BRADENTON, Fla. — Jefferson County, Ala., must restructure its troubled debt or take “other significant reorganization activities,” according to the county’s first audit in three years.

The audit for 2008 includes updates on critical issues, such as the county’s troubled sewer debt. It was released this week by Warren, Averett, Kimbrough & Marino LLC. The Birmingham-based firm plans to complete the 2009 and 2010 audits in the next four months.

The audit covers a year when the financial markets melted down, resulting in rating downgrades for many municipal bond insurers. Those events led to failed auctions for Jefferson County’s sewer warrants that resulted in penalty rates. The county sold nearly $3.2 billion of variable- and auction-rate sewer debt, most of which is now held by banks and insurers.

The situation ultimately required the government to make accelerated payments on the debt but defaults have occurred. The county also has variable-rate general obligation and school revenue warrants in the same defaulted state.

Auditors said their report was prepared assuming that Jefferson County would continue as a going concern, though they noted that defaults have occurred since fiscal 2008 and the county may not be able to pay all its obligations.

“These conditions raise substantial doubt about the commission’s ability to continue as a going concern without the restructuring of debt or other significant reorganization activities,” auditors said.

Commissioner Jimmie Stephens, who heads up the County Commission’s finance committee, said the board is in the process of reorganizing government with the help of turn-around firm FTI Consulting Inc., which is expected to present a preliminary review on Tuesday.

“I’ve been encouraged about the progress FTI has made and opportunities that lie ahead of us,” he said.

Stephens said he’s been told privately that FTI expects to recommend areas for “significant cost-reduction opportunities” as well as ways to create efficiencies and add technology to improve government services. Proposals also include new revenue streams to replace the $70 million in occupational and business tax revenue lost recently when the Alabama Supreme Court ruled the levies unconstitutional.

The commission is negotiating with lawmakers for limited home rule that would give officials more flexibility over certain collections that support the budget and the removal of legislatively imposed earmarks that fund specific operations, such as a small public hospital called Cooper Green, which the county owns.

The audit released this week also describes current “uncertainties” surrounding the financial problems of the sewer system, which does not generate enough revenue to pay back the debt. The report pointed out that a receiver has been appointed to oversee the nonrecourse warrants.

“Certain holders of system debt have expressed a desire to delay substantive negotiations until they can assess the effect of the receivership on net system revenues,” the auditors said. “The commission believes that a refinancing or restructuring of the system debt remains achievable outside of bankruptcy.”

Negotiations with bondholders, insurers, and liquidity banks are ongoing, Stephens said, but talks have “taken a back seat” due to the immediate liquidity problems caused by loss of the occupational and business taxes, which initially was said to represent about 30% of the general fund budget.

Because of non-discretionary legislative earmarks, such as $89 million dedicated to Cooper Green, Stephens said the occupational taxes actually supported 45% of the discretionary part of the budget that commissioners control.

Earlier this year, the current commissioners — all of whom took office only last fall — ordered the audits to be brought up to date and negotiated the sale of a county-owned nursing home for about $10 million. Stephens said commissioners may also sell Cooper Green.

“Everything is on the table as we move forward altering everything in the way county government operates,” he said.

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