Jefferson County, Alabama, commissioners approved a provisional agreement with holders of $3.14 billion of sewer debt to avert what would have been the largest municipal bankruptcy in U.S. history.
The County Commission voted 4-1 today to accept the terms of the agreement, which includes $1.1 billion in concessions from creditors. JPMorgan Chase & Co., which arranged most of the debt, would take the biggest loss. The terms also call for three annual sewer-rate increases of as much as 8.2 percent, followed by future annual boosts of no more than 3.25 percent.
“It’s time for resolution of this lingering debacle,” said Commissioner Joe Knight, who voted for the settlement. “There is enough blame to go around.”
The threat of bankruptcy has loomed over Jefferson County, home to Birmingham and more than 658,000 residents, for more than three years as officials sought to keep sewer fees from ballooning to pay off the debt.
The deal hinges on action by state lawmakers, and Commission President David Carrington said bankruptcy is still possible if final terms aren’t agreed on. The commission will negotiate with creditors to reach a definitive agreement over the next 30 to 45 days, he said.
Concluding the accord hinges on Governor Robert Bentley’s ability to persuade the Legislature to create an independent sewer authority to issue new debt backed by a so-called moral obligation pledge from the state. Lawmakers also will be asked to shore up the county’s general fund, which is facing a $40 million gap in its operating budget, after a state court struck down a levy on wages. The governor has said he would call a special session to act on an agreement.
“There is a lot left to do to make the settlement work,” Bentley said in a statement. “I look forward to continuing to work with county commissioners and legislators in preparation for a special session of the Alabama Legislature so that we can pass laws necessary to move forward with the settlement and to address the county’s general fund budget issues.”
If legislators accept the arrangement and the new bonds are marketed successfully, it would end the biggest debt crisis in the $2.9 trillion municipal bond market.
“If Jefferson County had to file for bankruptcy, there’s no telling how far the ripples would have stretched across the market,” said Matthew Buscone, a portfolio manager at Breckinridge Capital Advisors in Boston, which oversees $12 billion in assets. “A negative story like that could have caused individuals to redeem their mutual-fund shares, which would have had a negative effect far beyond Jefferson County.”
Jefferson County’s agreement, coupled with Harrisburg, Pennsylvania’s move to avoid default on its general obligation bonds this week, shows that most fiscally distressed local governments are taking pains to avoid bankruptcy, Buscone said.
Yesterday, an investor bought more than $1 million of the county’s auction-rate securities for 64.75 cents on the dollar, according to data compiled by Bloomberg. In July, the same debt traded for 61.5 cents, and the next day it traded at 74.5 cents.
Jefferson would have been the sixth municipal issuer to enter bankruptcy this year and the biggest since 1994, when California’s Orange County sought protection from creditors after losing $1.7 billion on interest-rate bets.
On Aug. 1, Central Falls, Rhode Island, filed a Chapter 9 bankruptcy petition, citing pension obligations it can’t afford. A filing by Jefferson County would have been the 625th municipal bankruptcy since 1937, according to data compiled by Jim Spiotto, a partner at Chapman & Cutler in Chicago.
Origins of Crisis
“We are encouraged by the county’s decision to refinance the sewer debt and look forward to working toward a successful resolution in the coming months,” said Justin Perras, a spokesman for JPMorgan in New York.
The bank would provide $750 million of the concessions under the settlement proposal, Knight said in an interview yesterday.
Jefferson’s crisis erupted in early 2008 when investors dumped floating-rate bonds used to refinance its fixed-rate sewer debt after companies that insured them lost their top credit ratings because of investments in subprime mortgages.
Jefferson’s floating-rate securities were coupled with interest-rate swaps, a money-saving strategy pitched by banks that backfired. As credit markets convulsed, the county’s interest costs soared. When banks demanded early payoffs of the bonds, the county defaulted.
Rife With Corruption
The county’s bond deals were rife with political corruption that caused the cost of the sewer project to soar as it was built during the 1990s. Democrat Larry Langford, a former County Commission president and Birmingham mayor, was convicted of accepting bribes in connection with the financing.
Two former JPMorgan bankers are fighting U.S. Securities and Exchange Commission charges that they gave $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 settlement in Birmingham followed weeks of negotiations with creditors involving concessions and how much the county would increase sewer rates. County commissioners scheduled special meetings on July 28, Aug. 4 and Aug. 12 in which bankruptcy was on the agenda, only to say that talks with creditors were continuing.
The size of sewer-rate increases became a sticking point because the residents who use the system have no other choice and can ill-afford higher costs, according to Commissioner George Bowman, who represents one of the two poorest districts in the county and voted against the agreement.
Almost 70 percent of sewer users are in the two districts with the lowest average incomes, he said. The county’s sewer rates have increased more than four-fold since 1997.
“I recognize the need for additional revenue,” Bowman said today. “But they are balancing that debt on the backs of the poor.”
Jefferson County’s sewer 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 and helped broker the settlement. The county’s median household income is $43,312 a year, U.S. Census Bureau figures show. The comparable figure in Birmingham was $31,704 in 2009, according to the latest census data available.
The average residential wastewater bill of $37.74 will increase $3.10 in the first year, Carrington said. The tentative settlement calls for the county to set up a bill-assistance program for low-income residents.
“I don’t see how anybody can afford more sewer rate increases,” said Charles Bigham, 54, an unemployed truck driver, in an interview. “It would be better to file bankruptcy and be able to start with a clean slate.”
Knight said the commission’s other options were to do nothing and have Young, the court-appointed receiver, impose a 25 percent sewer-rate increase or to file for bankruptcy and lose support from Alabama’s governor and Legislature for measures that would allow the county to raise more revenue.
“If we go into bankruptcy right away, we have no chance of a general fund fix,” Knight said.
Under the proposed deal, the county would refinance $2.05 billion to repay old debt. To ease commissioners’ concerns about the transfer of the sewer system’s assets to a new authority, the county would get the assets back after the refinancing debt is repaid. The authority would be prohibited from selling or transferring sewer assets without the county’s approval.
The governor’s willingness to help the county avoid bankruptcy by enhancing the creditworthiness of new sewer bonds was critical to the deal, Young said.
If the Legislature backs Jefferson’s debt, the county’s financing costs may be lowered by as much as 2 percentage points for an estimated savings of more than $1 billion, Young said.
The refinancing costs may be lowered further if Jefferson chooses to purchase as much $1 billion of bond insurance from Assured Guaranty. Debt guaranteed by Assured would carry a AA+ rating.
The so-called moral-obligation pledge to support the debt is a nonbinding promise from the state to cover any revenue gap. State legislation would include a provision requiring Jefferson to pay back Alabama if it comes to the county’s aid.
For the three years, Jefferson made little progress in negotiations with creditors.
A turning point came when Bentley, a Republican who took office in January, said he would do everything in his power to help the county avoid bankruptcy. The governor said a Jefferson bankruptcy might increase borrowing costs for the state and its municipalities and hurt Alabama’s image.
“That was a game-changer,” Young said last month.