Wednesday, July 27, 2011

Jeff Co Again

As the Jefferson County Commissioners battle the Harrisburg City Council for the front page of the muni tabloids, JeffCo is again awarded first place on this National Bond Insurance Enquirer. This is due to the importance of each debtor relative to the respective bond insurer and should not be considered indicative of the relative stupidity displayed by the competitors. In that regard, both are champions in the eyes of The Blue Dragon.

So to our subject, JeffCo will not be able to use chapter 9 to reduce sewer warrant debt. This was the principal statement in our recent analysis -available here - in which we discussed key impediments to impairing the sewer debt through chapter 9. Those impediments include Alabama's constitutional prohibition on sewer system revenues paying general fund expenses, the official statement explicitly stating chapter 9 would not result in an automatic stay preventing sewer debt payment, and the antithetical presumption that chapter 9 could be used to impair revenue growth. Basically it's like trying to use a saw to turn a screw; it's the wrong tool.

With that backdrop, the only real risk to holders of the sewer debt is their own skittishness. In April 2010, Syncora commuted $507M of exposure for a cash payment of $75M. Considered in a vacuum, this 15% haircut would be a mistake. To its credit, Syncora had liquidity and regulatory concerns and other very attractive uses of cash. The company's profitable deconstruction of impaired credits created a high opportunity cost for other projects such as waiting on common sense (or is it Gudot) in Jefferson County. We remain hopeful that Syncora did not and would not throw $75M dollars into the incinerator.

There will be more opportunities to be skittish. These pages have only discussed the ability of the county to use chapter 9 to impair creditors and not the likelihood of a filing.  Indeed, a chapter 9 filing could come this week followed by a successful campaign to impair general fund (i.e. not sewer) debt. While JeffCo has the ability to raise sewer rates to meet its sewer debt, it has been unable to replace an occupational tax that accounted for a large minority of all taxes collected for the general fund. This distinction is important because a chapter 9 petitioner must prove - among other things - that 1) it is insolvent as defined by the federal Bankruptcy Code and 2) that it has tried to avoid a filing or has satisfied certain requirements regarding negotiations with creditors. Simply not wanting to tap an unlimited source of revenue might contradict such a claim. The general fund seems a more qualified candidate.

The greatest threat to sewer system creditors is Luther Strange, the Alabama Attorney General who was granted the right to intervene on behalf of rate payers in the receiver's mandamus to meet the obligations of the sewer system. It is worth noting that the same judge, Albert Johnson both ruled Strange could intervene and appointed the receiver to meet the system's obligations. Whatever success Strange has in providing relief for his constituents will affect the timing of debt repayment but not to an extent justifying a 30% haircut.

While the details are acutely important, the common sense behind statutes can be of greater moment. Following centuries of political economic thought, Larry Speidell's latest publication through the Research Foundation of the CFA Institute discusses how sound institutions are a prerequisite for an economy to meet its full potential. In effect, clarifying the rules of the game makes a jurisdiction capable of attracting investments that generate economic growth. If an investor knows that a government will not expropriate her capital and earnings, she will have a lower hurdle rate (required expected return) for making productive investments. This is what makes The Contract Clause such a vital part of the U.S. Constitution.

Speidell's work is titled "Frontier Market Equity Investing: Finding the Winner's of the Future." It engenders hope for countries like Kenya and questions for the still-self-proclaimed Heart of Dixie. One of the most basic steps for government to attracting capital for economic growth is to create strong property and contract rights. The government itself is the first actor that must adhere to such laws. Hugo Chavez nationalized oil firms in 2007 and then comically attempted to attract capital in the same industry in 2009.  The Venezuelan example is a caricature. Nonetheless, the same reasoning has led well respected municipal analysts (that's right, not Whitney) to recommend avoiding all muni credits in Alabama (sometimes it seems a little bit more like this) due to the state's complacent stance on JeffCo's defaults.


The bigger risk associated with a JeffCo bankruptcy fall on general fund creditors. The biggest risk to sewer creditors is from the AG's intervention on behalf of ratepayers. If Syncora and other creditor interests enforce their rights to the full extent of the law, they can avoid a large haircut bankruptcy or not. Meanwhile Alabama would do well to adopt a basic tenet of attracting the capital for economic development.

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