Under the deal to settle the bankruptcy of Jefferson County, Ala., firms that invested in its distressed debt will have the most to gain, JPMorgan Chase will face a big loss, and residents will be wondering whether there will be any relief for them.
The terms of the agreement, laid out in federal bankruptcy court on Wednesday, are in several ways better for the county than the concessions that creditors were offering in the fall of 2011 as they struggled to keep the county from declaring bankruptcy. If the deal goes forward, original creditors would receive 80 cents on the dollar for the county’s debt, while alternative investment firms like hedge funds that invested later would receive close to 85 cents, saving Jefferson County more than $1 billion over time. The state would not have to back the county’s finances with a so-called moral obligation pledge, as proposed in 2011.
And the new deal would allow the county to keep control of its sewer system â€" the troubled cash cow at the heart of the bankruptcy. Two years ago, creditors tried to transfer the system to an independent authority to shield it from elected officials who some feared might try to manipulate its rates for political gain.
When the dust finally settles, JPMorgan Chase, which many in the county hold responsible for the financial collapse in the first place, will have given up nearly $1.6 billion as a result of its dealings with the county and its ill-fated effort to finance sewer repairs. The new deal calls for the bank to forfeit $842 million on the $1.22 billion of sewer debt that it holds, which comes on top of $647 million it forgave in termination fees on derivatives contracts with the county and a $75 million penalty it paid to settle a complaint by the Securities and Exchange Commission. The county, for its part, will drop a lawsuit against JPMorgan if the new agreement goes through.
Despite the improved terms, some county residents are still so angry about the debacle that the proposed concessions are not enough. Some still think the only fair thing is full-blown debt repudiation.
“The deal will force Jefferson County to return to the scene of the crime that crippled it: the bond market,†John Archibald, a columnist for The Birmingham News, wrote in an article published online Wednesday.
“Lucifer spells his name J. P. Morgan,†he added.
County officials said that a hearing on Wednesday before Judge Thomas B. Bennett of Federal Bankruptcy Court lasted less than an hour and attracted only a handful of protesters, a tiny turnout that one official attributed to a case of “sewer fatigue.†The judge stayed a lawsuit that contended the county’s sewer debt had been incurred unconstitutionally and needed to be written down more than the new deal proposes. That done, county officials said they could now turn to the bigger task of writing a plan of adjustment, the document that the judge must approve for the bankruptcy to be resolved.
“It was clear in the court proceedings today that the parties are beginning to relinquish their litigation posturing,†said Laurence L. Gottlieb, chief executive of Fundamental Advisors, a private equity firm that participated in the negotiations.
With the county headed toward an exit from bankruptcy, hedge funds and private equity firms stand to profit. When Jefferson County declared bankruptcy in November 2011, these alternative investment firms saw opportunity in the defaulted warrants of a county mired in the biggest Chapter 9 bankruptcy case in United States history. Speculative interest in distressed municipal debt is normally extremely limited because while distressed municipalities are not rare, officials willing to walk away from public debts are. When municipalities have defaulted in the past, they have usually been too small for hedge funds to bother with.
But Jefferson County had $3.2 billion of sewer revenue debt alone, and a total of $4.2 billion in debt when it went bankrupt. The scale attracted a number of alternative investment firms that took the unusual step of buying debt for about 60 cents on the dollar. While that would be routine in a Chapter 11 bankruptcy, where investors may buy deeply discounted debt in an attempt to take over a company, a Chapter 9 bankruptcy does not afford such opportunities: municipalities obviously do not issue stock, and it is impossible for a hedge fund to take one over in bankruptcy.
Instead, the alternative investment firms helped to negotiate a refinancing of Jefferson County’s debts. In return, they are being paid extra for bearing some of the risk if the municipal bond market steers clear of Jefferson County after the refinancing. They will receive an additional 4.9 cents on the dollar in exchange for a promise to buy 10 percent of the county’s new debt in the refinancing if other investors will not.
The investment firms, in other words, are providing a market backstop that could let Jefferson County refinance without having to rely on the state, and without raising sewer rates too much. Part of their extra payment will come from the proceeds of the new debt issue, and part from JPMorgan, according to people briefed on the agreement.
“Getting even 80 percent is a huge windfall to them,†said Matt Fabian, a managing director at Municipal Market Advisors, noting that the firms’ purchase cost may have been as low as 60 percent.
The underwriter of the coming debt issue will also have to promise to take 10 percent of the issue if the market will not. Other signatories to the deal appear content with their outcomes. Assured Guaranty, one of the insurers of Jefferson County’s debt, issued a statement Wednesday saying that the size of its loss would be smaller than the amount of reserves it had put in place to cover the loss.
Mr. Fabian said he doubted that the municipal bond market would have much appetite for Jefferson County’s coming issue of new debt, which would pay for the 80 cents on the dollar it will pay to extinguish the old debt.
“Most people expect they cannot sell it,†he said. “It’s going to be bought by very aggressive buyers.†The problem, he said, is that Jefferson County’s problems have been going for years, and investors are now in the habit of expecting things to go wrong.
“There’s a real potential for some kind of litigation, and a workout going forward,†he said. “You have to assume that. If anything goes wrong, they’re not going to do the right thing by investors. So you need a broad enough return that you can afford lawyers and restructuring counsel down the road.â€
To show it was bringing its new debt to market in good faith, he predicted Jefferson County would raise sewer rates one more time before the sale.
That’s what Mr. Archibald, the Birmingham columnist, was also predicting, in his column.
“Sewer rates will rise dramatically under this deal,†he wrote.
