CHICAGO - With its battered credit threatened by more downgrades, Chicago heads into the bond market with a new sense of urgency to convert its floating-rate general obligation debt to fixed.
Market participants will be watching to see where the city's interest rates land the week after they shot up in secondary market trading following Moody's Investors Service's downgrade of the city to junk Tuesday.
The city faces a narrowing of its investor base with a junk bond rating, but for buyers looking for yield, the Chicago paper could draw interest given the steep spreads seen in the secondary market, market participants said.
"For the patient investor, we believe both Chicago-area and Illinois state municipals offer opportunity," Lyle Fitterer, head of tax-exempt fixed income at Wells Capital Management, said in a blog post Friday titled "Chicago's pensions sink its credit rating; Trouble or opportunity?" "The path toward fiscal health remains uncertain, but the state and city have options," he wrote.
"Vital in this analysis is determining the appropriate additional yield to validate an investment," he continued.
Moody's two-notch downgrade to Ba1 with a negative outlook triggered a series of swap terminations and defaults on bank agreements, giving credit providers the ability to demand payment on $2.2 billion of floating-rate paper, interest-rate swaps, and short-term credit lines. The city is in negotiations with its banks to reach either forbearances or new terms.
Successful GO conversions of floating rates to fixed, followed by a sales tax bond conversion later this year, would resolve $900 million of the liquidity problem and an additional $200 million in swap terminations.
“Failure of the city to successfully remarket its variable-rate debt in fixed-rate mode would likely trigger a downgrade,” Fitch Ratings warned in its downgrade of the city’s credit Friday.
City officials said they can continue to tap credit lines even though the Moody's downgrade triggered default events.
The city currently has about $600 million outstanding on its short-term credit and commercial paper lines. The remainder of its liquidity risk is tied to swaps and bank support on $500 million of sewer or water debt.
The liquidity risks created by the Moody's downgrade quickly sparked two more downgrades.
Standard & Poor's Thursday lowered Chicago GOs two notches to A-minus and placed the rating on CreditWatch with negative implications.
"The rating action reflects our view that city's efforts are challenged by short-term interference," said Standard & Poor's credit analyst Helen Samuelson.
Fitch Ratings followed on Friday, lowering Chicago GOs and sales tax bonds one notch to BBB-plus from A-minus, and placing the credit on negative watch.
Kroll Bond Rating Agency recently, but before the Moody's downgrade, affirmed Chicago at A-minus with a stable outlook.
The city intends to remarket $182 million of 2003 bonds and $201 million of 2002 bonds.
Siebert Brandford Shank & Co. LLC is senior manager on the 2003 bonds that currently reset weekly and Ramirez & Co. Inc. is senior manager on the 2002 bonds that reset daily. Siebert said its remarketing was set for Tuesday, while Ramirez said it did not yet have a set date.
Earlier this month, the city tapped its short term borrowing program to make a $31 million payment to counterparties to terminate four interest-rate swaps on the 2003 bonds. The 2002 bonds have no swaps.
Prior to the downgrade, Chicago's GOs were already trading at speculative grade spreads of more than 200 basis points to the Municipal Market Data top-rated benchmark. Some surged another 100 basis points. Markit said the sell-off of Chicago paper had slowed by Friday.
One Chicago trade on $5 million Friday paid a yield of 5.77%, 300 basis points over MMD, and up 25 basis points from Wednesday, according to Greg Saulnie, municipal research analyst at MMD.
In its last GO sale in March, 2014, the city's 10-year tax-exempt maturity yielded 3.95%, a spread of about 145 basis points to MMD, while its 2036 maturity yielded 5.18%, 161 basis points over MMD. The city paid 84 and 89 basis points over MMD on comparable maturities a year earlier.
The city will soon return to convert two additional floating issues from 2005 and 2007 each for about $200 million. A mandatory tender and optional redemption notice was published by the city May 14 on the 2007 bonds and May 13 on the 2005 bonds with June 8 purchase dates.
The Moody's downgrade affected $8.9 billion of GO, sales-tax and motor fuel bonds. The downgrade reflected the agency's concerns that a recent Illinois Supreme Court ruling on state pension reforms could derail city efforts to tackle its own $20 billion pension burden.
