Interest-rate swap firms could get paid first as Detroit bankruptcy looms

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Under Emergency Manager Kevyn Orr's proposal last week to restructure the insolvent city's finances, the payments get priority over promises to retirees and holders of unsecured debt, including the pension borrowings. Being ranked among secured creditors gives the banks the same protection as investors in water and sewer bonds or general obligations secured by liens on state aid.
http://www.crainsdetroit.com/article...oit-bankruptcy

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Not surprising. The debt is secured - that gives it higher priority legally.

However THIS made me sick:

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In 2009, facing a possible swap-termination fee equal to one-fourth of its budget, the city pledged the gambling-tax revenue as collateral. Since then, the city has been paying about $50 million a year, with $878.7 million expected through 2035, according to Orr's report. The city budgeted about $57 million for public lighting this year.

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Wow. The City basically took a shitty pay day loan. $250M turns to $878.7M??? I'm astounded. I'm sure the bank quickly sold that debt stream off for a cool $500M and laughed their asses off.

I only pray they find corruption under this deal [[not unlikely). If they do, there's a possibility that could cancel out the entire debt, as happened with Chase Bank down in Bama.

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Originally Posted by TexasT

http://www.crainsdetroit.com/article...oit-bankruptcy



Not surprising. The debt is secured - that gives it higher priority legally.

However THIS made me sick:



Wow. The City basically took a shitty pay day loan. $250M turns to $878.7M??? I'm astounded. I'm sure the bank quickly sold that debt stream off for a cool $500M and laughed their asses off.

I only pray they find corruption under this deal [[not unlikely). If they do, there's a possibility that could cancel out the entire debt, as happened with Chase Bank down in Bama.

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That will only happen through bankruptcy, unless they voluntarily accept the cuts.

The thing is, the reason Orr was appointed in the first place was to prevent Detroit from filing for bankruptcy.

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Originally Posted by 313WX

That will only happen through bankruptcy, unless they voluntarily accept the cuts.

The thing is, the reason Orr was appointed in the first place was to prevent Detroit from filing for bankruptcy.

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Chase bank agreed to cancel the debt in a similar case where corruption was found as a part of its settlement with the SEC. Even in bankruptcy, I'm not sure this debt would be discharged since it's secured. Unlike our counsel, the bank's counsel covered their bases.

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Originally Posted by 313WX

The thing is, the reason Orr was appointed in the first place was to prevent Detroit from filing for bankruptcy.

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Where do you get that from? Mr. Orr was appointed to manage one of two processes: get Detroit on the path to fiscal sustainability without bankruptcy, if possible [[it isn't), or put Detroit in the most favorable position possible to go through a municipal bankruptcy in the minimum possible time with the least amount of disruption.

At no time did any responsible person fantasize that Mr. Orr would, with any degree of certainty, be able to "prevent" bankruptcy. Detroit is already insolvent, and has been for a very long time. Bankruptcy is just the act of getting a court to admit that you are insolvent; it is a declaration of an existing fact, which then opens up new avenues of solution which would have previously been unavailable.

I will be pleased, but shocked, if Mr. Orr is able to manage the City's way out of this mess without resort to the courtroom.

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Originally Posted by 313WX

That will only happen through bankruptcy, unless they voluntarily accept the cuts.

The thing is, the reason Orr was appointed in the first place was to prevent Detroit from filing for bankruptcy.

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I respectfully disagree. Orr was not appointed to avoid bankruptcy. He was appointed to try to negotiate through as much of it as possible without [[or before) the time and expense of the legal process.

Unfortunately, even in a bankruptcy scenario, I don't believe that these bonds can be discharged unpaid. Regarding pensioners, I would like to think that that they may have some recourse if fraud and corruption are demonstrated to be the cause of the demise and underfunding of the pension fund.

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Originally Posted by corktownyuppie

Regarding pensioners, I would like to think that that they may have some recourse if fraud and corruption are demonstrated to be the cause of the demise and underfunding of the pension fund.

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I sadly don't think they will. I think their money was pissed away, never to be recovered. :[[

But I keep seeing reference to pensions being raided - I've never seen Orr say anything about taking the money that's there, just that they can't make up the difference in what is unfunded. So if the pensions are funded at 85% or whatever, the haircut comes off the remaining 15%.

