Nov. 9 (Bloomberg) -- Jefferson County, Alabama, filed the biggest U.S. municipal bankruptcy after an agreement among elected officials and investors to refinance $3.1 billion in sewer bonds fell apart.
The county, home to Birmingham, the state’s most-populous city, listed assets and debt of more than $1 billion in Chapter 9 papers filed today in U.S. Bankruptcy Court in Birmingham.
The county’s bankruptcy attorney, Kenneth Klee, said the filing was necessary because talks with creditors and the receiver in charge of the sewer system built by the bonds broke down.
“There was an impasse reached,” Klee said in an interview today. “None of the creditors -- zero -- signed up to the deal that we have been negotiating for six weeks.”
The county’s major creditors, including JPMorgan Chase & Co., signed tentative agreements in September to reorganize the sewer debt to avoid bankruptcy. County officials said at the time that JPMorgan would provide $750 million of about $1.1 billion in concessions.
By October, the tentative deal began to fall apart as disagreements emerged among Jefferson County’s 25 state lawmakers. The deal required action by the state Legislature to help the county close its budget deficit, create an independent sewer authority and give state moral-obligation backing to new sewer debt.
So, the deal with bondholders fell apart because politicians couldn't agree on how to aid or facilitate the deal by closing the budget gap. Frankly, we all knew that was never going to happen and bankruptcy was the viable choice a couple years ago, but finally it's here.
The county and bondholders are about $140 million apart on how much sewer debt the county can bear, Klee said. The county would accept $2.05 billion, while creditors demanded more, he said.
The county also differed with the court-appoint receiver who runs the plant that was built with the defaulted bonds. The county was willing to raise rates paid by residents by 8.2 percent initially. The receiver wanted an 8.4 percent hike, Klee said. Both sides agreed that more hikes would come in the years that followed.
Thomas B. Bennett, chief judge of U.S. Bankruptcy Court in Birmingham, was named to oversee the case by the head of the 11th Circuit Court of Appeals. The first hearing in the case will be at 10 a.m. tomorrow, said a person who answered the phone in Bennett’s chambers who declined to be identified.
This is why bankruptcy is the right choice, muni budget deficits this large are almost impossible to get all the stake holders on board for the size and shape of cuts they need to take. Muni BK will force it on stakeholders (bondholders, muni employees and retirees, vendors, and even tax holders). And politicians (the winners) can escape the dirty work of who loses because that falls on the court now.
Threat of Bankruptcy
The threat of bankruptcy has loomed over the county for more than three years and inspired provisions in the federal Dodd-Frank law seeking to protect localities from complex financial trades involving derivatives.
Commissioners had asked creditors to forgive about $1 billion of the debt to spare residents from ballooning sewer rates needed to pay off the bonds.
Jefferson County is the 12th entity to file a Chapter 9 bankruptcy this year. Three of those filings were by small municipalities: Boise County, Idaho; Central Falls, Rhode Island, and Harrisburg, Pennsylvania. The rest were special purpose districts, or public-benefit corporations eligible to use Chapter 9 of the U.S. Bankruptcy Code.
Jefferson County supplanted Orange County, California, as the largest municipal bankruptcy. Orange County entered court protection in 1994 after losing $1.7 billion on interest-rate bets. While its petition initially listed more debt than Jefferson County, most of that liability was reduced in the early weeks of the case.
Maybe, what the country learns is that the world doesn't stop rotating just because a municipality files bankruptcy. And, that it's the right choice for many cities and counties. Jefferson County is a big enough entity to help remove the stigma of muni BK and maybe nudge the door open for others in the US to follow.
Chapter 9 gives municipalities more power over their creditors, including bondholders, than companies enjoy under Chapter 11. Creditors can’t force a city to sell its assets or file a competing reorganization plan.
In addition, because the 10th Amendment of the U.S. Constitution limits federal authority over states, U.S. bankruptcy judges wield little power over a bankrupt municipality.
In its bankruptcy petition, Jefferson County listed about $202 million in unsecured debt tied to general obligation bonds. The top three unsecured creditors related to those bonds were Bayerische Landesbank, JPMorgan Chase Bank and The Depository Trust Company.
The Jefferson County deal included proposed sewer-rate increases of 8 percent annually for three years and 3 percent in each of the next two years, Commissioner Sandra Little Brown said in an Aug. 9 interview.
Commissioners previously proposed raising rates 7.8 percent annually for three years, followed by 3 percent increases in two more. Creditors wanted 8 percent annually for five years, Little Brown had said.
Interesting to know that a municipality has more power in Chapter 9, in that they cannot be forced to sell assets. And that the judge has relatively less power. This reaffirms muni BK is a great choice for many cities and counties because they have a lack of power now, and muni BK hopefully provides the right tool if used correctly. I say that, because the City of Vallejo fumbled an opportunity a few years ago to make the right changes within muni BK.
The bankruptcy leaves banks such as JPMorgan, individual investors and bond insurers Financial Guaranty Insurance Co. and Syncora Guarantee Inc. facing hundreds of millions of dollars in losses. It may also burden county residents and businesses with higher taxes or sewer bills, which already have risen more than fourfold since 1997.
Jefferson County was a victim of the credit crisis in 2008. The sewer system’s floating-rate securities were coupled with interest-rate swaps, in which two parties make periodic payments based on an underlying measure of borrowing costs.
The contracts, arranged by New York-based JPMorgan, were supposed to save money by offsetting the floating rates the county paid and giving it a fixed rate that was lower than on traditional bonds. The strategy backfired in early 2008 as the subprime-mortgage market meltdown sent ripples through Wall Street, undermining the credit ratings of companies that insured Jefferson County’s bonds.
Does anyone feel sorry for JP Morgan or bondholders? I don't, they need to accept some of the responsibility of putting too much debt onto municipalities who can't afford it. It's no different than BofA losing money on a mortgage that went upside down and the homeowner walked. It's the risk you take when issuing debt.
Investors dumped the bonds and the county’s interest costs soared. When banks demanded early payoffs of the bonds, the county defaulted. The swaps exposed the county to hundreds of millions of dollars in fees to refinance.
Former Commissioner Larry Langford was convicted of accepting bribes in connection with the sewer financing, and two associates pleaded guilty in the scheme.
Two former bankers at JPMorgan are fighting a U.S. Securities and Exchange Commission lawsuit alleging that they made $8 million in undisclosed payments to friends of commissioners to secure a role in the deals. JPMorgan separately agreed to a $722 million settlement with the SEC.
The case is In re Jefferson County, 11-05736-9, U.S. Bankruptcy Court, Northern District of Alabama (Birmingham).
And there's the saddest part of it, tax payers get hosed as greedy politicians make shaky deals to benefit themselves and bond underwriters.
Bankruptcy Denial is something we need to get over in this country, whether it's personal, corporate, or municipal. It's just a tool, and we wait tool long in the case of municipal BK to get there. Jefferson County should have been there 2 years ago but their political leaders had their head lodged in the wrong place.
I say congrats to finally doing what should have been done, now maybe, MAYBE, they can make use of muni BK for the long term benefit of their residents/tax payers.
If used correctly, it should be the ultimate reset button!
Hope all is well.
J.D. Rosendahl, Rosey