Fitch Expects to Rate Jefferson County, Alabama’s Series 2013 GO Warrants; Outlook Stable

Fitch Ratings expects to assign a 'BBB-'rating to the following Jefferson County, Alabama general obligation warrants:

--$105 million GO warrants, series 2013.

The final rating is contingent upon confirmation of the county's current Amended Plan of Adjustment by the bankruptcy court overseeing the case that would allow the county to emerge from chapter 9 bankruptcy protection by the end of the year.

The series 2013 GO warrants will replace the county's outstanding series 2001-B GO warrants. The series 2013 GO warrants will be divided into two series with final maturity in 2021, consistent with final payout of the current GO warrants. The interest rate will be fixed based on the Wall Street Journal Prime Rate at the time of conversion plus 165 basis points.

The series 2001-B GO warrants are currently in default and held by liquidity providers Morgan Guaranty Trust Company of New York (a subsidiary of J.P. Morgan Chase Bank) and Bayerische Landesbank Gironzentrale. The GO liquidity providers will exchange the series 2001-B GO warrants for the series 2013 GO warrants.

At this time Fitch also expects to assign a 'BBB' rating to the county's implied unlimited tax general obligation security.

The Rating Outlook is Stable.

Security

The series 2013 GO Warrants are general obligations of the county of which the full faith and credit of the county is pledged. No legally available revenues, however, are specially pledged for payment.

Key Rating Drivers

Proposed Plan to Exit Bankruptcy: The county declared bankruptcy in November 2011 following default on its sewer warrants, general obligation warrants and lease obligations. The county has proposed a plan of adjustment including the issuance of approximately $1.8 billion in sewer warrants in order to settle claims with most of the concerned parties. Part of the settlement involves the restructuring of the GO Warrants. Approval and implementation of the plan is pending.

Lack of Home Rule Authority: The county's lack of authority over revenue decisions is a major credit concern, as all decisions regarding county revenues are left to the state. The county's inability to manage its revenue base restricts financial flexibility and creates ongoing uncertainties as to future state actions which could be detrimental to county operations.

Severe Budget Cuts Maintain Fiscal Balance: In response to the elimination of the county's occupational tax revenues, county officials have made extensive reductions in personnel and operations, cutting expenditures by about a third to match revenue declines. These measures have enabled the county to maintain fiscally balanced operations although at a much reduced service level.

Sizable Reserve Balances: Finances are characterized by ample reserve and liquidity balances, which have been maintained despite the severe revenue shortfalls. The reserves provide the county with a degree of flexibility partially offsetting its constrained revenue and spending options.

Manageable Long-Term Liabilities: The county's debt load is moderate. Overall carrying costs are high but largely due to limited obligation school warrants which continued to pay through bankruptcy from a dedicated sales tax. The county's burden net of school warrants is relatively moderate including payments for the well- funded pension system. Capital needs are relatively modest and no additional debt is planned.

Regional Economic Center: The county's economy is broad and relatively diverse anchored by its largest employer, the University of Alabama at Birmingham. Key sectors include education, healthcare, retail trade and professional and business services supplementing its traditional manufacturing activities. Employment continues to increase although wealth indices are significantly below the national averages.

One-Notch Differential: The security for the series 2013 GO warrants lacks a legally dedicated unlimited property tax pledge resulting in the one-notch rating distinction from the implied ULTGO. The lack of a tax pledge makes the series 2013 GO warrants effectively a general fund obligation of the county.

Rating Sensitivities

Balanced Operations: The county's sizeable reserves are a key credit strength given the lack of revenue control and limited spending flexibility following steep cuts. Failure to maintain balanced operations could put negative pressure on the rating.

Credit Profile

Current Offering Part of Plan for Emerging from Bankruptcy

The county is located in northeastern Alabama and has an estimated population of around 660,000 people. Beginning in 2008, a series of events occurred which led to the county's insolvency and filing for chapter 9 bankruptcy protection on Nov. 9, 2011 (the filing date). Since the county's bankruptcy filing there has been significant litigation between and amongst the county, county creditors, and other stakeholders. However, in recent months the county has filed its plan with the bankruptcy court for confirmation after reaching concession agreements with the majority of the county's creditors to reduce county-wide obligations.

Causes Contributing to Bankruptcy Sufficiently Mitigated

Fitch believes the events that ultimately led to the county's bankruptcy filing have been addressed and any threat of a subsequent bankruptcy filing is sufficiently mitigated because of the plan and the supporting components of the plan, as well as the internal changes to county operations. Consequently, the expected ratings on the county's GO warrants solely reflect the credit fundamentals of the county post-bankruptcy.

