CHICAGO — Cook County, Ill., plans to enter the market next week with $100 million of sales-tax-backed bonds, a new security for the nation's second-largest county and one that snagged a prized AAA rating from Standard & Poor's.
Bond proceeds will finance highway projects. The county will take retail orders on Tuesday and hold the institutional pricing on Wednesday.
Standard & Poor's is the only agency to rate the bonds.
Ahead of the deal, Moody's Investors Service and Fitch Ratings affirmed their respective Aa3 and AA-minus general obligation ratings on Cook.
However, Moody's revised its outlook on the GO credit to negative from stable, warning of the county's growing unfunded pension liability, risks with its massive public health and hospital system, and declining sales-tax revenue.
Fitch analysts had already maintained a negative outlook on Cook County.
Tariq Malhance, Cook's chief financial officer, downplayed Moody's negative outlook revision.
"They're talking about pensions, the hospital system, sales tax history — they didn't tell us anything new," Malhance said.
The county requested a rating only from Standard & Poor's due to the relatively small size of the sales tax deal and after examining the rating methodologies of all three major credit agencies, according to officials.
At Moody's and Fitch, an issuer's GO rating is typically the highest, while Standard & Poor's more often assigns higher ratings to non-GO revenue-backed deals. For example, Standard & Poor's rates Illinois' sales tax bonds triple-A, far higher than the state's struggling single-A-level GO credit.
Standard & Poor's rates Cook County GOs AA with a stable outlook.
"We are cognizant of [Moody's and Fitch's] recently published rating methodology, and we view our sales-tax credit as a unique credit with tremendous coverage, and Standard & Poor's has a greater recognition of that, as does the investor community," said Ivan Samstein, the county's deputy chief financial officer.
Cook County, the nation's second-most populous with more than five million residents, enjoys a broad and diverse tax base that includes Chicago and 40% of the population of Illinois.
The credit is strengthened by home rule status that gives it sole authority to raise fees and taxes.
It has $3.8 billion of outstanding debt, all of which is general obligation. Next week's deal will be the first time it has tapped its sales-tax stream for a borrowing.
The county originally planned to finance the highway projects with bonds backed by motor fuel taxes, a plan that board President Toni Preckwinkle touted a year ago.
But the underwriting team on the deal convinced the administration to instead tap sales tax revenue as a stronger credit, in part because of its home-rule status and because it will offer debt-service coverage levels of around 45 times, according to Malhance.
The county has less control over the motor fuel tax, which the state of Illinois collects and then distributes back to local governments.
The motor fuel tax, or MFT, generates roughly $95 million annually for the county, providing sufficient coverage for the bonds but less certainty than the sales tax revenue stream, Samstein said.
"The ability for the state to make changes reduces the marketability of the motor fuel-tax credit," he said. "There's a lot of revenue, but the state has the ability to adjust the allocations, and we felt, based on the state of Illinois' credit challenges, that providing a credit relying on home rule is a stronger overall package."
Chicago and DuPage County are the only two credits in Illinois to have floated MFT-backed bonds, Malhance said.
The use of the sales tax pledge also allows the finance team to stress the absence of state risks to repayment as they market the deal to investors this week.
The state's struggles to keep up to date on its payments due to local governments, transit agencies, schools and vendors — along with local governments' own headline risks stemming from their financial struggles — have forced most borrowers in the state to pay an interest rate penalty, even those with top ratings.
The penalty could carry less sting to the county this time around as investors hunt for yield, according to one investor. "The Illinois penalty is less and less these days just because of the lack of yield that's available in the market," said Michael Pietronico, head of Miller Tabak Asset Management LLC.
He said the market today compared to the county's last deal — a GO offering that had to be repriced several times to attract investors — is "night and day."
"Not to say that they can aggressively price this deal, but any deal with a reasonable rating and an excess amount of spread should easily be absorbed in this market," he said.
The county government expects to save 25 to 30 basis points, or $7 million, by using the triple-A rated sales-tax pledge instead, according to Malhance.
Wells Fargo Securities is the senior book-running manager. Rice Financial Products Co. is the co-senior. JPMorgan, Ramirez & Co., BMO Capital Markets, George K. Baum & Co. and PNC Capital Markets LLC round out the underwriting team.
Mayer Brown LLP and Charity & Associates are co-bond counsel. A.C. Advisory is financial advisor.
Debate over the sales tax rate has dominated Cook County's political landscape for the last few years, and helped Preckwinkle unseat former President Todd Stroger in 2010.
Stroger in 2008 pushed through a wildly unpopular 1% increase in the rate — raising it to 1.75% from 0.75%, a move estimated to bring in an additional $400 million annually. Preckwinkle ran her campaign on a promise to repeal the tax hike, which she has accomplished through a gradual, quarter-percent repeal over the last few years. By January 2013, the rate will be back down to 0.75%.
While in existence, the 1% tax increase brought in hundreds of millions in additional revenue for the county. Sales tax revenue jumped 70% to $659 million in 2009, the first full year of the 1% hike. It has since fallen steadily, and is projected to drop another 21% in 2013 to $361 million. The declining revenue is one of the drivers for Moody's and Fitch's negative outlook.
For Standard & Poor's, the importance of the sales tax revenue to Cook's general fund strengthens it as a pledge, according to Standard & Poor's analyst Helen Samuelson.
"The county relies on sales tax to fund its operations, so there's not a lot of incentive to issue debt against that stream," Samuelson said. "So you tend to see really strong coverage and there's not a lot of pressure there from the debt service."
Sales taxes are an economically sensitive revenue, but the sheer size of the county's tax base has helped inure it against major fluctuations, Samuelson noted.
"We took a look at it as if they'd been levying 0.75% the whole time, and overall it's performed pretty well," she said. "Drawing from such a large market area, you don't see the same volatility."
Debt service on the bonds will total $7 million annually through 2037. Sales tax revenue in fiscal 2012 is projected to total $319 million, providing 45 times coverage.
The bond indenture features additional security for investors, including a covenant not to lower the tax rate below a point that would cause pledged revenues to drop below 1.35 times annual coverage.
Officials said they have no plans to issue additional sales-tax-backed debt.
All three rating agencies warn that Cook's unfunded pension and other post-employment benefit liabilities are growing. Together, the county's pension and OPEB liability reached $5.8 billion, with a funded ratio of 57.5%, at the end of fiscal 2011, according to bond documents. Cook County is not legally obligated to pay retiree health care costs.
County officials are in the midst of crafting a final 2013 budget. Preckwinkle's preliminary budget figures, released last month, show a general fund deficit of $267 million, the bulk of which comes from the troubled health care and hospital system.
The administration has not yet released a plan to bring down the deficit. It expects to release a final blueprint by the end of October, and county commissioners will then spend the month of November debating a final budget. The county's fiscal year begins Dec. 1.
"While positive steps are being taken to reduce the county's annual operating shortfalls, with significant successes being recorded in fiscal 2011 and 2012, a structural imbalance remains in the county's operations as it continues to roll back a key revenue stream and fund increasing personnel expenditures," Moody's analyst Genevieve Nolan wrote in the report revising the outlook to negative.
"Moody's will continue to monitor the fiscal 2013 budget process closely as the county works to right size expenditures to available revenue sources," she added.
For the current budget, the county restructured debt to push off debt-service payments in 2012 and 2013 to bring down its deficit.
Malhance said Cook County does not plan to use similar one-time measures to balance the current budget.
