Turmoil in Municipal Bond Market Stuns Jefferson County Alabama

Jefferson County Alabama, home to Birmingham and 660,000 residents, is facing some tough choices.  The county needs to raise more money or start cutting public goods and services.  If a solution is not found soon, Jefferson County may face default on their derivative contracts and possibly bankruptcy.  

According to Craig Karmin and Liz Rappaport of the Wall Street Journal, Jefferson engaged in $5.4 billion worth of certain derivative contracts, known as interest-rate swaps, in an effort to lower its borrowing costs.  The biggest piece of this borrowing was $3.2 billion to update the county’s water and sewage system. 

Jefferson finds itself in this difficult position as a result of several factors.  The ongoing credit crisis has caused downgrades to the county’s bond insurers, Financial Guaranty Co. and XL Capital Assurance Inc., and the recent auction-rate securities failures have prompted credit firms to lower the county’s debt rating from investment-grade to junk.   

On February 27, 2008, Moody’s lowered Jefferson County’s rating three levels from A3 to Baa3, the lowest investment grade.  

Bank of America, Bear Stearns Cos., J.P. Morgan Chase and Lehman Brothers, concerned over the county’s ability to meet its obligations, are now calling for Jefferson to put up more collateral for the swaps.  To date, Jefferson has failed to do so. 

The Wall Street Journal has reported that county officials are negotiating with creditors and maintaining that they can avoid bankruptcy.  James H. White III, president of Porter, White & Co., the county’s financial advisor, has stated that “[w]e don’t have any present intention to seek relief in bankruptcy court.”      

Like Jefferson County, many cities, towns, universities and other public institutions have taken on debt through the tax-exempt municipal bond market.  These debt markets are suffering from the fallout in the subprime mortgage crisis.  As a result, Jefferson County may not be alone in the struggle. It is expected that other municipalities may also see their swap agreements lose value.  Both Houston and Durham County, North Carolina have used interest-rate swaps to fund local projects.

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