(Adds details of bond sale, Syncora objection, comments from Kevyn Orr, fund manager)
DETROIT Aug 25 (Reuters) - A U.S. bankruptcy court judge on Monday approved Detroit's proposal to repurchase nearly $1.5 billion of existing water and sewer revenue bonds tendered by investors and to refinance the debt to save money.
The ruling by Judge Steven Rhodes, who is overseeing Detroit's historic bankruptcy case, clears the way for the sale of about $1.8 billion of refunding bonds to pay for the tender and raise $162 million for new projects.
Treatment of the city's $5.2 billion of outstanding water and sewer bonds was a big hole in Detroit's plan to adjust $18 billion of debt after most investors in those bonds rejected the plan earlier this summer.
Detroit, which filed the biggest-ever U.S. municipal bankruptcy last year, launched a tender offer on Aug. 7 with the hope of getting enough of the debt back and replacing it with lower-cost bonds through a refinancing. Nearly $1.5 billion of the bonds were returned for repurchase by Thursday's deadline.
In testimony prior to Rhodes' ruling, Nicolette Bateson, chief financial officer of Detroit's water and sewerage department, said the refinancing bonds would be sold in the municipal bond market on Tuesday, with the deal's closing expected on Sept. 4.
Heather Lennox, a Jones Day attorney representing Detroit, told the judge that if the deal closes, the water and sewer bonds that were not tendered will be unimpaired in the city's debt adjustment plan.
In the absence of the tender, call protection would have been eliminated or interest rates would be reduced on "impaired" outstanding water and sewer bonds under the plan. Those bonds make up about $2.2 billion of the existing $5.2 billion of debt.
The refinancing bonds will be issued through the Michigan Finance Authority and priced in two deals by lead underwriter Citigroup.
This is a good deal for the city for several reasons," Kevyn Orr, Detroit's emergency manager, testified on Monday. "It provides money to the city that can reduce the debt. It will also provide a settlement with the bondholders."
Four insurance companies that guaranteed payments on the bonds agreed to the deal. Objections by hold-out creditor Syncora Guarantee Inc were rejected when the judge agreed with the city that the bond insurer lacked standing because it does not insure nor own any of the bonds.
Detroit expects the refinancing will cut annual debt service costs and result in savings projected at about $241 million over 26 years. While the current water and sewer bonds are rated junk, the city hopes the refinancing bonds will be rated higher and plans to insure some of the debt.
Detroit's treatment of bonds in the bankruptcy, which includes defaults on certain general obligation bonds and on $1.4 billion of pension debt, which it also seeks to void, has roiled the muni market.
Dan Solender, head of municipal investments at Lord Abbett & Co, said it was unclear who the buyers of the refunding bonds might be, although non-traditional investors like hedge funds may participate in the deals.
"The question is, 'What is the penalty for the way (the city) treated bondholders?'" he said.
On Sept. 2, the judge will commence a hearing to determine if the city's debt adjustment plan is fair and feasible. (Reporting by Peter Suciu in Detroit, additional reporting by Karen Pierog in Chicago; Editing by Chizu Nomiyama and Dan Grebler)