UPDATE 1-Creditors argue against Detroit's deal to terminate swaps

Mon Jan 13, 2014 5:04pm EST

By Joseph Lichterman

DETROIT Jan 13 (Reuters) - U.S. Bankruptcy Judge Steven Rhodes said he will rule Thursday on whether to let stand a deal struck between the city of Detroit and two investment banks to end toxic interest rate swap agreements that proved to be a strain on city finances.

Lawyers for bond insurers, banks, pension funds and others objected to the deal during a bankruptcy court hearing Monday, saying that the Dec. 24 deal with UBS AG and Merrill Lynch Capital Services, a unit of Bank of America Corp, was not in the best interest of the city. Detroit could have won larger concessions from the investment banks, the opponents argued.

Rhodes said he would announce his decision in a hearing on Thursday at 2 p.m. (1900 GMT). The hearing was postponed twice last week due to inclement weather.

If 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.

Caroline English, the attorney representing bond insurer Ambac Assurance Corp, 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," English said.

Detroit's emergency manager, Kevyn Orr, testified previously that the city settled with the banks because it had only a 50-50 chance of succeeding in litigation and it did not want to risk a lengthy and expensive legal process.

In response to the closing arguments, Corinne Ball, the attorney representing the city, said Detroit could lose access to casino tax revenue, which served as collateral in the swaps contract.

"That possibility and those consequences are things the emergency manager had to consider," Ball said, arguing that city residents should not have to wait for the city to be able to finance improvements to services.

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 gets casino tax revenue of about $180 million a year.

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 24.

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, 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," Ellenberg said.

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.

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