessing an estimated $11 million in monthly tax revenue from the city’s three casinos, claiming it had a lien on the money, which had been used as collateral since 2009 to secure the city’s interest-rate swap agreements. Detroit’s emergency manager, Kevyn Orr, and one of his top consultants said in sworn depositions that the casino revenue is key to city’s survival.