Jefferson County, Alabama, commissioners voted 4-1 to file the largest U.S. municipal bankruptcy after reaching an impasse over concessions with holders of $3.14 billion of bonds.
JPMorgan Chase & Co. (JPM), which arranged most of the debt to fund a sewer renovation, will likely take the biggest loss in the process, which begins with a hearing 10 a.m. local time tomorrow.
A provisional agreement with creditors that commissioners approved in September included $1.1 billion in concessions and called for sewer-rate increases of as much as 8.2 percent for the first three years. The county, which encompasses the state’s largest city, Birmingham, couldn’t get signed commitments from creditors, Commission PresidentDavid Carrington said today.
In addition, the 25-member legislative delegation for the county was unable to unite behind bills needed to implement the tentative settlement.
“We’ve reached that last resort,” said Commissioner Joe Knight. “We could continue and keep kicking this can down the road, but I think the people of Jefferson County have had enough.”
Governor Robert Bentley, a Republican, said he was disappointed by the commission’s vote.
Limiting the Pain
“The Jefferson County sewer-debt crisis has been an impediment to economic growth in the state, and the bankruptcy filing will now be an even greater challenge to overcome,” he said in a statement. “Now we must rise to this new challenge, move forward to bring economic growth and stability to the Birmingham region, and do everything in our power to limit the impact of this decision.”
The county’s efforts to negotiate a definitive settlement were frustrated by the recent sale of sewer debt to investors who didn’t want to restructure the bonds under the terms of the September agreement, according to the bankruptcy filing.
Justin Perras, a spokesman for JPMorgan, said the bank had not wanted bankruptcy. JPMorgan held more than $1.2 billion of the county’s sewer debt as of May, according to a document provided by Bentley’s office in September.
“We offered very substantial financial concessions to make the deal happen while keeping sewer rates within the parameters proposed by the county,” he said in an e-mail. “While we’re disappointed by the county’s decision to file, we will continue to work toward a fair and reasonable solution.”
Cities in Trouble
The vote by officials in Alabama’s most populous county occurred about a month after Pennsylvania’s capital of Harrisburg sought court protection citing millions in overdue bond payments tied to a trash-to-energy incinerator. On Aug. 1, Central Falls, Rhode Island’s smallest city, sought court protection, citing pension costs it can’t afford. The municipality listed almost $21 million in general-obligation debt outstanding.
Even with the Chapter 9 filings, local-government bond defaults declined to $949 million in the first nine months of 2011, about one-third the pace of 2010 and 10 percent for corporate debt, according to the Distressed Debt Securities Newsletter, published by Miami Lakes, Florida-based Income Securities Advisor Inc.
Municipal bankruptcies are rarer than corporate failures. Jefferson’s is the 11th this year. In 2010 there were 13,713 corporate Chapter 11 filings, according to a website maintained by the Administrative Office of the U.S. Courts.
The Jefferson filing eclipses the previous record, set in 1994 by Orange County, California. That county, which was driven into bankruptcy by $1.7 billion in losses on interest-rate bets, had about $2.2 billion in debt outstanding, according to a June 1995 financial report.
The Alabama filing might reignite concerns among investors over defaults in the $2.9 trillion U.S. municipal bond market.
“It’s going to create attention-grabbing headlines, and the question is how retail investors react,” Peter Hayes, a managing director at BlackRock Inc., the world’s largest asset manager and the owner of $95.6 billion of municipal bonds, said before today’s decision.
Bankruptcy had loomed over the county for more than three years. Commissioners sought to spare residents from ballooning fees needed to pay off the debt that financed a sewer project rife with corruption.
The crisis intensified in March when the state’s highest court struck down a tax on wages that generated $70 million annually for the general fund. The county put employees on unpaid leave, closed courthouses and scuttled road repairs after losing the levy that provided about a quarter of its revenue.
The size of sewer-fee increases became a hurdle because residents can ill afford higher costs, according to Commissioner George Bowman, who represents one of the county’s two poorest districts. Almost 70 percent of sewer users are in the two districts with the lowest average incomes, he has said.
Jefferson County’s system serves about 478,000 people through 144,000 accounts, according to a June report from John Young, the court-appointed receiver who runs the system.
The county’s median household income is about $45,000 a year, according to U.S. Census Bureau data. Many sewer customers reside in Birmingham, where the figure is about $32,000. The average residential wastewater bill is $37.74 a month, according to Young.
Banks and Bonds
The bankruptcy leaves banks such as JPMorgan, investors and the bond insurers Financial Guaranty Insurance Co. and Syncora Guarantee Inc. facing hundreds of millions of dollars in losses.
Michael Corbally, a spokesman for Syncora, declined to comment.
In addition to sewer bonds, Jefferson County has about $1 billion in other bond debt: $200 million of general obligation bonds and $814 million of school-construction bonds, according to its bankruptcy petition.
Jefferson now must show a federal judge that it can’t pay its bills and then draw up a plan for meeting obligations, which the court may reduce. Unlike corporate cases, creditors can’t try to seize or sell off county assets, and the court can’t appoint a trustee to run the county.
Municipalities have more leverage with creditors under Chapter 9 of the U.S. Bankruptcy Code than corporations have when reorganizing debt in Chapter 11 protection, said Marc Levinson, a lawyer who represented Vallejo, California, when that city went bankrupt. A judge has limited authority to force a municipality to take specific actions, Levinson said.
Limited Court Power
“About the only thing a judge has the power to do is dismiss the case,” Levinson said.
The crisis in Alabama arose when investors dumped Jefferson county’s bonds as the subprime mortgage-market meltdown sent ripples through Wall Street. Jefferson’s floating-rate securities were coupled with interest-rate swaps, a money-saving strategy pitched by banks that backfired. As credit markets convulsed in 2008, the county’s interest costs soared. When banks demanded early payoffs of the bonds, the county defaulted.
The debt deals also were rife with political corruption, leading the cost of the sewer project to soar as it was built during the 1990s. Former commission president and Birmingham Mayor Larry Langford, a Democrat, was convicted of accepting bribes in connection with the financing.
Two former JPMorgan bankers are fighting Securities and Exchange Commission charges that they made $8 million in undisclosed payments to friends of commissioners to secure the bank’s role in the deals. In 2009, JPMorgan agreed to a $722 million settlement with the SEC.
The financings arranged under Langford converted almost all the county’s sewer debt into securities that carried interest rates that periodically reset, a strategy promoted by Wall Street as a way for borrowers to save money using short-term interest rates on debt that didn’t mature for decades. The swaps paired with the bonds were meant to hedge against adverse changes in the rates.
Exposed to Crisis
That strategy left the county exposed in 2008, when the credit crisis pushed up municipal lending rates. As banks began hoarding capital, the market froze for auction-rate bonds, a type of security used by Jefferson, and the county had to pay penalty interest rates.
After some bond insurers incurred losses on subprime- related securities, threatening the credit ratings they used to guarantee other Jefferson debts, investors in 2008 dumped the sewer securities on banks that had agreed to act as buyers of last resort. That triggered contractual requirements for the county to pay off $850 million of the debt in four years instead of the 30 or 40 under the original agreements, according to government records.
The demands pushed the county into defaulting. The uncertainty that has reigned since then has led some businesses, politicians and residents to be thankful for any route that would bring the saga to a close.
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