Sewer System Difficulties Negatively Impact GO Warrants

Problems with the county's sewer warrants beginning in 2008 spilled over into governmental operations. Legal costs spiked as the county responded to claims and counterclaims from sewer warrant holders and other related parties. The resultant downgrade of the county's ratings led to the tender and ultimate purchase by liquidity providers of $120 million of series 2001-B GO warrants.

The warrants had been issued as variable rate debt which was synthetically fixed by a swap with J.P. Morgan. Once purchased, the GO warrants were subject to a three-year accelerated payment schedule in place of the original debt structure with final maturity in 2021. The accelerated debt service schedule called for annual $40 million payments, compared to the original $5.4 million payments. The county was able to make a partial payment on the GO warrants of $15 million but lacked the available cash to redeem them within the shortened timeframe. The county first defaulted on its outstanding GO warrants on Sept. 15, 2008. The county filed for chapter 9 bankruptcy on Nov. 11, 2011.

Limited Home Rule Authority

Complete dependence on the state legislature for revenue enhancements is a fundamental credit risk. The ability of the state legislature to adopt measures adverse to the county's credit was amply demonstrated by the legislature's repeal of the occupational tax in 1999, with the repeal eventually affirmed by the courts in March 2011, and its failure to approve a satisfactory substitute. While county officials contend that none of their remaining revenue sources are controversial, the county will continue to be subject to arbitrary actions at the state level.

New Governance Structure

In 2009 the Alabama Legislature approved a change in the county's governing structure such that county commissioners now serve purely legislative roles and the executive function is vested in a county manager. The county commissioners previously retained both legislative as well as executive duties, with each commissioner managing at least one of the county's departments directly. The new governing structure should help to alleviate possible conflicts of interest and avoid the lack of balanced spending oversight previously experienced.

Repeal of Occupational Tax Weakens Finances

The state's repeal of the occupational tax exacerbated the county's fiscal pressures. The occupational tax, a 0.5 percent levy on business earnings, was one of the county's largest single sources of revenues, providing $60 million annually or about a quarter of total revenues for general operations. Controversial from the time it was implemented, the occupational tax was repealed by the state legislature in 1999 and, after extensive litigation, the repeal was eventually upheld by the courts in 2009. Tax proceeds were partially escrowed in 2009 pending further action and the tax was ultimately eliminated in late 2010. Attempts were made in the state legislature to restore all or a portion of the tax or authorize the levy of other revenue sources, but those efforts have proven unsuccessful to date.

Operations Downsized to Match Reduced Revenues

In response to the loss of the occupational tax as well as reduced property tax and other revenues, officials were forced to slash operations to conform to the much reduced revenue flow. Measures included the elimination of over 1,200 positions or 33 percent of the county's workforce through a combination of layoffs and attrition, the closure of satellite courthouses, non-essential service reductions and the sale of the county-owned nursing home.

The county also closed the emergency room and inpatient areas of Cooper Green, its indigent care facility. In place of inpatient and emergency services, the county created a system of clinics with Cooper Green as the hub. Emergency patients are currently sent to private hospitals. In fiscal 2011, the county provided the hospital with about $12 million of financial assistance which Fitch expects will diminish over time.

General fund spending fell 33 percent by fiscal 2012 from a base of $275 million in fiscal 2008. The bulk of the contraction involves general administrative operations. General government expenditures decreased 32 percent to $104 million from $159 million while public safety costs declined by about $14 million or 19 percent. Capital spending was hit the hardest, falling by nearly 90 percent during this period as the county was forced to defer maintenance.

The county did benefit from decreased debt service costs between fiscals 2008 and 2013 as a result of its default on its GO and lease obligations, although the savings of approximately $20 million annually only partially offset the loss of the occupational tax.

Settlement and Surplus Supports Solid Reserves

The county's sizeable reserve position is the key credit strength mitigating its lack of revenue control and limited remaining spending flexibility. The fiscal 2012 unrestricted fund balance totaled $69.2 million or 38 percent of spending.

The county's fund balance position increased sharply in fiscal 2010 due to receipt of a $50 million payment from JP Morgan as a result of its settlement with the Securities and Exchange Commission over illegal payments to government officials. Remaining settlement payments of $25 million were received in fiscal 2011, partially negating the loss of the occupational tax and narrowing the fiscal 2011 general fund deficit to $6 million.

