BRADENTON, Fla. - Moody's Investors Service yesterday downgraded Jefferson County, Ala.'s $3.2 billion in outstanding sewer revenue warrants to Baa3 from A3.
The rating action concerns the county's highly complex and leveraged sewer enterprise program, of which more than $3 billion is in auction- and variable-rate warrants. Moody's said the program, which includes a series of swaps and overlapping swaps, is a unique, risky, and highly leveraged structure.
The risks inherent in those programs combined with downgrades of bond insurers, higher interest rate resets, and a growing mismatch between interest rates on the county's swap agreements converged and ultimately led to the downgrade, said Patrick Mispagel, Moody's lead analyst on the credit.
"The Baa3 rating reflects the unique and significant combination of exposure that Jefferson County has to interest rate risk and some of the termination events with the swaps and standby warrant purchase agreements," Mispagel said in an interview yesterday.
The downgrade, however, exposes the county to new financial pressure in addition to the crisis created by the downgrading of some bond insurers and significantly higher interest rates being experienced as a result of disruption in the variable- and auction-rate markets.
Agreements with Jefferson County's swap counterparties require that if the county's rating is downgraded below BBB by Standard & Poor'sor below Baa2 by Moody's, the county has 10 days to post collateral against its negative mark-to-market position or secure triple-A-rated insurance to cover potential payments to counterparties.
As of Jan. 31, the county reported to Moody's that its swap portfolio had a negative mark-to-market value of $341.3 million, up from a low negative mark-to-market value of $28 million just last June.
On Monday, Standard & Poor's lowered its underlying rating on the county's sewer debt three notches to BBB from A.
In addition to the convergence of market forces and complexity of the county's finance program, Mispagel said the county's cash position has declined somewhat in the last few months and the sewer budget has fairly narrow debt service coverage.
"It was unclear if the county would be able to craft a long-term strategy to eliminate the risk before it runs into a severe cash crunch," he said.
Moody's also placed its lower rating on review with the direction uncertain, reflecting continuing uncertainty about the county's ability to meet short-term liquidity needs as well as its ability to structure a viable long-term plan.
The rating downgrade also reflects the county's vulnerability to termination of liquidity facilities due to downgrades of financial guarantors.
The county, due to insurer rating downgrades and disruptions in the floating-rate markets, has experienced failed auctions in some of its $2.2 billion of auction-rate securities and some unsuccessful remarketing of $847 million of outstanding variable rate demand warrants, which has significantly increased interest costs.
Downgraded insurers have placed the county in default under its standby warrant purchase agreements giving liquidity banks the option to terminate the agreements. As of Tuesday, Moody's said no notices of termination had been received. XL Capital AssuranceInc. insures $737 million of variable-rate warrants and Financial Guaranty InsuranceCo. insures $110 million.
Moody's said the county sewer enterprise is estimated to have $193 million in cash available, which may not be sufficient to absorb the increasing interest expenses.
Jefferson County filed a seven-page disclosure on Feb. 20, which some experts agree was a good overview of current circumstances.
County officials have been advised by disclosure counsel, Balch & BinghamLLP, not to comment about the sewer debt program or its financial impact until a comprehensive disclosure package is prepared. The county's disclosure counsel said in a memo on Monday that it could take several weeks to complete the additional disclosure.
"We know they are working hard trying to work something out," said Bob Kurtter, senior credit officer in Moody's public finance group. "Their position is they can't discuss what they are working on until it's pretty well done and they can announce it to the market generally. We're waiting along with everyone else to hear about their efforts."
Moody's said yesterday that it is not aware of any other local government issuers across the country that have used variable rate and hedging tools to the extent that Jefferson County employed them.
"We believe that the degree of risk that this poses to Jefferson County as a result of current market disruptions is likely to be unique and not replicated in the vast majority of other municipalities," the agency said.