MuniLand

The state becomes the guarantor

Jefferson County, Alabama is getting a lot of attention as it negotiates with the holders of $3 billion of sewer bonds. The county would like to pay $2 billion to settle the $3 billion of bonds outstanding and limit the rate increases county residents would have to pay. This arrangement would pay bondholders (led by JP Morgan) 66 cents on the dollar — not a great recovery but not outrageous either. Bondholders want the state to guarantee this new arrangement and stand ready to pay in the event of another default.

There is an alternative option for settling the matter: a Chapter 9 municipal bankruptcy. The county is now prepared to go that route if necessary and have hired an expert attorney to lead them through the process if they so choose.

The county accumulated this sewer debt over a number of years to fund the development of an EPA-mandated sewer system. Its construction was laced with delays, cost overruns and corruption. It’s the poster child for disastrous public works and bad dealing by Wall Street. The credit rating for this debt started out as AAA in 1997 when it was issued. The bond insurer FGIC stood behind the debt and helped raise the credit to the highest level, AAA, from Baa1. In the chart above you can see the rating move in February 1997 as the insurer came in and pledged to repay bondholders if default occurred.

Jefferson County issued another very large amount of bonds in 2003 to pay for project overruns. This caused the rating on these earlier 1997 bonds to be lowered. This is due to the Jefferson County now having a heavier debt load to service. Credit ratings are a reflection of an issuer’s ability to carry and service the debt they have outstanding.

The financial crisis of 2008 decimated the bond insurer and caused Jefferson County’s rating to plunge. The rating briefly spiked in March 2008 as the guarantor briefly recapitalized their business. Since then the rating has been sinking lower and reflects that these bonds are near default.

Know your debt load

A quick and dirty way to evaluate the credit quality of a borrower is to look at his debt load relative to revenues. It’s not a perfect measure — it doesn’t take into account whether that debt is repaid over many years or whether it’s all due at once, for instance — but it suggests why investors view some states as better risks than others. I’ve made a set of charts so we can compare debt loads and revenues for the states in a simple, visual way. The amount of debt load is indicated by the full height of the bar. (Please note the vertical scales of the charts vary. California is the highest borrower by far.)

I’ll do another series of charts that includes pension liabilities and other post-employment benefits, and I’m warning you now: that set will look scary. Here is a link to these data and charts in interactive format. Feel free to embed and use them elsewhere (crediting Reuters of course).

Tax collection data is from the U.S. Census Bureau and debt load data is from Standard and Poor’s.

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