Regional News

Jefferson County, Ala., Takes Sewer Rating Hit

BRADENTON, Fla. - Standard & Poor'syesterday lowered its underlying rating on Jefferson County, Ala.'s $3.2 billion of outstanding sewer revenue debt three notches to BBB from A.

The agency also placed the rating on watch with developing implications due to recent negative financial pressures on the sewer system and the potential for the problems to worsen, Standard & Poor's said.

Jefferson County on Wednesday filed a seven-page disclosure notice discussing two recent failed debt auctions, downgrades that placed variable-rate demand warrants in technical default, and the effect on its massive $5.59 billion swap program. The county has about $2 billion of outstanding auction-rate debt.

The disclosure is the only definitive public statement Jefferson County officials have made concerning recent volatility in the auction- and variable-rate market. It also is what led Standard & Poor's to downgrade the county's sewer debt rating, the agency said in a release.

Jefferson County Commission President Bettye Fine Collins has asked fellow commissioners and the county's financial advisers not to comment about the situation. Collins did not respond to a request for an interview yesterday.

The county is expected to release a more complete disclosure in about a week concerning its options with respect to the troubled debt program.

Standard & Poor's three-notch downgrade relates primarily to thin debt service coverage and past reluctance to raise sewer rates, analyst Alexander Frasersaid yesterday.

The agency also is concerned about the downgrading of bond insurers that triggered events of default under existing standby warrant purchase agreements. The liquidity providers now have the right to terminate these agreements but have not yet done so.

The county has more than $500 million of bank warrants that bear a higher interest rate if tendered. If they are not remarketed, county officials could be forced to redeem the bank warrants in 16 equal quarterly principal installments. For the first four months of the current fiscal year, the county disclosed it has incurred $6 million of additional interest costs related to the warrants and is projecting higher interest costs to continue through the remainder of the fiscal year.

"We just felt a rating in the A category was not appropriate with the level of additional interest costs and need to immediately implement some corrective actions," Fraser said. He added that the rare action of placing a developing outlook on the new rating provides flexibility going forward.

"As Jefferson County officials make additional information available, we could raise or lower the rating," Fraser said. "We're waiting to hear back from them on where they're heading to resolve this situation and bring more certainty to their debt costs."

Standard & Poor's is conducting a full review of the county's sewer debt program, including its debt derivative profile, Fraser said.

Moody's Investors Service in December affirmed its A3 rating and stable outlook on the sewer debt program. At the time, Moody's said it believed that the county's use of derivatives to manage its debt portfolio did not present undue risks for bondholders. But it also said that under certain scenarios the county's financial stability could be affected by the need to post collateral within a short timeframe or by cost increases driven by the basis risk introduced by swaps.

Moody's noted that the sewer system then had 14 swaps outstanding relating to a total notional amount of $5.1 billion. Moody's said the county's swap portfolio is comprised of $3.1 billion of interest rate swaps and $1.9 billion of basis swaps.

Under existing agreements with counterparties, Jefferson County does not have to post collateral against out-of-the-money positions. However, if the county's rating is downgraded below BBB by Standard & Poor's or below Baa2 by Moody's, the county would have 10 days to post collateral against its negative mark-to-market position or secure triple-A rated insurance to cover potential payments to the counterparty. If Standard & Poor's rating falls below BBB-minus and Moody's rating falls below Baa3, the county has 10 days to secure triple-A rated swap insurance or face termination of the swaps, which would require payment of any mark-to-market difference at that time.

As of Dec. 31, 2007, the latest date available, the county's swap valuation reflected a negative mark-to-market of $242.9 million.


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