Rod Meloni blog: Trial over $350 million deal for Detroit begins

By Rod Meloni - Reporter, CFP ®

DETROIT - Local 4 Business Editor Rod Meloni is in court Tuesday as a trial begins over whether Detroit can borrow $350 million with Barclays of London.

10:24 a.m.

Court got off to a little bit of a late start as the result of the snowy weather.

Judge Steven Rhodes is hearing a trial, the first of its kind in this case, regarding the $350 Million "forbearance" agreement with Barclays of London.

This money is a loan the city and emergency manager Kevyn Orr want to use to pay off Bank of America and UBS to end the $1.44 billion "swaps" agreement former mayor and current federal prison convict Kwame Kilpatrick used to prop up the city's pension funds in 2005.

The city proposes using casino revenues and some tax revenue to pay this loan.

Barclays stands to make nearly $5 million just for handling this deal, plus a 1.25% of the overall loan value.

Local 4 News first reported the details of this agreement last July that is ultimately intended to free up $12 to $15 million a month of Detroit casino revenues now locked up in the swaps deal.

Orr intends to use the freed up cash to rebuild the city starting with updating the city's antiquated computer systems.

The city is represented by the Jones Day law firm and its representative Corinne Ball, who did the opening argument, saying this deal is vitally important to the city's restructuring and is the right answer to clear bad debt off of the city's books.

SPECIAL SECTION: Detroit bankruptcy

There was no opening by the objector union and pension fund attorneys but they did object to the testimony of the first witness Gurauv Malhotra an Ernst and Young financial analyst who for the past two years has been advising the city on its cash flow position.

He was called to the stand a number of attorneys attempted to prevent him from testifying saying he was not qualified to testify to the city's cash flow issues. Another was concerned there is no relevance to his testimony. Rhodes shot down the objections and Malhotra is not testifying about the city's financial issues regarding the "swaps" deal.

10:37 a.m.

Rhodes is anxious to expedite the hearings and is asking attorneys to keep their arguments away from digging deeply into why and how the city spends its money. He did ask the Jones Day attorneys to also help him understand as they build their case.

"I want to understand, as best as you can make me understand, the considerations that led to the agreement at 75% as opposed to some other percentage," he said.

He wants to know why the city of Detroit agreed to make this deal that would settle the "swaps" deal for 75 cents on the dollar. He wants to know why that number is not less.

Objector unions and pension funds are saying by allowing the city to spend this $350 million this way they will receive less for their claims. This will be a constant theme throughout these hearings because there are a lot of parties fighting over a very small pot of money.

Malhotra remains on the witness stand and is explaining the fact that the city defaulted on the original "swaps" deal, it needs to remove the massive burden the original deal placed on the city.

Malhotra testified the city would likely run out of cash by the end of the year and have another $100 million in debt by next summer if this deal is not allowed.

Orr is expected to testify later this afternoon.

11 a.m.

The judge is keeping time on the testimony and the trial. He just announced the city now has 319 minutes remaining… the objectors get 477 minutes.

We are now in recess for 15 minutes.

11:50 a.m.

For the past hour, Malhotra has been testifying on cross examination by objector attorneys. He stated repeatedly the cash flow projections he prepared for the city regarding what happens if they city does not receive the permission to do the Barclay's deal.

On all of the paperwork, Malhotra had included the standard disclaimer Ernst and Young provides in such cases where the information provided in the filing should not and in fact legally cannot be used by a third party or relied upon as factually accurate because no audit or assurance procedures had been performed.

Objector attorneys presented this as a reason to not rely on Malhotra's testimony and that the numbers provided are unreliable.

12:20 p.m.

After another hour of picking apart the swaps financing deal and trying to figure out the intricacies of the principal and interest payments the city would make and how the amounts were calculated, the judge has decided to break for lunch. We will reconvene at 2pm.

2:34 p.m.

On the stand now is Investment Banker Kenneth Buckfire of Miller Buckfire.

He negotiated the "forbearance" deal that would allow the city to escape the "swaps" agreement.

He said it was "one of the most difficult negotiations he has ever been involved with."

He said when he first became involved with the city in January 2013 it became evident the swaps were the city's biggest liability and highest cost financial issue.

The city had already defaulted in 2009 on the deal and the banks that held the note had negotiated a "lock box" agreement with the city and forced gaming revenues into an account and it would build up to a certain point then the banks would take out their payments and then release any remaining money to the city.

This arrangement cost the city some $45 million a year.

Buckfire said, "the city was at risk of default at any time." And the consequence of that default that could come at any time [the banks had held off enforcing] the city would lose all of its access to casino revenues. This accounted for some $120 million net of costs per year.

Buckfire called it a "one sided arrangement" in the banks favor.

At this point Buckfire says he recognized substantial risks and that it would have been cataclysmic to lose all the gaming revenue. He said, "In order to preserve access to cash flow we had to find a way to get rid of the swaps altogether."

2:49 p.m.

Buckfire said, "this was one of the most difficult negotiations I've ever had to conduct."

The concern was time, the city was running out of and he was "afraid if we did not get a new arrangement the banks would lose patience and enforce their default rights. If they knew the city had no more money the city would lose access to its gaming revenue."

Buckfire said he had only 11 days to get an agreement and did not have much to work with.

"There were no good cards to play, no time left either," he said.

Buckfire said he could only go into the negotiations threatening legal action. He said he told the UBS and Bank of America representatives "the entire transaction was questionable" and said they would litigate the case.

Should the city win, they [the banks] get nothing, if they win they get $400 million.

Rhodes wanted to know where that money came from.

Buckfire said, "the gaming revenues," explaining the banks had the right to pay themselves back entirely before the city could again have access to casino revenues again.

Rhodes wanted to know how long that would have taken.

Buckfire said four years.

It was here Buckfire said he proposed a 50 cent on the dollar settlement simply because it met the banks in the middle.

"They were upset at such a low offer," he said.

More than nine or ten days they negotiated that starting point to 75% and Buckfire said the banks did not believe the city would ever find the financing to fund the 75%, $350 Million dollar deal and agreed to pay off the swaps at a significant discount.

Buckfire also said "time was not the city's friend" when asked why he approved a 75% deal and he added again "this had never been done before" and it provided a good option for the city and the other city creditors because "it was a $70 million savings ahead of the unsecured creditors which is a net benefit to them."

In the end, Buckfire said, "I think the city got a highly competitive and low cost answer" to the city's problems. He noted when the city decided to try this path, it asked for 50 proposals, received a dozen answers and picked the best one. The city's attorneys from Jones Day has now finished its direct examination of Buckfire.  

Steve Hackney, Syncora attorney and objector to the city's bankruptcy and this swaps forbearance negotiated deal, is now cross examining Buckfire.

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