Jefferson County, Alabama, declared the largest municipal bankruptcy in U.S. history, capping a more than three-year saga that turned it into one of the biggest casualties of Wall Street’s credit crisis.
The move yesterday by Alabama’s most-populous county, with about 660,000 residents, came after state lawmakers failed to back a September agreement with creditors led by JPMorgan Chase & Co. that would have reduced its sewer-system debt of more than $3 billion. Governor Robert Bentley and local leaders worked unsuccessfully for two months to rally support for the deal.
“We’ve reached that last resort,” Commissioner Joe Knight said yesterday at the meeting before the 4-1 bankruptcy vote. “We could continue and keep kicking this can down the road, but I think the people of Jefferson County have had enough.”
The Chapter 9 filing leaves creditors including JPMorgan, the biggest U.S. bank by assets, facing hundreds of millions of dollars in losses and may revive concern that defaults will rise in the $2.9 trillion municipal bond market. The move also leaves residents of the county that’s home to Birmingham, the largest city in the state of 4.8 million people, facing unsustainable sewage fees to repay the debt that led to the debacle.
Cost of Deal
The September accord provided $1.1 billion in concessions. It also called for annual sewer-rate increases for the first three years of as much as 8.2 percent, which drew opposition from lawmakers concerned about the burden that would place on the poor. The county also couldn’t get signed commitments from creditors, said Commission President David Carrington.
The size of sewer-fee increases became a hurdle because many residents, particularly in Birmingham, can ill afford higher costs, according to Commissioner George Bowman, who represents one of county’s two poorest districts and cast the sole vote against bankruptcy. He has said that almost 70 percent of sewer users reside in the two districts with the lowest average incomes.
Bentley, a Republican, said he was disappointed by the county’s move to seek court protection.
“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.”
Jefferson’s bankruptcy is the legacy of a sewer project dogged by political corruption. In 2009, JPMorgan agreed to a $722 million settlement with the Securities and Exchange Commission over payments its bankers allegedly made to people tied to county politicians to win business. Former Commissioner Larry Langford was convicted on charges of accepting bribes and the shenanigans behind the financing inspired elements of the Dodd-Frank law to protect municipalities.
In 2008, the derivative-laden refinancing set up by JPMorgan unraveled as fallout from the subprime-mortgage market collapse rippled through Wall Street, sending debt costs soaring. The ensuing crisis led some county residents and businesses to press for bankruptcy, rather than bear the full cost alone.
Jefferson commissioners’ efforts to close the settlement deal were frustrated by recent sales of sewer debt to investors who didn’t want to restructure the bonds under the agreement’s proposed terms, according to the bankruptcy filing.
JPMorgan didn’t want the county to enter bankruptcy, said Justin Perras, a bank spokesman. The company 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. It had offered $750 million in concessions in the proposed settlement.
“We offered very substantial financial concessions to make the deal happen while keeping sewer rates within the parameters proposed by the county,” Perras said by e-mail. “While we’re disappointed by the county’s decision to file, we will continue to work toward a fair and reasonable solution.”
The vote occurred about a month after Pennsylvania’s capital, 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, entered bankruptcy, citing pension costs it can’t afford.
Municipal bankruptcies are rare. Since November 1981, fewer than 40 local governments have sought to restructure in bankruptcy, according to court records. Most of the more than 200 Chapter 9 cases filed since then involved special tax districts, or entities such as hospitals that were funded with state-issued bonds. In the same period, companies filed more than 20,000 Chapter 11 cases.
Jefferson County’s Chapter 9 filing eclipses the previous record, set in 1994 by Orange County, California. The suburban Los Angeles county was driven into bankruptcy by $1.7 billion in losses on interest-rate bets. It had about $2.2 billion in debt outstanding, according to a June 1995 financial report.
Less than an hour after Jefferson County’s late-afternoon filing, an investor bought more than $1 million of its sewer debt for 58 cents on the dollar, down from about 74 cents a month earlier, according to Municipal Securities Rulemaking Board trade data.
“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 the filing.
This year through September, the number of municipal defaults fell to 42, totaling $949 million, from 79 in the first nine months of 2010, amounting to about $2.89 billion, according to the Distressed Debt Securities Newsletter, published by Miami Lakes, Florida-based Income Securities Advisor Inc.
