Jefferson County’s Rise to Investment Grade Doubted: Muni CreditMichelle Kaske and Martin Z. Braun
Jefferson County, which filed the biggest U.S. municipal bankruptcy until Detroit, is selling $1.8 billion of sewer debt to help exit court protection. Standard & Poor’s rates the bonds above junk. Investors disagree.
The Alabama county’s borrowing marks the first time that a municipality is offering long-term debt using its own credit while still in bankruptcy, said Matt Fabian, managing director at research firm Municipal Market Advisors. While S&P ranks the underlying credit of the senior bonds two levels above junk, Fitch Ratings gives them a speculative grade.
Portfolio managers and analysts from Wells Capital Management Inc., Western Asset Management Co. and MMA say the S&P ratings don’t reflect the sewer system’s history of failing to raise rates enough to pay its obligations. Even with insurance giving the senior debt an S&P rank three levels below the top, the bonds are being offered at yields closer to speculative grade, data compiled by Bloomberg show.
“It’s definitely not an investment-grade credit in our mind,” said Lyle Fitterer, who helps manage $31 billion of munis at Wells Capital in Menomonee Falls, Wisconsin, and may buy securities maturing within 10 years. “The water and sewer rates are already high, and the question is, at some point will they come back and say that they’re effectively being over-burdened? That in our minds continues to be a concern.”
This week’s sale comes two years after the locality of 660,000 residents said it couldn’t pay what it owed on more than $3 billion of bonds sold for sewer work. Until Detroit’s July filing, it was the nation’s largest municipal bankruptcy.
The financing may pave the way for other insolvent municipalities, said Fabian at MMA. Citigroup Inc., the lead underwriter, is marketing the debt to buyers such as hedge funds, which typically don’t invest in munis.
“It’s very innovative and it could provide issuers who are in bankruptcy with a better form of refinancing,” said Fabian, whose firm is based in Concord, Massachusetts.
S&P said sewer-rate increases have been pre-approved for 40 years and that Jefferson County has improved oversight by installing a county manager for the first time. In the first 10 years, the county will have as much as two times the cash to pay debt service. If the county refuses to raise rates as specified under the bond deal, investors can ask the court to intervene. Residents are challenging the structure in bankruptcy court.
“The rate increases are high at almost 8 percent in the next four years,” James Breeding, an S&P analyst in Dallas, said in an interview. “Beyond that, 3.5 percent a year is by no means out of line with other major systems.”
The county’s sewer rates are among the nation’s highest, according to the bond prospectus. Rates rose 329 percent from 1997 to 2008, drawing residents’ ire. Under Alabama law, sewer rates must be reasonable and nondiscriminatory, and are subject to review by the courts.
In contrast to S&P, Fitch is less confident in the system’s ability to generate sufficient revenue.
The company is concerned it may be unable to boost fees enough to cover a projected $1.1 billion shortfall in years 2024 through 2040 for capital needs, Doug Scott, an analyst, said in a report.
While Moody’s Investors Service doesn’t rate the deal, it views the borrowing as having “non-investment grade characteristics,” Christopher Coviello, an analyst, said in a report.
“We felt that S&P is looking forward, while the others are looking at the past,” Jefferson County Commission President David Carrington said Nov. 15 in Birmingham, the county seat, after a hearing on the financing plan.
Jefferson County is borrowing to pay creditors. The latest accord replaced one reached in June that became unworkable when interest rates rose in the $3.7 trillion municipal market, partly because of Detroit’s filing on July 18.
The deal is scheduled to price tomorrow with sales to institutional investors such as mutual funds, after two days of marketing to individuals. Scott Helfman, a spokesman for New York-based Citigroup, declined to comment.
An insured segment of the senior debt that matures in October 2044 was being offered with a tax-free 5.5 percent yield, according to three people familiar with the sale who asked not to be named before prices are final.
That’s about the same as benchmark 30-year revenue bonds that are rated two steps above junk and are uninsured, according to a Bloomberg index. Top-rated debt of that maturity yields about 4.15 percent, Bloomberg data show.
That extra yield may attract buyers even with the system’s history, said Daniel Solender, who manages $16.5 billion as director of munis at Lord Abbett & Co. in Jersey City, New Jersey.
“If you can get comfortable with it, it’s an essential-service credit,” he said. “It has a lot of yield.”
Even with the higher yields, the risk rises on longer maturities because the bulk of the loan is set to be repaid in years 2039 through 2053, preliminary pricing data show.
Subordinate debt without insurance and maturing in October 2053 was being marketed with a preliminary yield of 6.5 percent, about one percentage point above the Bloomberg 30-year BBB revenue index. S&P rates the debt BBB-, one step above junk.
The bonds that mature in more than three years are too risky, said Matt Dalton, who oversees $1.8 billion of munis as chief executive officer of Belle Haven Investments Inc. in White Plains, New York. Debt service balloons 67 percent in 2024, reducing available revenue to pay bondholders.
“There’s just too many what-ifs, and too much optimism,” Dalton said.
Citigroup will market the bonds to investors domestically and internationally and paint a picture of debt that’s poised to improve over the next five years along with the sewer system’s finances, according to a July underwriting proposal.
“They’ll cast the net as wide as possible,” said Robert Amodeo, who helps manage about $30 billion of debt at Western Asset in New York.
If the sale prices at speculative-grade levels, it will join Puerto Rico as a locality that trades at yields equivalent to junk even though credit companies rank it higher.
All three major rating companies score the commonwealth one step above junk with a negative outlook.
Elsewhere in the municipal market this week, issuers from California to Maryland plan to sell about $7.6 billion of long-term debt with yields close to a one-month high.
Top-rated 10-year munis yield 2.82 percent, compared with 2.7 percent on similar-maturity Treasuries.
The ratio of the interest rates, a measure of relative value, is about 104 percent, and compares with a five-year average of 102.5 percent. The higher the figure, the cheaper munis are against federal securities.
Following is a pending sale:
The Illinois Finance Authority is set to offer about $135 million in revenue bonds this week for loans to localities for water and sewer projects and to refinance debt, according to a preliminary offering document.