Detroit should have litigated swaps termination, some creditors say

DETROIT Mon Jan 13, 2014 12:28pm EST

DETROIT Jan 13 (Reuters) - The agreement struck with two banks by Detroit to end toxic interest rate swap agreements was not in the best interest of the city, the groups objecting to the deal said during closing arguments in a bankruptcy court hearing on Monday.

The bond insurers, banks, pension funds and others objecting to Detroit's Dec. 24 deal to terminate interest-rate swaps with UBS AG and Merrill Lynch Capital Services, a unit of Bank of America Corp, presented arguments on Monday during a hearing set to determine whether the deal should be approved.

The hearing was postponed twice last week due to inclement weather.

If U.S. Bankruptcy Judge Steven Rhodes approves the agreements, Detroit will pay the banks $165 million plus fees to end the agreements at a 43 percent discount to their original cost to the city. Detroit entered into the interest-rate swaps in a failed attempt to hedge, or limit the risk, on some of the $1.4 billion in pension debt that it sold in 2005 and 2006.

But Caroline English, the attorney representing bond insurer Ambac Assurance Corp from the law firm Arent Fox, argued the city had strong legal arguments to support a full termination of the swaps agreement and should not have settled with the banks.

"This deal should have the swap counterparties paying the city, not the city paying the swap counterparties," said English.

Detroit Emergency Manager Kevyn Orr testified previously that the city settled with the banks because it only had a 50-50 chance of succeeding in litigation and it did not want to risk a lengthy and expensive legal process. He also testified that the city did not want to lose access to its casino tax revenue, which was used as a lien in the swaps deal.

But the objectors argued that the use of casino revenue as a lien violated Michigan law because the funds were not used to directly provide services to Detroit residents.

Detroit and the banks initially agreed to terminate the swaps for $230 million, or 75 cents on the dollar, but Rhodes encouraged the city to renegotiate the deal to secure better terms. The city reached its agreement with UBS and Merrill after two days of mediation on Dec. 23 and Dec. 24 of last year.

Detroit also has reached an agreement with Barclays Plc for a $285 million loan to end the swaps. Detroit plans to use about $120 million of the loan to fund improvements to city services.

But Vincent Marriott, who represents Detroit creditors Hypothekenbank Frankfurt AG, Hypothekenbank Frankfurt International SA and Erste Europäische Pfandbrief-und Kommunalkreditbank Aktiengesellschaft in Luxembourg SA, argued that the court should not approve the post-petition financing.

He said the city should have provided the Detroit City Council with more information about the loan and also pursued an unsecured loan.

"By beginning the solicitation process by offering collateral, the city ensured substantial collateral would be granted to the lender," Marriott said.

The lawyer representing Merrill Lynch, Marc Ellenberg, however, argued that the deal was in the best interest of both the city and the banks.

"There is such a thing as a win-win transaction," he said in response to a question from Rhodes about Merrill's motivation for reaching its agreement with the city.

"There is such a thing as the lesser evil and that's what we've tried to reach," said Ellenberg.

Detroit was declared legally bankrupt on Dec. 3, making it the largest U.S. city ever to go bankrupt. The city has more than $18 billion in debt and other obligations.

Orr had said he planned to file the city's plan to deal with its debt to the court in the first week of January, but that has been delayed until the issues surrounding the swaps are dealt with, spokesman Bill Nowling said in an email last week.

"If it looks like mediation efforts are bearing fruit, it could push back the release date as we look to include any mediated agreements in the plan," Nowling said.