The collapse of both Harrisburg and Central Falls, whose problems also were long brewing, failed to rattle municipal bond investors, and the same may apply with Jefferson County. Officials there have been considering Chapter 9 since 2008.
“I don’t think it will have a huge impact,” said Alan Schankel, director of fixed-income research for Janney Montgomery Scott LLC in Philadelphia. “Certainly it’s not a secret. It’s been floating around for quite some time.”
Municipal bond yields were little changed as of 10 a.m. New York time today, according to BVAL index data. They fell to a five-week low yesterday as investors sought safety in U.S. Treasuries amid concern that European governments won’t be able to avoid bond defaults.
Jefferson County can’t impose a tax or raise existing levies without legislative approval. Its money struggles intensified in March when the state’s highest court struck down a local wage tax that generated $70 million annually, or almost a quarter of the county’s general fund.
More than 500 county employees lost their jobs in response to the revenue drop and satellite courthouses were closed. Lines for services became so long that the county installed portable toilets.
The bankruptcy is a “catastrophic mistake” that will lead to rate increases for sewer customers, said John Young Jr., the receiver appointed to run the system.
“This utterly irresponsible act makes the dark cloud hanging over Jefferson County even darker,” Young said yesterday in a statement. He said increases would be “significantly higher” than the 8.2 percent called for in the proposed deal.
The bankruptcy also may affect bond insurers Financial Guaranty Insurance Co. and Syncora Guarantee Inc., which guaranteed the sewer debt. Michael Corbally, a spokesman for Syncora, declined to comment on the filing.
Assured Guaranty Ltd., a bond insurer that guarantees some of the debt, is “disappointed” that county commissioners voted to authorize the filing, Ashweeta Durani, a spokeswoman, said in an e-mail.
“We believe the settlement and refinancing transaction outlined in the term sheet approved by the County Commission on September 14, 2011, represented the parties’ best opportunity to resolve the county’s sewer debt crisis,” Durani said. “As secured creditors of the county’s sewer system, Assured Guaranty’s interests remain secured during the bankruptcy proceeding and we expect the rights and remedies available to the sewer system warrant holders under the transaction documents to be fully enforced.”
Along with its sewer debt, Jefferson County owes about $1 billion, including $201 million of general-obligation securities and school-construction bonds totaling $814 million, according to its bankruptcy petition. The county listed the top three unsecured creditors related to the its general-obligation debt as Bayerische Landesbank in Munich, as well as a unit of JPMorgan and the Depository Trust Co., both based in New York.
The county 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.
“About the only thing a judge has the power to do is dismiss the case,” Levinson said.
Credit Crisis Victim
The bankruptcy makes Jefferson County the biggest municipal victim of the unforeseen effects of the credit crisis. In 2008, investors dumped Jefferson county’s bonds in the wake of the subprime mortgage-market meltdown. 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 need for Jefferson County’s sewer financing began in 1993, when three citizens filed a lawsuit against the commission, alleging that during heavy rain, untreated sewage was being discharged from county treatment plants into the Black Warrior and Cahaba rivers in violation of the federal Clean Water Act.
The U.S. Environmental Protection Agency joined the taxpayers who filed the complaint in 1994, and a year later, the U.S. District Court for the Northern District of Alabama in Birmingham found in their favor.
In December 1996, the court ordered Jefferson County to set up a countywide sewer system for collecting overflows and cleaning the water.
Jefferson County’s debt-and-derivatives sewer financing was arranged in privately negotiated transactions with a handful of Wall Street firms led by JPMorgan. None of the bond or swap deals behind the collapse was awarded by competitive bidding, which allowed JPMorgan to charge the county above-market fees.
The county paid JPMorgan, Bear Stearns Cos, Bank of America Corp. and Lehman Brothers Holdings Inc. $120 million in fees for swap trades. Those fees were as much as six times the prevailing rate, according to a report by former county financial adviser Porter White & Co. of Birmingham, Alabama.
Three years before the subprime-mortgage lending crisis convulsed global financial markets and helped produce $2.1 trillion in losses and writedowns, Bill Slaughter, the county commission’s bond counsel at the time, said that he couldn’t figure out the math on the swaps that ended up burdening Jefferson’s taxpayers.
“Neither I nor anybody in the Jefferson County commission -- or for that matter, I’m not even sure that the JPMorgan people that we deal with -- really understand how swaps are priced in the global financial market,” Slaughter said.