CHICAGO The Illinois Finance Authority plans to sell $134.5 million of top-rated state revolving fund bonds as soon as next week in a deal that marks the state’s first SRF borrowing in nine years and ushers in a new master trust indenture to support an expanded $1 billion loan program.
Gov. Pat Quinn last year announced the Clean Water Initiative, expanding the program to $1 billion from $300 million. The program is promoted as an affordable means for local governments across the state to overhaul the state’s aging clean water and wastewater infrastructure.
The IFA is managing the financing with the Illinois Environmental Protection Agency continuing to administer the loan program.
The IFA will take retail orders as soon as Monday with the institutional pricing tentatively scheduled Tuesday, Nov. 19. The tax-exempt bonds mature between 2014 and 2023. The deal will refund outstanding SRF bonds from previous issues for savings and raise $58.5 million of new money. The bonds are being issued under a new master trust indenture.
The finance team is promoting the bonds’ top ratings. The ratings, market participants said, are key to helping hold down interest rate penalties imposed on credits associated with Illinois due to the state’s pension and liquidity woes that have driven its ratings down.
“The triple-A ratings from Standard & Poor’s and Fitch Ratings speak for themselves,” IFA executive director Christopher Meister said.
“The heart of the asset which is administered by IEPA has a decades long history of good financial management and we think investors will respond positively,” he said.
Traders and investors said the deal will still face some yield penalty, possibly in the five to 10 basis point range, but “demand for natural triple-A paper will draw buyers” and could help limit the so-called Illinois penalty, said Thomas Spalding, senior investment officer at Nuveen Investments.
Proceeds will refund outstanding bonds, fund new loans, and provide a state program match that enables the state EPA to leverage federal funds for new loans.
By refunding the outstanding bonds and shifting to the new master trust, the deal also will free up nearly $50 million currently held in a debt service reserve. The transaction will generate sufficient revenue to cover the state match for federal grants for federal fiscal years 2011 through 2013.
“The goal of the IFA and the Illinois EPA was to modernize the structure of the trust indenture and make it consistent with current standards, maintain our triple-A ratings, and also to free up the funds,” Meister said.
The deal with the federal match provides revenue to cover about $400 million in loans. Another $169 million in current loan repayments and $229 million in Illinois EPA funds on hand brings to $800 million the amount available for loans. The rate to borrowers is currently just under 2%.
“By freeing up the reserve and paying for three years of the state match, the General Assembly doesn’t have to appropriate scarce taxpayer dollars or scarce Illinois capital fund dollars,” Meister said.
The state overhauled its master trust indenture under the deal and is shifting to a SRF cash model with stronger cash flow and coverage ratios. About $1.75 billion of a pool of $2.48 billion in outstanding loans are pledged to the bonds. The bonds are additionally secured by funds on deposit in an equity fund.
Bank of America Merrill Lynch is the senior manager and Loop Capital Markets LLC and Ramirez & Co. Inc. are co-managers. The firms were drawn from pools previously established by the state after a competitive selection process.
Public Financial Management Inc. is financial advisor. Katten Muchin Rosenman LLP is bond counsel with Mayer Brown LLP serving as issuer’s counsel and Foley & Lardner LLP and Pugh Jones & Johnson PC acting as co-underwriters’ counsel.
The IFA last issued SRF bonds in a $130 million deal in 2004. Its predecessor agency, the Illinois Development Finance Authority, launched the first borrowing to fund SRF loans in 2002 with a $150 million sale.
The IFA expects to return to the market next year with the size being driven by loan demand. There are an estimated $35 billion in project needs across the state over the next two decades and the Illinois EPA has $1 billion in loan applications in various stages.
As part of the overhaul, the IEPA eased some of the features of the loan program, lifting the cap on loans and shifting to a rolling application process for loan applications instead of an annual deadline.
The expanded program “could be the difference-maker for communities all over the state who recognize the need to invest in infrastructure that will support jobs and economic development for the next century,” Illinois EPA director Lisa Bonnett said in a statement. The state revolving fund was first established in 1989 and has provided more than $3.6 billion in loans.
Under a cash-flow SRF model, bond enhancement is provided primarily by loan repayments in excess of bond debt service. “Cash flow projections demonstrate that the minimum semi-annual coverage on the state match bond debt service is a very healthy 1.7 times and 5.9 times on the leveraged bonds,” Fitch said.
The program benefits from strong coverage ratios that protect debt repayment against loan defaults. The ratio is expected dip over time as the program is further leveraged but should remain sufficient to maintain the top ratings, Fitch said.
“Because of this strong coverage, cash flow modeling demonstrates that the program can continue to pay bond debt service even with hypothetical loan defaults of 100% over any four-year period,” Fitch noted. That ratio far exceeds the Fitch’s standard for AAA credits.
The pool is large with more 400 borrowers. About 74% of the governments in the borrowing pool are unrated. The highly-rated Metropolitan Water Reclamation District of Greater Chicago accounts for about 17% of the combined pool. To date, there have been no pledged loan defaults in the IFA’s SRF programs, Fitch noted.
The credit benefits from a program a cross-collateralization feature in which excess funds from the clean water state revolving fund are available to cover deficiencies in the drinking water SRF and vice-versa.
Standard & Poor’s in a recent national overview of SRF debt highlighted the “fundamental credit strengths” of the programs “that continue to include robust financial policies and practices, exceptionally low borrower payment delinquencies or defaults, and maintenance of either significant reserves or high annual coverage of bond debt service.”
All but three of the 27 programs rated by Standard & Poor’s with $30 billion of debt outstanding hold AAA status. The agency reported that SRF programs continue to shift to coverage-based structures through a cash-flow model as the IFA is doing or a hybrid model, with a lessening reliance on reserve funds. “While Standard & Poor’s has no preference regarding the type of structure, the cash-flow/hybrid model, provides flexibility in the type of overcollateralization used,” analysts said.
Many programs for years relied on a reserve structure, often held in guaranteed investment contracts, to provide protection against borrower portfolio defaults or delinquencies. But with low interest rates and fewer highly rated GIC counterparties, states have moved to structures that emphasize annual coverage versus reserves on hand, the rating agency said.
Federal funding levels for fiscal 2014 pose a challenge, but shouldn’t damage credit quality, Standard & Poor’s said.
The latest Senate Committee on Appropriations budget allots $1.45 billion for capitalization grants for the clean water SRF and $907 million for capitalization grants for the drinking water SRF. However, the House of Representatives’ latest bill would result in unprecedented and drastic cuts to both programs of an 83% and 61%, respectively.
