By Bernie Woodall and Steve Neavling

DETROIT (Reuters) – Detroit said on Friday it would stop making payments on some of its about $18.5 billion debt, which would put it in default, and the “insolvent” city called on most of its creditors to accept pennies on the dollar to help it avoid the largest municipal bankruptcy filing in U.S. history.

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In a forceful opening salvo of negotiations with debt holders, Detroit Emergency Manager Kevyn Orr announced a moratorium on some principal and interest payments, including one payment he said was due on Friday.

Under his proposal, Orr said unsecured debt holders would be paid less than 10 cents on the dollar, but some creditors would get a bit more based on city revenue. Some $11.5 billion of the debt is unsecured and $7 billion secured, according to figures presented by Orr.

Orr said secured creditors would get better treatment, although how much better was not specified.

“We may try to get a discount from them, but the reality is they are secured,” Orr said.

Secured credit means an asset is pledged to back the debt. For example, Detroit has secured its interest rate swap agreements with casino revenue.

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He said the city would skip a $34 million payment due on Friday on $1.43 billion of pension certificates of participation, to allow the city to conserve cash needed to provide services to residents.

Fitch Ratings and Standard and Poor’s Ratings Services immediately downgraded Detroit’s rating to a level reserved for borrowers about to default.

“We expect default to be a virtual certainty,” S&P said in a statement accompanying its downgrade to CC from CCC-negative.

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A trustee for the bond issue will have to certify that Detroit failed to make the payment on Friday, which would trigger a formal default.

Detroit’s crisis is being closely watched by U.S. debt markets. It did not immediately affect the $3.7 trillion U.S. municipal bond market, where prices ended higher on Friday.

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Orr said he would meet with creditors over the next 30 days. Market participants said the outcome of those talks could lead to higher interest rates for the state of Michigan and even the broader market if Orr wins concessions from secured creditors.

“Financial mismanagement, a shrinking population, a dwindling tax base and other factors over the past 45 years have brought Detroit to the brink of financial and operational ruin,” Orr said in a statement.

Orr said the city was “insolvent,” unable to pay its debts and needed shared sacrifices from everyone, including debt holders, to have any hope of a revival.

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Insolvency and inability to pay debts are two tests a government must meet for a judge to accept a Chapter 9 municipal bankruptcy.

“It looks and feels like a pre-packaged bankruptcy plan,” said Richard Ciccarone, managing director at McDonnell Investment Management, in reaction to the proposal.

A pre-packaged bankruptcy is when an entity negotiates a deal with creditors and other interested parties in advance and presents that to a bankruptcy court judge.

Orr, a bankruptcy attorney brought in by the state of Michigan to clean up the city’s finances, repeated after the meeting that he sees a 50/50 chance of a bankruptcy filing.

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It would be a first for a major U.S. city as New York, Philadelphia and Cleveland all avoided formal bankruptcy filings during their financial difficulties.

New York also declared a moratorium on some debt payments in the 1970s, but creditors were ultimately paid in full under a restructuring agreement, said Jim Spiotto, a municipal bankruptcy expert at law firm Chapman and Cutler in Chicago.

In addition to the financial details, the 134-page document presented on Friday describes collapsing city services, rising crime and falling tax receipts.

Detroit is the poorest large city in the United States, with more than a third of its residents living below the official government poverty line, while its population has shrunk to about 700,000 people.

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The city has the highest violent crime rate of any major U.S. city, some 78,000 abandoned and blighted structures and 40 percent of street lights dark, the document said. Only about a third of the city’s ambulances were in service in the first quarter of 2013. Just 53 percent of owners paid their 2011 property taxes.

The document disclosed that Detroit could face unfunded pension liabilities, such as for retired police and fire workers, of $3.5 billion, up from the $644 million previously estimated.

Orr said unsecured creditors, including bondholders and pension funds, will receive a pro rata share of $2 billion of notes the city would issue and pay off as its financial circumstances improve.

An oversight board could be created for Detroit, similar to one set up after New York City’s financial difficulties in 1970s that would ensure reforms are sustained, Orr said. The New York board created in 1975 still exists, although it is largely symbolic.

City workers and retirees would also face changes to their pensions and health care coverage “consistent with available funding.”

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At the same time, Orr proposed investing $1.25 billion over the next 10 years to improve the city’s infrastructure, remove or repair crumbling houses and update computer systems.

Initial reaction from debt holders and labor unions was negative.

Emerging from the meeting, one bond holder who asked not to be identified, said of Orr’s proposal to pay them only pennies on the dollar: “It’s just too much. It is an unprecedented amount to ask.”

In the past, bondholders have not lost the principal amount owed them as a result of the financial restructuring of major cities such as New York and Cleveland.

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Much of Detroit’s debt is insured, giving bondholders protection against defaults. Two of the insurers, National Public Finance Guarantee Corp, a unit of MBIA and Assured Guaranty Ltd, confirmed they attended the meeting.

“In the event that debt service payments by the City of Detroit are interrupted, National will ensure that its policyholders receive all of their principal and interest payments on time and in full,” spokesman Kevin Brown said.

Leaders of some of Detroit’s 48 public sector unions were upset by Orr’s proposals, which included spinning off water and sewer services into an independent authority, as well as making the changes to pensions and health care coverage.

“When you’re backed into a corner, the only thing you can do is fight and the only way we can fight is to strike,” said Mike Mulholland, secretary and treasurer of AFSCME Local 207, the union that represents water and sewer workers.

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(Additional reporting by Karen Pierog, Deepa Seetharaman, Joseph Lichterman, Tiziana Barghini, Tom Hals and Alison Griswold; Writing by Karen Pierog and Greg McCune; Editing by Chris Reese and Andre Grenon)

[Image: Detroit’s emergency financial manager Kevyn Orr talks to members of the media outside the Detroit Newspapers building about the report he delivered to the State of Michigan about Detroit’s finances, in Detroit, Michigan May 13, 2013. Reuters/Rebecca Cook]