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Original article URL: http://bridgemi.com/2014/03/detroit-creditor-winners-and-losers/

Detroit bankruptcy and beyond

Detroit creditor winners and losers

Detroit Emergency Manager Kevyn Orr has proposed sweeping cuts in the money owed to city creditors. U.S. Bankruptcy Judge Steven Rhodes must rule on the plan.

Detroit Emergency Manager Kevyn Orr has proposed sweeping cuts in the money owed to city creditors. U.S. Bankruptcy Judge Steven Rhodes must rule on the plan.

Long before Detroit Emergency Manager Kevyn Orr rolled out his proposal in February for paying back the city’s creditors, bankruptcy experts knew the pain would not be spread evenly.

Because so much of the city’s debt – nearly $6 billion owed to pay back loans for the city’s sprawling water and sewer department – cannot be reduced in bankruptcy court, the creditors feeling the brunt of the cuts are retirees and city employees.

Orr hopes that his proposed cuts to creditors – if approved by the bankruptcy judge– will allow the city to spend $1.5 billion over 10 years for more cops, more street lights and the removal of tens of thousands of blighted buildings. That would be a big win for Orr, and for Gov. Rick Snyder, who appointed Orr and pushed for bankruptcy despite fierce criticism.

Though the final score won’t be known for years, here’s a summary of other likely winners, and losers, when the terms of Detroit’s debt payments are finally approved:

WINNERS

City residents

The list of winners might be smaller than the losers, but it includes those who bankruptcy was designed to help – the city’s nearly 700,000 residents. The population has been in decline for decades as thousands leave every year, complaining about the poor schools, high crime and deplorable living conditions they leave behind.

If Orr’s plan is implemented and the necessary fixes are adopted, it will mean more cops on the street. It will also mean better lighting, fewer potholes and a reduction in blight on those streets. But that’s if the plan is adopted and the money is allocated.

Mike Duggan

Should bankruptcy help stabilize the city’s budget and improve its ability to deliver services, it could have a profound effect on the man currently sitting in the mayor’s office. Though Duggan said he opposed bankruptcy when he was a candidate, Orr’s appointment and the bankruptcy filing itself have eliminated some of the politically difficult decisions that would have otherwise landed on the mayor’s desk: Making wholesale budget cuts and rewriting union contracts for city workers and retirees.

Duggan could benefit most if the plan goes through and Orr’s pledge to spend $150 million a year on improvements to basic city services comes to fruition. The mayor has already pledged to make sweeping changes in his first six months in office and those efforts could get a boost from Orr, who is working closely with the Democrat.

Bondholders

It might not make other creditors happy, but one chunk of city bondholders will be the most certain of winners. The city has promised to pay back billions in municipal bonds, debt owed to some of the nation’s largest banks and mutual funds. A huge portion of that debt, for the city’s water and sewer department, is protected by bankruptcy law and Orr has said he’ll pay 100 percent of the principal on those bonds, covering $5.7 billion in city debt.

LOSERS

Bondholders

Yes, they’re on both lists. Why? Because Orr has infuriated the bond market by identifying more than $538 million in bonds as unsecured – or not backed by the city’s tax revenues – and offered to pay just 20 cents on every dollar owed. (If Orr’s position is upheld, it could unsettle the broader municipal bond market, which has always operated on the assumption that these debts will be fully paid. This in turn could lead to higher borrowing costs for municipalities as risk rises.) Bonds issued for the Downtown Development Authority, which has $33.6 million in city debt, are also tabbed to get 20 cents on the dollar under Orr’s repayment proposal.

Pension bonds

The biggest unknown is what will happen to an estimated $1.4 billion the city borrowed in 2005 and 2006 to shore up the city’s pension funds for city workers. Orr claims the “certificates of participation” (or COP) loans were made in violation of state securities law and wrongly allowed the city to exceed debt limits. He’s playing chicken with the COP: At the same time his lawyers are threatening to cancel the entire debt via a lawsuit, Orr told bondholders they could get 40 percent of the the money owed them – but just the principal owed, not the interest – if they settle with the city without litigation.

Pension swaps

As part of the deal to lessen the blow of the COPs, the city agreed on interest rate “swaps” to keep the cost down when it borrowed the $1.4 billion to pump up the underfunded pension plans. Instead, when interest rates fell, the city was suddenly on the hook for millions more and, at the time of bankruptcy, owed $286 million more on the swaps alone. A deal to cut that to $85 million is pending. The swaps were costing the city more than $48 million a year.

Bond insurers

Some the staunchest opponents of the city’s bankruptcy filing have been the huge insurance companies which backed many of the bond issues. They have attacked some of the proposed deals, including the swaps deal, because they (not the city) will be on the hook for paying the balance.

