BRADENTON, Fla. – In Birmingham federal court Friday during a hearing to determine if Jefferson County, Ala., set proper sewer system rates to support $3.14 billion of defaulted sewer warrants, Bank of New York Mellon attorneys announced that the trustee will stop payments on the warrants.

A material event notice prepared by the trustee also states that BNY Mellon may attempt to accelerate payment of the warrants.

Sewer warrant payments will be suspended until further notice because holders of bank warrants with overdue principal payments will no longer consent to the distribution of principal payments on other warrants coming due at maturity, or because of mandatory sinking fund redemption, according to the notice.

In the past, bank warrant holders with defaulted payments allowed the trustee to distribute principal payments on other maturing warrants as if payment defaults had not occurred, according to the notice.

The trustee did not say why bank warrant holders changed their minds at this time. The county has a complex sewer warrant portfolio, with much of it in variable- and auction-rate mode. The structure collapsed in early 2008 when liquidity dried up in the market and bond insurers were downgraded.

As of Jan. 31, the trustee said it had $43.2 million of net system revenues on deposit as well as a reserve fund composed of various municipal bond debt service reserve insurance policies.

“The net system revenues currently on deposit with the trustee in the debt service fund and amounts available under the reserve polices for such purpose are not sufficient to make the principal payments overdue with respect to the bank warrants and principal payments with respect to other sewer warrants coming due at maturity or as a result of mandatory sinking fund redemptions in February and early March 2013,” the notice by BNY Mellon said.

In addition, BNY Mellon said it will also file a motion asking the bankruptcy court to determine if it has the power to accelerate payment on the sewer warrants.

The bank said a disagreement has arisen over interpretations of the indenture regarding who has the power of acceleration, and the effect it would have on Syncora Guarantee Inc., because of the insurer’s obligation under its reserve policy.

The court held hearings Wednesday through Friday on arguments about whether to grant relief to the trustee and other creditors so they can seek the re-appointment of a receiver in state court to resume control of the sewer system and setting its rates.

Judge Thomas Bennett removed the receiver early 2012, and returned control of the system to the county. The creditors want the receiver reinstated because they believe the county set sewer rate increases recently that will not support payment of the outstanding debt.

The county developed a new rate structure that is believed to incorporate allowances for corruption that has beset the sewer system from its contractors to some of those involved in issuing the debt.

On March 1, sewer rates increase nominally for the first time in more than four years. The rate structure is expected to generate $8.5 million in additional net revenues annually.

Jefferson County filed the largest municipal bankruptcy in U.S. history in November 2011 with more than $4 billion of outstanding debt.

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