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In Search Of Sewer Solutions

BRADENTON, Fla. - Officials representing Jefferson County, Ala., resumed negotiations with creditors yesterday, as a Birmingham councilor suggested the city buy the county's troubled sewer system and public finance professionals met to discuss the implications should the county file for bankruptcy protection.

In the state capital, Montgomery, the Jefferson County Commission's recently hired law firm, Bradley, Arant, Rose & White LLP, met with the county's main creditors, including JPMorgan. Lawyers from King & Spalding LLP were on hand representing bond insurers Financial Guaranty Insurance Co. and Syncora Guarantee Inc. - formerly XL Capital Assurance Inc.

FGIC and Syncora have $1.19 billion and $809 million of net par exposure respectively to the county's sewer debt and have already made some payments in connection with accelerated debt payments. Interest rates on the county's floating-rate sewer debt have soared to as high as 10%, largely because the insurers have been downgraded.

Alabama Gov. Bob Riley did not attend yesterday's meeting. Still unclear was how creditors were responding to a restructuring plan offered by the state on Aug. 29 for the county's $3.2 billion of sewer system debt and a massive swap portfolio associated with the transactions.

Riley, who stepped in to take over negotiations in recent weeks, reportedly offered annual increases in sewer system rates as part of a plan to eliminate auction- and variable-rate debt and replace those securities with fixed-rate bonds having longer maturities. The plan calls for creditors to accept some losses.

While Jefferson County is Alabama's most populous county with 659,000 residents, only about 146,000 residents are on the sewer system and they have seen rates rise 329% since the county agreed in a federal consent decree to repair its sewer system in 1996.

More than half of the ratepayers live in Birmingham, according to City Councilor Steven Hoyt, who on Tuesday suggested that the city look into purchasing the sewer system.

"It might be a long shot but it is an option we have," Hoyt said in an interview posted on the Birmingham News Web site.

Hoyt said the city has the bonding capacity and double-A ratings to finance such a purchase, but the details would have to be worked out.

"I would rather it be owned by a public entity," Hoyt said, rather than another entity that would not be as sensitive to the ratepayers as the city would be.

Earlier in the week, Jefferson County commissioners unanimously approved new forbearance agreements delaying swap and debt payments to creditors until Sept. 30, providing breathing room for negotiators to continue discussions with creditors.

It was the latest of several forbearance agreements the county approved since February when negotiations first got underway, and the willingness of creditors to agree to yet another forbearance shows they are not interested in a bankruptcy filing, said Andreas Rauterkus, an assistant finance professor as the University of Alabama at Birmingham.

"Creditors and banks do not like bankruptcy. They do not like to be dragged into a legal process," Rauterkus said in an interview on Tuesday. "The question is, what happens if the county goes bankrupt?"

County commissioners have authorized their attorneys to prepare paperwork to file what would be the nation's largest municipal bankruptcy, using the threat of such a filing as leverage in negotiations with creditors.

Rauterkus believes it is inaccurate to compare what Jefferson County could face if it files for bankruptcy to what happened after Orange County, Calif., filed for Chapter 9 in 1994. Its bankruptcy was related to risky derivative investments that went bad. Experts familiar with that case point out that Orange County paid all of its debt.

Rauterkus noted that Orange County's bankruptcy filing occurred at the beginning of a new economic boom, which may have helped the county recover more quickly.

"We are not exactly in a booming economy now," Rauterkus noted.

Rauterkus also said he believes the governor's initial reluctance to get involved with Jefferson County's problems, and his refusal to support a county bail-out plan by not calling a special session of the Legislature, sent a clear signal to investors that the state was not willing to assist its largest county.

That may place Jefferson County, other issuers in the state, and possibly the state itself at a disadvantage when trying to sell bonds in the future - especially if Jefferson County eventually files for bankruptcy. The fact that there are now fewer triple-A bond insurers to provide credit enhancement won't help either, Rauterkus added.

But some who participated in a panel discussion in Washington on Tuesday organized by the American Enterprise Institute to discuss the Jefferson County situation said they believed creditors will strike a last-minute deal with county officials.

"It's less bad to make a deal and take a haircut in a deal that you made than to put your fate in the hands of a bankruptcy judge," said Alex Pollock, a resident fellow at American Enterprise Institute and moderator of the panel.

AEI is a conservative think tank that promotes free markets and limited government.

Other panelists warned that the county's problems may still signal a coming wave of defaults or bankruptcies by municipal issuers squeezed by the credit crunch.

"This is an issue of extreme debt leverage [and] it's also an issue of extreme derivatives, which are all coming to bear right now on the early side of conditions that are going to hurt municipals in a wave," said Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management LLC. He noted that municipalities could be harmed by large declines in property values, which could in turn dramatically lower their tax revenues.

Ciccarone warned that complacency about the safety of municipal credits may be exacerbated as rating agencies continue to move toward a global rating scale that rates municipals the same as corporate and other types of bonds, resulting in most municipal debt carrying triple-A and double-A ratings.

Year to date, the ratio of upgrades to downgrades is 4.5 to 1 for the overall number of municipal credits in the market and 6.6 to 1 based on par volume, Ciccarone said, citing statistics from Smith's Research & Gradings.

Panelists noted there were a number of causes behind Jefferson County's problems, including insufficient skepticism by county officials when approached by Wall Street advisers pitching derivatives.

"I don't think they were stupid or foolish, necessarily - they were dealing with people who they thought were fiduciaries," said Larry Lavender, staff director for U.S. Rep. Spencer Bachus, the ranking Republican on the House Financial Services Committee, whose district includes a part of Jefferson County. "Those advisers by and large ... are people who are there to make a dollar, that's what's driving their behavior."

Meanwhile, Lavender said that the county's financial problems stem at least in part from the political composition of the Jefferson County Commission, which consists of five members elected from single-member districts. "So there's no county-wide leader who has the interest of the whole government in his mind," he said. "There's nobody who can develop a consensus and there's nobody who can develop a mandate."

In addition, each commissioner is given leadership over a single county department, such as finance or public safety or sewers, which ultimately limits overall accountability.

The theme of unsophisticated municipal issuers was echoed by Joseph Mysak, a columnist for Bloomberg News, who said issuers often do not fully understand what they are being sold. He characterized Jefferson County's situation as "amateur hour on parade."

Christopher Whalen, co-founder and managing director of Institutional Risk Analytics, urged states to impose "draconian" limits on the types of derivatives that municipal issuers can purchase. He also argued that state pension funds should be prohibited by law from investing in any securities that are not registered with the Securities and Exchange Commission.

Jefferson County will be the topic of another panel discussion on Tuesday at The Bond Buyer's 18th Annual California Public Finance Conference in San Francisco.

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