City workers, retirees and their unions

The biggest losers are those who’ve been closest to the city for decades: its employees and retirees. In his initial repayment proposal, known as a plan of adjustment, Orr laid out sweeping cuts for city workers and retirees, following a U.S. bankruptcy judge’s ruling that pensions could be reduced even though they are otherwise protected by state law. Orr called for cuts in pensions ranging from 10 to 34 percent. He also ruled out any future cost-of-living increases.

Orr’s also tackled the estimated $5.7 billion needed to pay for retiree healthcare benefits by creating a special fund, created with $526 million over 20 years, to pay health care claims.

The so-called voluntary employee beneficiary association would allow Detroit to wash its hands of all health care liability in 20 years. It would also reduce its annual payout for retiree healthcare benefits from the current $139 million annually to $42 million and, after 10 years, to $10 million a year. Retirees would get monthly stipends to offset their private plans and would be moved into Medicare (if old enough), or into plans bought through the Affordable Care Act.

Mike Wilkinson is Bridge’s computer-assisted reporting specialist. Mike held a similar role at The Detroit News. See more stories by him here.

5 comments from Bridge readers.Add mine!

  1. William C. Plumpe

    I am a recent City of Detroit retiree with a background in accounting and finance and while I do think retirees stand to come out of the bankruptcy in the worst position I don’t think that it is necessary.
    Mr. Orr is trying to do too much too quickly not because he wants to help the City but because he wants to look good.
    There will be outisde oversight of Detroit finances for at least a decade so their is no real reason to move too quickly. The bankruptcy must be resolved in an expeditious manner but that does not mean we need to be excessively hasty,
    For example the $8 billion in Water & Sewerage Bond debt is backed up by the considerable cash generating capability of DWSD and is almost a no brainer because it will be paid back by DWSD revenues which are in the $100’s of millions every year. Now if the Water & Sewerage bonds are somehow tied in to the swaps deal along with the casino revenues then we do have a problem but that is all the more reason to not give the banks involved another penny and in fact sue them for triple damages and return of the $200 million they’ve already been paid. That would provide another $800 million to refurbish Detroit, keep retirees happy and healthy and save DIA art from a sell off. Sounds like a good idea to me. Enough said.

  2. James Hohman

    Workers and retirees have been protected in ways other creditors have not, so it’s tough to see how they are the “biggest losers” in the process.

    1.) Workers have faced cuts before filing and this is the result of insolvency and not bankruptcy. They will be in a better position when bankruptcy frees up cash that would otherwise go elsewhere.

    2.) Retirees received special protections from the proposed state and the DIA deal that were not available to other creditors despite their unfunded liabilities having few protections.

    3.) OPEB is not any kind of liability but rather a gratuitous payment that cities have no legal obligation to maintain. Yet even these are going to be offered some protections.

  3. bobidt

    Losers? How about the biggest losers? We the folks in the rest of the entire state. I (for one) don’t want that hell hole of ” De-toilet” to get 1 penny from me. But the rest of us that have worked hard and lived within our means are paying for the bankrupt corrupt democrats in SE MI. Enough already. No more money! Not one more penny. The DIA? Hey, if You democrats want to see it, Pay with your money, not ours. Sell it! 99% of the folks in MI will never ever go there so sell it and pay your debts!!

  4. Scott Roelofs

    Very helpful article by Mike Wilkinson. This bankruptcy case is extremely complicated, and he summarized issues so they can be easily understood.

  5. Charles Richards

    Contrary to Mr. Roelofs, neither this nor Mr. Wilkinson’s previous article are very informative. The crucial figure is the $150 million a year that is proposed to be spent on improved services and blight removal. How do the various proposed cuts contribute to that figure?. His description of the benefits of the Voluntary Employee Beneficiary Association (VEBA) is the most informative, helpful sentence of the entire article. “It would also reduce its annual payout for retiree healthcare benefits from the current $139 million annually to $42 million and, after 10 years, to $10 million a year.” That is a contribution of $97 million a year towards the $150 million in the first ten years and a contribution of $129 million a year in the second ten years. Unfortunately, he did not give similar figures for the two pension funds. What will those reduced pension funds save annually?

    Nor were his glitzy graphics in the previous article particularly informative. One graphic showed liabilities for five categories. The second showed recovery rates for each category. What we needed to know was how much liabilities would be reduced for each category. Then we needed to know how much annual savings we could expect from those reductions in liabilities. Those figures were notable for their absence. For those who are interested, these are the reductions in liabilities for each of the categories: Unsecured city projects, $379,434,186, pension swaps, $230,400,000, Downtown Development Authority, $26,880,000. The total reduction in liabilities other than pension and retiree medical costs is: $636,714,186 Because he failed to provide the annual costs of each category, we have no way of knowing how much these reductions in liabilities contribute to the $150 million required annually.

    Bridge is not the only publication that has failed to provide adequate information. Neither of the Detroit papers has done so either.
    .

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