Jefferson County, Ala., might dodge bond default

Jefferson County, Ala., may yet avoid the largest municipal bond default in U.S. history.

That is good news for a market that has suffered because of fears about the ability of issuers to make timely debt payments, industry observers said.

Defaults “are a reminder that while most of the time muni bonds pay out, there are times when they run into trouble,” said Charles Lieberman, strategist and chief economist with Advisors Capital Management LLC, a Paramus, N.J.-based firm with $250 million in assets.

Jefferson County’s creditors have agreed to a rescue plan that would allow the county to get out from under $3.2 billion of bonds issued to upgrade its sewage system — bonds that carry variable interest rates that have soared this year, The Birmingham News reported last week.

The bonds would be restructured at a fixed rate, according to the report.

Bond insurers and banks involved in the deal would put up about $650 million in cash, the report said. Financial Security Assurance Inc. of New York would also provide insurance on bonds issued to replace the county’s floating-rate sewer debt.

INTEREST RATE SWAPS

JPMorgan Chase & Co. of New York would forgive $250 million owed by the county on interest rate swaps, according to the report.

The entire rescue package would reduce Jefferson County’s sewer debt to about $2.7 billion.

The rescue plan, however, has problems.

It is unclear who would buy the bonds Jefferson County would have to sell to refinance the debt, said Matt Fabian, a senior analyst and managing director of Municipal Market Advisors of Concord, Mass.

Wrapping the deal in insurance from Financial Security Assurance does little to sweeten it because the company has its own credit problems, he said.

Alabama Gov. Bob Riley appears to realize the problem. He has asked officials of the Department of the Treasury to use a portion of the $700 billion bailout plan approved this month by Congress to guarantee the county’s bonds, according to The Birmingham News report.

Even if he is successful, however, the rescue plan might still not pass muster with county commissioners. The county will likely be asked to pay creditors all or part of the excess from a 1% sales tax for school construction, impose sewer rate increases estimated at 2.83% a year and accept an oversight board to supervise the sewer system, according to the newspaper.

County commissioners have been resistant to similar terms in the past.

Just last Monday, one day before the rescue plan was made public, a resolution authorizing the county’s attorneys to file for bankruptcy was approved in committee. It is expected that the committee will vote on the full resolution tomorrow.

The dilemma that Jefferson County faces highlights concerns that many financial advisers have about municipal bonds, said Lewis J. Altfest, president of New York-based L.J. Altfest & Co. Inc., which manages $500 million in assets.

“You’ve got to be careful about the municipal issuers you invest in, and their ability to sustain themselves in this economic environment,” he said.

There are, however, opportunities to be had in munis; opportunities created partly by events such as those surrounding Jefferson County, Mr. Altfest said.

‘BUYING OPPORTUNITY’

“It’s the buying opportunity of a generation,” said John Mousseau, vice president and portfolio manager at Cumberland Advisors Inc. of Vineland, N.J., which manages about $1 billion in assets.

Many AA- or better-rated muni bonds were trading at 5.75% to 5.85% yields, he wrote in an Oct. 2 report. That was almost 140% of the Treasury yield.

Spreads have narrowed somewhat since then, but they are still very wide.

A successful Jefferson County rescue plan may help narrow spreads even more, Mr. Mousseau said. It is more likely, however, that spreads will remain wide as a result of other issues plaguing the muni markets, such as a lack of liquidity, he said.

A default by Jefferson County would make headlines, but it probably wouldn’t have a huge effect on the broader muni markets because it is such a unique situation, Mr. Mousseau said.

At least one of the major rating agencies agrees.

Jefferson County’s use of variable-rate notes and hedging techniques are “unique and not replicated in the vast majority of other municipalities,” according to a Feb. 27 statement from Moody’s Investors Service of New York.

E-mail David Hoffman at [email protected].