Jefferson County debt crisis
The Jefferson County debt crisis emerged in late 2007 as interest rates for the county's enormous sewer construction debts shot upwards during a national crisis in the mortgage lending market. The county negotiated a provisional settlement with creditors in September 2011, agreeing to refinance just over $2 billion in bond debt, out of a total of $3.2 billion which had been borrowed.
Negotiations were aimed at gaining forgiveness for a certain amount of debt so that sewer rates, which have increased over 600% since 1992, could be kept at "reasonable" levels. Eventually, the county voted to file for protection under chapter 9 of U. S. bankruptcy law. The filing represented the largest bankruptcy by a municipal government in United States history.
In June 2013 the county reached an agreement with a majority of creditors under which it would raise sewer rates sufficiently to fund debt service on a total of $1.835 billion, with creditors conceding the balance of the debt.
The Jefferson County sewer system incurred enormous debts in the late 1990s for repairs, upgrades and expansion of its sewer and water treatment infrastructure. Part of the work was required by a 1996 consent decree forged to insure that the system complied with the requirements of the Clean Water Act. Other expansion was undertaken at the same time to add ratepayers to the system to help pay back the debt and to promote development in the county. As costs continued to climb, rate-payers saw their sewer rates shoot upwards to service the bond debt. A 2003 audit of the sewer project found a critical lack of planning, unqualified project management, serious accounting deficiencies, and arrangements with contractors that opened the county to unusual risk. Later it was found that numerous county officials had accepted bribes from contractors.
Efforts to hold down increases in sewer rates led the county to negotiate numerous refinancings of its bond debts. Following the advice of outside financial consultants and its own finance director, Jefferson County entered into an extraordinary number of interest rate swaps.
Of the $3.2 billion borrowed, nearly $1 billion was used to create a reserve fund, to refinance old debts, and to pay consultants and underwriters. $100 million of that was spent on bond insurance and professional fees, which amounts to 3.2 percent of the total amount borrowed, more than triple the common rate of 1%. Based in part on those unusually high fees paid to bankers and advisors, the Securities and Exchange Commission has opened an investigation into possible violations of securities laws.
Due to a national crisis in the mortgage lending sector which emerged in 2007, the insurers, which were supposed to have kept the bonds' variable interests rates low, were no longer able to cover the bonds. As a result, interest rates shot up from around 3% to over 10% at variable-rate auction. With no ability to cover the massive debt service payments, the county entered into emergency negotiations with its bondholders and began openly considering Chapter 9 bankruptcy.
Commission president Bettye Fine Collins proposed applying $27 million per year in revenues generated by a 1 percent sales tax for school construction toward servicing of the bond debt. The proposal would have required approval from the Alabama legislature as well as from bondholders. In a two-day conference with county lawyers and bondholder representatives on Wall Street it was recommended that the debt be financed primarily through continued increases in sewer rates. According to the county's attorney Patrick Darby, investment bankers at those meetings "pounded on tables, screamed at us and told us to raise taxes." County officials maintained that sewer bond creditors are entitled only to revenues from the sewer system.
During the first half of 2008 the county employed Porter, White & Company as negotiators with bondholders' representatives. The company put together a proposal which combined the $27 million from sales tax revenues with $10 million a year from the general fund and an annual sewer rate increase of 2.85 percent. The Commission rejected the deal and terminated its contract with Porter, White in July. They also ended a contract Merrill Lynch & Company, which had been hired as advisors only a month before and signed new contracts with Sterne, Agee & Leach and Morgan Keegan & Company.
Meanwhile the bonds' insurers continued to see their investment ratings downgraded, increasing the county's interest payments, and lawyers challenging the constitutionality of the Jefferson County Occupational Tax filed for a lien against the county's general fund in probate court. That suit obligated the county to refund millions of dollars in previously-collected taxes.
In November 2008 District Court Judge David Proctor appointed two "special masters" to report on the county's financial situation and mediate its standoff with its bond insurers. Their combined 60-page report, delivered in February 2009, concluded that sewer rates would have to grow enormously unless the federal or state government intervened. They recommended adding a processing fee for private meters on irrigation systems, imposing a "clean water fee" on non-sewer customers who benefit from the environmental safeguards constructed into the system, eliminating the 15% credit for water not returned to the sewer, and raising rates 25% per year unless governmental relief is secured. Proctor ruled that the nearly $800,000 in fees billed by the special masters would be split evenly by the county and its insurers. They submitted a final report in July 2009 expressing regret that they did not effect a solution and repeating their recommendations for the county and other parties.
In March 2009 JPMorgan Chase & Co. terminated another set of interest-rate swap agreements, adding $748 million to the county's financial liability, which then exceeded $3.9 billion.
