Creditor cramdown could imperil money pledged for Detroit retirees

NEW YORK, April 10 Thu Apr 10, 2014 4:36am EDT

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NEW YORK, April 10 (Reuters) - Kevyn Orr, Detroit's emergency manager, said he has lined up support from enough creditors of the bankrupt city to force concessions from others, but doing so would risk the loss of more than $800 million in funding from the state of Michigan and philanthropic foundations.

A deal announced Wednesday with bond insurance companies, along with a previous deal with two investment banks, could give Orr authority under Chapter 9 of the U.S. municipal bankruptcy code to force other creditors to accept payment terms. But a so-called cramdown would violate a pre-condition of Orr's "grand bargain" with the state and foundations, which have pledged $816 million to ease pension cuts for retired city workers.

"The concept of a cramdown runs a risk of losing $816 million because I don't have a consensual resolution," Orr told Reuters in an interview late Wednesday. "So technically do I have the legal ability to do a cramdown? Yes. But can I exercise it without losing $816 million? Maybe not."

Orr also rebutted widespread reports that Detroit is putting the financial health of city pension funds at risk by seeking to invalidate $1.4 billion of debt Detroit issued nearly a decade ago in an effort to help the city catch up on delinquent pension contributions. If the bankruptcy court approves Orr's move to invalidate the securities, known as certificates of participation, the ruling would wipe out the debt altogether, Orr contended.

"If it's void it's void. It can't be resurrected against somebody else," Orr said. "The city does not pay that debt. The debt is wiped out. The debt is wiped out, 100 percent."

Orr's comments about the prospects of a cramdown and invalidation of pension debt came in a wide-ranging, hour-long interview, in which he also dismissed a valuation of the Detroit Institute of Art's renowned collection by a bond insurer, said Detroit almost certainly will operate with oversight from a financial control board after bankruptcy and said definitively he will never pursue elective office.

Orr's comments came on a day in which U.S. Bankruptcy Court mediators announced agreement in a case brought by insurers of some Detroit bonds. The mediators approved a plan in which bondholders will receive $287.5 million of $388 million owed. The payment represents 74 cents on the dollar owed on voter-approved, unlimited tax general obligation bonds.

With regard to negotiations with other creditors, Orr warned the city's pension funds, retirees, unions and others that a cramdown, while unlikely, still remains in his arsenal to get Detroit through the biggest municipal bankruptcy in U.S. history.

"Everything is always on the table. I want to be very clear about that. Every tool at my disposal is always on the table," Orr said.

With the bond insurers' case settled, Orr now awaits a Friday ruling by bankruptcy judge Steven Rhodes on an agreement with investment banks UBS and Merrill Lynch. Judge Rhodes, who is overseeing Detroit's case, will decide whether to approve the city's third try to end costly interest rate swaps with the two investments banks. Detroit has offered to pay $85 million, down from earlier proposed deals of $230 million and $165 million that Rhodes deemed too costly for the broke city.

The swaps turned out to be a bad and expensive bet on interest rates by the city, which used them to hedge rate risk on some of the pension debt that Orr is currently trying to invalidate. The deal Orr reached with bond insurers on Wednesday may enable Orr to avoid setting a precedent, laid out in his original bankruptcy adjustment plan, that would have treated general obligation bonds as unsecured debt. Orr's original plan could have set a precedent that would have roiled the municipal credit markets and potentially made it more difficult for Detroit to issue bonds in the future.

But Orr acknowledged that his plan to reduce pension benefits by as much as 34 percent, despite protections in Michigan's constitution, could yet plow new ground if appeals courts uphold Rhodes' ruling that federal law trumps the state's constitutional protections.

Orr said he has no intention of revisiting the question of the Detroit Institute of Art's collection. A valuation circulated Wednesday by bond insurer FGIC Corp. estimated the collection has a market value up to $2 billion. But the $816 million deal with the state and foundations is contingent on keeping the DIA collection intact, and Orr said Detroit cannot be forced by the court to sell any asset.

"As far as I am concerned, we have a proposal on the table and we're going to stick with it," Orr said.

Detroit's path out of bankruptcy will come with a huge price tag. Orr commands teams of attorneys and consultants and the city pays for lawyers for a court-appointed committee representing retirees. "I hope it's not hundreds of millions of dollars. We have put money aside, but it's not going to be cheap," he said.

Just the first 75 days of the bankruptcy case Detroit filed in July resulted in a $13.7 million tab for professional fees and expenses, according to a February report by a court-appointed fee examiner. Orr's spokesman said costs had since grown to about $59 million.

Orr's plan would also free $1.5 billion to fight blight and improve basic services.

"We're trying to leave them with adequate resources, not superlative resources," he said. Orr, whose term as emergency manager ends in September, said he agrees with Michigan Governor Rick Snyder's idea of a control board to oversee various aspects of Detroit's finances once he is gone.

"That's the state of the art," he said.

(Reporting By David Greising and Karen Pierog, additional reporting by Robin Respaut, Dan Burns, Martin Howell, Hilary Russ, Edward Krudy, Nicholas Brown in New York; Editing by Larry King)

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