By Joseph Lichterman
DETROIT, Jan 3 (Reuters) - Detroit asked a U.S. regulator to consider bringing charges against two banks for costly interest-rate swaps that factored in the city’s record-setting municipal bankruptcy case, Detroit Emergency Manager Kevyn Orr testified on Friday.
Orr said Detroit asked the U.S. Securities and Exchange Commission to investigate its deals with UBS AG and Merrill Lynch Capital Services, a unit of Bank of America , for interest rate swaps to hedge risk on some of the $1.4 billion of pension debt Detroit sold in 2005 and 2006.
The city thought there were “serious questions” about whether it owed the banks anything at all, Orr testified, and Detroit weighed trying to invalidate the swaps. But officials decided chances of prevailing in court were only “more or less 50/50,” so it decided to bargain with the banks instead.
Orr testified before U.S. Bankruptcy Judge Steven Rhodes at a hearing about a Christmas Eve deal to end the swap agreements for $165 million plus fees. That represents a 43 percent discount for Detroit, steeper than one initially proposed.
Rhodes, who is overseeing Detroit’s bankruptcy case, sent the city and the banks back to the bargaining table after postponing a hearing about the earlier deal to terminate the swaps for $230 million, or 75 cents on the dollar.
Bond insurers, Detroit’s pension funds and other parties have objected to the swap-termination plan. On Friday, Rhodes rejected their motion to force the city to release documents related to the legal options it considered to end the swaps. He was interrupted by a heckler, who was escorted from the courtroom after briefly forcing Rhodes to vacate the bench.
The city wrapped up its closing arguments on Friday. Objectors will begin closing arguments Monday morning.
“We have clearly met our burden,” said Corinne Ball, an attorney at law firm Jones Day, representing Detroit. Ball called the deal the city’s best option to avoid lengthy and expensive litigation.
Orr did not say during testimony how the SEC replied to his request for an investigation. Later, his spokesman Bill Nowling said in an email Orr inquired about the issue in 2013, but the SEC said its four-year window to examine the deals had expired.
Nowling said the SEC “also said it had previously looked at the swaps deals and ... would not open a full investigation.”
An SEC spokeswoman declined to comment. Spokespersons for UBS and Bank of America also declined to comment.
Orr testified that Detroit decided to settle with the banks because litigating the case risked having to pay the full amount or losing casino tax revenue the city put up as collateral. The casino tax accounts for about 20 percent of the city budget.
“Twenty percent of the city’s budget could go away,” Orr said. “If that happened to the city, you could not cut enough services.”
He said $165 million was the lowest termination fee the city could negotiate. Orr said the city’s initial proposal was for $145-$150 million, but the banks would not agree.
He said terminating the swaps was critical for Detroit’s future. “The city cannot plan unless it removes this potential risk from the table so any plans it does make ... are credible and realistic,” he testified.
The city plans to use a $285 million loan from Barclays Plc to pay to end the swaps. About $120 million from the loan will be used to improve city services in Detroit, which has more than $18 billion in debt.
Detroit initially secured a $350 million loan from Barclays, but the terms were reduced when the city renegotiated its deal with UBS and Merrill.
On Monday, the judges serving as mediators who helped negotiate the deal recommended that Rhodes approve the agreement to end the interest-rate swaps.
U.S. District Judge Gerald Rosen and U.S. Bankruptcy Judge Elizabeth Perris wrote that the deal was fair to all parties, adding that their advice “can best be captured and characterized by the admonition, ‘Do not allow the perfect to become the enemy of the good.’ ”
They wrote: “Although it is not a perfect settlement, the mediators believe ... it represents a fair and equitable solution that is advantageous to all concerned.”
In a document filed late Thursday, a group of objectors said the mediators’ recommendation was inappropriate.
“Here, the recommendation appears to impinge on the confidentiality of the mediation process,” they wrote. “Further, the recommendation makes observations regarding the benefits of the Forbearance Agreement and urges the Bankruptcy Court to overrule all objections to the Forbearance Agreement, a matter that is presently before the court and must be decided based on the evidence properly admitted.”