Union officials are in a tight spot. They can continue claiming the pensions aren't that underfunded [[and no need to Orr's investigation) but that means the pensioners are at risk of losing little money overall. The pension officials need to decide whether they are funded and everything is fine or whether they are underfunded and pensioners are at risk.

I see that there is a large misunderstanding has to how an interest-rate swap works.

While not knowing exactly how this specific CoD swap was set up, the generally go something like this:

Let’s assume the CofD has an existing debt of $1 million with an interest rate that is floating [[variable) pegged to say the 10 year Treasury Rate. At the time they issued the debt the 10Yr T was at 5.0% but could go up or could go down. Well, the CoD did not like the riskiness of a variable rate and wanted to have the known stability of a fixed rate loan. So they entered into a swap agreement. Banks arrange these things, sometimes with another, third party. Swaps are usually entered into as a protection against the risk of rising interest rates

In a swap, the CofD accepts from the third party a fixed rate at let’s say, 5.25% - they are willing to pay a modest premium over their current 5.0% variable rate in order to have the stability of a known, fixed rate.

But, this is a VERY sharp two-edged sword. If variable rates rise, then the CofD is protected from paying the higher interest rate. They would look like geniuses for buying this rate protection if rates had gone up.

However, if interest rates fall, as they have, to 2.46%, then the CofD still pays at the 5.25% interest rate. Had the CofD remained with the original variable interest rate, then they would now be paying a lower rate. Instead, the rate they are paying is more than double today’s variable rate.

It is really had to fault the CofD in a swap. They took a gamble with a third party [[using the bank as an intermediary) that variable interest rates would be going up soon. The other guy assumed variable rates would be dropping. These things are done in business each and every day.

Depending on which way variable rate move [[higher or lower) one party will be a HERO and the other party is a ZERO.

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Originally Posted by TexasT

I sadly don't think they will. I think their money was pissed away, never to be recovered. :[[

But I keep seeing reference to pensions being raided - I've never seen Orr say anything about taking the money that's there, just that they can't make up the difference in what is unfunded. So if the pensions are funded at 85% or whatever, the haircut comes off the remaining 15%.

Union officials are in a tight spot. They can continue claiming the pensions aren't that underfunded [[and no need to Orr's investigation) but that means the pensioners are at risk of losing little money overall. The pension officials need to decide whether they are funded and everything is fine or whether they are underfunded and pensioners are at risk.

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Spot on. If pensions are funded at 85%, and Orr is willing to give 10 cents on the dollar, 10% of the remaining 15% shortfall is 1.5%...so worst case scenario, you're at 86.5% funding. And supposedly, Police and Fire is 95% funded, so there's almost no problem there at all.

Moreover, there's no reason the 10% needs to distributed equally. It could all be given to people above 70. So now you're talking about what...a 2-4% haircut on pensions for police and fire??

Of course, it's not good news. But in considering the alternative [[and how much the unsecured debtors are getting), it's like winning lottery ticket.

But, of course, that's all predicated on whether or not the pension funding levels are what they are supposed to be. I guess we will just have to find out.

I misspoke. What I meant to say is that Orr was appointed so Detroit's debt could try to be restructured without bankruptcy. That said, if bankruptcy's unavoidable [[which it probably is), then it's unavoidable. But Orr was sent here to at least make a valiant effort to avoid the inevitable.

Why did Chase bank cancel that debt in Jefferson County, AL I might ask? My understanding is that the BK judge thought it was an equitable settlement. Does anyone have the reason? I guess theoretically, Detroit [[Orr) can pursue a civil lawsuit against these creditors for the interest rate swaps to see if there's any chance of the debt getting discharged [[like several other municipalities have done). He hasn't rule that out either, but it's unlikely as the costs would probably outweigh any benefit.

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Originally Posted by 313WX

I misspoke. What I meant to say is that Orr was appointed so Detroit's debt could try to be restructured without bankruptcy. That said, if bankruptcy's unavoidable [[which it probably is), then it's unavoidable. But Orr was sent here to at least make a valiant effort to avoid the inevitable.

Why did Chase bank cancel that debt in Jefferson County, AL I might ask? My understanding is that the BK judge thought it was an equitable settlement. Does anyone have the reason? I guess theoretically, Detroit [[Orr) can pursue a civil lawsuit against these creditors for the interest rate swaps to see if there's any chance of the debt getting discharged [[like several other municipalities have done). He hasn't rule that out either, but it's unlikely as the costs would probably outweigh any benefit.

