Alabama county files for largest municipal bankruptcy

MONTGOMERY, Ala. — Alabama's most populous county chose bankruptcy as a path to wrest control of its beleaguered sewer system from a court-appointed receiver, bolster its pleas for legislative action to prop up a massive revenue shortfall and wipe away as much of its whopping $4.15 billion in debt as possible.

Jefferson County's Chapter 9 filing on Wednesday — the largest municipal bankruptcy in U.S. history — gives it protection from its creditors while it develops and negotiates a plan for adjusting its debts. It could accomplish that by extending debt maturities, reducing the amount of principal or interest, or refinancing the debt by obtaining a new loan.

But there are risks. Perhaps the biggest is the potential impact on the county's 658,000 residents, who could be asked to endure even higher sewer rates than were contemplated under the out-of-court deal with creditors that fell through. That's because the sewer debt, which represents the bulk of what the county owes, is secured against net revenues from the sewer system, and the court will determine how much of that debt remains on the books and how the county will repay it. Unrestricted revenue in the county's general fund totaled only $152.5 million in the fiscal year ended Sept. 30.

"The county did not file this case rashly, improperly, or with any improper intent," its lawyers said in court papers. "Rather, it did so deliberately and grudgingly, yet with the desire to effect a prompt, efficient adjustment of its debts."

The problems were years in the making.


Its debt ballooned after a federally mandated sewer project was beset with corruption, court rulings that didn't go its way and rising interest rates when global markets struggled.

Since 2008, Jefferson County tried to save itself the cost and embarrassment of filing for bankruptcy. But after three years of trying to find another way, commissioners, by a vote of 4-1, decided it was time to bring the issue to an end and remove the cloud hanging over the county, home to state's largest city of Birmingham.

"Jefferson County has, in effect, been in bankruptcy for three years," said Commissioner Jimmie Stephens, who made the motion to file for protection in federal bankruptcy court in northern Alabama.

Just two months ago, the county seemed to strike a deal with creditors that would let it avoid making history.

Talks broke down and the sides couldn't come together on how to pay about $140 million of the total, Stephens said. Also weighing heavily in the decision, according to the filing, were the actions of a receiver appointed for the sewer system as part of the settlement efforts. The county's lawyers say the receiver wanted to raise sewer rates 25 percent and demanded the county immediately pay him $75 million in cash from its general funds. So, instead of continuing to negotiate, the commissioners decided to take the matter to court.

Ben Brooks, a professor of finance at the University of Alabama, said not all is lost.

"Bankruptcy is a good thing. The sooner Jefferson County can get this behind them the better," he said.

The financial questions and fallout from the fraud and corruption in the sewer program has been hanging over Jefferson County for years and it had to stop.


"The level of uncertainty has been holding back economic development for far too long," he said.

Bankruptcy was still a possibility even after the county struck a preliminary deal with Wall Street bankers in September. It required state lawmakers to approve a mix of local tax hikes, budget changes and other legislation to resolve the debt.

However, Republican Rep. Paul DeMarco of Homewood, co-chairman of the Jefferson County House delegation, said the governor never called the Legislature into special session to find a resolution because there never was a final plan.

The Republican governor said he was ready to call that session but was never given the chance. The bankruptcy filing said the county is hopeful the court action will bolster efforts at obtaining legislative action.

The settlement proposal with Wall Street investors led by JPMorgan Chase & Co included the lenders agreeing to forgive about $1 billion in debt, the county refinancing about $2 billion, and a series of sewer rate increases.

"JPMorgan worked very hard with the county and other creditors to avoid a bankruptcy filing," the financial company said in a statement. "We offered very substantial financial concessions to make the deal happen while keeping sewer rates within the parameters proposed by the county. While we're disappointed by the county's decision to file, we will continue to work toward a fair and reasonable solution."

Commission president David Carrington said the filing was not a negotiation ploy.

The size of Jefferson County's bankruptcy overshadows the one filed by record-holder Orange County, Calif., in 1994 over debts totaling $1.7 billion.


Pennsylvania's capital city of Harrisburg recently sought bankruptcy protection under similar circumstances as it struggled with about $300 million in debt from a trash incinerator that began operating in 1972.

In the 1990s, a federal court forced Jefferson County — home to Alabama's medical and financial centers — to begin a huge upgrade of its outdated and overwhelmed sewer system to meet federal clean-water standards. Officials used bonds to finance the improvements.

Outside advisers suggested a series of complex deals with variable-rate interest that were later shown to be laced with bribes and influence-peddling. Besides the sewer debt of $3.14 billion, the county faces a separate shortfall of more than $50 million in its operating budget because courts struck down a major local tax as unconstitutional. It listed other debts in its bankruptcy petition of $1.01 billion.

The bankruptcy filing likely won't affect other municipal bond rates much, if at all, said Matt Fabian, managing director at research firm Municipal Market Advisors.

"Big investors — mutual funds, insurers, banks— have been assuming the worst all along," he said. "If another county had filed, that would be a different story."

The market has been on edge for a while, with investors worried about rising defaults from local governments borrowing more to maintain services because of plunging tax receipts during the terrible economy. The doomsayers have been wrong — so far. Widespread defaults never materialized.

Still, for individual investors, the default could make them want to stay away from the bonds in general, he said.

"They think they've been misled about the risk of default. This doesn't help," Fabian said.


Gov. Robert Bentley said the filing would hurt the entire state, not just the Birmingham area.

"The Jefferson County sewer debt crisis has been an impediment to economic growth in the state, and the bankruptcy filing will now be an even greater challenge to overcome," Bentley said.

Jefferson County's problems multiplied when loan payments rose quickly because of increasing interest rates as global credit markets struggled. Soon the county could no longer afford its payments. Meanwhile, a string of elected officials, public employees and business people were convicted of rigging the transactions that helped put the county in so much trouble.

One benefit for the county: Chapter 9 is different than other chapters in the bankruptcy code in that the law does not allow the court to order the municipality's assets be liquidated and distributed to creditors. The court's functions are generally limited to approving the petition, confirming a plan of debt adjustment, and ensuring implementation of the plan.

A big negative will be the millions of dollars in legal fees the county could incur during the case. A municipality has authority to borrow money during a Chapter 9 case as an administrative expense, and it can employ professionals without court approval.

The Securities and Exchange Commission can appear in the case and municipal employees and local residents have a right to be heard on any issue.

The county has asked for expedited hearings to rule on motions related to the filing of objections, listing of creditors and the establishment of case management procedures.



Associated Press writers Harry R. Weber in Atlanta, Jim Van Anglen in Montgomery and AP Business Writer Bernard Condon in New York contributed to this report.

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