Monday, April 21, 2008

Jefferson County struggles against rising tide of debt

The following appeared in the Tuesday April 15 issue of the Financial Times on page 24. This is a warning to what will happen to the United States government if we do not get our borrowing and spending under control.

By Stacy-Marie Ishmael on why the municipality is facing the prospect of a major default

Alabama’s Jefferson County, one of the most indebted US municipalities, will today try to persuade creditors to extend the deadline for a $184m payment in its efforts to stave off default on its broader obligations.

Jefferson County has around $4.6bn in outstanding debt, and a default on that scale would dwarf 1994’s Orange County debacle, in which the California county defaulted on some $1.6bn in debt.

The country’s financial problems – it has already missed a series of payments to banks led by JPMorgan – are directly linked to the credit crisis that has rattled both Wall Street and Main Street.

Jefferson County has been hurt by soaring interest rates on the $3.2bn of debt it issued since 1997 to fund a sewer project. Investors started demanding higher interest rates in part because of problems facing the bond issuers that had guaranteed that debt, and partly as a result of a broader collapse in the auction-rate securities market, much used by municipal borrowers and where interest rates are set by auction every seven to 35 days.

County Commissioner Bettye Fine Collins said interest costs for the sewer project financing could reach $250m – almost twice the $138m in revenue the sewer system generates – if the county is unable to restructure the debt.

The county’s woes have been compounded by a series of complex agreements it entered into with Wall Street banks earlier this decade.

The agreements, known as interest rate swaps, were designed to reduce the risk and cost to the county of issuing variable-rate debt.

The swaps allowed Jefferson County to make fixed payments to investment banks including Lehman Brothers and Bank of America, and in return to receive floating payments linked to 3-month Libor.

But this strategy, which had been the favourite of municipalities across the nation, turned sour when the market for auction rate securities froze and three-month Libor started to fall. In other words, Jefferson County faced rising interest rate payments at a time when the swap contracts were paying out less than before.

Moreover, after the county skipped a $53m principal payment earlier this month, ratings agencies cut its credit ratings to the lower end of the investment grade spectrum. Those cuts triggered clauses in the swap agreements that allowed Jefferson’s creditors to demand $180m in additional collateral – money the county did not have.

Jefferson has already missed one such deadline, and a second one expires today. Unless it can persuade its banks to renegotiate the terms of the agreements, it may be pushed into bankruptcy, county officials said.

“If we don’t extend [the deadline], were basically calling in bankruptcy at that point in time,” county commissioner Jim Carns told the Birmingham News last week. But Alabama state officials are working to prevent such an outcome.

The state Senate has approved resolutions that would prevent the county from unilaterally declaring bankruptcy, for instance.

The Wednesday April 16, 2008 issue of the Wall Street Journal gives an update on the Jefferson County story on page C2.

Alabama County Votes To Delay Debt Payment

Alabama’s Jefferson County Commission voted Tuesday afternoon to approve an agreement with banks that allows the county to further delay a $53 million payment on its municipal sewer debt.

This measure gives the county, which includes Birmingham, more time to negotiate a rescue plan necessary to avoid bankruptcy. Such a bankruptcy would represent the largest-ever municipal default, roughly double the size of the Orange County, Calif., debt default in 1994.

A representative for Jefferson County Commission President Bettye Fine Collins said the five-person commission voted unanimously to approve an extension of the county’s existing forbearance agreements with banks, bond insurers and swaps counterparties related to the county’s sewer debt.

The representative couldn’t confirm the length of the extension that was agreed upon, and referred queries to the office of the county attorney, who didn’t immediately return a phone call.

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