Rod Meloni: Day 2 of Detroit's bankruptcy trial

3 months after bankruptcy filing, trial will determine whether Detroit really is eligible for Chapter 9

By Rod Meloni - Reporter, CFP ®

DETROIT - 9:30 AM --

Day two of the Detroit bankruptcy eligibility trial the morning session started with some important housekeeping.

Read: Day 1 -- Rod Meloni inside bankruptcy trial

Gov. Rick Snyder will testify starting at 1 p.m. on Monday.

Related story: Snyder will testify at bankruptcy trial

There was some back and forth over how this would work, but in the end, the judge wanted to make certain the governor only had to make one appearance at the trial. So, instead of court ending at 3 p.m. on Monday, it will run until 5 p.m.

9:40 AM --

Continuing on the stand this morning is Ernst and Young's Gaurav Malhotra. The financial analyst is being cross examined by American Federation of State County and Municipal employees attorney Jack Sherwood.

Sherwood appears to be setting up his case that the city did not need emergency management. His line of questioning surrounds asking Malhotra about the city's financial condition.

Malhotra has been with the city for nearly two years, watching the city's financial condition.

Malhotra testified he had a lot to do with Mayor Dave Bing's restructuring plan but when emergency manager Kevyn Orr came to the city, he had less responsibility.

In fact, he said, he had little to no impact on Kevyn Orr's restructuring plan that was given to union leadership and bondholders last June.

Read: City of Detroit Proposal for Creditors

Malhotra said the city was always trying to figure out ways to deal with its cash crunch. He was deeply concerned that the city was not managing its cash flow and debt crisis at all well.

He testified, "I told them there using deferrals and not actual cost savings" as their methodology of dealing with their difficult finances.

Sherwood is now asking Malhotra about the possibility of selling assets to deal with debts. He may have come up with the line of the day: "cash is cash" he answered Sherwood when asked about what happens when you sell an asset and get money for it to pay debts.

Sherwood is asking Malhotra about his relationship with Miller Buckfire, one of the financial consultants Kevyn Orr and the governor brought into the city.

Sherwood wanted to know whether Miller Buckfire was concerned that "if the city monetized assets that would have a negative impact to prove that it was eligible for Chapter 9 Bankruptcy?"

Malhotra said, "I have no recollection."

"Did Miller Buckfire in your presence express any concerns about selling assets in 2013?"

"I do not recall." 

Sherwood: You were at the counsel interview meeting at the airport on June 29th, when Jones Day gave its presentation?

Yes I was.

Were you interested in statements they made about liquidity and cash flow yes?

Malhotra: Yes.

Sherwood continues to ask Malhotra regarding the preparations of Chapter 9. At issue is a Jones Day meeting with city of Detroit officials at Metro Airport in June, where they briefed by the Jones Day law firm regarding the possibility of Chapter 9. There were two lines in the presentation Sherwood highlighted:  

A.)   Asset Sales pose challenges to generating substantial revenue

B.) Sales of assets to pay creditors may not promote revitalization 

Sherwood: "Did anyone suggest to the group that the city not engage in asset sales because it could prevent a Chapter 9 filing?

Malhotra: I do not recall that.

Sherwood continues along on the same questioning regarding Jones Day's presentation that had a peculiar line:
"Defense against calls for expense reduction and monetizing assets to pay creditors."

Once again, Sherwood asked Malhotra whether he had heard anyone discuss holding off selling city assets in order to make the case stronger for Chapter 9.

Malhotra: I have no recollection.

Some of the assets Sherwood was interested in was the possible sale were the city's half of the Detroit/Windsor Tunnel and Joe Louis Arena.

Sherwood moved to the Jones Day presentation document and showed that Compuware was identified as having an outstanding $250 million tax bill.

Malhotra said the city was doing what it could to get the tax collection efforts moving better.

Malhotra said the city was trying to develop a tax amnesty program and try and increase tax collections.

10:30 AM --

AFSCME Attorney Jack Sherwood continues discussing with Malhotra the city's attempts to solve cash flow issues and discussed a negotiated settlement the city reached with its unions that was never put into effect.

Malhotra's role was to provide financial information during the negotiations. Malhotra testified that it was the city's goal to obtain $60 million in healthcare savings along. Malhotra repeatedly said he cannot remember what the savings in total were for the tentative agreements reached.

Sherwood is showing Malhotra a number of documents asking him if they refresh his recollection regarding those negotiations.

Sherwood wanted to know whether the tentative agreements were ever approved for the city. Malhotra testified that they were not, and the city instead went with city employment concessions instead.

Sherwood asked if it was correct that the state refused to authorize the city to implement the tentative agreement … which by the way was the underlying point to this hour plus line of questioning.

It did not end with much of a crescendo as Malhotra said, "I was not part of those discussions."

The court is in recess for a break.

11:30 AM --

The court proceedings have resumed and the cross examination of Ernst and Young financial analyst Guarav Mohaltra.

A UAW attorney was interested in his ability or instructions to negotiate any new contracts with unions. Mohaltra said in answering numerous questions, he was never given that authorization. He also asked about the city's attempts to understand actuarial assumptions in order to obtain an understanding of the pension underfunding.

