Can revenue bondholders relax now?
Bond markets generally focus on who has rights to specific cash flows and control over assets. That was what Alabama federal bankruptcy court Judge Thomas Bennett was addressing when he issued an opinion Friday afternoon covering the insolvent Jefferson County sewer system.
To recap the situation in Jefferson County, re-read what I wrote in November:
Last year, amid the county’s fiscal and political meltdown, the Russell County Circuit Court appointed a water system professional, John Young, to take over the management and operation of the sewer system. This action came at the request of the bond indenture trustee, the Bank of New York, which wanted the bond payments protected. Now the county is fighting with the receiver and creditors for control of the sewer system in bankruptcy court.
The crux of Judge Bennett’s ruling related to whether the sewer receiver, John Young, could keep control of Jefferson County’s most important asset, the sewer system, while the county was trying to consolidate its assets in the bankruptcy process. Bank of New York and other bondholders argued that the federal bankruptcy proceeding could not trump judicial actions taken at the local level. In other words BoNY, representing bondholders, wanted to keep the control of the sewer system and its cash flows. Although revenue bondholders have a lien, or right, to the cash flows of the sewer system, they also wanted control of the asset.
Judge Bennett, in his ruling, confirmed the right of bondholders to receive the revenue payments they are due from the sewer system. This will make the municipal markets cheer because it confirms an important plank of the system. On the other hand, the judge also ruled that control of the sewer system must be returned to Jefferson County. Bondholders would have preferred to keep control of this asset, which was collateral for the bonds.
Chapter 9 municipal bankruptcy cases are rare and market players closely watch the outcomes. The judge made a sound ruling today and the case will grind on. Jefferson County is not yet out of the woods but the path is becoming a little clearer.
Kind thanks to the Birmingham News for posting Judge Bennett’s order.
How Jefferson County trips up national reporters
The New York Times really needs to improve the quality of its reporting on the municipal bond market. Mary Williams Walsh makes such a terrible hash of the situation in Jefferson County, Alabama, that she is bound to set off another muniland hysteria in the mold of Meredith Whitney.
In the opening paragraphs, Walsh contends that general obligation bonds (GO) issued by state and local governments and with the pledge of their “full faith and credit” may not be as creditworthy as always assumed. About half of the $3.7 trillion municipal bond market is general obligation bonds. She dramatically states that investors who own GO bonds might be in for a “surprise:”
People who own what is considered the safest type of municipal bond may be in for a surprise.
This safe debt, called a general-obligation bond, is said to be the next strongest thing to Treasuries because it is backed by a “full faith and credit” pledge. That means the government that issued it will pay it on time, no matter what.
But now Jefferson County, Ala., has stopped paying such debt, breaking with convention and setting up a fundamental test of what full faith and credit truly means.
What goes unmentioned is that the halted debt repayment is happening in the context of an insolvent county in bankruptcy. More importantly, general obligations bonds can be very high-quality from a strong issuer with top credit ratings, or they could be very low-quality from a near-insolvent municipality with the lowest possible credit ratings. The type of the bond is no assurance of ability to repay bondholders.
The point of a municipality seeking bankruptcy court protection is to halt the legal actions of creditors, including GO bondholders. This gives debtors time and a safe space to reorganize their finances. It’s not in any way “breaking with convention” to halt paying GO bondholders in bankruptcy.
The U.S. Federal Court system’s bankruptcy guide (page 49) describes Chapter 9 municipal bankruptcy:
The purpose of chapter 9 is to provide a financially-distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts. Reorganization of the debts of a municipality is typically accomplished either by extending debt maturities, reducing the amount of principal or interest, or refinancing the debt by obtaining a new loan.
One of the major challanges in the Jeffco Chapter 9 is that the securities at issue are not Bonds, they are Warrants. There appears to be an important question under Alabama law whether a municipality (like Jefferson County) can unilaterally act to raise taxes in order to satisfy these Warrants (assuming Jefferson County even wanted to voluntarily do so)without State approval.
We are currently investigating possible legal claims against certain parties involved with the underwriting of these Warrants.
