Why Banks Are Happy To Be Paid A Fraction Of What Detroit Owes Them

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Banks don’t usually get excited about being paid less than a third of what they are owed. But a pair of banking giants are hoping a bankruptcy judge will approve Detroit’s new proposal to pay them 30 cents on the dollar to resolve a questionable series of financial deals that could be canceled outright if the city is successful in its lawsuit to invalidate the deals.

Judge Steven Rhodes has rejected two previous attempts to resolve these deals, saying the city’s previous offers were too generous to the banks and that he believed it could prove the deals were illegitimate and avoid paying at all. Emergency Manager Kevyn Orr’s first offer would have cost Detroit $230 million and given the banks about 80 percent of what they are owed. Rhodes rejected the idea in December, and the city came back weeks later with a new proposal to pay about 60 percent of the on-paper value of the swaps. Rhodes rejected that deal as overgenerous and hasty, and said the city would be “reasonably likely” to succeed in a lawsuit to cancel the swaps without further payments. The city filed exactly such a legal action two weeks later, but apparently continued negotiating with the banks to produce the new settlement proposal.

At present, Bank of America Merrill Lynch and UBS are legally entitled to $288 million from the city under a series of interest rate swap contracts dating back to the mid-2000s. Those deals helped push Detroit into insolvency, and after filing for bankruptcy the city’s emergency manager sought to strike a deal with the banks to get the swaps off Detroit’s books. Resolving the swaps is seen as key to Detroit’s larger effort to get out of bankruptcy because the deals are tied to casino revenues that the city needs to start restoring services in the hard-hit metropolis, but as long as the swaps contracts are in effect the banks get first dibs on the casino money.

The new deal would pay the banks $85 million. Their willingness to accept a 70 percent cut to the swaps payments suggests they agree with Rhodes’ assessment that another court is likely to invalidate the deals and leave them with nothing.

While it might seem perverse for Orr to attempt to pay the banks $85 million rather than zero dollars, the deal would both provide a speedier resolution to the casino money question and turn the banks into an ally in the rest of the bankruptcy process. If the swaps settlement goes through, UBS and Merrill would then vote to approve the city’s official plan for emerging from bankruptcy. As Reuters explains, those votes would trigger a provision of Chapter 9 bankruptcy law that allows the city to force other creditors to accept the cuts proposed in the official “plan of adjustment.”

That plan, released late last month, appears to include massive cuts to retiree benefits. But the plan Detroit published omits the details of those cuts, making it hard to evaluate just how bad a deal the city is seeking to force on its struggling public servants.