Thursday, May 7, 2009

JPMorgan Says SEC Plans Action Over Jefferson County

JPMorgan Chase & Co. said U.S. Securities and Exchange Commission officials approved filing an enforcement action against it for securities law violations involving bond and swap sales for Jefferson County, Alabama.

Jefferson County, the home of Birmingham, faces bankruptcy on $3 billion of floating-rate sewer debt after interest rates surged when the credit ratings of insurers backing the bonds were cut amid losses on unrelated mortgage securities. The county is negotiating with creditors including JPMorgan to restructure debt payments.

The action comes amid a separate federal criminal antitrust investigation of the sale of derivatives to municipalities in the $2.69 trillion municipal bond market.

“The bigger the amount of money, the more temptation there is for corruption,” said Christopher “Kit” Taylor, the executive director of the Municipal Securities Rulemaking Board from 1978 to 2007. “Until you get strong ethical rules put in place nationwide, you’re asking for problems.”

JPMorgan of New York said in a statement that it may face allegations it violated federal securities laws and MSRB rules involving transactions in 2002 and 2003.

JPMorgan spokesman Brian Marchiony declined to comment. The bank said in a regulatory filing that it is “engaged in discussions” with the SEC staff to resolve the matter before the agency files a civil complaint.

SEC spokesman John Heine declined to comment.

Sewer Debt

The SEC’s move toward sanctioning JPMorgan comes four years after Bloomberg News reported that JPMorgan overcharged the county by at least $45 million on derivative contracts tied to the debt that financed the construction of its sewers. Those debts have pushed the county toward insolvency, threatening it with bankruptcy and soaring sewer bills to cover the cost.

JPMorgan said in September it would stop selling interest- rate swaps to government borrowers. At least seven former JPMorgan bankers are under scrutiny in a U.S. Justice Department criminal investigation of whether banks conspired to overcharge local governments on swaps and other derivatives, according to filings with the Financial Industry Regulatory Authority.

Interest-rate swaps, contracts in which two parties agree to exchange interest payments based on an underlying bond, also are usually awarded without competitive bidding. Fees -- which the banks make by adjusting the interest rates up and down --are frequently not disclosed to the buyer.

Borrowing Costs

Banks marketed unregulated derivatives as a way for municipalities to cut borrowing costs. Derivatives are contracts whose value is derived from tradable securities or linked to future changes in lending costs. The financing, which local officials across the country have said they didn’t understand, backfired last year as fallout from the global credit crisis caused borrowing costs to rise more than fourfold.

Jefferson County’s financial crisis unfolded in February 2008 after Financial Guaranty Insurance Co. and XL Capital Assurance, which guaranteed $2.8 billion of the county’s sewer debt, suffered credit rating cuts because of losses on securities tied to unrelated subprime mortgages.

That caused the investors to sell back the county’s $850 million variable-rate bonds to banks that agreed to be buyers of last resort, and to shun about $2 billion of debt whose interest was determined by auctions. Rates on some of the county’s debt increased to as high as 10 percent.

Higher Expenses

At the same time, interest-rate swaps the county bought from JPMorgan, Bear Stearns Cos., Bank of America and Lehman Brothers Holdings Inc. to shield it against rising borrowing costs stopped working. The floating rates it pays on its bonds, while the variable rates banks pay the county under the agreements have declined, pushing expenses higher.

Sales of derivatives to cities, towns and school districts boomed over the past decade, providing banks with a new source of fees as they earned less from arranging sales of tax-exempt bonds used to build schools, roads and other public works.

On April 28, the county’s credit rating was cut to Caa1 from B3, both non-investment grades, by Moody’s Investors Service because of a continuing failure to make full principal payments to banks holding some of $270 million of general obligation debt.

Moody’s maintained a Caa3 rating, the third-lowest non- investment grade, on Jefferson County’s $3.2 billion of sewer debt.

JPMorgan and other banks have given the county forbearances on the sewer and general obligation bonds as Governor Bob Riley negotiates with creditors on a debt restructuring, and state lawmakers consider legislation to raise new revenue for the county.