* Banks, creditors would like fees to increase by 22 pct
* They say county keeps revenue low in order to get better deal
By Michael Connor
Jan 30 (Reuters) - Wall Street creditors on Wednesday asked a U.S. judge overseeing America's biggest municipal bankruptcy to knock down a legal hurdle keeping them from pushing Alabama's Jefferson County for higher sewer rates to service $3.14 billion of defaulted debt.
In testimony coming a day after county officials returned from private talks with some creditors in New York, lawyers representing banks, insurers and hedge funds questioned County Manager Tony Petelos about procedures used by county officials to set sewer rate increases in November.
Those increases, totaling about 5.9 percent, were too low to pay interest and principal on the sewer debt, according to the creditors seeking an exemption to an automatic stay that bars lawsuits during a federal Chapter 9 bankruptcy case.
JPMorgan Chase, Bank of New York Mellon and other creditors want hikes of 22 percent or more and have requested that U.S. Bankruptcy Judge Thomas Bennett permit them to pursue a lawsuit on the rates in Alabama state court.
County officials have said in legal papers that the November hike would raise system revenue by $8.5 million a year and could be followed by other increases as part of a settlement with creditors.
Creditors have accused the county of keeping the sewer rates low as a tactic to show lower revenue and eventually to win better terms in any plan for exiting bankruptcy. The county has argued that the rate increases in November were reasonable and that they were decided after an extended process that included consulting experts in sewer fees.
Two of the county commissioners who okayed the November hikes, Commission President David Carrington and Commissioner Jimmie Stephens, met on Monday in New York with holders of the county's sewer warrants.
"The discussions were cordial, comprehensive and substantive," the commissioners said in a written statement. "At the end of the meeting, the participants agreed that the meeting was beneficial and that additional conversations would be held in the very near future."
The commissioners declined to discuss details and did not identify the creditors who were at the meeting. It was at least the third closed-door session in recent months. Large sewer debt creditors include hedge funds Brigade Capital Management LLC and Fundamental Advisors LP.
The talks are aimed at developing a plan of adjustment, which spells out the treatment of bondholders, vendors and others owed money when Alabama's most populous county exits Chapter 9.
So far no solution has emerged for the bankruptcy but one possible template in the talks may be a 2011 terms sheet, which was developed by some creditors and the county before the landmark Chapter 9 filing. It envisioned a $1 billion reduction in county debt but was never implemented.
The pre-bankruptcy terms included three years of sewer rate hikes of as much as 8.2 percent annually and a refinancing of about $2.05 billion of county sewer warrants into a 40-year debt backed by a pledge from Alabama's state government.
Now into a second year, the $4.23 billion bankruptcy filed by Jefferson County in 2011 is closely tracked in America's $3.7 trillion tax free market for legal precedents that may weaken bondholder safeguards.