Moody's Investors Service has downgraded to Caa3 from B3 the rating on Jefferson County's (AL) $3.2 billion in outstanding sewer revenue warrants. At this time, Moody's has also downgraded: to Baa1 from Aa2 the rating on Jefferson County's (AL) $270 million in outstanding general obligation debt; to Baa2 from Aa3 the county's $86.7 million in outstanding lease revenue warrants issued through the Jefferson County Public Building Authority; to Baa2 from A1 the county's $996.8 million in limited obligation school warrants; to Baa1 from Aa3 the rating on $20.3 million in special tax bonds issued by the Birmingham-Jefferson Civic Center Authority (BJCCA) partially secured by the county's occupational tax; and to Baa2 from A1 $40.86 million in debt issued by BJCCA partially secured by a beverage tax and lodging tax levied and the collected by the county.
The downgrade of the sewer revenue debt reflects the heightened probability of default on the county's sewer obligations within the next year and a lack of a concrete plan to avoid such default. The downgrades of the non-sewer debt reflect the risk that the financial crisis that has embroiled the sewer system may affect the credit strength of the county's other obligations, particularly given the uncertainties of the effects of a possible bankruptcy filing, should the county pursue that option.
SEWER DEBT UNDER THREAT OF DEFAULT
Downgrades of XL Capital (rated A3 on review for downgrade) and FGIC (A3 on review for downgrade), who together insure over 90% of the county's sewer debt, led to a series of failed remarketings of the county's variable rate demand sewer debt, totaling $847 million. These obligations are now owed to the liquidity banks. In addition, disruptions in the auction rate market led to a series of failed auctions on the county's auction rate securities (ARS), totaling $2.2 billion, resulting in increased interest rates to as much as 6.2%. Given the higher interest rates paid on these securities, combined with recent declines in the index on its swap agreements (one month LIBOR), and the term out provisions of the bank liquidity agreements, the county's debt service cash flow requirements have increased dramatically.
In addition, the downgrade of the county's sewer debt to below Baa2 constituted an event of termination under the swap agreements, which gave the counterparties the right to terminate the swaps, if, within 10 days, the county did not post collateral (estimated at $184 million) or obtain an insurance policy by a financial insurer satisfactory to the counterparties. In a Material Events Notice dated March 4, 2008, the county stated that it had notified the swap counterparties that it did not presently intend to post collateral or provide insurance to the counterparties for its obligations under the Swap Agreements. The swap counterparties currently have the right to terminate the swap agreements, requiring termination payments that would deplete the sewer system's cash position. Based on the sewer system's current resources, however, the system would be challenged make these termination payments.
Furthermore, the standby bond purchase agreements for the sewer obligations state that in the case of any event of default specified in agreements, upon election of the liquidity banks, all amounts payable under the agreement to the banks shall upon notice to the county become immediately due and payable.Moody's internal analysis indicates that cash flows are insufficient to meet an immediate repayment of all bank warrants. Under the current accelerated amortization, as required by the standby warrant purchase agreements, the first bank warrant principal payments, estimated at $53 million, are due on April 1. While our analysis indicates the sewer system would have sufficient funds to make the April 1 payment to the banks, it is not clear if they intend to do so. Reportedly, the county is negotiating a forbearance agreement with the liquidity banks, which would defer the April 1 payment, although we do not know what the terms of the agreement would be.
The county has not presented a concrete plan that would prevent a default on its sewer obligations. The county has publicly proposed using excess funds generated by a countywide 1% sales and use tax, currently securing the outstanding school warrants. The tax generated an additional $27 million in fiscal 2007 over the school warrant debt service; the initial intention was to use the excess for early redemption of debt. This proposal would require state legislation and it is unclear that the additional funds would provide enough revenue to cover the county's sewer obligations.
BANKRUPTCY FILING POSSIBLE
Given the severe financial distress created by the sewer system's crisis, and the lack of an agreed-upon plan for recovery, the county may choose to file for bankruptcy, given its potential inability to meet its sewer obligations. Moody's notes that the county is the legal entity that issued both the sewer debt and the other obligations, and would therefore have to file as a county and not solely as the issuer of the sewer debt. Given the lack of history of municipal bankruptcy, Moody's is unable to determine what county revenues, assets and debt obligations could be affected by bankruptcy proceedings, and the downgrades of our ratings on the non-sewer obligations reflects our concern that a bankruptcy filing could weaken the county's ability to meet its debt backed by pledges of the general obligation, lease revenue, and various dedicated taxes. While each of these securities could be affected by a bankruptcy, Moody's believes the general obligation remains the strongest pledge available to a municipality. Accordingly, the sales tax, lease revenue and other special tax obligations are lowered to Baa2.
Moody's has downgraded the BJCCA bonds secured by the county's pledge of $10 million annually from its occupational tax, as well as the City of Birmingham's (G.O. rated Aa3) $3 million payments from its occupational tax, to the same level as the general obligation debt. The county's obligation to support this debt ends in December 2008, with only two county payments remaining. Although a bankruptcy filing could disrupt these remaining payments, Moody's believes the disruption would be short-lived given the limited timeframe remaining on the county's obligation.
