Focus on Finance: The Restructuring of Detroit

Kenneth A. Buckfire is co-president, managing director, and co-founder of Miller Buckfire. Mr. Buckfire’s firm is currently in charge of overseeing the financial restructuring strategy for the city of Detroit, currently the largest municipality in US history to enter into Chapter 9 bankruptcy. Over the course of Mr. Buckfire’s career, he has advised clients in a broad range of industries and has also managed principal investments in distressed companies and in the utility industry. Mr. Buckfire received his MBA from Columbia University and his BA in Economics and Philosophy from the University of Michigan.

Some municipal investors criticized the proposed cuts for Detroit’s restructuring as going too far. This plan could essentially lock the city out of the capital markets for a number of years. How do you restructure Detroit in a way that enables it to fund its capital expenditure (CAPEX) needs solely through its operating budget?

The capital requirements that the city has projected are anticipated to be funded entirely by its operating budget. Therefore, we have structured a plan that acknowledges that we do not expect the city to be accessing the capital markets for a very long time.

Creditors ranging from institutional investors to city pensioners stand to experience significant financial loss due to Detroit’s bankruptcy. Was bankruptcy the only option for Detroit?

Inevitably, in a large complex restructuring, whether it is for a city or a company, creditors look at the situation from their own perspective but don’t consider the implications of the situation from the perspective of other creditors or the debtor. The debtor in this case, the city of Detroit, concluded that although there were interesting ideas that many creditors put forward that had merit, the overall situation could not be resolved without the intervention of a bankruptcy judge. This realization happens particularly when you recognize that the city was suffering from a severe cash shortage in June and its liquidity was under legal attack from many of those same creditors.

There was a recent decision by Judge Rhodes that ruled Detroit eligible for bankruptcy. The bankruptcy is being handled through federal court as opposed to state court. Can you explain what this difference will mean for Detroit’s pensioners?

Judge Rhodes has ruled that federal law—that is, the US Constitution itself—is senior to state law. State law protections are not protections of contract rights. Under federal law, the contract that the city has with the pension funds is like any other contract. That means that if the city cannot afford to repay all of its creditors 100 percent, they will be treated like every other creditor in the city.

Within the restructuring plan presented by Emergency Manager Kevyn Orr, there are significant proposed cuts to outstanding general obligation debt. This has created some waves within the municipal market. Could you speak specifically on your reasoning for the cuts to general obligation (GO) bonds?

This is not an issue of what the city would like to do or what its creditors would like to see the city do. It is rather an issue of what the law requires the city to do. The law is very clear. There are only two types of debt in bankruptcy: debt that is secured and debt that is unsecured. Covenants and contractual promises are not security interests. That is why Judge Rhodes’s eligibility opinion stated that while Michigan constitutional protections are interesting, they do not provide protection under the US bankruptcy code.

This is the same concept being applied to general obligation bonds. A general obligation bond basically states that a city has an obligation to raise taxes sufficient to pay the bond’s debt. The debt is not secured by a pledge of revenues; only revenue bonds are secured by a pledge. That is why the city’s position is consistent with the law in which we have promised to pay our revenue creditors in full.

Another aspect of the restructuring plan is the possibility of leasing out of the Detroit Water and Sewerage Department to surrounding counties through a newly formed regional authority. Some of these county leaders have publicly voiced concerns that the lease revenue will not be sufficient to meet the financial requirements of the authority, thus leading to higher water rates. Is this a legitimate concern?

I would observe that this is an incorrect concern of the actual situation. This argument is being made by county politicians that want their share of the system at the lowest price. There are financial and operational efficiencies that we have already identified and shared with the counties. The discussion that we have been having has been strictly about sharing the savings that would be created by a potential transfer of control to the counties. Under no scenario will rates go up. The counties are well aware of these facts. Therefore, the only negotiating going on now is how the savings will be split between the counties and the city.

In your opinion, what will prove more challenging for the city: financial or operational restructuring?

Detroit has underinvested in many aspects of city government for decades including areas such as management information systems. This underinvestment is a significant deterrent to effective government, and sizable investment will be required to bring those systems to a level where they allow effective administration of the city. It is an incredibly challenging issue.

How do you ensure that the restructuring plan’s operational enhancements will stay in place after Kevyn Orr leaves Detroit in October 2014?

We can’t ever be sure of anything. We have described in our Proposal to Creditors that after the rehabilitation period is over and Mr. Orr and his advisors have left Detroit, there will be oversight provided by a financial advisory and transitional advisory board to monitor the future solvency and functionality of the city.

You have had an incredibly successful career in corporate restructuring. What is the biggest contrast you have experienced in working with the city of Detroit?

I have been surprised more than I should be by how much public attention this restructuring has received. I have worked on far larger and more complicated transactions than this that attracted very little public attention. It is quite shocking.

Finally, what will be the biggest challenge in aligning all of Detroit’s creditors to one plan and moving forward to accept cuts?

Finding enough money to pay them. Simple as that.