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Chicago Hopes Budgetary, Pension Strides Will Aid Sale

MAY 15, 2012 7:23pm ET
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CHICAGO — Chicago enters the market Wednesday with $600 million of new-money and refunding general obligation debt, hoping investors turn a favorable eye on budgetary strides and the administration’s initial steps toward repairing pension woes.

The GO sale includes a $200 million new-money, tax-exempt series, a $300 million new-money and refunding taxable series, and a $100 million tax-exempt refunding series. The bonds are structured in a mix of serial maturities and term bonds.

Mesirow Financial Inc. is the senior manager with Goldman Sachs & Co. and Melvin & Co. serving as co-senior managers. Chapman and Cutler LLP and Cotillas & Associates are bond counsel and Ungaretti & Harris LLP and Golden Holley James LLP are serving as underwriters counsel. A.C. Advisory Inc. and Public Finance Advisors LLC are advising the city on the sale.

City finance officials and the financial team launched an extra effort to court investors as they did on a $400 million water revenue bond issue last week. In addition to highlighting budget progress, attention is also being turned to pensions.

Mayor Rahm Emanuel, who marks his first anniversary in office this month, unveiled a series of pension reforms before a state legislative committee last week. State action is needed to change benefits, leaving their fate uncertain.

The move followed soon after Moody’s Investors Service’s decision to revise its outlook to negative on Chicago’s $8 billion of Aa3-rated GO debt, primarily because of $15 billion of unfunded liabilities in the city’s four pension funds and the burden of a massive hike in payments to the pension that looms in 2015.

“We think investors are excited about the city’s future and like the mayor’s strategic direction … and the systemic changes that will pay dividends” for investors, said city chief financial officer Lois Scott.

Chicago and its sister agencies courted investors at a recent city-sponsored conference and Scott said the outreach continues with individual meetings and calls.

Moody’s declined to comment on the mayor’s proposals, saying the reform process remains in the early stages. Fitch Ratings earlier this month affirmed the city’s AA-minus rating and stable outlook and Standard & Poor’s affirmed its A-plus and stable outlook.

The city’s water sale last week, led by Siebert Brandford Shank & Co., benefitted from both a strong market and new investors who came to the table. The debt is repaid from fees paid by the system’s users and coverage ratios were girded by rate hikes approved last year.

The credit, which is somewhat insulated from city budgetary and state payment risks, drew 30 new institutional investors, including a range of insurance companies and money managers who submitted more than $3 billion in orders.

Chicago was able to shave more than 20 basis points off the initial projections it would pay 75 to 85 basis points over Muncipal Market Data’s triple-A scale. The final pricing resulted in yields about 57 basis points over MMD. “We are hoping the strong market response will spill over to the GO deal,” Scott said.

The GO credit is more exposed to the city’s economic health and state payment delays. Most Illinois-based issuers have paid a premium to borrow due to the state’s fiscal struggles.

Scott stresses to investors that little of the city’s budget comes from the state and it has liquidity to manage through any tax and aid payment delays.

Several market participants said it’s the city’s timing more than its fiscal strides that may drive demand for the deal with investors looking for even the slightest extra yield that paper out of Illinois offers.

“It’s a great market, especially for issuers in states like Illinois,” said Matt Fabian, managing director at Municipal Market Advisors. “Investors are willing to pay less yield and are very forgiving of credit and structure. It’s the market much more than anything.”

Proceeds of the $200 million series, which carry a final maturity in 2034, will finance citywide infrastructure projects. Proceeds of the taxable bonds that have a final maturity in 2042 will cover judgments and restructure near term debt service for one-time budgetary relief.

The $100 million refunding with a final maturity in 2032 will generate present value savings.

Emanuel’s pension proposals would raise the retirement age for city employees, suspend cost-of-living increases for a decade, and raise employee pension contribution rates. That along with other reforms could reduce the city’s unfunded pension liabilities by 40%.

Without action, Chicago faces a $700 million hike in its pension payments by 2015 due to previous state-imposed reforms aimed at shoring up its police and firefighter funds, while its two other funds remain on a path towards insolvency.

Some of the proposals closely mirror those unveiled for state workers by Gov. Pat Quinn recently.

“Doing nothing will force me to choose between either letting our pension funds go bankrupt, or raising the city’s property taxes by 150%,” Emanuel told lawmakers.

Labor leaders attacked the proposals as unconstitutional given the state’ strong legal protections against diminishing promised retirement benefits.

Moody’s revised its outlook on the city’s GOs due to “outsized pension pressures” and the lack of a plan to address them to date. Chicago’s current pension payments total $476 million, while a payment of $1.1 billion this year would be needed to meet the ARC.

Fitch said it views pension reform efforts favorably but remains concerned over the “magnitude” of the city’s liabilities, looming payment increases, and the “potential legal and policy hurdles” to enacting reforms. A failure to act or identify new revenue sources could negatively impact the rating.

Fitch praised the administration’s focus on eliminating the use of non-recurring revenues including reserves to cover budget shortfalls. Former Mayor Richard Daley used $288 million in reserves to balance the 2011 budget.

“New management, which took office in May 2011, has demonstrated a willingness to take potentially unpopular actions to achieve structural balance,” analysts wrote.

The credit also benefits from solid, remaining reserves of $634 million primarily from the city’s $1.8 billion Skyway toll bridge lease in 2005. The 2012 $6.3 billion budget calls for adding $20 million to reserve accounts.

Standard & Poor’s also praised the new administration’s efforts to close a $636 million shortfall going into 2012 with $529 million of structural budget changes, but noted the budget did still contain one-shots in the form of the upcoming debt restructuring to help erase the remaining red ink.

The city’s other credit strengths also include its role as an economic hub with a diverse economy and rebounding collections of sales and other economically sensitive taxes. The city remains challenged by elevated unemployment and individual poverty rates, below average per capita income levels, and a highly unionized workforce that constrains the city’s ability to manage some expenditures.

The city also is strained by a sizeable debt burden at 6.4% of market value due to heavy borrowing to finance capital projects and retroactive pay raises, and slow debt amortization.

“Fitch believes the debt burden will remain above average given recent tax base erosion, increasing debt service, and capital needs of overlapping municipal entities,” analysts wrote.

The administration recently won approval for a controversial plan to establish an infrastructure trust that could tap private partnerships, union investment, and foundation funds to help fund infrastructure improvements.

The city in the coming months will submit appointments to the trust’s board to the City Council for approval, Scott said. The trust would be used to fund up to $1.7 billion worth of “transformative” projects while preserving city bonding for routine projects.

The deal comes ahead of a series of additional financings planned in the coming months. The city will issue in late summer up to $1.75 billion of refunding third-lien O’Hare International Airport revenue bonds and passenger facility revenue bonds.

It also has on tap up to $600 million of new-money and refunding wastewater revenue bonds slated for sale in mid-to-late-summer and up to $1.5 billion of Midway new-money and refunding bonds in the fall, Scott said.

The size of the Midway deal largely depends on whether the city will attempt to resurrect a failed $2.5 billion 2009 privatization of the airport under a federal pilot program. The city is working with Credit Suisse to decide whether to again pursue a deal.

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