He was also interested in hearing from Mohaltra about his personal meeting with Kevyn Orr. He said he has met with him one-on-one a couple of times and quite often as part of been in staff meetings and conference calls.

Another attorney was curious what his role has been within the city of Detroit. He said his primary job over time was to manage and monitor cash flows, the expenses going out and the money coming because it was his job to know whether the city was going to run out of cash.        

11:50 AM --

The objector attorneys have completed their cross examination and now the city is on now wrapping up with Mohaltra.

The city's attorney asked him about his concerns over the city's cash flow situation.

Mohaltra testified, "Disbursements exceeded receipts, especially given that the city had gotten concessions from employees or deferrals."

He was particularly concerned that no matter how hard the city tried its expenses were exceeding income, that trend was led by legacy costs.

The city finished its rebuttal and the witness stepped down. 

Turnaround and restructuring consultant Charles Moore from Conway MacKenzie is scheduled up next. 

He will be asked about the pension underfunding figures he gave Detroit Emergency Manager Kevyn Orr. That number is $3.5 billion dollars. The reason it is coming up is the opening remarks of a union attorney who alleged bad faith of the emergency manager.

He said Orr did not have a factual basis to state with declaration that the pension claims were about $3.5 billion.

The city's attorney now says "it's squarely an issue in our case. We will ask Mr. Moore where that number came from and did he give that number to Mr. Orr?"

He said the answer is that the reports were given to him by pension actuaries and it is his intent to ask about that.

There were objector/union objections to this line of questioning citing that it requires expert testimony from actuaries and do not want to open the door to that expert testimony.

Judge Rhodes said he would allow the testimony to a point.

Moore has now taken the stand. He is laying out his bona fides and how he came to do the financial consulting work he is doing for the city.  

12:30 PM --

On the stand now is Chuck Moore from the turnaround firm Conway Mackenzie. He was initially engaged on some pro-bono work with the city to look at its finances and how it collects money, looking into municipal parking, the fire department the fire marshal's office -- where fees can be generated, building and safety and water and sewer. Later he was brought in on a paid basis to start looking into the city's operations.
He has helped with a 10-year business plan for both the water and sewer funds and looked for a way to monetize the water and sewer department for the city to get more cash coming in. It is his and his team's plan to create a regional water and sewer authority and is currently being negotiated with the surrounding counties. The plan is to have the city lease the asset to the authority and get lease payments back in return.

Moore and his team have looked at DDOT, suggesting fare increases and also trying to improve maintenance as he said that is a particularly difficult and poorly run part of the bus system. It is his and his team's belief that a regional transit authority that could get better service to customers and save money is in order. He is uncertain whether that can happen.

Moore and his team have looked into the Detroit lighting authority trying to improve that system. He said the year old program needs to get more lights on and other lights replaced. He is involved with the efforts to bring in a company to operate that department.

He and his team have looked into tax collections citing property, income and utility taxes as the main area where the city can bring in more money. He said efforts are underway using outside assistance to improve a system he called "very broken."

He said "getting bills out on time and to the right address and then have a system to manage the collections is needed."

He noted, "significant deficiencies" in the billing process. That has apparently already begun. Moore said because the city had cut its budget so greatly there were not enough people to process receipts, a system of changing banking information is bringing in larger amounts of money quicker to the city's coffers now.

Moore said blight is a major problem for the city in that it is an incubator of crime. He estimated 60% of all fire department runs are to abandoned buildings. He said "areas where there is blight the property tax values deteriorate quickly."

He believes it is vital for the city to eliminate residential blight wherever possible. Moore also spoke of "non-structural" blight, a term the judge wanted defined. Moore said empty lots with a lot of overgrowth hide activity that breeds crime.

Moore was heavily involved with Kevyn Orr and his restructuring proposal. Much of Moore's work was used in preparing Orr's restructuring plan handed to unions and bondholders last June and is the underpinning of what the city intends to use as its overall restructuring plan.

Of restructuring Moore said, "Often we find areas where cost can be reduced. What we found was a number of departments were severely broken. They could not even do the most basic functions." He says the city is in the process of changing how departments are managed and actually adding expenses. Hiring people to do necessary work is actually saving money in the long run.

Moore's testimony continued: He and his team have been working on a restructuring plan for the city. He says as it stands right now he and his team have uncovered the possibility of enhancing the city's net revenue/income by some $250 million.

Moore said, "Over the years as the city's finances suffered, the city was not able to put money in its assets."

He gave an example of city parking garages not in working order. He said, "without spending money on infrastructure to have income the city cannot move forward."

He said much needs to be done in the blight removal area. Moore testified that an estimate on blight removal  costs of would run roughly $500 million over six years.

In all, Moore believes in order to rebuild and reinvest in the city a $1 to 1.25 billion are needed over ten years.

As he wrapped up his pre-lunch break testimony, Moore said he had done tax benchmarking in the city. He wondered whether higher taxes might be in order. He said he discovered Detroiters pay the highest taxes in the state and higher taxes at this point are not in order. 

