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(Adds further explanation of settlement, statements from insurers, creditors, analysts)
By Lisa Lambert
WASHINGTON, April 9 (Reuters) - Detroit on Wednesday struck a deal with a core group of creditors that could ease concerns about the treatment of certain bonds in its landmark bankruptcy case and pave the way for compromises with other creditors.
Under the deal, Detroit will no longer try to classify nearly $400 million of general obligation bonds as unsecured, which had been a chilling prospect for investors who have long viewed municipal bonds as among the market's safest investments.
The settlement will also put about $100 million toward establishing an income stabilization fund to ensure city retirees, who are likely to see their benefits reduced in the bankruptcy, stay out of poverty.
U.S. Bankruptcy Court mediators said the settlement reinstates $287.5 million of the $388 million in claims on Detroit's unlimited tax general obligation bonds insured by National Public Finance Guarantee Corp, a unit of MBIA Inc ; Assured Guaranty Municipal Corp and Ambac Assurance Corp.
That is equivalent to paying 74 cents on the dollar. A revised debt adjustment plan the city released last week called for paying holders of bonds deemed to be unsecured only 15 cents on the dollar.
The settlement with the insurers will be included in an amended bankruptcy plan that the city's Emergency Manager Kevyn Orr will release soon, the mediators said.
"It should increase other unsecured creditors interest in negotiating," said Matt Fabian, managing director of Municipal Market Advisors, an independent research firm.
The city will cover the payout by issuing new unlimited tax obligation bonds, or UTGOs, secured by a fourth lien on the city's share of state revenue through the Michigan Finance Authority, according to a term sheet and announcement from the U.S. District Court for the Eastern District of Michigan.
The deal calls for bonds to be considered secured debt with a valid lien on property taxes, according to a statement from Assured Guaranty. The three insurers sued Detroit, which filed for bankruptcy last July, saying the city was illegally diverting voter-approved property taxes meant to pay off the bonds to the general fund.
The treatment of UTGO bonds as unsecured sent a chill through the $3.7 trillion U.S. municipal bond market, where debt backed by a state or city's full faith and credit pledge had been considered a safe investment bet.
U.S. Bankruptcy Judge Steven Rhodes must still approve any restructuring plan, and Orr has been furiously negotiating with creditors to find an agreeable resolution to the largest municipal bankruptcy filing in U.S. history by autumn.
Late last month, Detroit reached an agreement with UBS AG and Merrill Lynch Capital Services, a unit of Bank of America Corp, on costly interest-rate swaps. Rhodes, who rejected two previous swaps deals, is scheduled to rule on the latest deal on Friday.
"With this settlement, and hopefully the settlement that we have in front of the court this Friday, the swap settlement, we will now have a sufficient number of supporters to really push our plan forward, so we're very optimistic," Orr said on CNBC on Wednesday. "I implore all parties, specifically our labor parties, please come in and do deals. Please come in and do deals. I do not want to do a cram-down in this case."
Once a city wins agreement from a single class of creditors whose interests are impaired by bankruptcy it can then impose, or "cram down," settlement terms on other classes of creditors, under Chapter 9 of the federal bankruptcy code.
"The settlement is a step toward a consensual plan. Cram-down involves costly and time-consuming litigation, and the cram-down standards for Chapter 9 are somewhat fuzzy," said Juliet Moringiello, a professor at Widener University School of Law in Harrisburg, Pennsylvania.
The settlement gives Detroit leverage by pressuring other unsecured creditors and also frees up money for retirees, MMA's Fabian said.
The remaining 26 percent in claims, about $100 million, would be used for an income stabilization fund for the city's "most vulnerable retirees," the court mediators said.
That would be on top of $466 million pledged to retirees over 20 years by foundations and the Detroit Institute of Arts to avoid a fire sale of parts of the museum's collection. Michigan Governor Rick Snyder asked the state legislature for $350 million for Detroit's retired workers as well.
The city's two retirement systems and a court-appointed committee representing retirees are fighting the bankruptcy and the proposals to cut pensions by as little as 6 percent or as much as 34 percent.
"The retirement systems appreciate and are pleased that a by-product of this settlement is the freeing up of certain funds to aid pensioners," the pension funds said in a statement. "However, whether the settlement as a whole is advantageous to the city and to the retirement systems we just do not know not having had time yet to evaluate the settlement."
Dentons, the law firm for the retiree committee, said it was studying the mediators' statement and did not yet have a position.
As part of the settlement, the insurers will support Orr's restructuring plan, just as UBS and Merrill Lynch Capital Services agreed in the swaps deal.
"Our agreement with the city confirms the special status of the unlimited tax general obligation bonds and ensures that pledged property tax revenues will be used to fund future debt service," said Kevin Brown, spokesman for National Public Finance Guarantee Corp.
Ambac, which has exposure to Detroit's unlimited tax general obligation bonds of $77.6 million, was more uneasy saying it accepted the settlement because of the city's unique circumstances.
"Nevertheless, we are disappointed that Detroit chose not to fully meet its obligations for responsibly incurred debt, weakening its capital market access, which is a key ingredient to any revitalization and return to self-sufficiency," said the company in a statement.
Shares of all three insurers were up more than 1.6 percent in midday New York trade. (Additional reporting by Karen Pierog, Edward Krudy and Tom Hals in New York; Editing by G Crosse, James Dalgleish and Lisa Shumaker)