TURNER LAW OFFICES, LLC
hturner@tloffices.com
Notice: The purpose of this posting is to identify select issues that may be of interest to readers. Under Georgia’s Code of Professional Responsibility, portions of this communication may constitute attorney advertising. This posting should not be construed as legal advice or opinion, and is not a substitute for the advice
The cost of kleptocracy
Gary White, a former official of Jefferson County, Alabama, had his conviction on conspiracy and bribery charges affirmed by the U.S. 11th Circuit Court of Appeals today. White, a former county commissioner, is already serving a ten-year term in a South Carolina federal prison for his involvement in the sewer scandal that ended in the largest municipal bankruptcy ever. He’s just another piece of detritus from one of the largest cases of municipal corruption in recent American history. The Birmingham News reported the courts decision:
The opinion issued by the court, however, begins with stinging criticism of a period of corruption that included White and other Jefferson County commissioners.
“‘Kleptocracy’ is a term used to describe “[a] government characterized by rampant greed and corruption,” the court’s opinion began, citing three dictionaries. ”To that definition dictionaries might add, as a helpful illustration: “See, for example, Alabama’s Jefferson County Commission in the period from 1998 to 2008.”
It’s well known in the municipal bond market that Jefferson County’s default and subsequent bankruptcy are exceptional cases. Munilass, one of muniland’s most indispensable bloggers, said this of Jefferson County:
Portraying Jefferson County as a typical municipal credit is akin to portraying Enron as a typical corporate credit. With Jefferson County, various financial firms – but primarily JP Morgan – exploited an existing culture of corruption and made taxpayers the victims of one of the largest frauds in the history of the financial markets.
Because the issues of fraud and corruption were so well known in the markets, I’ve been wondering about the statements that Robert Bentley, Alabama’s governor, made after the bankruptcy filing. From the November 9th Birmingham News:
“I believe you pay your debts,” he said. “That’s what I told them and I still believe that.”
He said the county’s situation already has affected borrowing throughout the state and he expects the bankruptcy to increase the cost of borrowing even more. “The credit rating of Jefferson County is terrible already so it can’t get much worse, but certainly filing bankruptcy does not help,” he said. “I know they were frustrated but at some point, you have to step up and have to be a leader and have to be a statesman and you have to do what’s right. “Bankruptcy is not right.”
Thanks to you for helping out the common people in the main street ( us – investors ) who have no help and legal recourse in such FRAUD and I am not sure govt mostly local is helping much
Sending the person to jail does not recover my money ..
Reuters – thanks for showing the guts to publish such reporting
Make Jefferson County’s receiver its salesman
The story of Jefferson County, Alabama filing the largest municipal bankruptcy ever last week is well-known. The county went into hock for about $3 billion to build an EPA-mandated sewer system. On the way to completing the system, every local crook and corrupt politician piled onto the project to skim off some pork. Many of these players ended up in prison and left the taxpayers saddled with a sewer system they really can’t afford.
Last year, amid the county’s fiscal and political meltdown, the Russell County Circuit Court appointed a water system professional, John Young, to take over the management and operation of the sewer system. This action came at the request of the bond indenture trustee, the Bank of New York, which wanted the bond payments protected. Now the county is fighting with the receiver and creditors for control of the sewer system in bankruptcy court. My advice to Jefferson County Commissioners is to stop fighting John Young and change his role into a salesman for the system. The sewer system is an albatross, and it should be sold and creditors repaid with the sale proceeds.
The Russell County Circuit Court’s mandate covered raising sewer rates and lowering costs but did not grant Mr. Young a role in facilitating a settlement with sewer debt creditors. According to Young, he took on that responsibility “unofficially.” He claimed to have traveled many times to New York City to negotiate potential haircuts on the outstanding debt, meeting repeatedly with JP Morgan, the biggest creditor, and other Wall Street banks. Young had a lot of experience dealing with Wall Street as the former president of the publicly-held American Water Works Company.
There is a lot of animus towards John Young in Jefferson County because he has been paid over $1 million in the last year and is perceived to be representing Wall Street instead of taxpayers. The Jefferson County political elite, from U.S. Representative Spencer Bachus to the Jefferson County delegation to the state legislature (shown in the video above), want John Young out of the county’s affairs. The Commissioners of Jefferson County filed a motion in federal bankruptcy to remove Young as the sewer system receiver. That motion will be argued on Monday.