The county's cost-cutting efforts have enabled it to maintain sizable reserve levels in spite of the revenue disruptions. Fiscal 2012 general fund operations reported an $8.7 million operating surplus (after transfers). Liquidity levels are also healthy with fiscal 2012 general fund unrestricted cash and investments sufficient to cover nearly six months of operations.

Fiscal 2013 general fund expenditures were budgeted at $205 million, about $12 million below the fiscal 2012 budget although about 13 percent higher than actual fiscal 2012 spending. Management budgeted very conservatively in fiscal 2012. The fiscal 2013 budget also includes $15 million for legal fees, a sizable non-recurring expense which is expected to diminish considerably once all bankruptcy issues are settled. Projected fiscal 2013 general fund results show a small net surplus of about $2 million bringing general fund balance up to $90 million.

Fiscal 2014 Budget is Balanced; Debt Service Payments Resume

The fiscal 2014 general fund budget totaled $183.9 million. This represents a $21 million or 10 percent reduction from the fiscal 2013 budget. Much of the difference totaling about $14.5 million is attributable to an accounting change for property taxes received by the county and distributed to local governments. The budget increases the amount of capital spending and makes provision for payment of GO debt service of about $24.5 million, utilizing the 5.1 mill special ad valorem tax dedicated for debt service and capital spending. The fiscal 2014 budget increases allocations for the court system as well as IT and general services but anticipates significantly reduced legal expenses.

Regional Economic Center

The county is located in the north-central portion of the state and encompasses 1,111 square miles. The county's population of 660,000 has been static since at least 2000. The city of Birmingham (GOs rated 'AA' with Stable Outlook) is the county seat and largest city in the county and the state.

The county is the economic center of the Birmingham-Hoover metropolitan statistical area. The area economy has diversified over the past several decades from a focus on steel production to one based on a combination of healthcare, banking and professional services, retail trade, as well as some heavy industry. The University of Alabama at Birmingham is the largest employer with 21,550 jobs while UAB's medical school is the primary driver of the county's growing healthcare sector. The presence of the university has also fostered an active and expanding high-tech hub in medicine, telecommunications, engineering and aerospace. Other leading employers include Regions Financial Corp., AT&T, St. Vincent's Health System and Baptist Health System.

Employment on the Upswing

County employment declined by 10 percent during the recession elevating the unemployment rate to a high of 9.6 percent in 2009. Beginning in 2010, jobs within the county began to recover and have since experienced consistent growth. July 2013 jobs were up 1.1 percent year over year while the unemployment fell to 6.0 percent, below the state (6.6 percent) and county (7.7 percent) averages.

County wealth levels exceed the state norms but fall somewhat below the national averages. Since 2007, per capita income and median household income levels have declined relative to those of the state and nation. Educational attainment rates are above the national norms, typical of localities with a large university presence.

Housing values weakened significantly during the recession but appear to have recovered most or all of the losses. Median home prices in Birmingham and Hoover, two of the largest cities within the county, are up year over year by 9 percent and 15 percent, respectively, and are at or near their pre-recession highs according to Trulia.com. Home sales in both cities have also been trending upwards since 2011. Net assessed values dropped consistently since fiscal 2008 through fiscal 2012 for a cumulative contraction of 5.5 percent; however, the pace of the fall-off has narrowed signaling near-term stabilization.

Manageable Long-Term Liabilities; High Carrying Costs

Debt levels are generally moderate both on a market value and per capita basis. However, debt service costs relative to operations is high at 33 percent of governmental spending. This is largely attributable to over $700 million outstanding of limited obligation school warrants issued for school purposes and distributed to local school districts.

The school warrants are secured by a separate dedicated sales tax which continued to support timely payment of school warrant debt service throughout the county's bankruptcy. Carrying costs net of school warrants, supported by general county revenues, are less burdensome at 9.4 percent of fiscal 2012 governmental fund spending. Capital needs are manageable and officials have no plans to issue additional GO warrants for the foreseeable future.

Retirement obligations are not a pressure. The county administers its own defined benefit pension plan covering almost all of its employees. The plan is exceptionally well-funded at over 100 percent using a conservative 7 percent discount rate and annual pension costs are manageable relative to spending. Retiree health insurance costs are subsidized by the county. This other post-employment obligation is funded on a pay-go basis. The plan's unfunded actuarial, accrued liability of approximately $80 million is modest, representing less than 0.1 percent of taxable values.

Additional information is available at fitchratings.com.

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