Alabama County Bankruptcy Presents Rare Municipal Bond Loss

Alabama’s Jefferson County will brief a federal judge on Thursday on its progress toward exiting from bankruptcy, as the county appears likely to become the first big U.S. local government to impose losses on bondholders since the 1930s.

The case is seen as a testing ground for how bondholders fare when a local issuer breaks under excessive financial pressure. Jefferson County’s $4.2 billion bankruptcy filing is the largest such municipal case in history, the result of debts taken on in a costly overhaul of the county’s sewer system.

U.S. Bankruptcy Judge Thomas Bennett is likely to set a schedule on Thursday for the county to file a workout plan with creditors.

Although rare, municipal bankruptcies fan investor worries that the troubles of financially strapped cities and counties could make safe-haven municipal bonds riskier.

The cash-strapped Alabama county, which has cut back on government services and let go of hundreds of workers since 2011, may feel the sting of bankruptcy for many years, along with other borrowers.

“I think the county and state, which has done nothing to help, will have trouble (in the tax-free market) for years,” said Anthony Valeri, fixed-income strategist at LPL Financial in San Diego.

For some investors, this week’s hearing may deliver clues as to which bondholders will take the worst loss. About $3.2 billion of the county’s obligations are composed of the sewer and water bonds, which are expected to take the biggest haircut.

The county also has general-obligation debt backed by sales tax revenues, as well as appropriations and education bonds.

“The water and sewer debt is the one that will have the most losses for creditors, where you may see no loss for the sales tax debt,” said John Loffredo, co-portfolio manager of the $1.1 billion MainStay High Yield Municipal Bond fund.

Loffredo, whose fund has a bit more than 2 percent of its assets in Jefferson County warrants and other county debt, said it is unclear whether bondholders or insurance companies that “wrap,” or guarantee, the bonds, will bear the losses.

Syncora Guarantee Inc, a unit of Bermuda’s Syncora Holdings, and Assured Guaranty Corp are among insurers of Jefferson County’s debt.

PLAN OF ADJUSTMENT

Outstanding Jefferson County debt trades little. A 2020 limited obligation school warrant with a 5.25 percent coupon was bought in February at a price yielding 5.862 percent.

According to a valuation on eMAXX, a Thomson Reuters information provider, the issue, which defaulted in 2011, was yielding 5.27 percent on Tuesday, or 410 basis points over the Municipal Market Data scale of AAA-rated debt.

In addition to a schedule, Judge Bennett could issue outlines for votes on any county bankruptcy exit plan by JPMorgan Chase and other creditors, who may face differing settlement proposals, a lawyer for one of the leading creditors said.

County officials bargaining with some bondholders and bond insurers have reported progress. Jefferson County Commission President David Carrington told Reuters in April that he expects the county to save up to $1 billion on its debt. He expects a final plan to be filed in June.

He said the county made enough progress at a meeting last month in Atlanta to delay a mediation session required by the Eleventh Circuit Court of Appeals before it will hear appeals in one of the case’s many secondary disputes.

“There was enough substantive progress made that mediation could be postponed for a month,” Carrington said.

Bennett has not set a deadline for the county to produce an adjustment plan. In September he turned aside a request by creditors for a deadline. However, he could strip the county of bankruptcy protection if it does not produce an acceptable plan on time.

“The debtor wants to see how much appetite for waiting that the judge has,” said Gina Martin, a bankruptcy lawyer at Goodwin Procter in Boston. “It is more about taking the judge’s temperature than setting a deadline.”

Jefferson County has struck deals with creditors Ambac Assurance Corp and Depfa Bank Plc on some claims, but has complained that big creditors such as JPMorgan and Bank of New York Mellon show little willingness to compromise.

Creditors can vote on accepting or rejecting a plan but can be forced to accept the overall plan if the judge finds the terms proposed to be fair and equitable.

(Reporting By Michael Connor in Miami; Additional reporting by Melinda Dickinson in Birmingham; Editing by Tiziana Barghini and James Dalgleish)