I attended a luncheon yesterday of the Municipal Analysts Group of New York where John Young talked about his role running the sewer system, his trips to New York to meet with creditors and his current fight to retain control of the system in bankruptcy. What was clear from his presentation was that the sewer utility that he found when he stepped into the receiver role was run as a comfortable, good-ol’-boy operation with few management controls. He said that no income statement, balance sheet or long-term business plan had been developed for the system. As someone coming from a shareholder-owned company he first set to work getting operational metrics and cost accounting in place. Imagine transforming an utility that had just spent billions on infrastructure with few controls into a cost-driven operation. It’s a mighty feat.
Jefferson County goes kaboom
Crushed by sewer debt and stripped of 48 percent of its general fund revenues by a state court, Alabama’s Jefferson County filed the largest municipal bankruptcy in history yesterday. The filing brings three years of financial chaos to an end and represents the largest default of municipal bonds and derivatives ever.
It’s been a long road for the county. In 1996 a federal judge ordered it to upgrade its sewer and waste water systems. To comply with that mandate, Jefferson County has issued over $3 billion in sewer debt, some of which was done in a blatantly illegal manner. The former Birmingham mayor and county commission president are now serving prison terms for bribery. Twelve others were convicted of bribery and conspiracy, and over twenty people involved in construction of the project have served jail time. The lead underwriter of the sewer debt, JP Morgan, also made the largest derivatives-related settlement with the SEC for an illegal payments scheme, although the bank admitted no fraud.
Jefferson County has been the poster child for muniland corruption for years as its residents have born the cost of the illegalities. Sewer rates have been raised 329 percent in the past decade. 500 county employees have been terminated. The county’s reserve funds have been depleted. Because of the crushing cost of the fraud the county has nowhere to turn but to the protection of federal bankruptcy court. With this filing, the county brings all court cases it is facing to a standstill and can halt debt payments until its massive liabilities have been adjusted.
The county commission has been working intensely with its creditors since August when they postponed filing for bankruptcy at the last minute at the request of the governor. The governor promised to convene a special session of the legislature to give the county the right to raise taxes to cover its massive revenue shortfalls and create a state guarantee for new bonds issued by the county. The governor said recently though that he would not convene this special session until all creditors had agreed to the proposed terms. According to the bankruptcy petition, some of the sewer debt has been sold to new parties, which has complicated negotiations. Bloomberg reported:
The county’s bankruptcy attorney, Kenneth Klee, said the filing was necessary because talks with creditors and the receiver in charge of the sewer plant broke down.
“There was an impasse reached,” Klee said in an interview today. “None of the creditors — zero — signed up to the deal that we have been negotiating for six weeks.”
Alabama Governor Robert Bentley, is not happy with the county’s bankruptcy filing and said in a statement published by Reuters:
Crawling in the dark through the muni CDS market
I’m beginning to think that Europe’s sovereign debt crisis might kill more than municipal credit default swaps. As the financial system trembles alongside the deliberations of the Greek government, areas of the markets that have quietly lumbered along in the dark are getting more and more attention.
Bloomberg held an excellent state and local finance conference on Wednesday where there was a brilliant session with the state treasurers of North Carolina, Delaware and New Jersey. Bloomberg Editor-in-Chief Matt Winkler grilled the trio on the use of derivatives, mainly interest rate swaps, by public officials. In the most thought-provoking back-and-forth, Winkler asked what the difference was between Alabama’s Jeffereson County and Greece. Both Greece and Jefferson County have extensive ties to financial institutions through the bonds they issued and derivatives they have either entered into or that have been written on them. In the case of Jefferson County this exposure is mainly concentrated with JP Morgan Chase, the lead underwriter for most of the bonds and derivatives written on the county. In the case of Greece it’s fairly well-known who owns its bonds but it’s practically unknown how deep the interconnections are for derivatives. As Bloomberg wrote:
The European nations are linked in a network of debts, as Bill Marsh recently illustrated in the New York Times with a beautiful piece of graphic art. The image is like a complex wiring diagram for a ticking debt bomb. Yet what it shows may be less important than what it leaves out: a largely invisible network of ties among institutions around the world, which could ultimately cause global financial chaos.
