UPDATE 1-Bond insurers want overseer of Alabama sewer system

(Recasts; adds details, reaction, downgrade, byline)

By Michael Connor

MIAMI, Sept 16 (Reuters) - Insurance companies backing troubled sewer debt owed by Alabama's Jefferson County filed a lawsuit on Tuesday asking a federal judge to appoint a receiver to run the county's sewer system.

The suit comes as creditors, insurers and county lawyers are bargaining on a workout of $3.2 billion worth of county sewer debt and may, according to a county official, throw a wrench into talks aimed at avoiding a municipal bankruptcy filing.

The lawsuit, filed in federal court in Birmingham, Alabama, by Syncora Guarantee, a unit of Syncora Holdings Ltd SCA.N and FGIC Corp-unit Financial Guaranty Insurance Co, also asks for sewer rate hikes, a look at using other revenue sources and other actions to service the county's sewer debt, according to Syncora and a copy of the litigation.

An official at the court confirmed that the two companies, which back $2.8 billion of warrants associated with Jefferson County's sewer debt, filed suit on Tuesday.

The move by the insurers, which have made payments to creditors on behalf of the county, comes after more than six months of talks between Alabama's most populous county and creditors over its sewer bonds and related interest-rate swaps.

The Jefferson County Commission has authorized lawyers to prepare for a possible municipal bankruptcy filing.

Creditors, insurers and government officials are negotiating against a Sept. 30 deadline to reach agreement and avert what would be the biggest municipal bankruptcy filing since one by Orange County, California, in 1994.

"The County Commission's failure to meet its obligations has left us with no other alternative," said Syncora Guarantee President Edward Hubbard, adding the insurers still hoped to negotiate a deal.

Jefferson County Commissioner Jim Carns said the lawsuit was ill-timed and may rock negotiations, which have included Alabama Gov. Bob Riley for the last two weeks.

"These two insurers refused to cooperate when we had a good plan on the table months ago. Now, when Gov. Riley and Wall Street are in the midst of negotiations to arrive at the most reasonable solution possible, they file a suit that can negatively affect everyone involved," Carns said.

"I can only say they've created a very dysfunctional situation," Carns said in an interview.

Separately, Standard & Poor's Ratings Services downgraded its "CCC' rating to a "C" rating on several series of Jefferson County sewer debt. S&P also said in a statement that it had revised the credit ratings outlook of the debt to "negative" from "developing."

"The downgrade reflects the sewer system's use of its debt service reserve for debt service payments beginning in September 2008 and increased uncertainty of its continued timely payment on the obligations," S&P analyst Sussan Corson said. (Additional reporting by Melinda Dickinson in Birmingham; editing by Gary Crosse)