Detroit Emergency Manager Calls Interest Rate Swaps a "Ticking Time Bomb"

City requests approval for new settlement to get out of swaps contracts originally designed to protect pension fund against rising interest rates.

Bankers who sold Detroit interest rate swaps placed “a ticking time bomb” in their structure, the city’s emergency manager said in court as a trial resumed over a proposal for canceling the transaction.

Although the city collected $40 million over eight months from the swaps deal, falling interest rates helped the banks behind the deals turn a profit, Kevyn Orr, the emergency manager, testified today before U.S. Bankruptcy Judge Steven Rhodes in Detroit.

Since 2009, the city has paid more than $200 million to the banks behind the swaps, according to public records. The city has proposed paying UBS AG and Bank of America Corp. a $165 million termination fee to get out of the swaps contract.

Days before Detroit filed the biggest ever U.S. municipal bankruptcy, Orr negotiated an agreement to end the swaps at a discount. After that deal was attacked by creditors and questioned by Rhodes, the city on Dec. 24 announced a renegotiated termination payment about $65 million lower than the original.

The swaps are tied to pension obligation bonds issued in 2005 and 2006. They were designed to protect against rising interest rates by requiring the banks to pay the city if rates rose above a certain level. When rates instead went down, the city was required to make monthly payments.

Today’s session ended after Corinne Ball of Jones Day, an attorney for Detroit, made a closing argument in favor of the proposed settlement, saying it was best the city could do. Should Rhodes reject the deal, the city will be forced to litigate the swaps contracts. A settlement saves time and money, she said.

“We need to get on with it,” Ball said.

Court will resume Jan. 6, when critics of the deal make their case for rejecting the proposal.

Orr testified that after he became emergency manager last year he had “plenty” of concern over whether the swaps were fraudulently put together. He said he asked the U.S. Securities and Exchange Commission if it would be willing to investigate the deal.

Eventually, Orr testified, he decided to settle with the banks instead of suing them in order to avoid a risky trial and prevent any threat to casino taxes used to guarantee payment of the swaps.

Megan Stinson, a spokeswoman for Zurich-based UBS, said the bank couldn’t immediately respond to Orr’s testimony.


Bond Insurers

Creditors led by bond insurer Syncora Guarantee Inc. oppose the settlement, saying it’s too costly. The city didn’t prove it would lose if it sued to cancel the contracts instead of settling, Syncora said.

Syncora said in court papers that the deal could cost it money as the insurer of some of the bonds and swaps. Under the settlement, Syncora would be released from any obligations related to the swaps, according to the city.

Bond insurer Ambac Assurance Corp. claimed Detroit could win any lawsuit against UBS and Charlotte, North Carolina-based Bank of America over the swaps.

A mediator who helped craft the latest deal recommended the $165 million settlement, saying it was in the best interest of all parties involved.

The case is In re City of Detroit, 13-bk-53846, U.S. Bankruptcy Court, Eastern District of Michigan (Detroit).

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