Updated Wednesday, August 20, 2014 as of 10:39 AM ET

Detroit Seeks to Pay UBS, BofA $230 Million to Cancel Swaps

(Bloomberg) -- Detroit, the biggest U.S. city to file for bankruptcy, is seeking a permission to pay UBS AG and Bank of America $230 million to cancel payments on swaps that threaten the city’s revenue from casino taxes.

A three-day trial began today before U.S. Bankruptcy Judge Steven Rhodes in Detroit on the city’s request to make the payment as part of a deal to cancel interest-rate swap contracts that have cost it about $4 million a month since July 2009. To pay for the settlement, the city wants Rhodes to let it borrow $350 million.

Buying out the swaps will keep the casino taxes, one of Detroit’s best sources of money, from going to the banks, Corinne Ball, a lawyer for the city, told Rhodes today.

“Cash is the lifeline for the city,” she said.

Creditors led by bond insurer Syncora Guarantee Inc. oppose the settlement, saying it costs too much. The city hasn’t proved it would lose if it sued to cancel the contracts instead of settling with the banks, Syncora said.

“The swap counterparties -- who have already made hundreds of millions of dollars off the city over the last seven years -- stand to make hundreds of millions more in one fell swoop,” Syncora said in court papers.

Days before Detroit filed for bankruptcy in July, listing debt of about $18 billion, it reached a deal with the banks to terminate swaps contracts that a city service corporation signed with Zurich-based UBS and SBS Financial Products Co. Merrill Lynch, a unit of Charlotte, North Carolina-based Bank of America, took over the SBS position in July.

SWAPS BACKFIRE

Under the contracts, the city pays the banks when interest rates fall below a set threshold. When rates exceed the threshold, the banks must pay the city. Originally designed to protect the city from rising interest, the swaps backfired when rates fell after the 2008 financial crisis.

The contracts give the banks collateral rights that threaten about $15 million a month in casino taxes, one of Detroit’s most stable revenue sources.

Borrowing money to buy out the banks would be cheaper than paying the banks an average of $4 million a month on the swaps, according to the city.

The city service corporations defaulted on the 2009 swaps contracts, giving UBS and Merrill the right to demand a termination payment, the banks said in court papers.

TERMINATION PAYMENT

The banks can demand a $270 million termination payment “whenever they wish,” the city said in the Dec. 10 filing.

The swaps are linked to $1.4 billion in pension obligation bonds the city issued in 2005 and 2006. New York-based Syncora has claimed the right to reject any settlement because it insured the swaps and some of the bonds. The bond insurer said that if the settlement doesn’t give the banks everything they are owed, Syncora would have to pay instead.

The banks have agreed to give up any insurance payments they may be entitled to, according to court documents.

In court papers, the banks accused Syncora and other objectors of trying to disrupt the settlement to gain leverage in other aspects of the bankruptcy, including proposed cuts to the pension bonds. Syncora and other bond insurers would be forced to pay bondholders should the city persuade Rhodes to cut the bonds as part of any debt-adjustment plan.

The annual $12 million payments on the proposed $350 million loan would be far less than what the city pays annually under the swaps contract.

The case is In re City of Detroit, 13-bk-53846, U.S. Bankruptcy Court, Eastern District of Michigan (Detroit).

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