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Detroit emergency manager says city 'clearly insolvent'

A vacant, boarded up house is seen in the once thriving Brush Park neighborhood with the downtown Detroit skyline behind it in Detroit, Mich
A vacant, boarded up house is seen in the once thriving Brush Park neighborhood with the downtown Detroit skyline behind it in Detroit, Mich

By Nick Carey and Steve Neavling

(Reuters) - Detroit is clearly insolvent and could face a possible bankruptcy if talks with labor unions and creditors do not make substantial progress on easing the city's cash crunch, the city's emergency financial manager said on Monday.

In his first official report, Emergency Financial Manager Kevyn Orr presented a grim view of Detroit's problems. The city faces a $162 million cash shortfall because of pension deals that outstrip its ability to pay, and a $60 million operating deficit, all amidst a cityscape of abandoned homes and businesses, broken streetlights and fractured services, the report said.

Orr said talks would begin promptly with unions and creditors, and he told the Detroit Free Press editorial board that he should know by the end of June whether the city's finances can be repaired without a bankruptcy filing.

Speaking to reporters later, Orr was matter of fact about prospects for keeping Detroit out of bankruptcy. "We can achieve what we have to achieve without going in. If we can't, then we have to" file for bankruptcy, Orr said.

Detroit had $64 million in cash on hand on April 26, but only because it has deferred $226 million in payments on pensions, loans and other obligations. Orr's report projected the city could get through the end of December without running out of money.

"If we keep going the way that we're going, we're going to hit some bumpy ground in December," Orr said.

In issuing his report to the state Treasurer, Orr declared Detroit is far from solving the problems that caused Governor Rick Snyder in mid-March to appoint him as emergency manager.

"The City of Detroit continues to incur expenditures in excess of revenues despite cost reductions and proceeds from long‐term debt issuances," Orr wrote. "In other words, Detroit spends more than it takes in - it is clearly insolvent on a cash flow basis."

Legal experts indicated the declaration of insolvency is important because the city cannot make a bankruptcy filing without an official declaration of insolvency.

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

James Spiotto, an expert in municipal restructuring and partner at Chapman and Cutler in Chicago, said Detroit could avoid bankruptcy if Orr could work with the state and other parties to address deeply entrenched problems.

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

In the past, New York City, Philadelphia and Cleveland avoided bankruptcy with loans and grants designed to keep the cities afloat while a long-term recovery plan was worked out.

Orr said it was important to put out facts so all parties know what they were facing.

Operating expenditures have exceeded revenues by about $100 million a year since 2008, Orr's report found, bringing the accumulated unrestricted deficit to $326.6 million. Payments of Detroit's long-term debt are eating up nearly 20 percent of Detroit's budget.

Orr is looking to renegotiate or 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, the report stated.

Patrick O'Keefe, chief executive of turnaround specialists O'Keefe and Associates Consulting, based in suburban Bloomfield Hills, said Orr likely intends to use Detroit's fiscal distress as a weapon in negotiating with unions and debt holders.

"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 school yard in that he can't get any uglier."

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

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

At investment firm BlackRock in New York, Orr's report was only a small step toward addressing Detroit's major problems.

"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."

The Detroit NAACP on Monday filed a federal lawsuit against Snyder and other state officials calling for reversal of the state law that allows emergency managers like Orr.

Emergency managers in Benton Harbor, Pontiac and other Michigan cities have attracted controversy with their turnaround plans, and Rev. Wendell Anthony, head of the Detroit NAACP, said the law was applied unevenly by focusing primarily on cities and school districts with black residents.

(Reporting by Nick Carey and Steve Neavling.; Additional reporting by Bernie Woodall and Deepa Seetharaman.; Editing by David Greising, Sofina Mirza-Reid, Leslie Gevirtz, Toni Reinhold)

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