July 10, 2014 at 10:24 pm

Detroit plans $7 billion debt cut in bankruptcy

The People Mover in downtown Detroit (David Coates)

Detroit— The city expects to dump about $7 billion in debt in bankruptcy court by dramatically slashing retiree pension and health care costs, according to new figures that emerged Thursday ahead of a trial over Detroit’s restructuring plan.

A report obtained by The Detroit News offers the most detailed picture yet of Detroit’s plan to successfully emerge from the biggest municipal bankruptcy in U.S. history. The report by city adviser Kenneth Buckfire also highlights the impact on Detroit’s bottom line and how the moves would free up cash to reinvest in city services.

The report sheds light on the rising bankruptcy tab for taxpayers, who would pay Buckfire’s firm, Miller Buckfire & Co., a $28 million fee if Detroit emerges from bankruptcy in late October, and issues a gloomy warning for holdout creditors opposed to the plan.

“If the city’s bankruptcy case is dismissed ... its creditors will not be insulated from the city’s financial chaos and ruin,” he wrote.

The city wants to cut unfunded pension obligations by 54 percent and health care costs by 89 percent, according to Buckfire’s report. Along with cuts to certain bondholders and losses tied to a failed pension debt deal backed by former Mayor Kwame Kilpatrick, the city would eliminate more than $7 billion in debt.

The target will be scrutinized during a trial next month over the city’s debt-cutting plan.

Michael Sweet, a bankruptcy expert and attorney with Fox Rothschild LLP in San Francisco, says that shedding a big amount of debt is important but the city still has to be able to service its remaining debt and operate effectively for its residents.

“The trick is to focus on putting the city in the best possible position going forward, without the burden of prior debt on its shoulders,” Sweet said. “The question isn’t as much about shedding the debt as it is about what are you going to look like when you come out of bankruptcy. The question is, is the city positioning itself so that it won’t end up back in the same hole? If you leave some amount of debt and the operations can cover that debt, great.”

Detroit wants to reinvest about $1.4 billion in improving city services, a goal first floated more than a year ago, before filing the biggest municipal bankruptcy case in U.S. history.

That debt includes pensions and retiree health care and losses stemming from a $1.4 billion pension debt deal backed by former Mayor Kwame Kilpatrick.

Buckfire is expected to testify during next month’s trial. His firm is being paid $300,000 a month. Some of the money will be deducted from the $28 million bonus, according to the report.

Miller Buckfire & Co. so far has billed the city more than $2.8 million for work, which includes spearheading negotiations over a possible spinoff of the Detroit Water and Sewerage Department and securing financing for the city.

The bonus will be paid “upon a recapitalization or restructuring of the city’s debt securities and/or other indebtedness, obligations or liabilities, including a plan of adjustment,” according to the report.

Buckfire’s fees are “pretty normal,” bankruptcy lawyer Douglas Bernstein said Thursday.

“If you are not used to being around large bankruptcies, on its face, the hourly rates are kind of jaw-dropping,” he said. “In truth, in a large case that’s pretty normal.”

Sweet agrees that the potential $28 million payday for Miller Buckfire may well be worth it.

“Just because the number is large doesn’t mean it’s not acceptable,” Sweet said. “There’s a huge amount of money at issue and a lot of work that needs to be done to get the city back on its feet. I have to believe that if this deal is too sweet we’ll be hearing about it from others.”

The report also indicates Buckfire is pursuing $300 million in exit financing to help bankroll the city’s restructuring if Detroit successfully emerges from bankruptcy court.

Buckfire believes Detroit will be much more attractive to lenders after bankruptcy, according to the report.

“Based on the information available to date, Mr. Buckfire believes that the exit financing process is likely to be successful and that the city will have continued access to the capital markets,” he wrote in his report.

That access would flow after eliminating “significant liabilities,” he wrote.

The city’s revitalization plan involves investing as much as $1.4 billion in city services over the next decade. That is expected to lure a new tax base to Detroit, Buckfire wrote.

“Because of the flexible nature of much of the revitalization efforts, the city has increased control of its financial future and has flexibility to meet its reduced debt service obligations going forward,” he wrote.

The city wants to free up cash for services by dramatically slashing retiree costs.

Orr has proposed cutting unfunded pension costs 54 percent from $3.13 billion, according to the report.

Under the plan, past and present city workers would get a base pension cut of 4.5 percent and the elimination of annual cost-of-living increases. Police and firefighter pensioners would see their 2.25 percent annual cost-of-living-adjustment reduced to about 1 percent.

Sweet said a key factor in the city’s bankruptcy exit is reducing retiree expenses, especially the elimination of cost-of-living increases.

“Cost of living is significant because it means the share of the piece that the pensioners get keeps getting bigger. Putting a lid on that helps.”

Detroit also wants to recoup up to $239 million from retirees whose optional annuity savings accounts were credited with interest earnings that exceeded the retirement system’s actual investment returns.

Some 12,000 members of the retirement system face reductions in their monthly pension checks of up to 15.5 percent through the annuity savings fund recoupment, or clawback.

Active and retired workers are voting on the proposal. Ballots are due today.

Detroit also is trying to cut its unfunded retiree health care obligations by 89 percent. The plan would lower obligations from $4.3 billion to $450 million, according to the report.

The report represents “one side of the story,” Bernstein said, adding he suspects holdout creditors will counter with different experts and conclusions during next month’s trial, which starts Aug. 14.

“What they will try and do is pick holes in the report’s assumptions, conclusions or both,” he said. “In no bankruptcy does everybody walk away smiling and say ‘that’s a fair amount.’ ”

Finance Editor Brian J. O’Connor contributed.