UPDATE 2-Detroit seeks $350 million ground-breaking loan

Thu Aug 29, 2013 6:55pm EDT

By Bernie Woodall and Tom Hals

DETROIT Aug 29 (Reuters) - Detroit, which made the largest Chapter 9 municipal bankruptcy filing in U.S. history, on Thursday filed a request for proposals for $350 million in unprecedented financing, the city emergency manager's office said.

Detroit is the first large U.S. city to seek so-called debtor-in-possession (DIP) financing after asking for bankruptcy court protection.

The city plans to use about $250 million to terminate a complicated swaps deal related to previous bonds issued to finance pension debt, said Bill Nowling, press secretary for Detroit's state-appointed emergency manager, Kevyn Orr.

About $100 million would "provide the city with adequate liquidity throughout the restructuring case to start reinvesting in Detroit today," Nowling said in an e-mail to Reuters. It would be a line of credit the city could draw from, but it may not use all of it, he said.

Nowling also said Orr plans to use proceeds from the financing to invest in "quality of life" improvements for Detroit's nearly 700,000 residents.

In 1950 the city had 1.8 million people at a time when the three automakers that still call the Detroit area home dominated the auto industry. But in recent years the city that has accumulated more than $18 billion in debt and has made international headlines with its urban blight, roaming packs of feral dogs and outdated and sometimes inoperable police and fire equipment.

The termination of the swaps payment would be made to Merrill Lynch, a unit of Bank of America, said Nowling.

The state's emergency manager law grants to Orr most of the powers once afforded to the city's mayor and city council, including responsibility for the city's finances.

"The city is contacting a range of financial institutions, commercial banks, investment banks and hedge funds," Nowling said in an email to Reuters. He said the city would expect the U.S. Bankruptcy Court to approve the loan.

Orr told Reuters earlier this month the city could complete its restructuring without borrowing money, but piling up money now could give the city leverage and help it avoid a cash crunch later if the ground-breaking case gets bogged down.

Detroit heads to a trial in October to prove it is eligible for bankruptcy. The city filed for Chapter 9 protection in mid-July.

On Wednesday, U.S. Bankruptcy Judge Steven Rhodes, who is overseeing Detroit's bankruptcy petition, cleared the way for the city to seek approval next month of the $250 million swaps deal that will give it unencumbered access to its casino revenues.

Detroit collects about $180 million annually from casinos, which is among the city's most stable sources of revenue.

In an interview with the Detroit News on Wednesday and published on Thursday, Orr said he wanted to use the casino tax revenue to back the borrowing. In the interview, Orr first publicly mentioned his intent to seek the funding.

Lending to a bankrupt entity might seem like a bad idea, but the loans are repaid ahead of almost all other creditors and Wall Street banks and hedge funds often provide a debtor-in-possession, or DIP, loans.

UNPRECEDENTED

But under Chapter 9 of the bankruptcy code, which covers the rare municipal bankruptcies, there is no real precedent for a DIP loan. As a result, there is no blueprint for determining the collateral the city can pledge, and how much power the judge has to enforce a lender's rights if Detroit defaults.

The only example of a municipal bankruptcy loan that turned up in a search of court records by Reuters was Prichard, an Alabama city with about 30,000 residents, which received court approval for a loan in 2000 during the first of its two recent bankruptcies.

The lack of precedent may make the loan a tough sale or may prompt lenders to demand control of the bank account receiving the casino revenue, lawyers told Reuters. DIP loans in corporate bankruptcies are often used to as a way to control a restructuring, and it was through a DIP loan that the U.S. Treasury guided the 2009 bankruptcies of GM and Chrysler.

Speculation about the need for such a loan has been a topic among lawyers and advisors who specialize in bankruptcy, and one lawyer told Reuters earlier this month he had been contacted by hedge funds about lending to Detroit.

"They see that it's a mess, and whenever there's a mess and they have a mop, someone will pay to clean it up," said Lewis Feldman, a lawyer who specializes in public finance at the law firm Goodwin Proctor.