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Chase was in trouble with the SEC - there was corruption underlying the transaction. So as a part of its settlement with the SEC, it canceled the debt [[and refunded some of the money to the municipality). The CoD took such a shitty deal, it wouldnt surprise me if someone was paid off to accept it.

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Originally Posted by Packman41

I see that there is a large misunderstanding has to how an interest-rate swap works.

While not knowing exactly how this specific CoD swap was set up, the generally go something like this:

Let’s assume the CofD has an existing debt of $1 million with an interest rate that is floating [[variable) pegged to say the 10 year Treasury Rate. At the time they issued the debt the 10Yr T was at 5.0% but could go up or could go down. Well, the CoD did not like the riskiness of a variable rate and wanted to have the known stability of a fixed rate loan. So they entered into a swap agreement. Banks arrange these things, sometimes with another, third party. Swaps are usually entered into as a protection against the risk of rising interest rates

In a swap, the CofD accepts from the third party a fixed rate at let’s say, 5.25% - they are willing to pay a modest premium over their current 5.0% variable rate in order to have the stability of a known, fixed rate.

But, this is a VERY sharp two-edged sword. If variable rates rise, then the CofD is protected from paying the higher interest rate. They would look like geniuses for buying this rate protection if rates had gone up.

However, if interest rates fall, as they have, to 2.46%, then the CofD still pays at the 5.25% interest rate. Had the CofD remained with the original variable interest rate, then they would now be paying a lower rate. Instead, the rate they are paying is more than double today’s variable rate.

It is really had to fault the CofD in a swap. They took a gamble with a third party [[using the bank as an intermediary) that variable interest rates would be going up soon. The other guy assumed variable rates would be dropping. These things are done in business each and every day.

Depending on which way variable rate move [[higher or lower) one party will be a HERO and the other party is a ZERO.

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The credit swap is not the entire issue. The deal they accepted to terminate the credit swap is [[$50M/yr for total of over $800M).

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Originally Posted by TexasT

Chase was in trouble with the SEC - there was corruption underlying the transaction. So as a part of its settlement with the SEC, it canceled the debt [[and refunded some of the money to the municipality). The CoD took such a shitty deal, it wouldnt surprise me if someone was paid off to accept it.

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Well we'll never know unless the deal Detroit got is litigated [[outside or inside bankruptcy).

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Originally Posted by 313WX

Well we'll never know unless the deal Detroit got is litigated [[outside or inside bankruptcy).

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The SEC can launch an investigation whenever. If Orr turns up something, there is a good chance they will.

There's will an urban theory if Chapter 9 bankruptcy loomes in Detroit city government.

Cleaning up delinquent city taxation:

Detroit homeowners and other folks in the suburbs who work for the city of Detroit may see higher tax bills come next year. Taxation amnesty will come to end. So Detroit homeowners and other who are paying property taxes may to pay their bills in full to its creditors and wall street otherwise face liens to their property, sudden garnishments or possible jail time if they 3 to 5 years behind on their taxes. This would worry a lot of folks!

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Originally Posted by Packman41

I see that there is a large misunderstanding has to how an interest-rate swap works.......


It is really had to fault the CofD in a swap. They took a gamble with a third party [[using the bank as an intermediary) that variable interest rates would be going up soon. The other guy assumed variable rates would be dropping. These things are done in business each and every day.

Depending on which way variable rate move [[higher or lower) one party will be a HERO and the other party is a ZERO.

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The particulars in this case are worse than simply getting caught by the decline in interest rates. The CoD's irresponsible delays in completing the 2007 and 2008 fiscal audits caused the ratings agencies to downgrade the city's debt. Since the swap agreements were predicated on the city maintaining its general obligation debt ratings, the downgrades triggered a termination event in early 2009 which would have obligated the city to make an immediate $400 million termination payment to the swap counter-parties.

The CoD dodged that Chapter 9 bullet by agreeing to make larger annual payments on the swaps and to post collateral for those payments using its quarterly casino tax receipts:

Swaps Deal Will Save Detroit From Insolvency-Mayor

CHICAGO, April 13, 2009 [[Reuters) - Detroit Mayor Kenneth Cockrel Jr called on the city council on Monday to approve a deal that will allow the city to avoid paying a financially crippling $400 million in termination payments for interest rate swaps.