We are now on lunch break, Moore's testimony will continue @ 1:45pm.

2:20 PM --

Chuck Moore is back on the stand. We are starting to get to the meat of his appearance. He testified to his position as the leader of a task force on pensions within the city of Detroit. He admitted he was the one who provided emergency manager Kevyn Orr with the number of a $3.8 billion pension funding obligation shortfall.

He was asked where he got the information about that shortfall and he said he received it from the Milliman report, an actuarial firm that looked at the Gabriel Roder numbers… Gabriel Roder is the actuary firm the city's pension funds use. Moore acknowledged Milliman made adjustments to some of the numbers and came up with this much larger number. Roder's numbers are lower.

This is becoming the most important part of today's testimony.

The unions dispute Moore's number saying he is not an actuary, he has no personal knowledge of the numbers or how they were arrived at, and therefore the reports and the information Moore offered in relation to this part of his testimony should not be allowed. The judge overruled.

Moore's testimony by the way is being offered "not for the truth of it" as expressed by Detroit's attorney.

AFSCME attorneys want Moore's testimony struck because of attorney client privilege with workings of this task force. Claiming they [the city] is making selective use of this. The judge overruled this objection too. Moore is continuing to testify.

AFCME lawyers are now moving into the area of how much state revenue sharing dollars have been lost in the last 11 years. 30% has been lost since 2008.

2:45 PM --

AFSCME attorney Jack Sherwood is now cross examining Chuck Moore. He want to know whether Moore had ever told Kevny Orr that the city's analysis of the pension funding had not been completed.

Moore: I recall specifically telling him we were looking for sources and additional analysis on the funding numbers.
Sherwood: Do you recall telling Mr. Orr that the city was trying undertake a process to create a more clear set of numbers.
Moore: Milliman would be making its own analysis
Sherwood: Did you tell him it was hard to negotiate with that number because there was not consensus on the number?
Moore: No I did not

There was another line of questioning:
Sherwood: "Were you authorized to negotiate for the city" at meetings with union leadership?
Moore: "I was authorized to go to those meetings and I was authorized to bring information back so I was authorized."

2:50 PM --

Chuck Moore has left the stand.

We are now awaiting financial heavyweight and turnaround expert Kenneth Buckfire. He has just walked into the courtroom and taken the stand.

3PM --

Kenneth Buckfire is a University of Michigan grad who grew up in Detroit suburbs but now lives on Park Avenue in New York City.

He is co-founder of Miller-Buckfire that is an investment bank that specializes in helping troubled companies and governments deal with financial crisis. He is a turnaround specialist who has helped with the Kmart and Lear bankruptcies and the Stockton, CA, municipal bankruptcy.

He was first hired by the state of Michigan in March of 2012 and led a 60-day review of the city's finances and worked with the city on its consent agreement and its restructuring components.

4:40 PM --

Buckfire has a long list of credentials and history with turnarounds and municipal bankruptcies. He worked with large bankruptcies like Kmart and Lear among many and in the municipal bankruptcy space he worked closely with the city of Stockton, California.

His job after taking the job that paid his company $150,000 a month in the city of Detroit was to diagnose financial pressures.

Initially, his company did a 60 day review of city finances and later was asked to reapply for the opportunity to become an advisor as the city neared its consent agreement.

Buckfire said he worked very closely with the state and the city on the consent agreement.
Buckfire was shown the original consent agreement and was asked by a minimum of $50 million was required to remain in escrow for the life of the agreement. He was asked by one of the city's attorneys from Jones Day why that number and Buckfire opened the window into the severity of Detroit's financial troubles.

He said the city had an annual Billion dollar budget, 10,000 employees and it took roughly $50 million dollars to cover three weeks expenditures. He went on to say "the city's revenues are lumpy," meaning they did not come in a steady flow.

He said it was becoming very difficult for the city to have adequate reserves of $50 million on hand and the state wanted to make certain if something happened there would still be enough money to keep the city running and its services going.

At one point he testified, "We were very worried about the city's ability to perform. In 2009 it had defaulted on the swaps [loans against the pension fund]. As a way out of that failed deal the city pledged its $180 million a year casino revenues and in 2012 the city defaulted again on the swaps. I was very concerened about this default and threat of the loss of the highest quality income, $180 million a year and 20% of the city's budget."

This is when the city started discussing the possibility of Chapter 9 municipal bankruptcy.

Buckfire said, "The threat of Chapter 9 was real. There was a lack of cash and the city was operating on a razor's edge. We had to be concerned about what the swap banks would do and the city did not know what it would do. It could cause the city incredible damage. We had to consider Chapter 9 as an answer of what to do."

Later he went on to testify: "The city's cash position was far worse than I ever thought possible. It was effectively operating with no cash. I was very alarmed. There was no solution and at any moment the city's services could end."

Buckfire is expected to continue testifying tomorrow as the cross examination has not yet started and usually there is a line of attorneys looking to ask questions for various objector unions.

But tomorrow promises to be an eventful day with Detroit Police Chief James Craig and Detroit Emergency Manager Kevyn Orr taking the stand.

Good Night.

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