This hidden network has been created by institutions that buy and sell unregulated credit-default swaps. These are essentially insurance contracts on bonds; in the event of a default on the bond, the seller of the swap promises to pay the buyer the bond’s value.
This web of interconnections is amplified many times over because of the intense concentration of derivatives on the trading books of a handful of large, global banks. The graph below from the blog Jesse’s Cafe shows the level of concentration for U.S. commercial banks using data from the Office of the Comptroller of the Currency (OCC). Basically five U.S. banks control the whole U.S. market and embody the concentrated risk. A publication from ISDA, the trade association that represents the large, global banks in the derivatives area, said the OCC reported the notional amount of derivatives outstanding at the five largest U.S.-based dealers was $281 trillion as of June 30, 2010. That is a massive spiderweb of risk given that the U.S. annual GDP is about $14 trillion.
Thumbs down on Obama’s muni tax
Thumbs down on Obama’s muni tax
Unsurprisingly, the Treasurer of California and Bloomberg’s editorial board are pushing back on the Obama administration’s proposals to reduce the municipal bond tax exemption for those earning more than $200,000 per year. I wrote previously how the Republicans are cool to the proposal. The California Treasurer says that the increased tax would raise municipal borrowing costs and estimates that over time the act could add $2.7 billion to $7.7 billion to statewide borrowing costs. Bloomberg’s editorial board goes further and suggests that any changes to municipal bond taxation should be done as part of a broader tax reform effort. From Bloomberg:
How disruptive would this new tax, which the administration estimates will bring in $30 billion a year, be for the muni market? A report from Morgan Stanley Research saw little impact, pointing out that the premiums investors demand to hold munis over Treasuries “have little direct relationship with tax rates historically.” A report from Citigroup Global Markets, by contrast, argued that curbing the exemption would “increase state and local borrowing costs significantly.”
On balance, we suspect the impact on interest rates will be relatively small initially. (Certainly the proposal has had little effect on the market since the announcement, according to Bloomberg pricing data.) Of course, that could change rapidly if historically low Treasury yields rise and munis start to look less attractive.
If the aim is to help states build infrastructure and create jobs, Obama’s proposal starts to look somewhat unserious, given that it would probably make public-works projects more expensive. When one considers its chances of passing in Congress — approximately 0.0 percent, according to the latest Bloomberg View calculations — it starts to look downright disingenuous.
One element of the discussion which has been left out is that the U.S. municipal market has been shrinking and that individuals hold only about 29% of outstanding municipal bonds. Reuters reports:
The central bank’s estimate of state and local governments and authorities’ outstanding bonds has come under fire lately, with the market’s main information gatherer, the Municipal Securities Rulemaking Board, saying the real market size is closer to $3.7 trillion.
[...]
Individuals are still the largest holders of municipal bonds, accounting for $1.07 trillion of the market in the second quarter.
The effect of various tax proposals on municipal borrowing rates, including full removal of any tax-exempt status, should be analyzed against the various classes of muni bond ownership. U.S. tax-exempt organizations, for instance, control $8.2 trillion in assets; if municipal bonds became taxable they could prove to be a great asset class for pension funds and other organizations which do not pay taxes on interest income. This is also true for personal retirement accounts like 401Ks, which are not taxed until savings are withdrawn.
Overseas buyers have already been increasing their purchases of municipal bonds. Recent data from the Federal Reserve shows that foreign investors bought $8 billion in the second quarter and $8.8 billion in the first. I think it’s a fallacy that the rich are the only ones who have demand for municipal bonds. Many groups of buyers could be prospective buyers for municipal bonds, depending on their tax status.
Obama’s muni tax is one of the most absurd proposals coming out of this supposed “Democrat” administration. This is something we’d expect from Romney or Perry, but Obama?
When cities and states are just now repairing their finances after getting hit by the double wammy of the ’08 financial crash and the Great Recession, Obama tries to eliminate the tax deductibility of muni interest!!
It just goes to show that Obama has encircled himself with neo-conservatives who wear the Democrat badge as a press pass.
