CHICAGO - Chicago is readying a $300 million second lien wastewater revenue bond pricing Tuesday to finance ongoing projects in a 10-year program supported by big rate hikes.
The fixed-rate, 30-year sale follows the city's issue nearly a week ago of $400 million under its water enterprise system. The wastewater bonds face more competition - with volume up to $6 billion from $3.46 billion last week - but the higher yields demanded for even highly rated Chicago bonds as a penalty for the city and state's fiscal struggles should draw attention, several traders said.
The city's water bonds were 11 times oversubscribed resulting in a re-pricing across the scale with a tightening of spreads by five to 17 basis points, market participants said. The 10-year bond yield priced at a 92 basis point spread to the Municipal Market Data benchmark rate at the market close that day and the city's long bond in 2044 priced at an 84 basis point spread.
Bank of America Merrill Lynch is senior manager with Mesirow Financial Inc. and Ramirez & Co. Inc. as co-senior managers and another 10 firms as co-managers. Schiff Hardin LLP and Hardwick Law Firm LLC are bond counsel and A.C. Advisory Inc. is advising the city.
Chicago won an upgrade from Standard & Poor's, which lifted its rating one notch to AA-minus on the second lien and to AA from AA-minus on the senior lien. A stable outlook was assigned.
"The upgrade reflects the city's actions to improve its financial position while addressing its capital needs in a timely fashion and still maintain rates that will not stress its service base," said analyst Corey Friedman.
Fitch Ratings affirmed the second lien rating of AA but revised its outlook to stable from positive.
Moody's Investors Service affirmed the wastewater ratings of A2 on the senior lien and A3 on the second lien with a negative outlook. Moody's limits the enterprise rating, citing the city's general obligation bond credit, which has fallen to Baa1 with a negative outlook due to pension strains.
Kroll Bond Ratings Agency assigned a AA-minus rating and stable outlook to the bonds.
The city will have $1.6 billion of second lien bonds outstanding after the issue and $35 million of senior lien. The bonds are secured by system revenues that primarily come from user fees.
The city's sewer fees are currently charged at a rate of 96% of the water rate with the percentage rising to 100 % in the coming years following a rate hike package requested by Mayor Rahm Emanuel and approved by the city council in 2012.
The hikes will allow the city to rely less on debt than it has to fund projects with about 25% financed on a pay-as-you-go basis in the early years and rising to an overall percentage of 40%. Higher rates will generate more cash this year allowing maximum annual debt service to grow to 2.1 times from 1.6 times last year. The city's ongoing capital program calls for $1.5 billion worth of projects through 2018.
While the city's water system serves the city and suburbs, the sewer system is largely confined to city users, with residential and business customers accounting for nearly 90% of revenues. The city is not responsible for wastewater treatment.
"The foundations of this credit are a robust service area, significant growth in revenues, a clear plan to reinvest in needed infrastructure, and limited exposure to pension obligations," the city's chief financial officer, Lois Scott, said in an investor presentation.
Of the wastewater debt portfolio, 26% are floating rate bonds all swapped to a fixed rate. The city has three swaps, two with Deutsche Bank for $233 million and $50 million, and one with Bank of America for $50 million. Combined, they carried a negative valuation of $63 million as of June 30.
While the city is one ratings level away from a swap termination event on its GOs, it has much more breathing room on its water and sewer portfolio. The city's wastewater rating would have to fall to below the high triple-B level to trigger a termination event.
The city has three bank credit facilities that all expire in December and Fine said the city expects to extend them. The wastewater rating would have to fall below the mid-double B level to trigger a default event.
The city is working to raise the triggers.
"That's a city wide effort that we are undertaking" across the debt portfolio, deputy comptroller Jeremy Fine said in the investor presentation.
Fitch attributed its outlook change to the greater pension funding burden placed on the enterprise system under reforms approved by state lawmakers earlier this year.
The plan calls for the system's current annual contribution to jump 500%, to $28 million, by 2020. "While the increased expense is material, Fitch believes the increases are manageable given the system's robust recent financial results and remaining rate flexibility," analysts wrote.
