11.22.13

R-o-l-a-i-d-s. Northern Alabama Chief U.S. Bankruptcy Court Judge Thomas Bennett late yesterday cleared Jefferson County, Ala., to exit Chapter 9 protection with a plan that cuts its $3.1 billion sewer debt nearly in half but places a heavy repayment burden on residents for decades to come and carves out a unique role for the U.S. bankruptcy court. The approved plan lays out a sewer bond-repayment strategy and the difficult cost-cutting measures―crafted around about $1.4 billion worth of bond breaks that county officials negotiated with bondholders, who began extending money to the county in 1997 for construction projects to stop sewage from flowing into local rivers. Money from the bond sale, which could be finalized on Dec. 3rd, is supposed to pay off current bondholders, which could enrich some distressed-debt-focused hedge funds that purchased the county’s bonds at a discount. Judge Bennett’s confirmation, the last major step in the bankruptcy process, was granted after about 14 hours of courtroom arguments, mostly from two activist lawyers who questioned whether the county can afford the $1.7 billion in sewer debt that still remains and who told the court the sewer rates under the proposed agreement were too high; but Judge Bennett said: “Absent that, the rates would be even higher today.” Jefferson County is scheduled to repay its new sewer debt over 40 years for a total cost of about $6.7 billion, with the biggest payments to bondholders coming as the repayment period ends in 2053. Under the county’s agreement with its current creditors, all lawsuits against them involving the county, sewer customers, or any other bankruptcy related group are to be dismissed and they cannot be sued in the future. During the confirmation hearing, one lawyer objecting to the restructuring plan said the county should abandon the plan and pursue corruption-related lawsuits against Wall Street firms to try to win what he estimated could be $1.6 billion in damages. (Jefferson County’s swap agreements with J.P. Morgan Chase & Co. were tainted by a bribery scandal in the wake of which several former officials were sentenced to prison, and J.P. Morgan Chase & Co. agreed to pay $722 million to settle with the SEC, which accused the bank of improperly courting elected officials in Jefferson County. The bank did not admit wrongdoing.) Jefferson County lawyers criticized that approach as expensive and uncertain, and Judge Bennett noted that the county’s case has incurred “significant, extensive complex litigation from the day [it] was filed.” In addition to the keystone sewer-debt reduction agreement, Jefferson County testified to the court that county officials had imposed cost-cutting measures to save more than $100 million in annual expenses: throughout the bankruptcy, the county closed remote courthouses, cut staff “in essentially every department,” and scaled back operations at Cooper Green Mercy Hospital, the county-owned hospital for the poor: “These measures fulfill a basic purpose of debt adjustment under Chapter 9—matching expenses to revenues.”