Cockrel said the agreement in principle reached last month saves Detroit, which is already facing a projected $300 million accumulated deficit, from financial insolvency and from likely intervention by the state of Michigan.

Joseph Harris, Detroit's chief financial officer, said the agreement, which should be presented to the council in a few weeks, requires the city to appropriate payments annually on the swaps and to post collateral for those payments from its wagering tax.

In addition, Detroit will face an additional payment of $800,000 a year starting in 2011 on top of the $50 million a year already being paid on the swaps, according to Harris, who added that without the deal he believed the city would be bankrupt........

With the casino tax receipts now pledged as collateral, the CoD could no longer use that source of funds as collateral for short term borrowing to smooth out the matching of receipts with expenditures, thus making the CoD's cash flow crunch even worse.

If you have a strong stomach, read this Oct. 13, 2009 memo to the City Council from their fiscal analysis director regarding approval of another series of Tax Anticipation Notes, which he reluctantly recommends that they approve, despite his warning that they are going to be used to pay off another short term borrowing - not to cover a timing mismatch. He restates his warning in a way that even the dullest Council member should have been able to understand: "this is like opening up a new credit card to pay off an existing one".

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Originally Posted by Mikeg

...snip...If you have a strong stomach, read this Oct. 13, 2009 memo to the City Council from their fiscal analysis director regarding approval of another series of Tax Anticipation Notes, which he reluctantly recommends that they approve, despite his warning that they are going to be used to pay off another short term borrowing - not to cover a timing mismatch. He restates his warning in a way that even the dullest Council member should have been able to understand: "this is like opening up a new credit card to pay off an existing one".

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It does make you sick to your stomach to see just how irresponsible city officials have been. How do we stop this from happening elsewhere? Why are there not mechanisms in place to prevent cities from mortgaging their futures on the backs of their citizens?

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Originally Posted by Wesley Mouch

It does make you sick to your stomach to see just how irresponsible city officials have been. How do we stop this from happening elsewhere? Why are there not mechanisms in place to prevent cities from mortgaging their futures on the backs of their citizens?

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Different states have different systems of municipal finance, so the answer is probably different, but in Michigan I would suggest that any debt with a term of more than one year [[or maybe a little more, but certainly less than five) have to have an associated revenue stream, either a new millage or a redirection of existing income, which would be approved by the voters. There should also be a limit on the total amount of short term debt as a percentage of the municipalities total revenue.

That would allow genuine cash-flow activities, like revenue anticipation notes, to proceed as usual, but would require anything that was "mortgaging the future" to have the approval of the citizens.

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Originally Posted by mwilbert

Different states have different systems of municipal finance, so the answer is probably different, but in Michigan I would suggest that any debt with a term of more than one year [[or maybe a little more, but certainly less than five) have to have an associated revenue stream, either a new millage or a redirection of existing income, which would be approved by the voters. There should also be a limit on the total amount of short term debt as a percentage of the municipalities total revenue.

That would allow genuine cash-flow activities, like revenue anticipation notes, to proceed as usual, but would require anything that was "mortgaging the future" to have the approval of the citizens.

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That seems quite simple and reasonable. Snyder ought to push something like that through. I think the citizens of Detroit deserved the opportunity to know what their leaders are doing. Too much of this happens behind doors that may be unlocked -- but are hidden from view.

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Originally Posted by Wesley Mouch

It does make you sick to your stomach to see just how irresponsible city officials have been. How do we stop this from happening elsewhere? Why are there not mechanisms in place to prevent cities from mortgaging their futures on the backs of their citizens?

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Yes, thanks MikeG and Texas T – I did not know the rest of the story. I was not up to speed on the termination event, required debt repayment and 2009 refinancing to pay that debt.

And yes, Wesley it does make you sick to your stomach to see this. However, you said that city officials were “irresponsible.” I would suggest some more accurate adjectives, such as:

Malfeasance …

Breach of Duty …

Negligence …

Corruption …

Failing to get timely and accurate financials and audits is much more than “irresponsible.”

If the SEC watched over municipal finance as much they do with business finance, then a whole lot more people would be in jail right now.

Now you guys are talking about how we enact some new laws to prevent our idiotic government officials from their own malfeasance. Somebody, please tell me how you fix stupid. Wow, just wow!

Detroit is in a lot more trouble than we know. And people still question the need for an EM!