By Nathan Bomey and Brent Snavely

The City of Detroit late Monday revealed a proposed settlement with UBS and Bank of America Merrill Lynch to pay off a controversial debt deal called swaps, which helped plunge Detroit into bankruptcy.

The city agreed to pay the banks $85 million to eliminate a disastrous pension debt interest-rate bet brokered by Mayor Kwame Kilpatrick's administration in 2005. As part of the settlement, the banks have agreed to support Detroit emergency manager Kevyn Orr's bankruptcy restructuring plan in court.

The new settlement allows Detroit to escape a $286-million debt by paying 30 cents on the dollar. The city will save about $201 million, more than its annual Fire Department budget, for example.

U.S. Bankruptcy Judge Steven Rhodes, who must sign off for the settlement to take effect, rejected the city's previous offers to pay off the swaps for $230 million and then $165 million. He questioned the legality of the original transaction, saying $165 million was "just too much money" and chiding the city for making hasty financial decisions.

"Assuming he likes this number, he saved the city of Detroit a great deal of money," Wayne State University bankruptcy law professor Laura Beth Bartell said Monday night.

If approved, the settlement would solve one of the key pieces of the puzzle that the city needed to emerge from Chapter 9 bankruptcy -- and it marks the first tangible step toward gaining the support of creditors for its restructuring proposal, called a "plan of adjustment."

The city asked Rhodes to set a hearing to consider approving the settlement on or before March 20.

"We appreciate the banks' willingness to work with us to reach a solution that we think balances our goal to provide realistic recoveries to creditors while freeing up critical funds that we can invest to improve the quality of life in Detroit," Orr said in a statement. "We look forward to Judge Steven Rhodes' decision on our proposed settlement, and we hope the 'swaps' resolution serves as a model for compromise on other matters related to Detroit's finances."

The city's bankruptcy lawyers said in a court filing that it's still "reasonably likely" they could win a challenge to the legality of the swaps, but they said it could take years and could cost tens of millions of dollars.

At 30 cents on the dollar, the banks are still getting a better deal than unsecured general obligation bondholders, which the city has proposed to pay 20 cents on the dollar. That could draw objections from creditors who believe they are being treated unfairly.

But the banks' decision to support the plan of adjustment gives the city the legal power to ask Judge Rhodes to forcibly implement the city's restructuring plan over the objections of creditors -- a legal maneuver called a "cram down."

The city won't necessarily take that route. Jones Day lawyers, who represent Detroit in bankruptcy, said in a court filing that the swaps settlement will free up more cash to make consensual deals with other creditors more likely.

The city also said it won't need to secure fresh debt to pay off the swaps. Instead, the banks have agreed to allow the city to pay off the debt gradually after it exits bankruptcy.

Orr still plans to pursue post-bankruptcy debt to allow Detroit to pay off creditors and reinvest in city services.

The original swaps deal -- brokered under Kilpatrick's administration in 2005 -- is costing the city nearly $50 million a year, or about 5% of its annual budget.

The swaps provided a steady interest rate of 6% on a $1.4-billion debt deal that allowed Detroit to eliminate its unfunded pension liabilities at the time.

But the deal soured when U.S. interest rates plummeted, sticking Detroit with a costly contract and prompting the city in 2009 to pledge its vital casino revenue as collateral on the deal.

After Rhodes questioned the legality of the swaps, the city threatened to sue the banks to wipe out the deal -- and the banks relented.

Without the swaps on its balance sheet, Detroit will have substantially more cash to reinvest in city services, such as public safety and blight removal.

(c)2014 the Detroit Free Press