Detroit Emergency Manager Says City is 'Clearly Insolvent'

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Michigan's biggest city is "clearly insolvent" and needs to restructure its debt and renegotiate its labor contracts to address its problems, Detroit's emergency financial manager said on Monday.

Emergency Financial Manager Kevyn Orr, in a report issued on Monday, presented a sweeping review of Detroit's problems, from gaping budget deficits to a crushing debt load to abandoned homes and broken streetlights.

All contribute to the city's problems and must be addressed for him to accomplish the chief task of putting Detroit's fiscal house in order, Orr said in the report, which was issued online.

"The City of Detroit continues to incur expenditures in excess of revenues despite cost reductions and proceeds from long-term debt issuances," Orr said in his first official report since stepping in as emergency manager on March 25. "In other words, Detroit spends more than it takes in—it is clearly insolvent on a cash flow basis."

Some matters will press on Orr immediately. For example, investors who hold $377 million in interest-rate swap contracts obtained the right to demand immediate payment the moment Gov. Rick Snyder appointed Orr to the job, Orr disclosed.

Detroit had only $64 million in cash on hand and current obligations of $226 million on April 26, 2013, a negative net cash position of $162 million, the report said.

James Spiotto, an expert in municipal restructuring and partner at Chapman and Cutler in Chicago, said Orr drew a bleak picture, but bankruptcy could be avoided with cooperation between the city and state.

"Obviously, there is an urgency, but it's not time to panic,"Spiotto said. "You need a sustainable, affordable recovery plan."

Operating expenditures have exceeded revenues by about $100 million a year since 2008, Orr's report found. The city had an accumulated $326.6 million unrestricted deficit. Detroit is projected to add an additional $60 million to the accumulated deficit by the time the current fiscal year ends June 30.

"Continuing along the current path is an ill-advised and unacceptable course if the city is to be put on the path to a sustainable future," Orr wrote.

Payments of Detroit's long-term debt are eating up nearly 20 percent of Detroit's budget, and Orr is looking for ways to renegotiate or possibly restructure Detroit's $8.65 billion in long-term debt.

He may reschedule payments, reduce the principal, renegotiate interest rates or issue new debt guaranteeing bondholders payment on Detroit's existing obligations.

Patrick O'Keefe, chief executive and founder of turnaround specialists O'Keefe and Associates Consulting, based in the Detroit suburb of Bloomfield Hills, said the city's financial weakness gives it negotiating leverage with the holders of the swap contracts.

"My guess is they (Detroit) don't have the money so they are not that worried,"O'Keefe said. "It's a little bit like fighting the ugly kid in the schoolyard in that he can't get any uglier."

Pension payments to city workers represent another drain on the city's finances. Detroit will make $31 million in pension payments this year, but will defer another $108 million. Orr said a city task force is reviewing actuarial assumptions Detroit uses to estimate its obligations.

The city also has $5.7 billion in unfunded retiree benefit obligations, more than previous estimates, the report found. To catch up on pension and health benefits to retirees, the city would need to spend $339 million, about a third of its fiscal 2013 revenues, Orr estimated.

All told, Detroit has liabilities totaling $9.4 billion in debts from special revenue bonds, revolving loans, pension obligations and other financial instruments.

"Debt service payments place a significant strain on the city's budget," the report said.

New York City, Philadelphia and Cleveland avoided bankruptcy courts with loans and grants designed to keep the cities afloat while a long-term recovery plan was in the works.

At investment firm BlackRock in New York, Orr's report was seen as a summary of information that the market already knew.

"The identification of these items are still far from the resolution of these items,and that is ultimately what has to take place here," said Peter Hayes, head of BlackRock's municipal bonds group, which has $114 billion in assets under management.

Labor is among the city's largest challenges. Noting that state law authorized him to "reject, modify or terminate" any of the city's 48 collective bargaining agreements, Orr said he was considering all options.

"This power will be exercised, if necessary or desirable, with the knowledge and understanding that many City employees already have absorbed wage and benefit reductions," the report said.

The report also noted that a review of police, fire and other emergency services was ongoing and that Detroit's "infrastructure and public safety fleet are aged and decrepit, which, in turn, increases the City's operating and repair costs and decreases its productivity."

Both the police and fire departments are in need of restructuring, Orr found.

Orr's report also noted that changes to the city's charter and legislation may be required to reduce bureaucracy and improve operations.