Jefferson County, Alabama, can’t fully repay $205 million in general-obligation bonds without raising taxes, the county’s bankruptcy lawyer said, threatening investors with losses not seen in the U.S. since the Great Depression.
Since the 1930s, no large U.S. county, city or town has used the power of a federal court to force investors to take less than they are owed, lawyers and municipal-debt analysts said.
The failure of the state legislature this week to authorize $60 million in taxes will add a year to how long Jefferson County will remain in bankruptcy, Kenneth Klee, the county’s bankruptcy attorney, said in a telephone interview today. Unless the county can get permission from the state to reinstitute a $60 million wage tax struck down by the courts, the county won’t have enough revenue to pay its general-obligation bonds in full, Klee said.
The bankruptcy in Alabama’s most populous county is forcing investors to add local politics to the list of risks they evaluate before buying municipal bonds, Richard Ciccarone, Chief Research Officer at McDonnell Investment Management LLC in Oak Brook, Illinois, said in an interview today.
“In a crisis you don’t want to get to a point where a government has to choose between police and fire service and debt service,” Ciccarone said. “The fact is, in a crisis you have to rely on the political stability of the government.”
Jefferson County entered the largest U.S. municipal bankruptcy in November after local and state officials and creditors failed to implement an agreement to cut the county’s sewer debt by about $1 billion. The county owes creditors about $4.2 billion, including more than $3 billion in bonds related to the sewer system, according to court records.
Investors have long known the sewer debt probably won’t be repaid in full, mainly because it is only backed by monthly sewer fees, and not guaranteed by county or state tax payers, Klee said. Up to now, the county had planned to fully repay about $205 million in general-obligation bonds, even though it missed a $15 million interest payment, Klee said.
Without new revenue the county will be stuck in bankruptcy until early 2014, at the latest, Klee said. To exit bankruptcy, the county must win approval from U.S. Bankruptcy Judge Thomas Bennett for a so-called plan of adjustment that balances revenue with debt.
Up to Judge
In that plan, the county will ask Bennett to reduce the principal on the general-obligation bonds, Klee said. He declined to say how much the county will attempt to pay.
A failure to repay the principal would shock the bond market, James Spiotto, who represents some of Jefferson County’s creditors, said in an interview today. Spiotto, a bankruptcy attorney with the law firm of Chapman & Cutler LLP, has studied the history of municipal bond defaults.
He said he cannot identify any large municipalities that haven’t fully repaid the principal on their debt since the Great Depression in the 1930s. In that era, about 4,000 municipalities defaulted leading to about 1 percent, or about 40, not fully repaying the debt.
Now, investors are starting to ask how far cash-strapped local governments will go to pay their debts.
“When you say it is backed by your full faith and credit does that mean you are going to use everything in your power to raise taxes and raise revenue to repay your debt?” Spiotto said.
The Alabama Legislature ended its annual session on May 16 without passing a bill to give Jefferson County legal authority to bring back a wage tax struck down by the state Supreme Court.
The legislative delegation from Jefferson hasn’t been able to agree on a solution, as lawmakers are divided between those opposing taxes and who oppose additional cuts to services that would affect low-income residents.
National Public Finance Guarantee Corp., which insures about $96 million of Jefferson County’s general-obligation bonds, will make sure bondholders receive their principal and interest payments on time, spokesman Kevin Brown said in an interview today.
The county of 660,000, home to Birmingham, will miss another interest payment in October, Klee said. County officials have dismissed 800 employees and reduced services. They say they need a state law to allow them to raise taxes to close a $40 million shortfall.
The case is In re Jefferson County, 11-05736, U.S. Bankruptcy Court, Northern District of Alabama (Birmingham).
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