Jefferson County, Alabama Files Record Chapter 9 Bankruptcy
November 11, 2011
By Howard J. Cure
Director of Municipal Research
Jefferson County, Alabama declared bankruptcy this week after the state legislature failed to implement a September agreement with creditors that could have reduced the county's $4.1 billion in debt. As this is the largest default on record, it is likely to revive concerns among individual investors that defaults may rise in the municipal market with a corresponding effect on prices and yield. However, in our view, the causes of this bankruptcy are specific to Jefferson County and are not symptomatic of a wider trend of defaults for municipal governments.
Jefferson County (population 658,000) issued $3.1 billion in debt from 1997 - 2003 to address environmental concerns over its wastewater system. The capital program layered on complicated variable rate debt instruments and derivative products that ultimately failed to protect the county once the liquidity crisis hit in 2008. In addition, the project was plagued by political corruption that resulted in some convictions of some of the parties involved and undermined public confidence and support.
The county's general operations have also struggled as a consequence of the March 2011 decision by the state's highest court to strike down a local wage tax that generated about a quarter of the Jefferson County's general fund revenues. The county's inability to impose a tax or raise existing levies without state legislative approval has only compounded its problems. This lack of autonomy provides additional political hurdles in coming to a palatable compromise.
Within the municipal bond world, the events in Jefferson County have now overshadowed the state declaration on November 9th of a financial emergency in Flint, Michigan (population 102,000). This declaration allows the state to takeover the finances of this depressed industrial city. Unlike Alabama, Michigan has a long history of state oversight programs that offer financial support, expertise and operating flexibility to troubled communities. The state recently enhanced its oversight programs through the passage of Act 4, which allows a state appointed Emergency Financial Manager to amend the budget, eliminate positions, sell assets, amend and approve obligations (including dissolving collective bargaining agreements), and take over underfunded local pensions.
State and local governments across the United States are facing financial pressures for a number of reasons, including potential cuts in federal programs, locally generated revenues that have not recouped from pre-recession levels, stubbornly high unemployment rates, increasingly onerous fixed costs such as pension and health benefits, and political difficulties in raising tax rates. On the whole, however, the vast majority of entities with relatively stable economies have the political will to address their financial problems and avoid defaults and bankruptcies. In fact, many entities have made significant spending cuts to structurally improve their operating budgets including formulaic changes to education and health programs, downsizing staffs and cutting benefit programs.
We are also comforted by the fact that many state governments have taken a pre-emptive approach, as Michigan has, to instituting oversight programs as a way to make unpopular but necessary financial decisions and protect bond holders. Recent examples of this proactive process include New York's reimplementation of a separate finance authority for Nassau County, as well as Pennsylvania's and Rhode Island's expansion of state oversight following problems in Harrisburg and Central Falls, respectively. Sadly for Jefferson County, the State of Alabama did not insert itself into the financial and political process until late in the negotiations.
The municipal bond market has experienced tremendous gyrations to date in 2011 and we expect to see more before the year is out. Significant withdrawals at the beginning of the year from municipal bond mutual funds and widespread selling on the part of smaller investors led to higher tax exempt yields after a high profile financial analyst predicted hundreds of billions of dollars in defaults that, ultimately, never materialized. More recently, in late September, concerns about the Euro zone, the potential for a domestic double dip recession and reduced new municipal bond issuance led to historic lows in municipal bond yields. Now, the developments in Alabama and Michigan, while years in the making and well—documented throughout, are likely to prompt further anxiety.
At Evercore Wealth Management, we recognized the fiscal struggles faced by municipalities and have broadened our portfolios away from traditional general obligation debt into other sectors that provide satisfactory yields and diversify our client's individual portfolios. This includes dedicated revenue streams (income, sales and gas taxes) and essential purpose revenue systems. We are also selectively purchasing bonds for individual universities, hospitals, airports, toll roads, and state housing agencies.
We are monitoring the changes in demand prompted by these high profile news stories. We will focus on these disruptions as they can provide trading opportunities. Evercore Wealth Management will also maintain its ongoing credit research to protect the individual holdings of our clients.
Download: Jefferson County, Alabama Files Record Chapter 9 Bankruptcy (PDF)
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