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Jefferson County Will Not Post Collateral on Sewer System Swaps

BRADENTON, Fla. — Jefferson County, Ala. officials said in a new disclosure late Wednesday that they do not intend to post collateral or provide insurance to avoid termination of 13 swaps.

The material event notice said the swap counterparties — Bank of America NA, Bear Stearns Capital Markets Inc., JPMorgan Chase Bank, and Lehman Brothers Special Financing Inc. — had been notified of the county’s intentions. The swaps cover a notional amount of $5.4 billion.

Rating downgrades on the county’s $3.2 billion of sewer system warrants triggered the requirement for the county to either post collateral or obtain insurance to avoid termination. Moody’s Investors Service now rates the system’s sewer warrants B3 and Standard & Poor’s rates them B.

Jefferson County had until Friday to post collateral or insurance. However, the new disclosure said the counterparties could terminate their swap transactions and the county would be obligated to pay a termination fee, calculated at approximately $184 million as of Feb 27. The notice did not say how the county intends to pay the termination fee if the counterparties exercise their right to terminate the swaps.

The disclosure reiterated the fact that bond insurer downgrades had caused defaults on liquidity facilities with several banks supporting outstanding variable-rate demand warrants. As of Tuesday, the county said no notices terminating the liquidity facilities had been received.

As stated in a previous notice, the county said Wednesday that it is working with advisers to address the situation but it could provide no assurance that sewer system revenues would be sufficient to pay its obligations.

Jefferson County officials are dealing with troubles related to their massive and highly leveraged sewer debt program, which includes $2.2 billion of outstanding auction-rate warrants and about $1 billion variable-rate warrants. As of Feb. 27, the county had experienced failed auctions on $869.5 million of auction-rate warrants and higher interest rate resets on variable-rate warrants largely because of bond insurer downgrades.

Those problems now have been exacerbated by two rounds of rating downgrades of the county’s sewer debt, both of which occurred after the county released disclosure notices outlining its exposures and the possibility that it may not be able to cover its obligations.

On Feb. 22, Standard & Poor’s downgraded the sewer warrants to BBB from A. However, it was Moody’s downgrade to Baa3 from A3 on Feb. 26 that triggered the collateral or insurance posting requirements.

Last Friday, Standard & Poor’s downgraded the sewer warrants again, lowering them to B from BBB, and Moody’s released a second round of downgrades on Tuesday lowering the sewer debt rating to B3 from Baa3.

However, Moody’s went a step further and placed Jefferson County’s other credit ratings on review for possible downgrade, including the county’s Aa2 general obligation rating, Aa3 lease revenue rating, A1 limited obligation school warrant rating, and A1 special tax bonds. The action came even though the county’s sewer operation is an enterprise program.

“We simply don’t know where this is headed,” Robert Kurtter, Moody’s senior credit officer, said Tuesday. The county has not discussed its recovery plans with analysts, Kurtter said.

“It is possible that one of the outcomes is a bankruptcy filing of some kind. A municipal bankruptcy is so uncertain and we don’t know what a bankruptcy judge might rule,” said Kurtter, referring to potential impact on other county finances.

“Until there’s some firm proposal out there, some clarity, we thought it was important to make the bondholders of the general fund and of the related credits also aware there are some potential risks there,” said Kurtter.

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