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. (JPM), 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.
Debt Difference
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.
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.
Chapter 9
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.
Losses
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.
Fees
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).
