BRADENTON, Fla. – As underwriters began pricing the sewer warrants critical to Jefferson County, Ala.’s exit from bankruptcy on Friday, investors and analysts continued to express concern about the political and legal security of the rate increases necessary to repay the debt.
The county’s political resolve and legal requirements to raise sewer system rates over the next 40 years to pay back $1.8 billion in sewer warrants came across as a sticking point for several participants in a teleconference Friday to discuss the rationale for Fitch Ratings’ non-investment grade for the debt.
Fitch rated $500 million of senior, insured sewer warrants BB-plus, a notch below investment grade, and $1.24 billion of subordinate-lien warrants BB.
The most significant factor driving the ratings was the schedule of rate increases adopted by the county commission and intended to span the next 40 years, said Fitch analyst Doug Scott.
“The transaction doesn’t work without the adopted rate structure,” he said, adding that on the negative side local sewer rates are already high and poised to increase each year, placing pressure on the rate base.
Another concern for Fitch was opposition Jefferson County stakeholders, from the state attorney general to at least one county commissioner, as well as past litigation over rate increases.
In answer to a question about whether future commissions could rescind the automatic rate increases, Scott said, “That is one of the concerns that could come up. A future group of commissioners could take action to negate what this commission has done.”
Doing that would violate the rate covenant and could be addressed by bondholders in court, he said.
When asked if the current commission could legally obligate future boards to set rates, Scott said Fitch did not conduct an independent legal examination of the issue but Jefferson County represented that the new rate structure is a legal obligation to service the debt.
In the past, local residents – many poor - packed public hearings to implore commissioners not to raise sewer rates.
On Friday, Jefferson County held a required public hearing on the $1.8 billion sewer warrant financing. Less than a dozen people showed up and only two addressed the commission.
One person thanked the board for helping the county get out of bankruptcy. The other speaker was state Rep. Mary Moore, who said the poor are overly burdened by high sewer rates. She also questioned why non-sewer users do not contribute to its costs.
Jefferson County plans final pricing of the sewer warrants on Tuesday, but closing is contingent on successfully emerging from bankruptcy. A confirmation hearing on the plan of adjustment is scheduled Wednesday, and it is expected to become final well before the end of the year if the new sewer warrants are sold.
The sewer system financing is the most critical piece of the exit plan since $1.7 billion of warrant proceeds will be used to write down $3.1 billion of outstanding sewer debt.
Because the financing has little wiggle room due to the structured sewer rate increases, a high-yield expert said the deal may not price cheap enough.
“Due to the built-in constraints on the range of interest rates the county can afford to pay as part of the bankruptcy plan, the issue may not come cheaply enough to entice even those high yield investors who are willing to take a gamble,” Triet Nguyen, managing partner at Axios Advisors, wrote on muninetguide.com.
“Surprisingly, the issue is also being marketed to retail investors, who really shouldn’t be involved in this kind of credit, in our humble opinion,” Nguyen wrote.
The warrants are also being offered to investors overseas where county officials traveled during pre-sale marketing efforts.
Still, the deal faces stiff headwinds from domestic investors who say Jefferson County’s name carries baggage, according to a veteran municipal analyst.
“A number of investors will not participate just based on the name association,” the analyst said.
If the entire deal can’t be sold in the primary market, there are contingency plans, including a backstop from hedge funds that bought existing sewer warrants at a discount and are parties to settlements with the county. Members of the sales syndicate can also earn a risk fee of 25 cents per sewer warrant for debt they cannot sell and are required to keep on their books. The maximum risk fee is $434,602 per underwriter.