Did Jefferson County ratings shop?
Jefferson County, Alabama is raising $1.7 billion of new debt to repay $3.1 billion while it is under the protection of the Federal Bankruptcy Court in a Chapter 9 proceeding. A lot of information that normally remains private to the issuer and underwriter has become public.
Barnett Wright, a reporter at the Birmingham News, published the list of fees that are being paid for raising the new debt, including to the credit raters:
Firms and the amounts to be paid on the deal include underwriters Citigroup Global Markets Inc., $4.9 million; Merchant Capital, $1.3 million; and Drexel Hamilton, $568,000, according to the county.
Expenses to rating agencies include: $263,000 to Standard & Poor’s; $125,000 to Fitch, Inc. and $90,000 to Moody’s Investors Service, Inc.
Keeping in mind that ratings are merely opinions, here is a short summary of the raters’ views:
Standard & Poor’s gave Jefferson County the highest rating and explained why in a teleconference (summarized by The Bond Buyer):
A series of events and actions helped Jefferson County obtain higher than anticipated ratings, including adoption of a sewer rate structure for the life of the warrants to be confirmed by the bankruptcy court, hiring a professional manager to run day-to-day operations, adopting fiscal policies, obtaining professional financial projections, and adequate debt service coverage, according to [S&P analyst James] Breeding.
The metrics underpinning the debt allow the county to cash-fund capital expenses, operations and maintenance for 10 years while providing time to address additional revenue needs after that.
Over the 40-year-life of the debt, 75% of capital expenditures are cash funded. “There are a lot of higher-rated systems that can’t say that,” Breeding said.
Considering the combination of ability and willingness to pay along with conservative financial projections “provided just that sufficient comfort to get to the investment-grade level,” he said.
For Fitch, which gave the second-highest rating, the key rating drivers were:
PRIOR BANKRUPTCY TRIGGERS SUFFICIENTLY MITIGATED: The onerous regulatory requirements, risky financing structures, and corruption – among other things – that led to the county’s filing for chapter 9 bankruptcy protection in Nov. 2011 and the need to seek concessions for a significant portion of system obligations appears to be either actually or effectively eliminated. General concerns remain regarding pressures the system faces post bankruptcy, but these concerns are not anticipated to affect system operations or debt repayment going forward beyond what is contemplated at the currently expected rating level.
OUT-YEAR FINANCIAL CONCERNS: System cash flows appear sufficient to generate favorable debt service coverage (DSC) and meet capital demands from surplus revenues over the next 10 years. However, projected cash flow shortfalls for capital beginning in fiscal 2024 (despite anticipated sound DSC) are a significant concern.
VERY HIGH DEBT BURDEN: System debt levels will remain high even with a substantial reduction in system obligations resulting from the county’s plan to emerge from chapter 9 bankruptcy protection. Further, the anemic amortization of the proposed financing will leave the system’s debt burden elevated for decades even without additional borrowings.
ADOPTED ADJUSTMENTS BUT POSSIBLE CHALLENGES: The approved rate structure (ARS) adopted by the county commission, which calls for annual rate adjustments through the life of the warrants, is a key credit positive as it provides more certainty to the projected cash flows. However, rates are already high and ongoing adjustments contemplated under the ARS could spark increased political concerns, litigation, and elasticity in usage, any of which might erode actual financial results.
STRONG AND DIVERSE SERVICE AREA: The service territory is broad and has grown into a diverse economy over the previous decades with a stable population base. Major sectors now include finance, medical and education along with the county’s more traditional manufacturing roots. Unemployment continues to post favorable results, although income levels in the county remain meaningfully lower than the U.S.
For Moody’s, which gave the lowest rating, key credit factors include:
New, higher sewer rates – critical to debt repayment – face financial and governance risks
With a high debt load and deferral of principal repayment, comparative financial metrics are weak
Debt service coverage will decline as principal payments increase in later years
Significant future capital needs loom and will require further rate increases
Service area, anchored by a large university healthcare complex, has average wealth levels
New debt structure provides satisfactory legal security
A wide diversity of rating opinions is critical for a healthy credit market. It is not clear whether or not Jefferson County ratings shopped, but seeing the fees paid to the raters alongside the ratings they assigned is revealing. In a January, 2008 report to Congress on credit rating agencies I explained what ratings shopping is (page 17):
Rating shopping happens when an issuer reviews the preliminary ratings of NRSROs to determine which rating agencies will assign the highest rating to its securities. The issuer then chooses the NRSROs with the highest rating to work with and compensate.
Jefferson County Commissioner Jimmie Stephens did not respond to a request for comment.
The Birmingham News has a great explainer of the debt structure of the sewer debt: