Friday, January 17, 2014

Federal Bankruptcy Judge Rejects Swap Deal Payment to Bank of America and UBS

January 16, 2014 7:30 PM

Detroit bankruptcy judge rejects $165M swaps deal with banks

By Crain's reports
and wire services

U.S. Bankruptcy Court Judge Steven Rhodes
A Detroit bankruptcy judge denied the city permission to pay UBS AG and Bank of America Corp. about $165 million to end interest-rate swaps that have cost taxpayers $202 million since 2009.

U.S. Bankruptcy Judge Steven Rhodes today refused to approve the settlement with UBS and Bank of America's Merrill Lynch unit. Rhodes called the $165 million payment plus a fee of more than $4 million "too high a price."

"The court will not let the city continue hasty decisions," Rhodes said. It's not in the best interest of Detroit to "enter into bad deals" to solve its financial problems, he said.

The decision is a setback for Kevyn Orr, Detroit’s emergency financial manager, who is trying to adjust about $18 billion in municipal debt in a matter of months. The city can try to reach a new deal with the banks or sue them to void the contracts, an option that creditors said should have been considered more seriously in the first place.

To pay for the swaps settlement and other projects, the city had asked the judge to approve a $285 million loan from Barclay's. Rhodes today approved only $120 million of it, which would be used to improve city services.

"We are reviewing today's decision, but we are thankful the court has approved our ability to pursue quality-of-life financing for the benefit of the city's 700,000 residents," said Emergency Manager Kevyn Orr in an emailed statement. "As recommended, we will continue to work toward a resolution of the pension 'swaps.'"

Bill Halldin, a spokesman for Bank of America, and Megan Stinson of UBS declined to comment on the ruling.

The judge's ruling came as a shock to many observers because the proposed deal had been mediated by Gerald Rosen, the chief mediator in the case and the chief district judge of the U.S. District Court for the Eastern District of Michigan.

"The judge's ruling gives clear guidance that he will not be a 'rubber stamp' endorser of any settlement," said Douglas Bernstein, managing partner of the banking, bankruptcy and creditors rights practice group at Plunkett Cooney PC in Bloomfield Hills, "and that the parties are going to have to conform to the requirements of the bankruptcy code.

"I think it is a surprise in a way, but it is consistent with his commitment to following the law and with his history of being able to make difficult decisions, even if they are not as expected."

Even though Rhodes approved a $120 million of the proposed loan, the question remains whether Barclay's will want to move forward with a much-altered deal.

"They will need to know that there is a funding source for repayment, and that they will be comfortable with it," said Bernstein. "If their approval contemplated the gaming revenues as a component, and they are no longer available, then it would appear to be a different deal that needs further negotiation."

David Brophy, professor of finance at the University of Michigan Ross School of Business, had this take on Rhodes' decision:

"You've got the dealmaker in jail, Kwame Kilpatrick. And I imagine what is in the judge's mind is: 'You bastards [the banks] had as much complicity in the original deal as Kwame did. Among all the debtors, you're the guys who are in some sense that are getting out and all the rest of the debtors are pretty angry so you should pay more, you should take a bigger haircut.'

"He's taking the side of the people of Detroit. But this ruling certainly heightens the anxiety."

Days before Detroit filed the biggest U.S. municipal bankruptcy, it reached a deal to pay $230 million to terminate the swaps contracts, which a city service corporation signed with Zurich-based UBS and SBS Financial Products Co. Merrill Lynch, a unit of Charlotte, N.C.-based Bank of America, took over the SBS position in July.

Buying out the contracts would keep casino taxes, one of Detroit's best sources of revenue, from going to the banks, Corinne Ball, a lawyer for the city, told Rhodes when a trial over the settlement began last month.

Rhodes suspended the trial and told the city to try to renegotiate the terms. On Dec. 24, Detroit announced a new settlement that reduced the termination payment to $165 million.

Creditors led by bond insurer Syncora Guarantee Inc. opposed the settlement, saying it was too costly. The city didn't prove it would lose if it sued to cancel the contracts instead of settling with the banks, Syncora said.

Detroit has paid about $202 million on the swaps, according to Bill Nowling, a spokesman for the city's emergency financial manager, Kevyn Orr.

Detroit filed a record $18 billion municipal bankruptcy in July, saying decades of economic decline had left it without enough money to pay creditors and still provide services to about 700,000 residents.

The city’s 5 percent sewer bonds that mature in 2025 fell almost 3 percent to 85.57 cents on the dollar after the ruling, according to data compiled by Bloomberg.

Rhodes’s decision is “stunning and extraordinary,” said Lee Bogdanoff, one of the lead lawyers in Jefferson County, Alabama’s $4 billion bankruptcy.

In municipal bankruptcies, judges have limited power over the decisions of civic officials, Bogdanoff said in a phone interview. In all cases, judges generally defer to the business judgment of a debtor’s managers about whether to settle a legal dispute, he said. A mediator appointed by Rhodes had recommended approving the settlement.

“In the short run, you are going to have more litigation,” Bogdanoff said. It’s too early to tell whether that would make it harder for the city to win support from creditors for a plan to adjust its debts, he said.

Bloomberg News, the Associated Press and Crain's reporter Amy Haimerl contributed to this report.

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