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Chicago Transit Sets $2B Pension/OPEB Deal

CHICAGO - With ratings in the double-A category and clearance from the Illinois auditor general, the Chicago Transit Authority is readying its long-planned issue of nearly $2 billion of taxable pension-related bonds for sale as soon as next week.

The need for the auditor's review and a timeline that gives the CTA fewer than 120 days to complete the transaction were included in legislation approved in January by the General Assembly that authorized the issue. The fixed-rate financing represents one piece of the transit bailout package that included a sales tax increase in the Chicago area and an increase in the city's tax on real estate transactions.

The tax hikes will generate about $500 million annually for the region's transit agencies that operate under the Regional Transportation Authority, including the CTA, whose share totals about $120 million this year and $200 million in future years.

The deal includes two tranches - a nearly $640 million Series B to fund a permanent trust that would be established to cover other post-employment benefits, or OPEBs, for retirees' health care. The Series A for nearly $1.3 billion would bring the funded ratio of the CTA's pension fund up to about 80%.

The sales and transfer tax receipts revenue bonds are secured by deposits made into a sales tax receipts fund and transfer tax receipts fund. The deposits come from proceeds of the increase in Chicago's tax on real estate transactions and the CTA's share of RTA sales taxes collected in the region after sufficient funds are withdrawn to cover the RTA's own debt service obligations, operational costs, and distributions to Pace suburban bus service and Metra commuter rail service. Deposits also include the CTA's share of matching public transportation funds provided by the state.

The structure relies heavily on bullet maturities with term bonds tentatively expected in 2013, 2021, and 2040 on both series, although the size of various bullets will be driven by market demand closer to the pricing date, according to the preliminary offering statements.

"The current market forces us to be flexible," a member of the finance team said.

The majority of interest in the taxable debt is expected to come from overseas buyers. The CTA has talked with potential insurers but given the premium costs amid a shaken insurer market and new uncertainties over the triple-A ratings of insurers thought safe - Assured Guaranty Corp. and Financial Security Assurance Inc. - the decision to include coverage would have to be driven by buyers at pricing.

About $1.1 billion of Series A will be deposited in the CTA's pension retirement plan with other proceeds covering capitalized interest through next year, funding a debt service reserve and paying cost of issuance. About $529 million of the Series Bwill fund a new health care trust with the remaining proceeds also covering capitalized interest, a reserve, and issuance costs. The agency's total pension and health care liabilities are $3.5 billion, for a 30% funded ratio.

Morgan Stanleyand Loop Capital Markets LLC are co-book-running senior managers on the transaction. UBSwas originally a senior manager until its withdrawal recently from the municipal market. The CTA elevated another firm selected as a co-senior manager Goldman, Sachs & Co. to assist the book-runners. "Given the market volatility we wanted to make sure there is sufficient capital to support the issue," said one member of the large finance team.

The other co-seniors include Cabrera Capital Markets LLC, Depfa First Albany Securities LLC, and Siebert Brandford Shank & Co. Another seven firms are co-managers.

The financial advisers are Mesirow FinancialInc., Peralta + Garcia Solutions,Columbia Capital ManagementLLC, andScott Balice Strategies LLC. Mesirow and Peralta produced the auditor general reports. Bond counsel is Katten Muchin Rosenman LLP and co-bond counsel is Burke Burns & Pinelli Ltd. and Gonzalez, Saggio Harlan LLC. Underwriters' counsel is Perkins Coie LLP and Chapman and Cutler LLP. Co-underwriters counsel are Charity & Associates PC and Golden and Associates.

The bond sale and the increase in operating aid help ease three of four significant financial burdens that had threatened the CTA's long-term health - ongoing budget deficits, skyrocketing pension costs, and growing OPEB expenses.

"We believe we have mostly solved the first three and hope the final [capital funding] will be addressed this year in Springfield," CTA chief financial officer Dennis Anosike said in an interview earlier this year.

The legislation requires both the agency and its union employees to increase their contributions, restricts some benefits for new hires, revises fund oversight, and for the first time segregates health care benefits for retirees, with the future funding burden relying on contributions to the new trust from employees and retirees.

As the CTA and its finance team crafted the deal, they sought both to meet the funding and structural requirements of the state legislation and to achieve strong ratings given the credit's status as a new one that would be selling in a market made more complex by insurer downgrades and the credit crunch.

In rating the bonds Aa3, Moody's Investors Service said the new credit reflects the region's broad and diverse economy, the CTA's important role in the region's transportation network, the increase in operational aid from the sales tax hike, a senior claim held by the RTA on sales tax revenues, and the various legal provisions of the transaction.

"What we are most comfortable with is that the level of residual sales taxes that are distributed to the CTA after the RTA meets its debt service obligations provides ample coverage for the bonds under any number of stress scenarios," analyst Shawn O'Leary said.

In assigning a credit two notches above Moody's, Standard & Poor's gave significant weight to the sales tax funding.

"We expect that the amount of additional RTA sales tax revenue debt that the state will eventually authorize will be manageable, and that the large and diverse tax base supporting the CTA's bonds will continue to provide strong debt service coverage from sales tax revenues," said analyst John Kenward.

Despite the structure's strengths, there are some weaknesses stemming from the legal provisions and economic risks. The RTA holds the first claim on sales tax revenues, and the city tax on real estate transactions is considered one of Chicago's more volatile taxes. Collections were down 15% in fiscal 2007 over the prior year due to the real estate market slump. The CTA in its debt service schedule offsets some of that risk with conservative growth rates anticipated in its taxes.

Other weaknesses include a reliance on a "somewhat aggressive" 9% rate of return anticipated from pension investments, according to Moody's. As part of its discussions with the auditor's office, the CTA also produced schedules based on lower assumption rates. Ultimately, the auditor's review notes that it will take "many years" to discern whether the pension borrowing is "financially advantageous."

The CTA still faces significant capital needs. It has $2.4 billion of projects it hopes to fund through 2012 and another $6 billion in unfunded needs. Help on that front at the state level has been stymied by legislative gridlock as Gov.Rod Blagojevich and lawmakers have failed to reach an agreement on how to fund a proposed $34 billion capital budget.

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