County Commissioners worked with various advisors, including Citigroup and Haskell Slaughter Young & Rediker, to create a plan to eliminate the debt and avoid bankruptcy. Those plans generally involved small, steady increases in sewer rates beginning in 2012 coupled with certain automatic revenue increases (such as property tax, occupational tax and sales tax) which would be triggered by the amount of payments due. No progress on that plan was made during the subsequent legislative session.
A competing plan, suggested by David Bronner, head of the Retirement Systems of Alabama, was for the county to proceed with authorizing a Chapter 9 bankruptcy filing and then selling the sewer system to raise cash. He estimated the system's assets were worth about $1.5 billion, which would leave $1.7 billion in debt to be absorbed by the county's bondholders and bond insurers. Bronner suggested that the RSA could negotiate to be the purchaser of the system and would be willing to sell it back to the county for the same price.
The Commission was divided on how to proceed. Collins, Bowman and Smoot favored further negotiations aimed at avoiding bankruptcy, while Carns and Humphryes were convinced that filing Chapter 9 was unavoidable. Over their objections, the Commission voted in early August to hold a non-binding referendum during the November election to get public input on the issues facing the county. Facing what they described as a "groundswell of community support" for Bronner's plan, Collins initiated a public relations campaign aimed at educating voters about the dangers of bankruptcy. WilbanksElam put together a broad-based effort to counter Bronner's plan under contract with the County and with financial assistance from local businesses as well as from national lenders who stood to lose hundreds of millions of dollars if the county entered bankruptcy protection. A proposed settlement would have waived payment of the swap termination fees and provided other concessions totaling $1.3 billion, or about a third of the total debt.
Governor Riley's efforts to negotiate with bondholders continued into 2009 as various bills intended to improve the situation were debated in the Alabama legislature. The most crucial legislation would have allowed sales taxes collected for school construction to be applied toward paying down the sewer debt. That bill died in session. Other legislation replacing the controversial Jefferson County occupational tax also died in the state legislature, effectively cutting a quarter of the county's annual revenues and forcing drastic cuts in county services.
In March 2009 the County Commission acted on one of the recommendations from the February 2009 special masters' report by imposing a $12 processing fee on newly-installed private water meters used on irrigation systems. In early July, District Court Judge David Proctor accepted a final report from the special masters, but later the same month enjoined them to continue working alongside magistrate judge John Ott to try to reach a negotiated resolution.
On November 4, 2009 JPMorgan Chase & Co. agreed to a settlement to end the SEC's probe of its financial dealings with Jefferson County. Under the terms of the agreement the investment bank canceled $647 million on fees it would have charged the county to refinance its auction-rate security debts and made a one-time payment of $50 million to the county. The SEC had alleged that JPMorgan's Charles LeCroy and municipal derivatives head Douglas McFaddin made millions of dollars of illicit payments to bankers considered "friends" of Jefferson County officials in order to secure the county's bond business. The firm then charged the county higher fees and interest in order to make up for those payments.
Rather than raise rates as recommended by the special masters, the county defaulted on payments while seeking other means of reducing its indebtedness. A lawsuit was filed by the Bank of New York Mellon, trustee over much of the system's obligations,. On September 22, 2010 Circuit Court Judge Albert Johnson appointed New Jersey Water Works executive John S. Young as receiver, granting him power to administer, operate and protect the system; including the power to raise rates.
In March 2011, Young said that he expected to recommend rate increases of up to 25% for most residential sewer customers. His own research indicated that the median monthly household sewer bill was $40, or $23 less than the board's estimate, and that an increase would be affordable to most families. Those with incomes below $30,000 a year would be eligible for an assistance program. Young's recommendations were turned over to Judge Johnson in May. The County Commission challenged his recommendations. Legal fees for both the county and the receiver were paid for from county funds.
In July 2011, Johnson affirmed Young's role as receiver by granting him exclusive signatory authority over the county's collected sewer revenues, amounting to $60 million at the time of the order.
In September 2010 details of a proposal being negotiated with creditors on the county's behalf were revealed. Under the proposal, creditors would write off about half of the $3.2 billion in outstanding obligations while limiting sewer rate increases to 2.5% per year and creating a $30 million relief fund for low-income ratepayers. The agreement also called for establishment of an independent oversight board, a new state authority to oversee issuance and repayment of bonds, and the settlement of all outstanding litigation between the county and its creditors.
Parties who would have to agree on the proposal include the County, the State Legislature (to establish the bond authority), and the bondholders, which included JPMorgan, Lloyds Bank of Scotland, State Street Bank of Boston, Société Générale of Paris and the Bank of Nova Scotia.
