"This is an important development for the city and its residents because it means we can start moving forward on implementing needed investments in public safety and services," Detroit city emergency manager Kevyn Orr said.

CHICAGO — Bankrupt Detroit would shave about $65 million of its costs to terminate interest-rate swaps that hedge its pension certificates under a new settlement agreement reached Tuesday with its bank counterparties.

The original settlement called for a roughly 75-cent-on-the-dollar payout — totaling about $230 million — to counterparties USB AG and Merrill Lynch Capital Services Inc. to terminate the swaps that have contributed heavily to the city's fiscal woes.

The new agreement reduces the cost to $165 million and will result in a drop in the size of the city's proposed $350 million debtor-in-possession loan from Barclays to $285 million, according to city emergency manager Kevyn Orr's office.

The new agreement was struck shortly before noon Tuesday between Orr and the bank counterparties. Orr's office said a statement the settlement would close the "chapter on a financial deal that helped drive the city to insolvency" and free up access to $15 million in much-needed monthly casino revenues.

"After two days of intense negotiations led by Chief Mediator U.S. Chief District Court Judge Gerald Rosen, the city of Detroit and the swap counterparts have reached an agreement," an advisory from the U.S. District Court for the Eastern District of Michigan said. "The agreement is subject to approval by Bankruptcy Judge Steven Rhodes." A bankruptcy court hearing is set for Jan. 3 at 9 A.M Eastern Time.

"This is an important development for the city and its residents because it means we can start moving forward on implementing needed investments in public safety and services," Orr said in a statement. The banks and city agreed to the new terms supported by the mediator.

The city said the deal marks "a significant reduction" in the costs for terminating the swaps compared to the original deal. The payout of $230 million as proposed in the original settlement represented a 25% reduction in the swap debt that was valued at $293 million. The new agreement's payout of $165 million raises the city's discount to 43%, according to the statement.

As a result of the new deal, the city said it would lower the DIP loan to $285 million with $165 million going to cover the termination payment and $120 million to fund improvements in city services.

The city and its counterparty banks began federal mediation Monday aimed at striking terms more favorable to the city after Rhodes suspended hearings last week on the settlement proposal and the DIP loan.

Mediation began amid a threat from the city that it would consider suing the banks if a more agreeable deal to the court, objectors to the deals, and city couldn't be reached. Orr has called the termination settlement and DIP central to his plan of adjustment to deal with the city's more than $18 billion of debts.

The original settlement was opposed by several bond insurers and city pension funds who believe it offered the banks and Barclays overly favorable terms at the expense of other creditors. Their reaction to the new deal was not immediately available.

Lawyers from Jones Day who represent the city said ahead of the mediation talks that if a new agreement was reached Orr could be deposed on the agreement Dec. 31. Representatives for UBS declined to comment and Merrill Lynch did not respond immediately for a comment but has declined to comment on previous developments.

Rhodes suspended the hearings on the transactions last week after the reaching an impasse with Detroit's lawyers who refused to disclose details behind the city's strategy for treating the swaps as a secured debt and entering settlement negotiations.

The city has lumped most of its general obligation debt and pension in the "unsecured" category with much steeper haircuts proposed. In filings, the city acknowledged there are issues it could litigate involving the status of the swaps — as the settlement's objectors have argued — but said any litigation would be prolonged and tie up access up to much-needed city casino revenues that serve as collateral on the swaps.

At an impasse with Rhodes and attorneys for the objecting parties, the city suggested a temporary delay in the hearings. Rhodes urged the city to attempt to renegotiate the swap settlement. Rosen then entered a mediation order for Monday and Tuesday between Orr, the bank counterparties; and the settlement objectors including insurers Syncora Guarantee Inc. and Berkshire Hathaway Reinsurance Group, as well as other insurers and a committee representing holders of the pension certificates tied to the swaps.

Under the deals, a pledge of the city's casino revenues that currently backs the swaps will be shifted to the DIP deal. City income taxes would also be pledged. The DIP agreement with Barclays expires on Jan. 7, 2014.

Ernst & Young Capital Advisors LLC consultant Gaurav Malhotra testified during hearings last week that the city could exhaust its cash by the end of 2013 and face a $284 million shortfall by June 2015 if the swaps are not terminated. The original settlement would generate between $1.5 million to $3 million in monthly savings on interest rate payments, he said. The original swaps settlement was reached days before Orr filed for Chapter 9 in July.

Under the original plans, the DIP loan would consist of two loans: "Swap Termination Bonds," totaling $230 million, and the "Quality of Life Bonds," totaling $120 million. City attorneys had said a more favorable swaps settlement would raise the amount available for city quality of life projects and services.

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