Judge Steven Rhodes

CHICAGO -- The mediators in Detroit's bankruptcy case Monday recommended that the bankruptcy judge approve a newly inked settlement over the city's interest-rate swaps, calling the deal a significant step toward resolution of the historic bankruptcy case.

U.S. Bankruptcy Judge Steven Rhodes will hold a hearing on the matter Friday. Detroit emergency manager Kevyn Orr is set to be deposed Tuesday on the agreement.

The mediators, U.S. District Chief Judge Gerald Rosen and U.S. Bankruptcy Judge Elizabeth Perris, recommended that Rhodes approve the settlement, reached on Dec. 24 after two days of mediation.

"We believe this settlement is a significant first step in the resolution of Detroit's bankruptcy," the mediators said in the filing.

"As in the case in almost all settlements in bankruptcy (or indeed in most litigation), this settlement and the mediators' recommendation of it, can best be captured and characterized by the admonition, 'Do not allow the perfect to become the enemy of the good'," they wrote.

The new deal calls for the city to pay counterparties UBS AG and Merrill Lynch Capital Services Inc. $165 million — down from roughly $200 million — as well as $4.2 million to terminate the swaps.

That's a roughly 62% payout on the face value of the swaps compared to 75% in the original swap settlement, making the savings about $35 million, or 13%, compared to the original agreement. The size of Detroit's termination penalty has fallen steadily over the past few years in line with interest rates.

The new settlement prohibits the city and the banks from terminating the swaps before Jan. 31, 2014. The counterparties are currently allowed to terminate the swaps at any time, which has led the city to argue that in fact the swaps hedge nothing because the banks would simply terminate the deals if they owed the city any money.

The Jan. 31 deadline also gives the parties time to obtain a final determination from the bankruptcy court, the city said in a court brief defending the deal filed late Friday.

The banks have agreed to release all money from accounts that hold back a piece of the casino revenue as collateral. That was true in the previous agreement as well, but the new deal features a more explicit provision, according to the city.

"Although it is not a perfect settlement, the mediators believe that, in the interest of all parties, it represents a fair and equitable solution that is advantageous to all concerned," the mediators wrote.

The city will win more favorable terms, and the counterparties will "avoid the risk of losing all that they invested and further avoid the lawsuit the city threatened to bring which, if successful, could have forced them to disgorge and pay back to the city all of the payments they received under the swaps," the filing said.

As part of the agreement, the mediators recommended that Rhodes dismiss a related case, Syncora Guarantee Inc. v. UBS AG.

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