In October 2010 the Birmingham Water Works Board accepted a report commissioned from Raftelis Financial Consultants, recommending against the possibility of purchasing the county's sewer system out of possible bankruptcy.
In January 2011 new Commission president David Carrington and commissioner Jimmie Stephens met with creditors in New York. He told Leadership Birmingham and Operation New Birmingham during his trip that no settlement is likely before audits of the county's financial dealings over the past several years are completed in early 2012. He also said that the county's pending civil lawsuit against JPMorgan would not be taken off the table in order to smooth the way for an earlier settlement. A week later, the bank informed the county that if it lost a suit filed by bond insurer Syncora Guarantee Inc., that it would file a claim for the $400 million judgment from the county.
In July 2011 Governor Robert Bentley and state finance director David Perry drafted a proposed compromise aimed at avoiding bankruptcy. As mediators in the dispute, they presented the plan to creditors without involving the County Commission.
In September 2011, county commissioners and JPMorgan announced a tentative agreement for creditors to forgive about $1.09 billion while the county restructured the remaining $2.05 billion in debt over a 40-year term. Sewer rates would be capped at 8.2% per year for three years, and then 3.25% per year afterward. The deal depended on approval by minority creditors and on the creation of a "General Utilities Services Corporation" by the Alabama State Legislature to issue the refinanced bonds.
Agreement in the Jefferson County Legislative Delegation over the requirements for a negotiated settlement proved unforthcoming, leading Governor Bentley away from calling a special session. With no prospect for the legal grounds for a settlement, the County Commission voted on November 9 to file Chapter 9 bankruptcy.
Immediately after the county's petition was filed with the United States District Court of the Northern District of Alabama, it was assigned to U. S. Bankruptcy Court Judge Thomas Bennett. He held a preliminary hearing on the morning of November 10, 2011 to hear arguments from attorneys Patrick Darby (Bradley Arant Boult & Cummings) and Kenneth Klee (University of California Los Angeles) on behalf of the county and attorneys for the creditors, led by JPMorgan Chase & Co. The hearing was held at a temporary courtroom in the Federal Center on 20th Street North due to renovations ongoing at the Robert Smith Vance Federal Courthouse Building two blocks away.
An early ruling in the case clarified that the court, rather than receiver John S. Young, now held jurisdiction over the assets and properties of the sewer system. Negotiations with creditors continued through 2012 and into 2013. An agreement with major creditors, including JP Morgan, was announced on June 4, 2013. Under the proposal the county's sewer debts would be reduced from $3 billion to $1.835 billion while sewer rates would be allowed to increase by 7.41% for four years and by no more than 3.49% per year afterward to service that debt. Most bondholders would see about 60% on their initial investment while JP Morgan agreed to concede 70% of its sewer debt holdings in furtherance of the deal to exit bankruptcy.
A Wall Street Journal report on the proposed deal concluded that the county could end up paying more than $6.9 billion to creditors over the 40-year term of the $1.875 billion in refinanced debt. The payment structure was weighted to increase payments during the latter years of the deal, with no indication that the proposed rate increases would suffice to cover those payments. County officials argued that the plan provided sufficient funding to usher the county into position to re-finance under better terms before interest rate increases were triggered.
Ultimately the county wrangled enough additional concessions from creditors to move forward with the sale of $1.8 billion in new warrants to service the remaining debt. Judge Thomas Bennett approved the plan on December 3, officially moving the county out of bankruptcy.
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- Braun, Martin Z. and William Selway (November 4, 2009) "JPMorgan Ends SEC Alabama Swap Probe for $722 Million" Bloomberg.com
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- "Alabama Gov. Robert Bentley says Jefferson County sewer settlement near; commissioners say not so fast." (July 9, 2011) Bloomberg News/The Birmingham News
- Dickinson, Melinda and Matthew Bigg (September 16, 2011) "Alabama county backs deal to settle $3.14 billion debt." Reuters.
- Selway, William (September 16, 2011) "Jefferson County, Alabama’s Path From Scandal to Debt Settlement: Timeline" Bloomberg
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- Hubbard, Russell (January 6, 2012) "Court-appointed receiver John S. Young has no power to raise Jefferson County sewer rates." The Birmingham News
- "JeffCo approves deals to exit bankruptcy, cut sewer debt." (June 4, 2013) Birmingham Business Journal
- "Jefferson County Debt Plan Is Costly" (June 17, 2013) The Wall Street Journal
- Wright, Barnett (December 3, 2013) "It's over. Jefferson County today emerges from bankruptcy following sale of new sewer warrants." The Birmingham News
- Sangha, Jayden (December 11, 2019) "The Jefferson County, Alabama, Bankruptcy" MunicipalBonds.com