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Moody's: Jefferson County's Sewer Deal Should Be Junk

BRADENTON, Fla. Bankrupt Jefferson County, Ala.'s $1.7 billion of new sewer warrants should be rated in the B or Ba range, reflecting "substantial-to-high credit risk," according to a special report by Moody's Investors Service.

Moody's was not asked to rate the deal and said that its comments, which were published Wednesday, are part of the rating agency's ongoing efforts to analyze industry trends and distressed credits.

The county plans to take retail orders for the sewer warrants on Monday and institutional orders on Tuesday.

Proceeds will provide cash settlements to creditors holding $3.1 billion of outstanding, defaulted sewer debt. The deal is critical to the county's Chapter 9 exit plan.

The new debt will carry "materially less credit risk" than the outstanding debt because of the large reduction in principal and establishment of a plan to resume debt service payments, Moody's analysts said.

"Still, we judge both [senior and subordinate] liens to be non-investment grade investments at the upper end of the speculative grade rating categories [such as B or Ba] subject to substantial-to-high credit risk," they said.

Key credit factors underpinning the warrants include higher sewer rates that face financial and governance risks, a high debt load and deferred principal repayment, weak financial metrics, declining debt service coverage as principal payments increase in later years, and significant future capital needs requiring additional rate increases, said Moody's.

Jefferson County officials have said investors should be "comforted" by the fact that the new warrants, and the planned sewer rate increases to support the debt, are subject to approval by the bankruptcy court and ongoing oversight throughout the 40-year life of the warrants.

Moody's called into question the court's jurisdiction to act if future commissioners fail to increase rates.

"While the bond trustee could then ask the court to compel the county to enforce its bankruptcy plan, we are not aware of a precedent for a federal court to compel public utility rates of this nature, given the federalism issues involved in this bankruptcy," analysts said.

Jefferson County is one of only two rated local government issuers in the U.S. to default on sewer revenue bonds since 1970, and "it is the only one to impose material losses on creditors," Moody's said.

"Our forward-looking opinions about credit quality do not impose an automatic 'penalty box' on past defaulters, but willingness to pay is a key element of our analysis, and past performance is often an important indicator of future actions," the agency said.

While Jefferson County's sewer system financings were fraught with corruption, Moody's said the past debt structure was also motivated by the county's desire to keep sewer rates low.

County commissioners also did not raise sewer rates from 2008 to 2013 despite insufficient net revenues to cover debt service.

"This history separates Jefferson County from the overwhelming majority of sewer revenue bond issuers who routinely demonstrate willingness to pay debts by implementing single-digit, annual rate increases to cover their operating and capital expenses," said analysts.

They also said that current commissioners have demonstrated a change from past practices, by implementing 40 year schedule of rate increases and appointing a professional, experienced management team.

Future commissions could revisit the rate increase schedule, Moody's warned.

The two agencies that were asked to rate the new sewer warrant deal had a significant split between their ratings.

On Tuesday, Fitch assigned a preliminary sub-investment grade BB-plus rating to the $500 million of senior sewer revenue warrants and a BB rating to $1.23 billion of subordinate warrants.

Standard & Poor's gave the deal investment-grade ratings of BBB to the senior warrants and BBB-minus to the subordinate warrants.

S&P said its ratings have generated questions that it plans to answer during an interactive webcast Thursday.

Municipal Market Advisors Managing Director Matt Fabian said in his Weekly Outlook column Tuesday that S&P's ratings are shocking because "there remain substantive and undeniable risks."

The deal is likely "the best possible structure, absent a state guarantee, to ensure full payment to holders of the new loan" and appears reasonable for high yield investors, Fabian said.

However, future lawsuits and non-compliance with the rate covenant means that "associated legal action is almost a given."

He also pointed out that the federal court could decide compliance with its orders falls short of bondholders' expectations, and another Chapter 9 filing by the county could put the entire financing in jeopardy.

Additionally, financing and projected revenues are "extremely tight through maturity implying a brittle cash flow that may not hold up well if additional economic or financial shocks emerge," Fabian said.

He also pointed out that the transaction structure is worrisome because it will offer retail-friendly $5,000 minimum denominations.

"The underwriting team reportedly intends to distribute the bonds to speculation-oriented investors, but we do worry about bonds ultimately finding their way into brokerage accounts of individual investors or local banks without the capacity to understand what exactly they own," he said.

The deal still is a positive development because it resolves a long-running source of negative media attention on the municipal bond market, said Fabian.

It is also expected to give Jefferson County's indenture and rate covenant the protection of a federal court order, and may "lay the groundwork for future refinancings of troubled debt."




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