If the purpose is to raise more revenue from the upper 1% earners, then pass a Wealth Tax: 2% Wealth Tax on all persons, corporations, trusts, foundations, etc. that have a net worth greater than $10 million. That will balance the budget in just a few years.
Municipal bonds are not just for rich people
This Bloomberg interview with John Miller, co-head of fixed-income at Nuveen Asset Management, is a good overview of the current state of muniland although I disagree with his comment that “many, if not most municipal bond holders are in the highest tax bracket”.
Actually IRS data tells us that about 75% of filers who claim exclusion for tax-exempt municipal interest earn less than $200,000 per year. As with all financial assets the richest own the most by quantity but municipal bonds are held pretty broadly. It’s not just a rich persons asset class.
Further: Citibank: US Municipal Strategy Special Focus
Big, big day for Jefferson County, Alabama
The Jefferson County Commission will hold a meeting today to determine whether to accept their creditors proposal for settlement of defaulted sewer bond debt or declare bankruptcy. My opinion is that they will settle and creditors will take a haircut of about 33 cents on the dollar. This will be a very important precedence for muniland workouts. Stay tuned. Here is some of the coverage:
AL.com: Sewer debt crisis: Jefferson County, creditors likely to settle
Where are muniland’s cross-over buyers?
It’s an odd moment in muniland. There is an irregularity in the pricing of municipal bonds. Generally muni bonds have a lower yield than U.S. Treasuries because munis give investors a tax advantage. Investors use them to shield their investment income since coupon payments on municipal bonds from their state of residence are generally triple-tax-free — that is, they are not taxed at the local, state or federal level.
In this Bloomberg video Timothy Pynchon, a portfolio manager at Pioneer Investment Management, talks about how 30-year muni bonds are trading at 105 percent of the value of the 30-year Treasury. These bonds would usually trade at less than 100 percent of Treasuries because of their tax advantages. This is a very unusual situation and would usually attract so-called “cross-over” buyers from other parts of the bond market. In the video, Cumberland Advisors’ David Kotok suggests that since U.S. Treasuries are mispriced (too expensive with low yields as a result of a flight to quality) it’s having a carry-over effect for long-dated municipal bonds. Basically the long end of the municipal bond market has moved away from its normal pricing relationships and is cheap relative to Treasuries.
Further:
Bloomberg: Colorado Refunds Transport Debt as Yield at Lowest Since 1994: Muni Credit
Bond Buyer: Muni Funds See Outflows for Fifth Straight Week
“What we had here was a wholly corrupt situation”
“We don’t have a deal”
The Jefferson County Commission met last Friday to decide if they would accept a proposed settlement from creditors led by JP Morgan on their $3 billion of sewer debt. After many hours of meeting in executive session and in public, the Commission voted to reject the proposal, remove the court appointed receiver and directly negotiate with the creditors.
I watched the live webcast of the meeting and it was actually one of the most open and informed county commission meetings that I’ve ever seen. I give the Commissioners a lot of credit for their efforts to clean up a problem which they did not create. In the meeting there was a lot of indignation against JP Morgan and their role in burdening the county with several billion dollars of derivatives. Several Commissioners felt especially that there had been fraud in these transactions and were not willing to release their right to sue JP Morgan and other banks for these problems. There were also calls for increased transparency in the process. There was a lot of drama in the meeting.
The drama was only heightened when county commissioner, T. Joe Knight, saw a message on his mobile device in the middle of the meeting that said the Wall Street Journal was running a headline announcing that an agreement had been reached. You can see the video of Commissioner Knight above shouting, “We don’t have a deal”. When I clicked over to the WSJ.com the paper was running a story that quoted the state finance director and said that the Commission had accepted the proposal although the Commission had not yet voted. The Wall Street Journal eventually yanked the false story and replaced it with this account which makes their error seem less odious:
As Friday’s closed-door meeting was ending, an Alabama official sent out an email to a reporter saying that commissioners “appear to have a conceptual agreement in place for settlement.” After reading Wall Street Journal headlines about the announcement, commissioner Joe Knight threw down his mobile device, saying: “We don’t have a deal.”
Here is the Twitter thread:
cate_long Cate Long
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Resident Muniland expert
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