Exiting Chapter 9—with a Fail Safe Federal Role. Jefferson County’s successful sale of enough of its $1.7 billion in refinanced sewer warrants could open the door for the county to exit to exit chapter 9 municipal bankruptcy as early as December 3rd. Jefferson County’s plan of adjustment, which the court must deem feasible, provides a road map of the county’s future tax and spending decisions; it also is intended to prove to Judge Bennett that the county is not likely to land back in federal bankruptcy court, because the successful sale of the warrants also demonstrates that the plan contains enough financing for the county to pay its projected debts. The plan, building upon previous plans in Vallejo and Central Falls, also will include a provision leaving Jefferson County subject to the federal bankruptcy court for the life of $1.8 billion in sewer-revenue debt that it sold over the last few days. Should Jefferson County falter at some point, even decades from now, the federal bankruptcy court would have the authority to enforce rate increases to produce the revenues necessary to pay back the $1.8 billion on schedule, with interest. This is an important backstop for the county, because the implicit court protection makes it possible for the county to sell its bonds, or, as we noted yesterday, as Matt Fabian of Municipal Market Advisors remarked: “Without the assumption of court protection, the financing would have been more difficult, if not impossible,” as well as to note the key role the county could provide for other cities and counties in severe fiscal distress: a new source of financing. When we sought major concessions from the retirees and the actives employees, they told us that while they trusted the state receiver to live up to the city’s obligations under the plan of debt adjustment (most importantly to maintain balanced budgets), they were quite reasonably concerned that when the receiver was terminated and the city officials were returned from advisory capacity to full capacity, the city officials would return to bad past practices of running deficits and then, in order to balance the budget, the city would seek additional concessions from the retirees and actives on top of the ones they had agreed to under the plan. This unique protection for both the County and its sewer debt holders mirrors a pioneering plan of adjustment requirement insisted upon by the State of Rhode Island in Central Falls’ plan of adjustment: a requirement that the city’s elected officials file with the court so called “attestation statements” in which, on a quarterly basis, the elected officials are required to disclose the financial position of the city to the U.S. Bankruptcy court based on reports that the elected officials received from the city’s financial manager. In addition, Central Falls elected officials, under the plan, are also required to file annual attestation statements after the annual budget is passed attesting to whether the budget was projected to be balanced. Furthermore, the plan provides that if the city’s budget goes out of the balance during the five year plan, any party in interest (i.e. actives, retirees, the Director of Revenue, etc.), could seek an order from the Bankruptcy Court requiring the city to get back into balance.  If the city did not honor such an order, the elected officials would be subject to the court’s very powerful contempt powers. In order to maintain jurisdiction to enforce the five year plan, the court provided in the confirmation order that it would keep the case open for five years after confirmation.

Next Steps. Judge Bennett last night began going over with attorneys the details of a proposed written order that he will file in the case. Current plans call for Jefferson County to finalize the sale of its new warrants refinancing $1.78 billion of its remaining sewer debt on December 3rd—the official date for the county to exit municipal bankruptcy. Jefferson County Commission President David Carrington late yesterday said the end of bankruptcy means the county can focus on economic development and job creation: “We are excited to move into the next phase of this commission…what the county needs is more jobs, more businesses…That will stimulate a growth in population and that will stimulate housing developments.” Unsurprisingly, Calvin Grigsby, an attorney representing a group of sewer customers in a lawsuit, said that he would appeal to a federal court.

Costs. As we have tried to communicate, municipal bankruptcy is expensive—draining resources critical to meeting essential public services, to meeting pension and post-retirement benefit promises. To bring the point home, Judge Bennett yesterday made clear that among the criteria a bankruptcy judge considers in confirming a plan is the “amounts to be paid by the debtor or by any person for services or expenses in the case or incident to the plan have been fully disclosed and are reasonable.” The document filed in his bankruptcy court provide a list of attorneys and consultants who worked on the bankruptcy case for the county—with the documents indicating these individuals and firms have been or will be paid about $25.7 million.

Re-entry. The City Council of Desert Hot Springs, Ca. this week voted unanimously to declare a fiscal emergency, a required first step in California in order to be able to file for Chapter 9 bankruptcy. The city projects it will be insolvent or out of cash by March, according to a report from Bob Adams, interim city manager, who wrote in a report to the Council: “With few exceptions, the City of Desert Hot Springs’ expenditures have exceeded revenues for several years…Currently, the general fund revenues of $13.9 million are not sufficient to cover budgeted expenses of $20.1 million…If significant action is not taken, the projected depletion of the city’s reserves to meet the city’s financial obligations would cause the city to file bankruptcy.” Mr. Adams recommended 200 different places to cut expenses at a special meeting of the Council. The vote follows just two weeks after we reported that Amy Aguer, the city’s interim finance director, had recommended officials declare a state of fiscal emergency in a report posted on the city’s website two weeks ago. Desert Hot Springs currently has a projected deficit of $3.07 million if it exhausts reserves, according to the city’s financial documents. Desert Hot Springs filed for Chapter 9 bankruptcy in 2001 after losing a legal judgment involving a mobile home park developer. It exited bankruptcy in 2004. Consequently, a new filing could endanger the debt it sold to get out of that bankruptcy. The city has $18 million in debt comprised of $8 million in certificates of participation and $10 million in bonds issued to repay the judgment that forced the city into bankruptcy in 2001.

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