(Bloomberg) – Detroit won approval of a debt- cutting plan that backers say will allow the one-time hub of the U.S. auto industry to exit its record $18 billion municipal bankruptcy and rebuild after decades of population decline and industrial decay.
The plan to eliminate $7 billion in debt is an "ideal model" for other distressed municipalities, U.S. Bankruptcy Judge Steven Rhodes announced in court today in granting his approval. "There is no more money available for creditors in the city's financial projection."
Detroit has enlisted charities, creditors and billionaires such as Quicken Loans Inc. founder Dan Gilbert to help rebuild, eliminate blight and prop up a beleaguered pension system. It still needs to address the deeper roots of its decline, according to Erik Gordon, a professor at the University of Michigan Ross School of Business.
"Detroit has a new start in terms of debt relief that can quickly go sour if it doesn't fix the underlying causes of the debt pile-up," Gordon said before the hearing today. "A thousand young people moving into center-city apartments won't support the cost of serving 500,000 other Detroiters."
Emergency Manager
The city filed for creditor protection in July 2013, after Michigan passed laws permitting the appointment of an emergency financial manager to tackle its financial woes. It has looked for ways to pay for everything from new streetlights to ambulances, while cleaning up dilapidated neighborhoods in a community whose population has dropped to less than 700,000 from a peak of 1.85 million in the 1950s.
Rhodes ruled after a two-month trial on the fairness and feasibility of the plan, during which he heard from investment bankers, a court-appointed financial expert, the mayor and city workers.
Last year, after drafting a recovery plan, emergency manager Kevyn Orr shepherded Detroit into court protection, where he negotiated cuts with pension systems, labor unions, hedge funds and bond insurers. All major creditor groups eventually agreed to accept less than they were owed, in some cases just pennies on the dollar.
A key settlement, known as the "Grand Bargain," will bring in as much as $816 million from charitable foundations and the state to prop up pension systems for retirees including police and firefighters.
Art Masterpieces
In exchange, the city agreed not to use its collection of art masterpieces to pay debts. Some bond investors and insurers had bridled at the accord, saying it unfairly put the interests of public workers and civic boosters ahead of their claims.
"The cornerstone of the plan is the Grand Bargain," Rhodes said today. The deal, which preserves all or most of city workers' pensions, "borders on the miraculous," he said.
Detroit will use the newly available money to fund about $1.7 billion in restructuring programs. In 10 years, it plans to spend $440 million on blight remediation and $439 million on police and fire protection.
Detroit has proposed borrowing as much as $325 million in exit financing to bankroll its emergence from bankruptcy. Martha Kopacz, of Phoenix Management Services, told Rhodes last month that the city can afford at least $700 million in new debt once it's out.
New Mayor
Much of the rebuilding burden will fall on Mayor Mike Duggan, who took office in the middle of the case. The 56-year-old Democrat told Rhodes during the trial that Detroit has recruited top municipal and corporate executives from New York to Kentucky to help carry out the changes.
Among his partners in the recovery will be some of the bond investors and insurers who fought the city in court before settling during confidential mediation.
Financial Guaranty Insurance Co. would indirectly own and pay to redevelop the riverfront site of Joe Louis Arena, which will be demolished in 2017 when a new arena opens a mile away. FGIC would also get a share of $141.4 million in new notes.
A group of creditors that includes Aurelius Capital Management LP and BlueMountain Capital Management LLC, owed about $1.1 billion, will be in charge of building a hotel and retail space in a downtown that civic leaders view as a linchpin of economic recovery.
Rhodes said the deals the city struck were vital because they eliminated potential lawsuits that could disrupt the city's revitalization effort.
High Stakes
"For the city, the stakes in any of the creditor litigation were high," the judge said. "Even a single loss to any creditor would compromise its goals in this case."
Gilbert and fellow billionaire Roger Penske, both of whom have invested in the city, testified in favor of the plan.
Gilbert headed the city's task force on blight, putting out a report on cleaning up some of its most dilapidated neighborhoods. Gilbert-affiliated ventures own more than 60 buildings in downtown Detroitwith more than 9 million square feet of space.
Penske, a former auto racer, compared the city to General Motors Co. — the automotive giant that went through a government bailout and reorganization in 2009 — saying bankruptcy has a "cleansing effect."
The Detroit case cost taxpayers more than $132 million in fees for legal, financial and restructuring advisers, according to a September report from the city.
Jefferson County
That's more than the second-biggest U.S. municipal bankruptcy, involving Jefferson County, Alabama, which listed more than $4.2 billion in debt when it filed in 2011. That case ended last year.
Ken Klee, the lead bankruptcy attorney for Jefferson County, called confirmation of Detroit's plan "an historic event." Still, he said, questions remain about whether the city's "underlying economic challenges have been addressed."
"The benefits to Detroit of confirming its plan are enormous, but the cost of the case was quite high," he said in an interview. "Scholars can assess the efficiency of the process and whether the fee examiner fulfilled his function."
The case is In re City of Detroit, 13-bk-53846, U.S. Bankruptcy Court, Eastern District of Michigan(Detroit).
–With assistance from Chris Christoff in Lansing.
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